Friday, August 28, 2009

Household Debt, GDP and Mr. Obama

Back to the main focus of this blog: debt and the economy.

A comparison of nominal GDP (i.e. in current dollars, not adjusted for inflation) and household debt clearly shows a rapidly rising debt burden for America's families. The ratio of such debt to GDP has been rising for a long time; the chart below is familiar to most of us and has been displayed in this blog several times. Notice the leap from 65% to near 100% beginning in 2000.

Household Debt As A Percentage of GDP (Data: St. Louis Fed)

We can further analyze the annual growth rates of the two elements of the ratio, i.e. nominal GDP and household debt, to produce the chart below. We can immediately identify two time periods during which debt grew much faster than GDP: 1984-1987 and 2000-2007 (grey boxes).

Annual Growth Rates In GDP and Household Debt

There are two major differences between the two periods:
  1. The most recent period lasted twice as long as the first one and ultimately resulted in the onerous debt burden of 100% of GDP for American families.
  2. During 2000-07 conventional mortgage rates were less than half than those that prevailed in the 1980's (more so when we consider the recent popularity of adjustable-rate mortgages which peg off much lower short-term rates).
In other words, we can conclude that today's debt burden was not created by a temporary spike in interest rates which added to the principal amount owed by Americans during an economic slowdown, but came about by taking out more and more loans against inflated assets, principally real estate. During 2000-07 GDP (and earned incomes) grew slowly, and even this anaemic growth came about from mostly from borrowing and spending instead of investing and producing. The bursting of this credit/asset/consumption bubble was a foregone conclusion long before the collapse of 2008.

Looking forward, what can we say about the prospects for a rebound? First of all, it is obvious that this downturn is completely different from every other post-WWII recession. Its causes are so entirely different (e.g. they have little to do with excess inventory build-ups) as to make comparisons and predictions based on past cycle analysis misleading, if not worthless.

From this follows that the current focus on bailing out the financial industry is akin to sheltering the flu virus instead of containing and eradicating it. It means that Mr. Obama is either (a) mostly ignorant of (somewhat sophisticated) economics and has thus allowed Messrs. Bernanke, Geithner, Summers and their Wall Street brethren to bamboozle and/or scare the daylights out of him or, (b) is completely in bed with them. From my sizing up of the man I opt for (a) in combination with a realistic assessment of Democratic Party internal power plays (e.g. Mrs. Clinton at State).

Therefore, I come up with both an explanation for what has been happening thus far in financial markets (don't worry boys, the guy is essentially clueless and can't/won't stand up against us) and a prediction of the future (the mutated virus will come back with a vengeance).

What should Mr. Obama be doing instead of listening to the Wall Street harpies? Immediately shift focus to the real economy, where real jobs and earned incomes are generated, preferably by overhauling the energy and transportation infrastructure of the United States. There are millions of highly skilled jobs waiting to be created right there, not to mention the tremendous added benefits of shifting away from petroleum (slashing the defence budget, geopolitical gains, environmental and health improvements).

Addendum: August 31, 2009

A reader asked for a longer chart of the Household Debt/GDP ratio. I don't have one, but I can provide a Total Debt/GDP chart going back 100 years.

Thursday, August 27, 2009

Bifurcated Sentiments

Lurking just below the Conference Board's headlines about August consumer confidence is clear evidence of the time-shift schizophrenia that has gripped Americans, going on several months now.

Here are the relevant charts (via Market Harmonics), for yet another month:
  • The headline number jumped a healthy +6.7 points to 54.1. Not a stellar reading by any means, but a whole lot better than the abysmal 20's reached earlier in the year.
  • ..but it came about, as it has for several months now, only because the forward-looking Expectations part of the index has been rising sharply. It is now back to 73.5; in August alone this sub-index jumped +10.1 points. Yes, that's what hope looks like in chart form.
  • Meanwhile, Americans' view of their present situation (you know, that pesky reality?) is refusing to budge much from the bottom.

We thus have a bifurcated citizenry, one that views their present situation as bleak - and how could they not, with unemployment and home foreclosures at highs not seen in decades? - but at the same time views the future as shiny and bright.

Of course, expectations historically lead reality and a close study of the above charts will show this. For example, the Expectations index bottomed out in the Spring of 2003 around 60 and then jumped 30 points, even as the Present index stayed put. This 50% rise was, however, understandable given the "victory" in Iraq. Remember the powerful images of the (staged for TV) toppling of Saddam's statue in Baghdad, which worked as a powerful psychological release.

