Stimulus Bill Now Being Debated In Senate

A new $819 billion stimulus bill was passed by the House earlier this week, and the debate has moved on to the Senate, despite major opposition from House Republicans. Not a single Republican voted in favor of the bill according to the Wall Street Journal, but to get the 60 votes necessary to clear the Senate, the bill’s supporters will need to garner at least some Republican votes without losing any of the 58 Democrat senators. To secure those necessary Republican votes, some concessions will likely need to be made. One way or another, it is expected that this bill will be passed, but it remains to be seen how much political capital Obama will have to spend to make it happen.

The major divide between the two parties on the bill basically boils down to the allocation of the funds. Both parties support a stimulus bill in principle, but Republicans want to see the funds going toward things such as tax-cuts where as Democrats prefer government spending. In reality, this debate isn’t new, and considering the heavy numbers advantage that the Democrats enjoy in the House, Senate and now White House, the bill should lean toward their ideology. However, it is likely that Republicans will get a bone or two thrown their way in the process. Obama has stated time and time again that he wants broad, bi-partisan support for this bill, but it is unlikely that Democrats will be willing to give up too much considering their steep numbers advantage.

As a side note, the Wall Street Journal reported the formation of a coalition which backs the stimulus bill and which includes labor and environmental groups. The purpose of the group is to raise pressure on senators—specifically Republican senators—to support the bill. They announced Thursday that they will air ads around the country to encourage Republicans, "to support the Obama plan for jobs, not the failed policies of the past." The ads will run in Maine, New Hampshire, Iowa and Alaska according to the Journal. You can be certain that Democrats will remind Republicans and their supporters that their policies have been nothing but failures of late. The public is largely on board with this sentiment, evidenced by numerous polls. If nothing else we should get a chance to see how these new policies actually work in today’s economic climate.

GDP Falls Sharply, But It Could Have Been Worse

The GDP report for the fourth quarter of 2008 showed a steep decline, however, experts thought it was going to be even worse than it was, so that is positive news. There are certainly some indicators that show we should be alarmed about the economy right now, but there are also some positive sparks coming out of these reports that we shouldn't overlook either. James Picerno from the Capital Spectator looks closer at the report and shines some light into what this all means in his blog post below.

Today's report on last year's fourth-quarter GDP wasn't good. In fact, it was quite ugly. But it could have been a lot worse.

Even so, the 3.8% contraction in the economy in 2008's final three months was the steepest decline since 1982. The previous recession in 2001 never came close to what's unfolding now. The 1990-91 slump was deeper, but even that will look mild by the time the current downturn has run its course.

In other words, we're now in the thick of the worst recession since the early 1980s. That said, the crowd was expecting a far deeper loss. The consensus forecast for Q4 GDP was -5.5%, according to Briefing.com. By that standard, the reported 3.8% retreat was a surprise.

Of course, today's GDP report is the first of three estimates from the government and so we must brace ourselves for the possibility of downward revisions. But for the moment, it's fair to say that the recession isn't quite as bad as some had feared, at least if we're using GDP as a benchmark.

That's a thin reed, of course, since it's likely that the pain will run on for some time. Meanwhile, no one should be complacent about the trend. Last year's third quarter posted a mild -0.5% setback, but the wealth destruction became materially worse in Q4. The first three months of this year are likely to be no better and even money says it's likely to get worse for a quarter or two.

Indeed, there's no way to put a positive spin on the fact that consumer spending—the main engine of economic growth for the U.S.—continued to decline at a robust pace in Q4. Personal consumption expenditures fell a hefty 3.5% in last year's final three months, almost as fast as Q3's 3.8% decline. The pain is especially acute in durable goods spending, the so-called big ticket items such as appliances. The huge 22% fall in durable goods spending in Q4 is certainly humbling; it's also a sign of just much has changed in the consumer mindset.

