Wednesday, April 30, 2008

Your Votes At Work

As we move towards anointing another Defender of The (Oil) Faith (aka US President), how do the wannabes stack up in confronting the mounting energy crisis? Here are some facts on their "energy policies".
  • Clinton and McCain both favor suspending the 18.4 cent per gallon federal gasoline tax for the summer driving season. This populist measure is analogous to pushing for lower cigarette taxes as tobacco prices rise. Let's all root for more cancer and emphysema, shall we?
  • Obama and Clinton promise $150 billion over 10 years to develop alternative energy. Do a simple comparison: at today's prices the US spends $1 trillion per year on crude oil alone. Anyone that believes that $15 billion is going to make a real difference is naive, uninformed or in denial - or just throws out round numbers to palliate voters. Or all of the above.
  • Clinton and Obama both want higher fuel economy standards from the current 25 mpg. Admirable, but Clinton wants 55 mpg by 2030 and Obama 50 mpg by 2026. Since our politicians love stargazing while whispering sweet nothings to our ear, how about 100 mpg by 2100? Perpetual motion by 2200? How about the simple fact that, should they get elected, they will be out of office by 2016 at the very latest? The problem is now and we must confront it right away. Forget McCain, he comes from another planet altogether: in 2003 he voted down a measure to increase fuel economy to 40 MPG by 2013.
  • Clinton and Obama want to "investigate manipulation of oil prices". That's what I call the Darth Vader initiative: send noble knights to fight the Dark Side and liberate the Republic from the claws of the Evil Manipulator. Plays well with those who view issues in black and white and cartoons in Technicolor (IQ<100 a must).
To summarize, these policies are best described as follows: the "Fuel Low" warning has lit up in the middle of a flight, high above the Atlantic Ocean. Instead of altering course for the Azores or Iceland, the Captain decides to stick to his original flight plan, passes free booze to everyone - including himself and the co-pilot - and blames the ground crew for the empty tank. He also promises that after 25 years the plane will go further with less fuel.

No wonder the passengers are getting nervous...

OK then, what should be done? Well, first of all we need to land the plane without killing everyone on board. After decades of mostly forced growth (think of how foie-gras is made) we actually need a prolonged period of shallow recession to retool the national (and global) economy away from the Permagrowth model. If the rest of the world doesn't want to follow, too bad. That's what we have the Customs Service for.

Some concrete proposals:
  • Legislate a stream of steady increases in taxes for carbon-based fuels (e.g. 10 cents/gallon every six months, 5 cents/kwh of "black" energy), to raise at least $100+ billion per year and recycle the money into alternative energy sources and systems.
  • Impose sales and annual use/registration taxes for automobiles on a sliding fuel economy scale. Those getting over 50 mpg will pay very little or nothing, whereas gas guzzlers will pay 5% of their original factory MSRP every year. Recycle the money into public transport, including high speed trains.
  • Withdraw from Iraq and Afghanistan within one year and reduce the overall size of the military involved in securing fossil fuel sources and routes, at a pace commensurate to the switch to alternative energy. This will save a minimum of $150 billion/yr at once and eventually at least $300 billion/yr. (the total military expense is now $630 billion/yr).
  • Revamp the current pensions and medical benefits scheme, since it is entirely based on the Permagrowth and serial bubble paradigms. This is key because people will not accept both present and future sacrifice. If changing energy is difficult, this is an order of magnitude harder.

Monday, April 28, 2008

Empty Homes

The Census Bureau announced its quarterly housing data yesterday. The homeowner vacancy rate moved to 2.9% in the first quarter of 2008, the highest reading since 1956 when records started.

Worse yet, as the number of housing units in the country increased by 2.1 million units from a year ago, vacancies also rose by a huge 1 million units, affected by rising foreclosures. For comparison, here is a chart with prior years' increases in housing units and vacancies.

Putting it into dollars, at least $200 billion in housing capital became idle in just one year. This amount likely understates reality because it reflects national median prices, whereas vacancies are higher in the West and South where houses are more expensive. For example, the homeowner vacancy rate is 2% in the Northeast, but 3.2% in the West.