Today's situation, however, looks entirely different to me. The Expectations index has tripled, all right, but based on what? On the wholly religious belief that the Fed and the government hold magical and instantaneous powers to arrest and reverse a disease that has been eating away at the foundation of the U.S. economy for many, many years. The symptoms are well known: huge debt, bubble asset markets, stagnant earned income, zero saving rate, a devastated manufacturing sector..

I don't know what name psychiatrists should give to this syndrome of opinion bifurcation, particularly if it persists for a long time. Perma-optimism, chronic delusion, The Eternal Hope of A Befuddled Mind, Waiting For Godot? But I do know what sentiments will rise if this very strong hope does not soon materialize into the tangible reality of a robust economy: frustration and anger.

Wednesday, August 26, 2009

Uncle Gregor Samsam

One morning, when Uncle Gregor Samsam woke from troubled dreams, he found himself denuded of all his weapons and munitions. His vast armies were no longer in uniform and did not acknowledge or follow any of his orders. His own currency, which he used to buy a huge array of imports and maintain an enviable lifestyle, was no longer accepted by his trading partners who, instead, demanded valuable goods in exchange.

"What's happened to me?" he thought. It wasn't a dream...

Gregor Samsa by Migvel Tepes

The illusion of global power can become a "Metamorphosis" of harsh reality very quickly, indeed. Just ponder the abrupt extinction of The Bug, genus Sovieticus and the collapse of its associated aphids, once crawling madly about its anthill.

And presently we have come to an extremely difficult choice for Messrs. Obama and Bernanke: Should they (a) quickly restore fiscal and monetary sanity, albeit at the cost of prolonging the economic contraction and its deflationary pressures, or should they (b) continue to pump "air" dollars (windhandel) into a world that is increasingly questioning their worth as a global storehouse of value?

This is no small matter, for it is the ability to issue readily accepted dollars into the global economy that has allowed the United States to maintain its empire and a very high living standard, despite astonishingly foolish behavior from its leaders. This became very clear during the eight years of the Bush II administration, with such astonishing pronouncements as: you're either with us or against us, go shopping, etc. The world did not completely disavow the dollar then because it believed that Americans would eventually see their error and shift to a more rational course*. Perhaps that's another reason why Mr. Obama was greeted with enthusiasm and hope from the entire world, financiers included.

The time has come for us to show the world that we mean business, that we mean to put our actions where our (very big) mouths are and to keep our promise that we shall make good on the flood of IOUs we so recently issued. I, for one, would rather see a policy of radically shifting our economy towards the German or Danish model, with all the associated pain this would entail for the present generation, rather than bequeathing my children with the ruins of a collapsed Dollar Empire.

The time to act is now and the way forward is known: get as far away as possible from debt-induced maxi-consumerism and, instead, save to invest in a rationally sustainable economy. Create alternative energy sources and networks, transportation systems, organic/responsible farming, arrest environmental destruction.

Otherwise, I fear, choice (b) may result in a Kafkaesque nation: Amerika.

* "You can always trust the Americans. In the end they will do the right thing, once they have exhausted all the other possibilities." Winston Churchill.

Thursday, August 20, 2009

Wisdom From The Geese

I was at the beach yesterday, watching a large flight (gaggle?) of geese aloft a perfectly blue sky circling and weaving, forming and breaking up, apparently preparing for their long trip south. So soon? Is the summer already over? I puzzled. But of course it is, came the answer embroidered in beautiful sky-swirls, at least if you are a cautious migratory bird.

And thus came the thought that, after a spring of economic thaw and a summer full of green shoots and blooms, there may come an autumn chill and a winter of discontent. Why do I think so? In a word, because of "crisis".

Crisis here, crisis there, crises everywhere. The world is awash in "Crisis", the word liberally slathered onto every news item and analysis. In my discussions with shopkeepers and small business owners (I always talk to them to get a sense of the real economy) it invariably pops up: "'s the crisis, you know..", and they shake their heads. But they always go on to say that they expect things will get back to "normal" next year, next season, next whatever cycle they operate on. When I ask them why, their answer is based on only two items: (a) hope and (b) the recent performance of financial markets, a.k.a. the Dow Jones Industrial Average. (Ain't propaganda grand, in all its modern ticker-tape manifestations?)

