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

How great is this? Every state in the US, as identified by their major TV show:

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Thinking PseudoGeographically via The Reformed Broker

Noah Rosenblatt of UrbanDigs has created a unique realtime tool for tracking Manhattan RE.

This is a terrific tool for residential Real Estate agents who are looking to use analytics, or any one in the market to buy Manhattan RE.

Look for this coming to other cities by 2012.

Free

Charts

In stark contrast to the much weaker than expected NY survey out on Monday, the Nov Philly Fed survey was well above expectations at 22.5 vs the forecast of 5 and up from 1.0 on Oct. It’s at the best level since Dec ’09. New Orders jumped to 10.4 from -5. The Employment index went to 13.3 from 2.4 and the Average Workweek rose almost 17 pts to +10.9. Order backlogs rose to 3.7 from -8.9 and Inventories rose 12.7 pts to -5.9. Prices Paid rose 2.5 pts to 34, the best since May and Prices Received rose 7 pts but remained negative at -2.1. The 6 month outlook also improved to 49 from 41, the highest since March. Bottom line, there is nothing to quibble with in this data point as the improvement was broad based but on the heels of the very negative NY #, let’s see some more regional surveys and a reconciled ISM before jumping to conclusions. With this said, most of the economic data, ex housing, does continue to slowly improve.

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I am off to speak at the Maxim Growth conference (which refers to the economy and not my weight).

I am on a panel with Todd Harrison of Minyanville and Anthony Scaramucchi of SALT Skybridge on “The Current State of the Equity Markets.”

If you are near the Grand Hyatt, swing by and say hello . . .

Peter T Treadway, PhD
Historical Analytics LLC
U S AND CHINESE INTEREST RATES GO UP!
November 18, 2010

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“Inflation has long been the weapon of choice in sovereign defaults on domestic debt and, where possible, on international debt.”

-This Time its Different, Kenneth Rogoff and Carmen Reinhart, p 175

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US and Chinese interest rates going up at the same time? Can things get worse?

As I have been arguing for the past two years in The Dismal Optimist, the dollar- based international monetary system is broken. That has now become the accepted view, in governments and in the markets, as the system has become progressively more broken. Investors, now face unprecedented volatility and uncertainty.

The markets in the last few days have experienced a rise in US and Chinese interest rates. Considering that low rates have been baked into asset prices globally, this is big.

Let’s start with the US.

It’s Our Currency, Your Problem

The above heading of course is a perennial favorite quote, courtesy of Nixon’s Treasury Secretary, John Connolly. Helicopter Ben Bernanke, in the Connolly tradition, has launched QE2 with the assumption that the US could do what it damn pleased regarding monetary policy and the world would put up with it. Ordinary countries might experience higher interest rates and currency collapses if they engaged in irresponsible money printing. Their currency, their problem. The US doesn’t have to worry about such trivia.

But this time we got a hint things might be different in the future. As President Obama discovered at the recent G 20 Meeting, Bernanke’s QE2 has evoked global outrage. And not only that. US longer term Treasury rates, if only momentarily, moved up.

Once upon a time in the good old pre-1914 days when gold underpinned both national and international monetary systems, central banks had only two tasks related to what today would be called monetary policy. The first was to buy and sell gold at an unchangeable fixed rate against their national currency and the second was to nudge short term interest rates up or down so as to encourage or discourage capital flows so as to maintain their country’s gold exchange rate. Actually in that blissful time the US didn’t even have a central bank. (The run on US gold in the Panic of 1893 was in part caused by fears that silver would partly replace gold in the US and the US would leave the gold standard) Central banks at that time were privately owned and profit making. The tasks of promoting full employment, softening the impact of deflationary bubbles, targeting inflation rates, or even targeting money supply, were not their problems. It was only after 1914, when the vast killing machines of an interminable war required endless financing, did the central banks morph into their current dual roles of national monetary central planner and agent of monetary debasement.

The world is well aware of two things: One, the US has borrowed in its own currency. Two, it is headed towards fiscal insolvency. Distinctions between US international and domestic sovereign debt are meaningless. The US will never default via non-payment of principal or interest. It can always print more dollars. If the US defaults, it will be via inflation.

I have been of the view that the Fed would not move up US interest rates in the next 12 months because the US consumer was mired in a massive real estate focused debt deflation. This is still my view. I have assumed the Fed could get away with this for at least another year and that its inflationary money printing would first hit outside the United States and in the global commodity markets.