Consumer Sentiment and Spending

Everyone agrees the US economy is all about consumer spending - personal consumption expenditures (PCE) make up 72% of GDP. Naturally, there is a tight relationship between how confident people feel and their spending.

Here is a chart that compares the percentage change in real, inflation adjusted PCE (red line) with the consumer sentiment index published monthly by the University of Michigan (blue line).

At 62.6, the sentiment index has now reached the lowest level in 26 years, portending further declines in spending. Headline data on sales may be muddled by sharply higher food and fuel prices and the ongoing racket of manipulating official CPI inflation*, but you can't hide the "real" reality manifesting itself on the ground.
  • Starbucks just slashed its outlook. This icon of discretionary consumer spending is seeing lattes-to-go go down the drain. "It's amazing how fast business has derailed", said RBC Capital Markets analyst Larry Miller.
  • People are cutting back on laser eye surgery. Elective LASIK surgery can cost thousands of dollars per eye - the other end of the discretionary spectrum from a cup of coffee. But the principle is the same: unnecessary spending is being curtailed. A 17% drop in procedures is forecast for 2008.
As we come up to stimulus time - those $600 checks borrowed abroad on behalf of the American people by the Bush administration - I expect most of the money spent will go towards basic, pressing necessities: food, gas and debt payments.

And since I mentioned gasoline, consumption has stopped growing (see chart below) and for the year to April 18 it is down 1.12% from last year.

Data: EIA

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(*) Everyone should read this damning article by Kevin Phillips in the latest issue of Harper's Magazine: Numbers Racket. Kevin used to be a mainstream Republican political strategist. I am increasingly getting the feeling that economic reality is getting swept under the carpet, an uncomfortable parallel to the late Soviet Union's "official" reality until it imploded all at once.

Friday, April 25, 2008

One Sentence, One Picture, One Story.

(A) The Sentence:

Ambac's CEO Michael Callen said his company has enough capital to keep its AAA rating.

(B) The Picture:

Ambac Share Price

(C) The Story:

Kindly combine (A) and (B).

Wednesday, April 23, 2008

The Greenback: Toward A New Monetary Policy

As we transit to a world of resource depletion and the reversal of the Permagrowth model, what is the proper monetary and currency regime? Clearly, not the existing fiat/credit currency, which depends entirely on financing present consumption by discounting future growth that may never occur. Just as bad would be a throwback to precious metals. It would suppress economic activity without providing incentives for developing alternative energy resources.

Instead, I believe we should implement a monetary system that uses renewable, "green" energy as a benchmark. In previous posts I have called the new currency the "Greenback", an allusion to the fact that for most people nothing would change in their daily routine. Same dollars, same bank accounts, same credit cards. The monetary institutions would also be retained: the Fed and the fractional banking system. The only change - admittedly a big one - would be the rate at which money supply is allowed to expand. Let's call this rate "M green", or M(g) for short and see how it will be calculated.

To begin with, we have the following energy consumption data from the US Energy Information Administation (EIA, see chart below). The discrepancy in percentages is in the original data, but it is very minor.

Data: EIA (2006)

We see that of the total 99.4 quadrillion BTU the US consumed in 2006, 86% was produced by "black" fossil fuels, the rest from nuclear and renewable sources. Adding the last two together gives us the percentage of "green" energy. Though I hesitate to call nuclear "green", it is an indispensable energy source in transiting away from fossil fuels.

For any given period, then, the allowed growth in money supply would be calculated by this formula:

M(g) = ΔE(g)/E(b)

where:

- ΔE(g) is the change in "green" energy consumption from the previous period, in BTU.
- E(b) is the total "black" energy consumed in the previous period, in BTU.

For example: let's say that in 2008 we consume 85 black BTU and 15 green BTU. The following year, we consume the same 85 black BTU but increase green to 17 BTU.

Therefore:

M(g) = (17 - 15)/85 = 0.0235 = 2.35%

i.e. broad Greenback money supply (the equivalent to M3 today) would be allowed to expand by 2.35%.

Putting it in simple terms, money growth would increase with "green" energy use and be constricted if "black" energy grows.