Well, I think it is entirely misleading to describe the current state of affairs as a "crisis". The term denotes a sharp, but short-lived condition leaving behind an aural after-taste that everything will be OK pretty soon. Particularly, when combined with talk about massive doses of monetary and fiscal sauce being poured over the cooked goose of the economy.

Instead, we should be using a terms like Stagnation or "The Long Emergency" (note: I am NOT fond of Mr. Kunstler's tirades and expletive-laden tent-revival style. But this book is not half bad).

Let me give you reality from the trenches - well, the sand dunes...

  • At the same beach I met a regional sales manager for a huge global telecoms equipment manufacturer. Sales in his region are down a whopping 75% from last year and he sees signs of only a very modest uptick in 2010, say 5-10%.
  • Two weeks ago I was at a very popular vacation spot and shopkeepers and restaurant owners told me that while visitors were down only about 10%, their sales collapsed a whopping 35-45%. People are still going on vacation for the most part but they are cutting down very sharply on extras like souvenirs, impulse purchases and fancier meals.
Yet, financial markets are basking in the sun and blue skies of summer...

And that's precisely the contrarian wisdom of the geese: if you know that winter is to come start your trip south when the weather is good, not when the storms are already upon you. Otherwise you are very likely to end up on a rocky coast as a pile of smashed feathers and bone.

Monday, August 17, 2009

Book Plug

I can't think of anything intelligent to say these days so I will just recommend a book: "The Great War for Civilization:The Conquest of the Middle East".

Superbly written by Robert Fisk, master journalist, legendary Middle East correspondent for The Times of London and a raft of other papers and news organizations, it takes us to Afghanistan in the time of the Russian "intervention", gives us a seat next to him when he (twice) interviews Bin Laden and explains a heck of a lot of the what and why that is the Middle East conflict.

Not a finance book per se, it nevertheless helps connect a bunch of global finance-related dots.

Read it.

Monday, August 10, 2009

The Jailhouse Diet

With the latest monthly employment report out last Friday, it is interesting to look a bit more closely to the underlying job situation.
  • A vibrant economy is one where a large percentage of the population is at work. In July the employment/population ratio dropped to 59.3%, the lowest in 25 years.
Employment/Population Ratio (16 years and over)
Charts: BLS
  • Another indicator of job dynamics is the average number of weeks those out of work stay on unemployment. The current reading jumped to 25.1 weeks, the highest ever.
Average Weeks Unemployed
  • The number of people unemployed over 27 weeks has gone up five-fold since the end of 2006, from 1.1 million to 5 million in July. One out of three unemployed Americans can't find a job after six months, up from one in seven at the end of 2006.
Number Unemployed 27 Weeks and Over
  • In the latest report we were told that the employment picture is "improving" because the number of jobs lost in July were "only" 247,000, the least in a year.
Jobs Lost Per Month

OK, how about this parallel: you are in prison and your jailer is faced with severe budget cuts. To save money he reduces your daily food allotment, making the adjustments once every month. From a generous 3,000 calories/day, the first month he cuts 200 calories from your daily intake, then 300 in the second month and 500 in each of the subsequent two months.

The menu is now down to 1,500 cal/day, well below the daily recommended 2,500 cal/day for an adult male. You and the entire inmate population are losing weight fast and the mood is getting seriously ugly.

The warden is concerned, so he tweaks things a bit; in each of the next four months he cuts "only" 300, 200, 100 and zero calories respectively. From his jaded perspective, things are "improving". But the inmates are, of course, starving because they are now eating only 900 calories per day. How long before they riot and demand the warden's head on a plate - literally?

"Improved" Starvation Statistics

The analogy with the employment situation is simple arithmetic: as more and more people lose their jobs there are fewer people employed and thus fewer can be fired. Today there are 6.6 million fewer people employed than two years ago, so the pool of the "firable" is shrinking.

The problem is that the economy's "wardens" are focusing on bailing out the financial sector, with only a token nod towards the real economy where millions of jobs are lost. Just imagine what could have been, if a big chunk of the trillions in direct subsidies, loans and guarantees that went to the financial industry had instead gone to promote alternative energy, a robust and smart electric power grid, conservation and efficiency efforts..

But we will never know because Wall Street has trumped Main Street, occupied Capitol Hill and taken over Pennsylvania Avenue.