Yet there was a bit of good news. Spending in services by consumers actually rose in Q4, advancing by 1.7%. That compares favorably to Q3's marginal loss. Given the heft of services in the economy, the growth is particularly important to offset weakness almost everywhere else.

Alas, the export machine that had offered so much hope last year as a buffer to economic pain elsewhere is now in full retreat. Exports fell 20% in Q4, the deepest drop in many a moon. Imports slid as well, although not quite as fast.

Overall, today's GDP report is a reminder that we're now in the midst of what promises to a deep recession, perhaps the worst since the Great Depression. The great question is how all the government stimulus will affect GDP this year. The monetary stimulus is only now starting to filter through the economy, and it will be soon followed by another round of fiscal stimulus. Stay tuned.

This post can also be viewed on capitalspectator.com.

New Home Sales Continue Their Plunge

The December existing home sales report shocked everyone when it showed an increase over 6 percent, however, the new home sales report was not quite as optimistic. The new home sales report showed more of the same, a drop in sales activity and an increase in inventory. Tim Iacono from The Mess That Greenspan Made dives deeper into this report in his blog post below.

The Census Bureau reported(.pdf) new home sales fell to record lows in December and, after revisions to prior months' data (as shown below), inventory has skyrocketed.

New home sales plunged 14.7 percent from November to a seasonally adjusted annualized rate of just 331,000 units and downward revisions to prior months' data totaled another 40,000 pushing the inventory of unsold homes to 12.9 months of supply, also a record.

For the entire year of 2008, new home sales totaled just 482,000 units, a decline of 38 percent from 2007, to the lowest level in 26 years.

The median price for a new home plunged 6.0 percent, from $219,700 in November to $206,500 in December, and is now down 9.3 percent on a year-over-year basis.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Is Free-Market Ideology Flawed?

In a controversial article published in the Guardian, Jeffrey Sachs calls out free-market ideology as flawed and applauds the measures being taken by Obama to get the government more involved in business. America is known for its relatively free-market economy, and for years it seemed to work great, but Sachs argues that things have changed. Whether or not one agrees with Sachs it is interesting to hear his perspective on things. Mark Thoma from the Economist's View presents Sach's article in his blog post below.

Jeff Sachs seems to be pleased with the new administrations commitment to "a new age of sustainable development":

Rewriting the rulebook for 21st-century capitalism, by Jeffrey Sachs, CIF, The Guardian: One of President Barack Obama's historic contributions will be a grand act of policy jujitsu - turning the crushing economic crisis into the launch of a new age of sustainable development. ... Obama is already setting a new historic course by reorienting the economy from private consumption to public investments directed at the great challenges of energy, climate, food production, water and biodiversity.

The new president has taken every opportunity to underscore that the economic crisis will not slow, but rather will accelerate, the much-needed economic transformation to sustainability. ... The fiscal stimulus ... will lay down the first steps of a massive generation-long technological overhaul...

Obama has started with the most important first step: a team of scientific and technological advisers of stunning quality... He has also focused on two core truths of sustainable development: that technological overhaul lies at the core of the challenge, and that such an overhaul requires a public-private partnership for success. Taking shape, therefore, is nothing less than a new 21st-century model of capitalism ... committed to the dual objectives of economic development and sustainability...

Consider the challenge of a bankrupt automobile sector... In the Obama strategy, GM will not be closed to punish it... It's worth far too much as a world leader in the electric vehicles of the 21st century. ...

Conservatives are aghast. The bail-out of the auto industry was hard enough to swallow. Government investments in infrastructure and research and development are viewed with scorn, compared with the tried and true (if disastrously failed) tax cuts of the Bush era. Rightwing pundits bemoan the evident intention of Obama and team to "tell us what kind of car to drive". Yet that is exactly what they intend to do (at least with regard to the power source under the hood), and rightly so. Free-market ideology is an anachronism in an era of climate change, water stress, food scarcity and energy insecurity. Public-private efforts to steer the economy to a safe technological harbour will be the order of the new era.