This system would broadly encourage the consumption of green energy and penalize the consumption of black energy, by controlling the money base. A monetary policy that targets money supply has not been used since the early 1980's, when the Fed switched to targeting short-term interest rates (i.e. Fed funds). Nevertheless, the tools and procedures for targeting money supply are simple and consist mostly of buying and selling Treasury securities in the open market.

There are certainly further details that will need to be worked out. Initially, at least, the formula will lead to a restrictive monetary policy and high interest rates. Left unchecked, the elevated cost of money would prevent even "green" projects from going ahead, so exceptions and subsidies should be provided. For example, the government could provide low-cost financing for alternative energy projects.

In addition, GDP growth as measured currently would be impacted negatively. To avoid a prolonged period of high unemployment resulting from sectors of the Permagrowth economy becoming obsolete, the government should implement an appropriate mix of fiscal policy initiatives. For example, increased taxes in "black" sectors could be recycled into "green" sectors, including education and retraining programs and incentives.

Notice that I have not called for a government-sponsored and financed "Greenshot" effort, a throwback to the Apollo Moonshot project. I believe that the proper mix of monetary and tax policies, balanced with liberal subsidies for green/sustainable efforts, will create more than enough opportunity for private enterprise. The prospect for attractive profits will promote vigorous technological advance and produce high value-added jobs.

The whole process will re-invigorate the American economy and society, leading to a long period of global superiority in intellectual and creative advancement. Crucially, we will no longer need to maintain a vast military-industrial complex to guard the world's oil sources and routes. America will once again become the beacon of liberty and hope, instead of fighting bloody resource wars that besmirch our national pride and give birth to sworn enemies.

Final Note: Some readers may not be familiar with actual macro-economic and monetary data and may thus be puzzled by the Greenback's ability to transform the economy. To illustrate, here is a real-life example:

Between 2005 and 2006 US "green" energy consumption grew by 0.53 quadrillion BTU, a tiny increase when fossil fuel consumption in 2005 was 86.4 quadrillion BTU. This means that broad money supply under the above Greenback system would only be allowed to grow by 0.6% for the year. By comparison, the last official reading of M3 growth, before its publication was discontinued in early 2006, was 8.0%.

I expect that the economic effects of such a large difference in money supply growth rates are obvious. If not, please refer to basic texts on monetary policy.

Monday, April 21, 2008

Heads In The (Tar) Sands

This is a follow-up post on common sense evidence that easily accessible crude oil is in depletion and its relationship to debt and central bank policies.

I just watched a TV documentary about the Alberta tar sands and the way oil is mined by Syncrude. Some facts:
  • The teeth of the giant shovels that scoop up the tar sands have to be replaced every 12 hours. That's a lot of steel to chew through in half a day - it surely isn't beach sand...
Photo: Graig Smith
  • Imagine rubbing #40 sandpaper on your skin. Now guess what happens to every pipe, vessel, pump and valve that handles the tar sand slurry. The company has two separate process trains working in parallel, switching from one to the other in order to constantly replace worn parts.
  • The giant 400-ton trucks that carry the sands cost $6 million. Their 3,550 HP engines have to be replaced every two years, at $1+ million a pop. Tires cost $60,000 - each.

When it comes to evaluating resource depletion, deeds speak louder than words. Oil isn't available for the price of a straw stuck in the sand any more. Back when "gushers" were common, easily accessible crude had EROEI of as much as 100-to-1. Saudi crude is now extracted at 10-to-1 and tar sand oil at 5-to-1. We can argue dollar prices forever, but a kilowatt is always a kilowatt. Try this simple thought experiment: instead of thinking of oil prices in dollars per barrel, reverse the point of view and think in terms of barrels per dollar. That is, price the artificial entity (dollars) in terms of the real item (oil). Do you see the difference?

As I see it, our global human society has two choices. We can keep our heads buried in the (tar) sands, perma-consuming until all we have left to bequeath our children are dregs. Or we can stop right now and start moving towards a sustainable regime. The current debt "crisis" is not only a warning sign that we have already consumed too much of our future. It is also a golden opportunity to reverse some of the excess, to un-mortgage humanity's future by letting some of the debt go bust.