This recent move-up in US Treasury rates may indeed just be a blip. In the last two years we have experienced occasional backups in US Treasury rates. Like summer thunderstorms, they’ve gone away. But in my opinion the back-up in US rates is an early warning even if reversed for now. The US, unlike Japan (the other low interest rate major debt deflation country) is dependent on foreign buyers to buy its debt. Bernanke has thrown sand in the eyes of the markets and world political leaders. He may discover that the Fed doesn’t quite control US long term Treasury rates the way he thought it did. As I write this, some are even speculating that Bernanke will have to curtail his QE2 plans.

Investors have to face this fact: With the Fed printing high powered money with wild abandon and with the US fiscal situation (including the states) continuing to worsen, sooner or later US longer term interest rates will trend upward.

For investors this is a nightmare. Zero to low US Treasury rates have been baked into asset prices around the world. Bond yields have come down. Investors, earning next to nothing in short term instruments, have been forced to reach for risk. In Asia, that has meant buying real estate. If US rates trend upwards, asset valuations will require recalculation – downwards. The Bernanke bubbles will deflate.

Economists and policy makers around the world expect a wall of QE2 money to hit global asset markets. That certainly has been my expectation. Perhaps this is too simple. Markets have a way of fooling us when “everybody” expects something. Prices get bid up in advance, money flees the oncoming wall, governments react with sometimes very stupid measures.

For example, capital controls are now becoming acceptable. Governments will not hesitate to interfere with markets when they feel threatened. Remember the ill-fated interest equalization tax instituted by President Kennedy in July1963 in response to brewing US balance of payments problems. The following quote from Wikipedia is worth noting:

“Interest Equalization Tax was a domestic tax measure implemented by U.S. President John F Kennedy in July 1963. It was meant to make it less profitable for U.S. investors to invest abroad by taxing the interest on foreign securities.”

Think about this. The Bernanke Fed has already made it less profitable for US investors to invest in domestic fixed income securities with its policy of near zero short rates and quantitative easing. Why not screw US investors on their international investments?

Meanwhile Back in the Middle Kingdom

In the last week China has announced a number of measures including increased reserve requirements on banks and higher bank deposit rates. All of this in response to an ever higher rate of consumer price inflation. More measures are expected including price controls on food (ugh!). All this occurring at the same time the world is in an uproar about QE2 and Ireland has become a global problem. The Chinese stock market—and to a lesser extent all of Asia — as a result has suffered a sharp drop.

Along with many others, I have been expecting a ratcheting upward in Chinese inflation. All this comes back to the Chinese exchange rate policy of undervaluing the renminbi. Keeping the renminbi below what the market would require has forced the Chinese to buy dollars, thereby increasing Chinese bank reserves and domestic money supply. All part of the broken international monetary system.

The last Dismal Optimist reviewed what I consider the mercantilist and misguided features of the East Asian Economic Model, a version of which China espouses. It should be clear now to the authorities in Beijing that the current policies have their cost in terms of increased inflation and consumer unhappiness.

I believe China has reached a crossroads, perhaps as momentous as that faced by Deng Xiaoping in the early 1980s when he successfully reoriented his nation towards a more market oriented approach. The East Asian Economic Model of an undervalued exchange rate, overreliance on investment and exports, significant tariff and non-tariff barriers and massive accumulation of definitely risky US dollar reserves is on its last legs.

Japan with its sclerotic political system has been unable to find a way out of the dead end into which the East Asian Model eventually leads. Japan was lucky. It started thirty five years before China when a robust US economy could suck in Japanese exports. China, at this point with a much lower standard of living than Japan, doesn’t have the luxury of wallowing in Japanese indecision and paralysis, especially with a much weakened US now an unreliable engine of global growth. The bull case for Chinese stocks – and indeed for Hong Kong, Taiwan, Singapore and Korea – assumes that China will make the tough decisions and move away from this Model. That is my view but the next few years could be bumpy as China, to use Deng’s famous expression, makes its way across the river and “feels the stones.”

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Peter T Treadway, PhD
Historical Analytics LLC
www.thedismaloptimist.com
pttreadway -at- hotmail -dot- com
305 761 4718
852 9409 1186
Fax: 305 489 7807

Peter T Treadway also serves as Chief Economist, CT RISKS, Hong Kong

Initial Jobless Claims were 2k less than expected at 439k but last week was revised up by 2k to 437k, so thus about in line, but to see two weeks in a row below 440k is definitely encouraging in terms of the level of firings. Continuing Claims were exactly in line with the estimate, falling by 48k to the lowest since Nov ’08. Extended Benefits rose a net 121k and the overall level still remains elevated and points to an economy that is creating jobs but not fast enough. Nov 30th is the expiration of the last extension of unemployment benefits and if it’s not extended it will create a short term disruption in the economy BUT there are 3mm job openings out there and hopefully will then get filled up.

