The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Digital Nostalgia work commissioned for Wired Italy.  (March 2010 issue).

via Behance Network

Kudos to BR for a nice tout in this week’s Up and Down Wall Street column in Barron’s, penned this week by Randall Forsyth:

A graphic from the U.K. Guardian passed along by Barry Ritholtz on his terrific blog, The Big Picture (www.ritholtz. com/blog), shows that the U.S. consumes 25% of global oil output while having less than 5% of the world’s population. This helps explain the Brits’ feeling that we Yanks are being less than honest with ourselves in our pique at BP. “They raise a valid point,” he adds.

Beyond that, Mr. Forsyth jumps right into a recent discussion had right here at TBP, to wit:  The future of the bond market:

THERE’S MORE TO LIKE ABOUT Treasuries other than the lack of alternatives. Even though their yields are down substantially from early April—when the benchmark 10-year note was 4% and the conventional wisdom said it had nowhere to go but up—don’t be surprised if it drops back below 3%.

Hmmm…sounds like a familiar theme.

Of most interest in the column, however, was this (emphasis added):

The real problem is that the economy remains mired in a debt-deflationary cycle from which the only way out is through paying down the debt. Nomura chief U.S. economist David Resler says that, even after households paid down debt for the seventh straight quarter in the first quarter, the process still has a long way to go. That, even with a $374 billion reduction in household borrowing from its peak of $13.9 trillion in the second quarter of 2008, with most of the drop coming in mortgage debt.

In fact, financial deleveraging has just begun, according to BCA Daily Insights, a publication of the Bank Credit Analyst. That points to renewed underperformance by financial stocks, which has started during the market’s current corrective phase, it adds. [...]

“The end of the implosion in credit quality has also helped support profits, but there has been a massive amount of wealth destruction. This implies that credit creation will remain weak and it will be difficult for the financial sector to re-expand.

“As long as credit growth remains flaccid, hiring stays weak and inflation non-existent, there’s no logical reason for the Fed to start tightening. And with short-term rates (and inflation) hovering near zero, a sub-3% 10-year Treasury and a long bond under 4% hardly seem unreasonable.

Now, if there’s meaningful data point out there to be mined, you can pretty much rest assured that David Rosenberg has mined it.  And, in fact, his current presentation includes a slide, which I’ve replicated below, that shows the extent of the problem described by Mr. Forsyth via David Resler and BCA Daily Insights:

(Source: Federal Reserve Flow of Funds, BEA.gov)

Dave titles this slide “The U.S. Will Spend Years Deleveraging This Chart,” and it’s certainly hard to quibble with that.  If anyone has a reasonable argument to make that the downtrend in the chart above is going to reverse itself any time soon, I’m all ears.

Former Fed Chair Alan Greenspan discussed the Federal deficit in a WSJ OpEd yesterday. In it, he argued that the budding “urgency to rein in budget deficits” is occurring “none too soon.”

Like most of the former Fed Chair’s analyses, forecasts, and economic beliefs, this one is pure, unmitigated nonsense. A brief look at the Greenspan legacy, along with his track record of forecasts, leads to the obvious conclusion: Greenspan is an economist to blithely ignore, as his commentary contains almost nothing of value other than its status as a contrary indicator.

Before we get into the details of his deficit commentary, I must highlight this sentence: “The financial crisis, triggered by the unexpected default of Lehman Brothers in September 2008, created a collapse in global demand that engendered a high degree of deflationary slack in our economy.”

No, Alan, the financial crisis was not triggered by Lehman’s collapse. You are getting the causation exactly backwards: The crisis is what triggered LEH’s collapse. Further, the fall of Lehman was hardly “unexpected.” Whether you want to look at stock price before the collapse, spreads on its debt, David Einhorn’s forensic accounting (he was short LEH) or our own quantitative analysis (we were short LEH), there were plenty of warnings about Lehman’s collapse. It was only unexpected by those whose ideological beliefs blinded them to reality. (Remind you of anyone?)

Moving onto his discussion about the deficit, the hypocrisy leaps out in nearly every paragraph. Any Greenspan related discussion of current deficits must begin with his specific role in helping to create them.

Not, understand one thing: I pay my share of taxes, and they are not insubstantial. Thus, I am in favor of properly funded tax cuts – meaning, reductions in taxes that are paid for with a matching reduction in spending. But Not Greenie . . . When the Bush White House proposed a trillion dollars in unfunded tax cuts in 2001, and again in 2003, Greenspan publicly endorsed them. (Why a sitting FOMC chair got involved in the politics of tax legislation, as his support of privatizing Social Security, is best saved for another day).

Regardless, Greenspan’s lent the considerable prestige of the FOMC Chair to the debate, and arguably helped tip the scales in favors of these huge, unfunded, deficit creating tax cuts. His present argument now rails against the net results of his prior arguments. Perhaps some sense of guilt is driving him.

Regardless, history has proven him wrong about the costs of the tax cuts in 2001/03, History — namely, the post depression 1937/38 recession — shows how misplaced his current focus on deficit reduction is today.