In this sense, repeated bailouts by central banks (BOE is the latest addition) are profoundly wrong, misbegotten and ultimately dangerous. Speaking in thermodynamic terms, they are trying to convince us that their kilowatt is worth more than one kilowatt. They are just drilling their heads deeper into the sand, forcing us along for the ride. Unfortunately, we will have to work that much harder to dig ourselves out - assuming we will still have some food left over.

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Note: A reader asked for a book recommendation on Thermoeconomics: Try "The Entropy Law and The Economic Process". It's now on the Amazon bar on the right.

Friday, April 18, 2008

Brave Words From A Dissenter

Two Fed presidents dissented with the previous rate cut. One of them was Charles Plosser, president of the Federal Reserve Bank of Philadelphia. Yesterday, in a speech at Drexel University, he had this to say about the limits of rate cuts:

The idea that interest-rate cuts can solve any economic ills is a misleading perception. Not only is that not true, it is a dangerous misconception and runs the risks of setting up expectations that monetary policy can achieve objectives it cannot attain.

To ensure the credibility of monetary policy, we should never ask monetary policy to do more than it can do. Lower rates, for one thing, cannot solve the problem of bad debts in the mortgage markets. Nor can they reprice the risks of securities backed by subprime loans.

Mr. Plosser, you just became my Federal Reserve resident hero.

Many think that further rate cuts can and will provide an economic boost. But with real rates already at minus 1.75% - after the fastest plunge into negative territory ever - what we are going to get is plenty of dashed hopes, if the economy does not pull out of its tailspin very soon.

Data: FRB St. Louis

The real estate bubble was created by Mr. Greenspan's spate of negative rates. We are now getting a frenzy in commodities from Mr. Bernanke's negative rates. But unlike previous bubbles that mainly involved speculators in shares and housing, the current spike in food and fuel prices is causing hunger and misery across the globe.

In a fiat currency world experiencing resource limitations there are no more "good" bubbles to blow by using negative rates. Instead, we are implementing a "beggar thy neighbour" policy by stealth, a version of the Smoot Hawley Act updated for 21st Century conditions.

A fiat currency regime, where monetary policy reigns supreme, was appropriate for an expanding world unhindered by resource depletion. An ever-expanding supply of money fit the Permagrowth model well - indeed, it was a necessary condition. However, we are now transiting to a different socio-economic model and the evidence is all around us, plain for all to see: zooming prices for low value-added necessities.

Why has the price of rice quadrupled? Does it now contain four times as much technological or knowledge value-added? Of course not. It is all about scarcity value, a concept we have not experienced in centuries, outside of war.

If I may spin Mr. Plosser's remarks to another level: We can't buy Manhattan for a bag of beads any more. There are too many buyers around and the natives are restless.

The Lords of Hedgistan

The top 50 hedge fund managers in 2007 made a combined personal income of $29 billion and now plan to incorporate themselves as a country. They are looking at Antarctica, which is getting balmier all the time. Despite record high crude oil prices ($115/bbl) that may restrict consumption and cause fewer greenhouse gases, they are nevertheless going ahead with plans to eventually grow cotton in the vast lands of the South Pole. Apparently, the Founding Lords of Hedgistan - for that is to be the name of their new nation - are betting heavily that burning coal will more than compensate.

Antarctica will be obtained from its current owners/claimants in exchange for immunity from speculative attacks on their currencies and domestic financial markets. America's McMurdo Station is widely expected to be renamed the Dead Buck Station as a warning to other countries that may resist surrender.

The new nation will have a tiny population (50 plus household members and serfs), but based on the earnings of its residents its GDP will exceed that of 100 out of 180 countries tracked by the IMF. Next on the list is Kenya (pop. 32 million, 2007 GDP $29.3 billion). One of the Lords suggested its outright purchase, but he was voted down. "Why waste equity when we have leverage?" was the sensible objection from the other 49.

The fifty Founders are to award themselves hereditary titles of aristocracy proclaiming their exalted station. Heraldic work is already under way for Order of Quantum, Lord of The Citadel, Harbinger of Perpetual Good News and Rex of Renaissance. The new nation's highest recognition for financial bravery has already been established, and is called Pour Les Cochons Volants. The medal of solid gold depicts two winged piglets encircled in a wreath of cocktail sausages.

And since (exploding) penguins come from the Antarctic...