Wednesday, August 5, 2009

Cousin Charlie and Uncle Bob

In finance, as in politics, love and most other aspects of human life, there are things we talk about, but don't do and there are things we do, but don't talk about. It is in finance, however, that we do things which we talk about in such an obfuscatory and banal way that - by design - no one from the public at large can possibly understand what is going on. (If you have any doubts, attempt- for example - to understand an IPO prospectus.

Usually there is little, if any, harm done. A bunch of professionals charge an arm and a leg to other professionals to come up with documents in a language only professionals can understand, all to assuage and comply with government regulations. Net-net it's a bit like my pet hamster running around in his little carousel - though it does keep pricey restaurants and luxury resorts in business.

But, there are times when such obfuscatory banality is absolutely, positively designed to confuse and deceive, despite its compliance to the letter of the law. How about this, for example: The Federal Reserve has decided to not apply Section 23 for XYZ big bank's transactions with its subsidiaries. "Blah, blah, blah" think Joe and Jane Average Citizen, presuming that if this was really important their government would speak in plain language - right?

Well, it so happens that the entire financial industry bailout process engineered by the Fed and Treasury is couched in exactly such anodyne terms. They completely obscure the unprecedented and breathtaking scope of liabilities, present and potential, all undertaken in the name of Mr. and Mrs. Average. Trillions, anyone?

Here is the truth, as an example that can be easily understood:

My rich cousin Charlie got the idea that he could get filthy rich by betting on the ponies. He set up a bunch of accounts with a whole lot of bookies and started placing his bets. At first he hit a winning streak - he styles himself a horseflesh expert - and let his winnings ride. After a while, he ramped up to such an extent that the bookies simply accepted his markers instead of cash. He was a winner, a champ, a fella - and, of course, an excellent customer who paid a whole lot of vig.

Hey, very nice! thought Charlie and started spending his filthy lucre; Lamborghinis, beach house in Southampton, mega yacht, chalet in Aspen. He even tried to get legit by making a sizeable donation to The Met, but the hoity-toity crowd took his money and still snubbed him, of course.

Needless to say, the roof caved in on cousin Charlie when the ponies started to fail to win, place or show as he predicted. Losses mounted and the bookies got nervous. Soon thereafter they stopped accepting his markers and demanded cash, instead. With liquidity flowing out much faster than it was coming in, Charlie was in deep trouble. Faced with the very real prospect of broken bones or worse, he turned to his Uncle Bob.

Now, Uncle Bob is not rich, as such. But he does have the ability to raise a ton of cash in short order because he works for the Treasury. He can also change crucial regulations as he sees fit, without having to consult with his ultimate boss, i.e. the people. Uncle Bob is not always easy to deal with and he does from time to time make an example of his wayward nephews and nieces by hanging them out to dry.

Charlie, however, was quite smart. He realized that if he failed to pay his losses he would set in motion a domino effect that would touch lots and lots of bookies. After all, he was dealing with most of them and they in turn had laid off their positions with yet more bookies. So Charlie got on the phone and quickly convinced them to appeal to Uncle Bob together; if you don't bail us out, they said, the whole bet-bookie-pony system will collapse.

The rest of the story, everyone knows...

Monday, August 3, 2009

Further On GDP - And Stocks

Delving deeper into the GDP numbers just released it becomes quite easy to discern a pattern and possibly make a prediction about the direction of corporate profits.

The following figures are in current dollars, at seasonally adjusted annual rates.

During the first two quarters of 2009..
  • Personal consumption expenditures (that's about 70% of GDP): -$21 billion.
  • Non-residential fixed investment (that's structures, equipment, software, etc.):-$481 billion.
=> Businesses slashed their investment far faster than consumers reduced their spending. Corporate profits (finance excluded) benefited from cost-cutting, not growth in sales.

Furthermore, in the same period..
  • Private inventories were slashed by a cumulative: -$283 billion.
=> Businesses sold a lot out of inventory already in stock, as opposed to making new items. That's another short-term boost to the bottom line.

Both of the above positive effects cannot, and will not, last long. Therefore, the crucial question is what happens with consumer spending. My thinking is not to expect a turnaround any time soon; indeed, I think things are going to get significantly worse in the next several quarters. Jobs are being lost in the hundreds of thousands each month and hours worked for those still employed are at the lowest level (33 hours/week) since at least 1964.

Bottom line: corporations can "save" earnings for a few months by slashing spending but in the end the consumer's behavior will determine the top line (sales). And that's where it all plays out..