More Greenspan foolishness:

“Despite the surge in federal debt to the public during the past 18 months—to $8.6 trillion from $5.5 trillion—inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued. This is regrettable, because it is fostering a sense of complacency that can have dire consequences.”

This is classic Greenspan, demonstrating a lack of knowledge, inconsistency, and disconnected belief system:

1) To say that “remarkably subdued” inflation and long-term interest rates is regrettable reflects 1) a lack of understanding of the current deflationary environment;

2) If inflation and higher interest rates are the “typical symptoms of fiscal excess,” then perhaps the message of the markets is that deficits during the immediate aftermath of a huge recession are not a problem? For a guy who supposedly placed incredible trust in the markets, he sure does cherry pick what he wants, and disregards the rest.

3) The surge was caused by the enormous shortfall in tax revenue due to the recession, and the massive costs of bailing out the banking sector. Treating these costs as if they are ordinary budget items is ridiculous.

I can go on and on, but its the weekend. Before I give it a rest, I must point out that Greenspan’s forecasting inability. After Greenspan announced his retirement in 2005, I discussed some of his greatest hits in Myths of the Greenspan Era:

July 20, 2004: Greenspan testified before Congress saying that rising energy prices “should prove short-lived.” Crude prices tripled form there.

Summer 2004: Greenspan’s advice to would-be homeowners: Consider adjustable-rate mortgages. Surprising advice, considering that fixed-rate loans were near half-century lows. He then started raising rates, contributing to the huge foreclosure surge.

May 2003: Greenspan made an amazingly bad call on natural gas when he warned of potential shortages; natural gas prices tumbled shortly thereafter.

Summer 2003: Fed concern about deflation led Greenspan to suggest the Fed stood ready to make open-market purchases of Treasuries to ensure rates stayed low. He even convinced the Treasury market into believing that rates would stay low for a long, long time. Bond buyers discovered (to the detriment of their holdings) that this statement was false.

October 1999: The Fed erroneously anticipates a Y2K-induced run on the banks, and it infuses liquidity. That surge in money supply effectively doubled the Nasdaq Composite from October 1999 to March 2000; I presume you recall how that ended.

1996: “How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions?” Markets proceeded to rally strongly for another four years.

Greenspan is arguably the most incompetent economist of his generation, yet still retains some credibility amongst the uninformed. OpEds such as this one serve as reminders of that . . .

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Sources:
U.S. Debt and the Greece Analogy
ALAN GREENSPAN
WSJ, JUNE 18, 2010
http://online.wsj.com/article/SB10001424052748704198004575310962247772540.html

Myths of the Greenspan Era
Barry Ritholtz
The Street.com, 01/31/06 – 11:08 AM EST
http://www.thestreet.com/story/10265345/myths-of-the-greenspan-era.html

China’s decision to gradually abandon their hard peg to the US$ takes us back to pre July ’08 when it more freely floated. Yes, this comes right before the G20 meeting and with growing international pressure, particularly from the US Congress, but China understands that the move is in their best long term interests in terms of growing the purchasing power of their citizenry, tempering inflation pressures and slowing the incredible trade imbalances that has seen their FX reserves grow to $2.4 Trillion, about 70% of which is in US$s. For China’s growing stature in the world this is great news, although short term difficult for low margin Chinese manufacturers. To those critics in the US of China’s fixed peg, be careful now of what you wished for. The Renminbi has taken a big step to being a global reserve currency and smaller trade imbalances will mean less Chinese purchases of US Treasuries. At last count they own $900b worth.

As evidence that shifting higher the value of one’s currency is not a panacea for its competitors whose currency moves lower, all we need to look at are the Japanese and the yen move from 278 in Nov ’82 to the 90ish level today, a 67% appreciation. At the same time, Toyota became the most successful car company in the world while GM eventually went bankrupt. Bottom line, today’s move is more symbolic than anything because the revaluation of the yuan will be very gradual and not one off but it is a very important step in China’s maturation and global economic relevance.

Global equity futures are up strongly on the weekend announcement by the People’s Bank of China regarding the depeg of the Yuan to the dollar (US Futures below).

To be blunt, the Chinese announcement is only that — an announcement which may or may not be followed through. As such, we should treat it as a precursor, and not the significant shift the market seems to be making of the announcement.

I am neither a currency nor a China expert; however, a few items have emerged:

• Protectionist legislation is being discussed in the US due to the über cheap Chinese exports; this announcement may preempt Congress from passing it.

• In theory, a rising Yuan can help reduce Sino-inflation, which has been running way above global trend;

• China might be concerned that global economies, especially in Europe and America, remain soft, and this could be of aid to the exporters in those countries.

Whenever the PBOC makes a grand announcement, I am reminded of the Ralph Waldo Emerson comment:  “What you do speaks so loudly that I cannot hear what you say.”

Rather than make grand changes to your asset allocation mix, we would suggest waiting until their is evidence of action, rather than react to mere announcements . . .

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As these charts show, Bank failures in 2010 are running double the pace of 2009 . . .

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Charts courtesy of Ron Griess, The Chart Store

Via Visual Economics