I bid you all a fine weekend with the above Monty Python skit. The penguin bit comes near the end.

Wednesday, April 16, 2008

Crunch Metrics

Probably the best measure of the seriousness of the credit crunch is the ratio of rates for 3-month bank CDs to those for 3-month Treasury bills (see chart below, click to enlarge).

Data: FRB St. Louis

After decades of banks paying just a tad over T-bills for CD funds (ratio slightly over 1.00), their deposit costs exploded upwards reaching 3.20 times more than bills in the week of March 21. This was a somewhat misleading reading, however: with CD rates at 2.62% it was a low 0.81% T-bill rate that caused the ratio to shoot up so much, coming as it did amidst the Bear Stearns panic.

Last week the ratio eased back to 2.10 as bill rates moved up (CDs at 2.75%, Bills at 1.31%), but it is still high by historical standards and a continuing sign of severe risk aversion. Should it persist for much longer it will restrict lending practices even further and wreak havoc to bank profitability.

In a related topic, ISDA today announced that notional amounts outstanding for CDS rose to $62.2 trillion at the end of 2007, up 75% from 2006. The credit crisis is surely prompting many to seek default protection, but I think outright speculation is an even bigger factor. I have often said that CDS can be used as phantom equity equivalents and this comment supports my view: "Trading volume has gone up dramatically,'' said David Vershoor, a default swap trader at BNP Paribas SA in Hong Kong. "People are punting it harder than they punt equities.''

ISDA estimated CDS gross and net market values at at $9.8 and $2.3 trillion respectively which, though lower than notional, have now climbed to be significant on their own. By comparison, global stock market capitalization in February 2008 stood at $56 trillion. And if the Bear Stearns snafu taught us anything it is this: we can't ignore counterparty risk, i.e. we can't ignore gross market values for derivatives. Which ultimately means that notional amounts also matter a great deal and can't be dismissed out of hand as "unimportant".

Data: ISDA

Commenting

I have taken the patently unfair step of deleting every comment made in the previous post in order to make a point. I will not allow the comment section to become uncivil. Electronic schoolyard bullies will not be allowed to "play".

I thank those who make constructive and often pointed remarks; they add value to the discussion. From now on I shall excise only those comments that do not follow common sense rules of decency.

Thank you once again.

Tuesday, April 15, 2008

Crude Facts

With crude oil hitting new all-time highs over $114 per barrel, everyone is concerned - to put it mildly. Some of the appreciation is surely attributed to misbegotten monetary policy factors, as the Saudis claim. The US dollar is the benchmark currency for oil pricing and Mr. Bernanke's Fed is throwing good dollars after bad in his attempts to bail out Wall Street, leading to the debasement of the dollar. Another factor is commodity speculation, with risk capital betting on even higher prices. Finally, and most important of all in my view, is the depletion of easily accessible high quality crude oil, i.e. the forerunner of geologic Peak Oil.

There have been millions of pages written about Peak Oil, both pro and con, and I don't claim to be an expert. But I do want to add just one fact based on common sense. Exxon is the world's largest non-state oil company and the largest publicly traded corporation by market capitalization ($478 billion). If anyone has both the incentive and the resources to find and sell more oil, it is them. But they can't. In the last five years, as the average price of oil more than tripled, their production has been flat (see chart below, click to enlarge).


And it's not as if they haven't been trying: their capital and exploration expenses for upstream operations have nearly doubled in recent years.

Data: Exxon Annual Reports

These are not comforting facts.

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P.S. Senator McCain, he who wants to be President, today called on Congress to suspend the federal gasoline tax. Sure thing, Senator... and while you're at it, why not re-instate the draft? After all, we're going to need every boot possible on the ground to safeguard America's energy future. The hard way.

Friday, April 11, 2008

Bear Market-Less Recession?