There is plenty of room for blunders... Government activism can founder on the shoals of massive budget deficits, tax-cutting populism pushed by the right, politically motivated investments such as corn-based ethanol..., and more. Yet Obama is absolutely correct that we have no choice but to try...

This post can also be viewed on economistsview.typepad.com.

All States Are Suffering From Job Losses

A report issued by the Labor Department yesterday indicated that unemployment rose in every single state in December. When oil was still near record highs a few months ago, at least the big energy-producing areas were doing well, but now they are suffering like everyone else. This goes to show you that no area is being spared from economic turmoil. The states that lead the housing boom—such as California, Nevada and Florida—were the first ones to really feel the pain from the downturn. One would think that because they led the downturn they might also lead the rebound, but if that is the case then we still have more pain coming because things are still going from bad to worse in those states. According to the Wall Street Journal, California saw an increase in unemployment of 0.9 percent in November and December, while Florida and Nevada saw increases of 0.7 percent and 1.0 percent respectively.

The last 4 months of 2008 were especially bad. Around 2 million jobs were eliminated from September 2008 to the end of the year. Then on Monday this week—now dubbed “Black Monday”—over 70,000 jobs were cut on a single day. So when is the carnage going to end?

Certainly the new stimulus package won’t hurt the employment outlook, with early projections estimating that the bill will create or save around 4 million jobs, according to the Associated Press. The bill is being reviewed by the House and it is expected to be passed later in the day according to the Wall Street Journal. After passing the House, the bill will then make its way to the Senate. There is still some lobbying to change parts of the bill, but it is widely expected that it will pass in one form or another and arrive on the President’s desk within the next few weeks.

It remains questionable at best whether the bill will work as planned. This current economic environment is different than anything we have ever seen before, and we are really just guessing on the true impact of these initiatives. Will $825 billion be enough? Is the money being allocated to the appropriate places? Will borrowing the money to finance the programs cause problems in the debt markets? These are just a few of the many questions that lawmakers are trying to answer. The truth is, though, that no one knows the answer. They can make educated guesses at best. Let’s just hope that Obama knows what he is doing...and wishing for a little luck won’t hurt either.

What Will The Fed Do To Stimulate The Economy Now?

Bernanke and the Fed already played their last interest rate card, so if they can't lower rates what else can they do to get the economy back on track? There is a lot of speculation going around right now about what they might do, but we shall find out for ourselves later today. James Picerno from The Capital Spectator talks about the Fed meeting and the economy in general, adding some valuable input in his blog post below.

The press release that follows the Fed's FOMC meeting today may offer clues about how the central bank will proceed now that it's out of conventional monetary policy ammunition. Then again, maybe not. We're all trapped in gray zone of trial and error about what to do next and the Federal Reserve is also now faced with grasping at straws.

Typically, an afternoon FOMC press release attracts interest for an update on where short-term interest rates are headed. Today, and probably for some time to come, everyone already knows the answer. The Fed controls short rates, starting with the all-powerful Fed funds, but with the effective Fed funds at roughly 0.16%, the mystery about what comes next is, like the price of money, virtually nil.

Yet Bernanke and company may yet surprise us by dropping fresh clues about how the Fed plans to practice unconventional monetary policy from here on out—quantitative easing, to use the phrase of the dismal science. The details are a work in progress, although the immediate goal is still clear: stabilize general price levels.

We won't belabor the issue of deflation today, in part because we've discussed it often in recent months, including here and here. Let's just say that the D risk is still very much with us, and so the Fed has a fair amount of work to do in the months ahead.

The market appears to understand this, at least by way of monitoring Fed funds futures. For the year ahead, all the contracts are expecting Fed funds to remain under 60 basis points, and quite a bit lower for the immediate future.

Long rates remain in a holding pattern as well. The yield on the benchmark 10-year Treasury Note is in the 2.5% range and it may go lower yet, depending on what the next round of inflation reports reveal, although those won't arrive for several weeks.