The wheels seem to be officially in motion for the EU and IMF to extend money to Ireland who will in turn further restructure and recapitalize their banking system. Whether money in excess of this will go to Ireland’s general budget remains to be seen but Ireland seems intent on only keeping this ‘bailout’ for their banks and nothing more. This is in contrast to Greece whose government ran out of money. Bank bondholders again are getting saved and while its good to see this fire put out and some time being bought, the excess leverage that was the genesis of the problem still remains when there was a perfect, albeit painful, opportunity to cut debt levels. China did officially announce price controls on “important daily necessities” that they say will only be temporary and seem to be targeted. Because the policy wasn’t broader, Chinese stocks bounced after the drubbing they’ve taken over the past week. The rest of Asia followed the rally.

Following the AAII reading of individual investor sentiment last week where Bulls rose to the highest level since Jan ’07, the market correction since has quickly changed sentiment. Bulls fell from 57.6 to 40, the lowest since Sept 2nd while Bears rose to 32.5 from 28.5, also at a level last seen on Sept 2nd.

Terrific appearance by Bruce Springsteen on Jimmy Fallon’s show — very interesting conversation and relaxed banter, followed by a couple of tunes. He seems to be having a really good time on the show.

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Springsteen Rocks Jimmy Fallon

(New episodes are posted the day after their original air dates and may stream for 17 days — and is why Hulu sucks!)

via Arts Beat: Because the (Late) Night: Springsteen Rocks Jimmy Fallon

By Paul Kedrosky, Infectious Greed

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I asked recently on Twitter for some book recommendations, and here are just a few that came hurtling back.

• Super Sad True Love Story, by Shteyngart
• Godel, Escher, Bach
• Incompleteness, by Goldstein
• The Drunkard’s Walk
• Shadow of the Wind
• Kapitoil
• Strength in What Remains, by Kidder
• The Art of Racing in the Rain
• You Never Give Me Your Money
• Crisis Economics
• The Co-Evolution of Climate and Life
• What Have You Changed Your Mind about, by Brockman
• Columbine, by Cullen
• Wolff Hall, by Mantel
• The Blue Sweater, by Novogratz
• Stories of Your Life, by Chiang
• Midnight in the Garden of Good and Evil
• Master Switch, by Wu
• Extremely Loud and Incredible Close, by Foer
• F*ck IT: The Ultimate Spiritual Way
• The Burning Tigris, by Balakian
• Two Gentlemen of Lebowski, by Bertocci
• The Splendid Blond Beast, by Simpson
• Safe from the Sea
• The Trouble with Physics, by Smolin
• Wisdom of Crowds, Surowiecki
• Thomas Paine, by Hitchens

GM history in the second half of the 20th century is a story of executive arrogance, missed opportunities, poor decision-making and reckless finance.

After WW2, everyone was making money hand-over-fist, and GM became known as “Generous Motors.” Starting in the mid-1950s, rather than risk a strike that could slow production and sales, GM chose to kick the can down the road. When it came to wages, and benefits, the execs made the union contracts, guaranteed pension benefits, health care costs someone in the future’s problem.

Then the future arrived.

The industrial giant went from owning their market, to being an insolvent, hollowed out rust bucket of a company. The website The Truth About Cars started a GM Deathwatch several years before the company finally succumbed to its own failures.

Contrary to popular belief, it wasn’t the credit crisis and recession that killed GM — the crisis merely revealed the structural deficiencies that were there all along. The company had diversified into auto finance, then home finance, all the while designing boring, poorly manufactured machines that got poor gas mileage and were vastly inferior to their European and Japanese counterparts. Insolvency was inevitable.

The weakened mid-western firm lacked the lobbying muscle to force an ill advised bailout. Rather than give GM the Hank Paulson bank treatment — throw trillions at them and hope for the best — Uncle Sam actually took an intelligent approach to the issue.

But even a weakened giant, a shadow of its former self, GM was still a substantial employer. That had political ramifications in an election year. Instead of letting them do the Lehman Brothers face plant into the pavement, the choice was made for a prepackaged bankruptcy.

This was the single best decision of the bailout era.

It seemed to be the only decision that was not made in a panic. It adhered to the rules of capitalism — when your company is insolvent, it goes into reorganization or dissolution. The brutal, Darwinian rules of the market and of bankruptcy applied — not the influence of lobbyists, or special favors from Senators. The Treasury Secretary’s former gig was not running an auto company, he ran a Wall Street bank — so there could be no special favors expected to come from that quarter either.