A regular reader (eh) wondered if we are throwing a recession, but all the market bears are refusing to come to the party. My thinking is as follows:
  1. Unlike the 1999-2001 period when everyone got hit with stocks-on-the-brain, stocks today are mostly owned by the super-rich, many through a variety of hedge and private equity funds that won't sell until they have to (fees, you see..), plus by corporations through buybacks and LBOs of an unprecedented scale. Those types of well-heeled and (supposedly) sophisticated stockholders can hold on to positions longer, even if they show losses.
  2. There is definitely a lot of contrarian double-think going on amongst those players. Their theory is that, if we are already in a recession, then we will come out of it in another 6-8 months because of the Fed's largesse* and thus the time to buy is now. Also, there is admittedly way too much negative sentiment on the economy and markets (this blog included), usually a sign of a bottom. Putting those two together, "sophisticated" investors and speculators are betting on a bottom.
This is a parallel to the 1999-2001 bubble, when it was mostly the small fry retail investors who got nailed, thinking they could quit their regular job and become millionaires by day-trading stocks. Today it is the nouveau-riche Asians, Russians and Arabs (plus the usual assortment of Westerners) who believe they can be set for several lifetimes with portfolio income, if they can just make a big killing right now with as much leverage as possible. The phenomenon has even permeated the official sector, with sovereign wealth funds investing in highly leveraged hedge and private equity funds. Let me put it this way: in this bear market it will be the super-rich that will lose big.

Before anyone chimes in with accusations of pinko-bolshism, forget it. The Cold War is over and we won, so move on. What I am observing is plain old hubris. In 2000 it struck the hoi polloi, today it is striking the princely class. It's their turn to get struck down, that's all...

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(*) Here is an example from today's news: Lehman repackaged a bunch of risky LBO loans into an entity called Freedom (make your own snide remarks about the name) which then issued bonds of its own, conveniently rated A by the usual suspects. Lehman then took those new bonds to the bend-over-backwards-to-oblige Fed as collateral and...presto: cash. Feel free to bulge your eyes in incredulity and scream, if it helps.

Wednesday, April 9, 2008

a + b = \

As even optimistic analysts now believe that a recession is upon us, the debate has shifted to its "lettering": will it be a quickie in-and-out (V), a more prolonged (U), a double-dip (W), or a Japanese version (L) ? My opinion is somewhat different and is not described by a letter, but the - aptly named - slash (\). To wit, I believe we are in for many years of painfully slow contraction, akin to a maddening Chinese drip-drip-drip torture.

The reasons for this view are:

(a) The elements dragging down the economy are deeply-rooted and fundamental. Huge debt, low earned income, zero saving rate, resource depletion and climate change cannot be reversed by a "mild purgative" recession. If left completely unattended, the economy would go into a tailspin (|).

But, at the same time:

(b) Monetary, fiscal and political authorities, steeped as they are in decades of Keynesian and central banking traditions, will be confident of their abilities to cure the economic cycle's weakness. They will keep applying their customary medicines to stop the decline, with some temporary success. If that was all, the economy would go into a flat-line ( _ ) or a slight uptrend (/).

But because of (a), this slowdown virus will prove far too resilient against the usual treatments designed to combat the common economic flu, and the decline will resume until a completely different set of doctors take over and prescribe the necessary radical treatment.

Symbolically, then: a + b = \

or, if you remember your vector physics: | + --- = \

P.S. Crude oil hit $111 per bbl today. One hunnerd an' eleven... them's a lot of castles in the sand for all the khalifs (with banners flying from their "Peaks"?).

Tuesday, April 8, 2008

The Fed's Dowry Fund Is Running Low

If you assume that the Fed has nearly unlimited capacity to bail out the US financial system, you better think again. A look at the size and makeup of its balance sheet versus the "shadow banking system" is enough to send shivers down your spine. To wit, look at the chart below (click to enlarge):

Data: FRB

After providing a very generous dowry to JP Morgan for marrying Bear Stearns plus beauty salon money for the bridesmaids, the quality of the Fed's own balance sheet has deteriorated rapidly. Holdings of Treasury securities plunged from 90% to 65% of assets and will drop further as more ugly spinsters come asking for makeovers.

Furthermore, its Treasurys now account for a low 3.5% of the debt issued by the US financial sector, down from 8.5% in 1996. In gross terms, the Fed's capacity to provide bailouts to the financial system without resorting to the printing presses is 60% less than twelve years ago. And this is before we account for the considerably higher risk being carried by the financial system as a whole versus a decade or more ago.

I leave the conclusions, once again, to the informed reader.