Meantime, there's plenty of guesswork about what the Fed's next move. "With rates going nowhere for some time, the market's focus will be on whether the Fed will be looking to buy government (or corporate) securities in the near future," Sacha Tihanyi, an analyst at Scotia Capital, opines via AFP.

John Authers in today's FT argues that the critical variable is housing prices. What can the central bank do on that front? "The Fed can give details on quantitative easing— the ugly phrase for the art of buying bonds so as to push down the yields they pay, and stimulate the economy with lower rates, especially for mortgages," he writes. "If there is a single key variable to determine when the crisis in the US banking system can be brought under control, it is house prices. The further they fall, the higher the likely default rate on the mortgage-backed securities that banks now hold on their balance sheets."

Unfortunately, the news on housing prices is still discouraging, even after several years of a falling market. One of the latest bits of housing data shows that prices fell again last month even as sales perked up. Existing home sales rose 6.5% in December, albeit driven by distressed sales at bargain prices, the National Association of Realtors reports. Nonetheless, the median national price of existing homes in the U.S. still dropped by a hefty 15.3% last month.

Even if the Fed is successful in fending off deflation, which we expect it will be, that by itself isn't a cure for what ails the economy. "Ben Bernanke is rightly concerned about deflation right now," Desmond Lachman of the American Enterprise Institute explains in The Christian Science Monitor. But that's merely step one in a multi-step recovery program. "Getting inflation back into the system … is not going to be sufficient," Lachman notes.

Convincing banks to lend and consumers and businesses to borrow is arguably the next big step beyond containing the deflation risk. Solving the latter will be easy by comparison. The real challenge will come later this year in trying to promote growth. But first things first, and so we await today's Fed commentary.

This post can also be viewed on capitalspectator.com.

Low Consumer Confidence Pushes Dollar Higher

Consumer confidence fell again, this time to the lowest level on record. Consumers fear the worst, and as a result they are losing all appetite for risk. That means they will be heading for the relative safety of US dollars according to currency expert Kathy Lien. For more insight into how currencies should perform based on the latest report, read Kathy Lien's blog post below.

In more than 40 years, we have never seen US consumers this pessimistic. The Conference Board’s report on consumer confidence fell to 37.7, the lowest level on record. The disappointing consumer confidence report will drag down risk appetite and drive investors into the safety of US dollars. The rally in the US dollar is a reflection of more panic selling and not optimism about US economy. On the heels of the report, we have already seen the EUR/USD and equities turn negative. We may not see a recovery in confidence Until job security is no longer a major concern. Unfortunately with headlines in national papers touting the 74k jobs axed in one day this morning, consumers will not turn optimistic anytime soon. The one silver lining in the report is that we have seen an increase in plans to buy automobiles within the next 6 months. Major discounts are enticing consumers to buy new cars. Looking ahead, discounts and incentives will be the only for businesses to push inventory. Fourth quarter GDP is due for release on Friday and weak consumer confidence supports the market’s belief that growth was the weakest in 26 years.

Earlier this morning, S&P/CaseShiller reported that house prices fell 18.18 percent in the month of November, the largest decline on record. Unfortunately house prices still have room to fall as the labor market remains weak and more inventory floods the market over the next few months.

This post can also be viewed on kathylien.com.

Silver ETFs Continue To Grow

Silver prices have been going up and down, and up and down, but what has continued to steadily increase is the amount of silver being help inside the Silver ETFs. This means that despite the volatility, investors still see silver as a great investment opportunity and are funneling more money into the metal. Commodity investment expert and well known blogger Tim Iacono, takes a closer look at the recent Silver ETF data in his blog post below.

Like its big golden brother, the iShares Silver Shares ETF (NyseArca:SLV) is now regularly making new all-time highs, the latest move coming yesterday with the addition of 199 tonnes. This brings the net gain to 550 tonnes so far in 2009.