Instead, Uncle Sam’s involvement was to provide Debtor-in-Possession financing. The bankruptcy plan was obvious: Wipe out shareholders, give bond holders a haircut, fire management, pare the company down to a sustainable size without sentiment.

This was what was done. A turnaround plan was created and executed. If the company met its milestones, the firm would be taken public, which would allow the government to significantly reduce its stake and exposure to GM. The Fed also helped, keeping financing rates at ultra low levels.

The long term stock sale plan would lead to the taxpayers being made nearly whole. All told, it was a wild success. Malcolm Gladwell argued that Rick Waggoner should get more credit and Steve Rattner less, for GM’s effective turnaround; many of the new models that are now doing so well were first created and planned for under Waggoner’s tenure 5 years ago.

So what is arguably the most successful bailout of the 2007-2010 era was in fact a non-bailout: It was a bankruptcy reorganization that eliminated the most toxic aspects of a century old rust bucket of a company. The new firm has clean books, is well capitalized, is without crushing debt, has a less onerous labor contract, pension and health care obligations. Its hard not to see how this was anything but a ginormous winner for all involved.

Which brings me to the Banks.

Currently, the United States has a weakened financial sector. Many of the largest Banks are technically insolvent, but thanks to an accounting rule change, are not required to admit this simple mathematical fact. They are carrying an enormous amount of bad loans on their books. They are sitting on several million REOs — bank owned foreclosures for which there is essentially no market. This shadow inventory of houses amounts to years worth of sales, not mentioning the depressing effect the excess supply will have on prices.

The reckless lending of the 2000s was merely the tip of the iceberg. From start to finish, the engaged in all manners of irresponsible behavior. When a company’s actions are so reckless it compromises the firm’s ability to survive, why would we expect it to have performed any of its other duties competently? They didn’t, which is why we have learned about how poorly the banks not only made these loans, but also administered, securitized, serviced, and foreclosed on them. The entire process was reckless, it was done on the cheap, riddled with errors, fraud and felonious behavior.

It has become a national embarrassment.

The bank bailout plan was ill conceived and poorly executed. Trillions were thrown at them before Uncle Sam had any idea as to how much debt was actually on the books. What were once considered decent holdings were eventually revealed to be highly toxic assets.

Recapitalizing the banks is a huge priority. But after the first round of trillions were given away to the banks, the public was disgusted. The politicians lost their appetite for overt bailouts. But the banks were still under-capitalized, their balance sheets were still laden with junk. A direct transfer of taxpayer monies was out of the question.

An easy backdoor was found: Arbitrage the Fed and Treasury. Zero interest rates and QE allowed giant Wall Street banks to borrow at no cost from the Fed, and then turn around and lend this same zero cost money back to the Treasury at 3% or so. Do this for another 10 years or so, and the banks would be recapitalized. By then, maybe there might even be a market for all those REOs. Sure, that would mire the nation in a decade long Japanese-like slump. Hey, at least the bonuses would be paid on time.

The motto of the bank bailouts: To hell with the banking system, save the banks!

The results should not be surprising. The banks remain in a weakened condition, perilously at risk for additional problems in RE. Despite the massive liquidity, Credit still remains tight. If financing is the fuel that drives the economy, the US is running on fumes.

Wall Street has returned to business as usual. The Street is nothing if not savvy. Just as a shark detects blood in the water, the Street can smell weakness and exploit it like no other industry. Once they figured how to play chicken — mutual assured destruction –  with the entire global economy, there would be no restraining them.

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Compare the differences between the banks and GM/Chrysler, and will see the full folly of how we rescued the financial sector.

Instead of letting insolvent banks fail, we turned over the keys to the castle. We could have fired the incompetent management that caused the problems — but most of these execs are still in the same highly placed positions in their firms. In terms of senior personnel, the industry is literally unchanged.

Bad debt? Still on the books.

Sufficient capital? Many years away.

Business model? The same highly leveraged reckless strategy that got them into trouble in the first place

Regulatory Oversight? A modest improvement which the newly elected, bought and paid for Congress, seems hellbent on overturning.

If you want to understand why we should never have bailed out the banks, just look at the differences between the Auto and Banking industries. One is healthy, with a likely cost of near zero. The other remains a debacle, whose costs are incalculable are likely to be an economic drag for years if not decades.

Too bad the minds behind the bank bailouts did not have the foresight to appreciate the full advantages of prepackaged bankruptcy for the sector . . .

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Previously:

Looking at the 1980 Chrysler Bailout (November 20th, 2008)

Why Are Banks So Different From Autos? (December 9th, 2008)

Why Bankruptcy For Autos But Not Banks? (February 23rd, 2009)

Banking Sector Remains (literally) Unchanged (January 4th, 2010)