Monday, April 7, 2008

Jobs, Again: Double Trouble

I continue on the employment subject because I believe it is of great importance in evaluating the economy's prospects, shorter and longer-term. First, a chart (click to enlarge) that compares the annual growth rate of the civilian labor force (those that want to work - red line) to growth in the payrolls of the private sector (those that are currently working in businesses - blue line).

The initial observation is that we are likely already in a recession, if we judge by the history of past drops in the growth rate of payrolls below that of the labor force. The economy is now creating jobs slower than people need them.

Also important is the simultaneous decline of both growth rates to near zero. The drop in payrolls means that the economy is losing jobs right now, whereas the drop in labor force means the economy is unlikely to create many jobs in the future. This has only happened twice in the previous 50 years, in 1991 and 2001. Interestingly, the recoveries following both recessions were called "jobless".

But in 1991 and 2002 household debt as a percentage of disposable personal income was 85% and 108% respectively, whereas today it is at 136%. Since debt must be serviced from future earned income, the current combination of record-high debt and zero (soon, negative?) job growth is very dangerous, both from a short and long-term perspective.

Therefore, I believe that the current credit crunch is not merely a cyclical event but a fundamental problem that will be with us for a long time to come.

Friday, April 4, 2008

It's The Jobs, Stupid

As jobs go, so does the economy - and financial markets. This was always true but even more so today because of Americans' hand-to-mouth existence (saving rate down to zero) and record-high debt (household debt is 134% of disposable income vs. 92% just ten years ago). More than ever, the lifestyle of spend-borrow-spend is teetering at the edge of the employment precipice. And with personal consumption making up 70% of GDP, job losses now have a disproportionately negative effect on the economy.

So, how are jobs doing? Putting aside the poor performance of qualitative indicators like part-time jobs and people dropping out of the labor pool statistics because they cannot find a job, even headline numbers are starting to look decidedly unhealthy. Weekly initial jobless claims spiked to 407.000 yesterday and continued claims to 2.937 million (see charts below, click to enlarge). After initially modest damage, the employment picture is now deteriorating at an accelerated pace.



And how about financial markets? Looking at stocks in particular, I sense a heightened willingness by leveraged speculators to go bottom fishing. They interpret the bad employment data as lagging indicators that will soon peak, and at lower levels than previous recessions. Their optimistic reasoning is that Fed and Treasury initiatives have the power to provide the economy with enough fuel to keep demand going, even under current conditions.

I disagree, precisely because these conditions are so fundamentally problematic and cannot be soon turned around by using a lot of monetary policy and a bit of fiscal stimulus. Furthermore, I do not subscribe to the "sheeple" concept, which I find derogatory in the extreme. I am certain Americans are well aware they are being crushed in the vise of low earned income and high debt, and that their ability to borrow ad infinitum to maintain spending has ended. Therefore, a long period of family balance sheet repair is ahead of us, with reduced consumer spending a given.

I believe I do not have to spell out what this means for the economy and, furthermore, what it means for politicians who send out "tax rebate" checks (i.e. more money borrowed from abroad), urging Americans to go shopping. Little wonder the current administration has such abysmal approval ratings, a fact that is further damaging consumer confidence.

One of these days there may come a politician with a sound, independent understanding of the relationship between peoples' income statements and their balance sheets, one that won't rely on voodoo economics and Street advisers. He/she may even get elected... I can dream, can't I?

Wednesday, April 2, 2008

Terms of Endearment

The fourth largest US investment bank raised $4 billion in new capital (we used to call them brokers, but that moniker is considered demeaning nowadays). Markets cheered, but should they have? Let's look at the terms of the transaction...

Preferred shares paying 7.25%, convertible at any time into 20.05 shares of common stock, i.e. at a conversion price of approx. $50 (the stock closed at $44 yesterday, up 18%). That's 80 million potential new shares vs. 550 million common outstanding, or 14.5% potential dilution. By comparison, the common pays a 1.5% dividend at current prices and - lest we forget - Fed funds are at 2.25%.

Measured by any yardstick you wouldn't describe these terms as "favorable" to the seller. And they claim that they really didn't need the money, but raised the capital essentially to prove that the market still loves them (press release).

Terms of endearment, indeed...