The price of physical versus paper forms of precious metals was a hot topic over the weekend at the Cambridge House Investment Conference. The shortage of coins and small bars last year combined with the fact that both of the major ETFs continued to add inventory as prices fell just adds to the discussion, however, not always in an entirely productive way.

Louis James of Casey Research was one of the more level-headed panel participants acknowledging that, while the physical market is a relatively small part of the overall bullion market, recent developments will have an outsized, long-term impact on investor psychology and the market in general.

Full Disclosure: Tim Iacono is Long SLV

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Bad Arguments Against Obama's Stimulus Plan

The debate is heating up now surrounding Obama's $825 billion stimulus plan, with conservatives leading the opposition. They are making all kinds of arguments for why the plan won't work, but according to Paul Krugman most of them are bad arguments at best. Seeing as the opposition ranks are pretty small at this point, it just seems like a matter of time till the bill gets passed, and thus a moot point. But just for fun, let's look at a recent article from Krugman, and his response to the objections, curtesy of Mark Thoma at The Economist's View.

How to identify "fundamentally fraudulent antistimulus arguments":

Bad Faith Economics, by Paul Krugman, Commentary, NY Times: As the debate over President Obama’s economic stimulus plan gets under way, one thing is certain: many of the plan’s opponents aren’t arguing in good faith. Conservatives really, really don’t want to see a second New Deal, and they certainly don’t want to see government activism vindicated. So they are reaching for any stick they can find with which to beat proposals for increased government spending.

Some of these arguments are obvious cheap shots. John Boehner ... has already made headlines with one such shot:... he derided a minor provision that would expand Medicaid family-planning services — and called it a plan to “spend hundreds of millions of dollars on contraceptives.”

But the obvious cheap shots don’t pose as much danger to the Obama administration’s efforts to get a plan through as arguments and assertions that are equally fraudulent but can seem superficially plausible... So as a public service, let me try to debunk some of the major antistimulus arguments... Any time you hear someone reciting one of these arguments, write him or her off as a dishonest flack.

First, there’s the bogus talking point that the Obama plan will cost $275,000 per job created. Why is it bogus? Because it involves taking the cost of a plan that will extend over several years... and dividing it by the jobs created in just one of those years. ... The true cost per job of the Obama plan will probably be closer to ... $60,000...

Next, write off anyone who asserts that it’s always better to cut taxes than to increase government spending because taxpayers, not bureaucrats, are the best judges of how to spend their money.

Here’s how to think about this argument: it implies that we should shut down the air traffic control system. After all,... surely it would be better to let the flying public keep its money rather than hand it over to government bureaucrats. If that would mean lots of midair collisions, hey, stuff happens.

The point is that nobody really believes that a dollar of tax cuts is always better than a dollar of public spending. Meanwhile, it’s clear that ... public spending provides much more bang for the buck than tax cuts — and therefore costs less per job created (see the previous fraudulent argument) — because a large fraction of any tax cut will simply be saved.

This suggests that public spending rather than tax cuts should be the core of any stimulus plan. But rather than accept that implication, conservatives take refuge in a nonsensical argument against public spending in general.

Finally, ignore anyone who tries to make something of the fact that the new administration’s chief economic adviser has in the past favored monetary policy over fiscal policy as a response to recessions.

It’s true that the normal response to recessions is interest-rate cuts from the Fed, not government spending. ... But ... we’re in a situation not seen since the 1930s: the interest rates the Fed controls are already effectively at zero.

That’s why we’re talking about large-scale fiscal stimulus: it’s what’s left in the policy arsenal now that the Fed has shot its bolt. ...

These are only some of the fundamentally fraudulent antistimulus arguments out there. Basically, conservatives are throwing any objection they can think of against the Obama plan, hoping that something will stick.

But here’s the thing: Most Americans aren’t listening. The most encouraging thing I’ve heard lately is Mr. Obama’s reported response to Republican objections to a spending-oriented economic plan: “I won.” Indeed he did — and he should disregard the huffing and puffing of those who lost.

This post can also be viewed on economistsview.typepad.com.

Existing Home Sales Rise Unexpectedly: Is The End Near?

There has been a lot of talk this morning about the unexpected rise in existing home sales in December, and specifically whether or not it signals the beginning of the end. Unfortunately, we also saw a less positive statistic released: The median home sale price fell 15.3 percent in 2008—the largest drop on record since 1968, according to the Associated Press (AP). So what exactly are we to make of these statistics?

In my mind, this is positive news overall. First and foremost, property values are still too high and they will continue their decline until they reach equilibrium with income levels. That prices dropped so much means that we are ever closer to that point. Increased home sales in December is also a good sign, but one must wonder how much can be attributed to suppressed mortgage rates.

Most homebuyers do not look at the overall cost of the home, but rather focus on how much money they need to put down and the resulting monthly mortgage payment. When mortgage rates were under 5 percent, that dream home was suddenly within reach, and many people came down off the fence to buy. As rates rise again the opposite will happen.

Let’s also not lose site of the fact that thousands of people are losing their jobs every day, and as long as job losses and layoffs are on the rise, it is hard to imagine that the real estate market or any other sector of the economy will recover any time soon. And let’s keep in mind that although home sales increased in December, overall 2008 saw 13 percent fewer home sales than in 2007 and the lowest total since 1997, according to the AP.

This correction was necessary, and we are closer to recovery every day. I wouldn’t get too excited about it yet, as we should expect to see an over-correction before total recovery in this type of market, but as the chart below further illustrates, we are getting closer to what appears to be an historical equilibrium.

*Chart from The Mess That Greenspan Made.

Political Lobbying Behind TARP Funding Decisions

In case you need more examples of how the Troubled Asset Relief Program (TARP) has failed us, a recent article in the Wall Street Journal describes several instances where politicians were able to directly influence the decision of whether or not to provide TARP funds to banks. States that have had the most political lobbying or representatives in the right committees have enjoyed the highest success rates for getting help for their local banks.

It probably should go without saying, but shouldn’t the decision of whether or not to allocate funds to these banks be based on something more fundamental than the lobbying efforts of politicians? Remember that they are using taxpayer money to make these capital injections. By offering money to these banks, we are betting that they will turn around, and if they go on to lose the TARP funds, taxpayers are just out of luck. However, if they are able to use the funds to turn their operations around and once again become profitable, then taxpayers will get their money back, and possibly even a little extra. With this in mind, shouldn’t our goal be to identify those banks which we believe can and will revitalize their operations with this borrowed capital? It appears that instead of creating a system with the goal of achieving highest taxpayer return (both monetary and economic), the program has turned into a display of political lobbying power.

I hope that the new administration fixes the TARP before the second round of funding is spent in the same fashion as the first round. This whole program was hastily put together to begin with, and we are now paying dearly for the lax regulation that was included with the bill. Due to the lack of direction, politicians and regulators are able to lobby for their own best interests. President Obama and Treasury Secretary Timothy Geithner need to step up and fill these holes in the program. The U.S. government doesn’t have $350 billion more to waste. We have to ensure that every dollar is used in the most effective manner possible, and I think it is safe to say that we aren’t anywhere near maximum return. Here’s hoping that we figure out a way to keep politics out of this program and focus on how we can allocate this next $350 billion to best help the economy and taxpayers.

Reviewing The Latest Quarterly Gold Report

Despite the extreme volatility of gold prices, investors continued to dump more money into gold throughout 2008. The latest quarterly gold report shows us some interesting figures and clearly displays that despite the volatility, many investors feel more comfortable holding gold then various other investments. Tim Iacono from The Mess That Greenspan Made takes a closer look at the report and tries to shed some light on the precious metal's up and down performance.

The World Gold Council released their quarterly Gold Investment Digest yesterday and it contained a number of very good charts including the one below that recounts the many financial market crises that drove investors away from other financial assets and into gold.
They noted that the rising price of gold was quite impressive given all the carnage that occurred elsewhere, most equity markets and many other commodities tumbling 40-50 percent or more for the year as the price of gold posted its eighth annual gain, up four percent.

Holdings by the ten gold ETFs around the world climbed to new record highs with another 96 tonnes purchased during the fourth quarter following a whopping 145 tonne addition in the third quarter.

As shown below, the total amount of gold in the ETFs rose to 1190 tonnes by year-end, worth more than $33 billion. Note that the SPDR Gold Shares ETF (NYSEArca:GLD) just added another 13 tonnes yesterday after a three tonne increase on Monday bringing its holdings to 819 tonnes, by far the largest of the bunch.
Elsewhere in the report, mine production was said to be stable, up just two percent overall from a year ago with a number of countries, notably South Africa, experiencing sharp declines. China passed South Africa last year as the world's biggest gold producer.

De-hedging continued but will have a much smaller impact in the future as the total outstanding hedge book now stands at just 526 tonnes. As shown to the right, during the four quarters ending in Q3-2008, miners de-hedged a total of 368 tonnes.

Note that official central bank gold sales dropped sharply, ending up considerably below the 500 tonnes allowed during the fourth year of the Washington Agreement on Gold.

Jewellery demand rose during the third quarter (the most recent quarter for which data is available) and was up modestly on a year-over-year basis, however, the fourth quarter will likely show a big decline due to the worsening worsening economic conditions around the world.

As should be clear in the table, it is the increase in investment demand, not jewellery demand or industrial uses, that supported the gold price in 2008 and this is likely to continue this year.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

New Construction Continues To Fall

It is no secret that builders are hurting, and some experts predict that upwards of half of them will be out of business before this economic crisis is over. The tough real estate market plagued by indecisive buyers and oversupply, combined with the restrictive lending environment, means that even those builders who manage to stay in business are still going to be hurting. It should be no surprise then that new construction is reaching all time lows. Overall it is a good thing, and something that needs to happen in order to allow the market to recover, but it is painful for builders nonetheless. Tim Iacono from The Mess That Greenspan Made looks closer at the latest new homes report and offers his take in his blog post below.

The Census Bureau reports new home construction reached record lows last month, a fitting end to the worst year in the home building business since record keeping began in 1959.
Housing starts fell 15.5 percent in December to a seasonally adjusted, annualized rate of just 550,000, worse than the previous low of 651,000 set in November.

In population-adjusted terms, the previous record monthly lows in the low-700,000 range set in the mid-1970s are about double the current rate of home building, an astonishing statistic.

For example, prior to 2008, the low-water mark was 709,000 in May of 1975 which would be just over one million after adjusting for the growth in the U.S. population.

During all of 2008, housing starts totaled just 904,000, a decline of 33.3 percent from the level of 1.36 million units in 2007. The previous low was in 1991 when 1.01 million units were started, a total that, after adjusting for the increase in population was actually worse than last year.

Building permits, a leading indicator for new home construction, dropped to an annual rate of 549,000 in December, a decline of 10.7 percent from November, and also a record low.

This follows yesterday's dismal report by the National Association of Home Builders that pessimism has reached new all-time lows. The monthly confidence survey dropped to just 8 in January, down from 9 in December. Recall that, not more than two years ago, this index was over 50.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

What Is Going On In The Forex Market Right Now?

The currency markets have been going crazy lately, with several currency pairs forming new, or close to new, records. With all this volatility what are currency investors to think? Currency expert Kathy Lien attempts to answer this question in her blog post below.

There has been a lot of volatility in the foreign exchange market this morning, driving currencies to historic levels:

GBP/USD - 23 Year Low
USD/JPY - 13 Year Low
NZD/USD - 6 Year Low
EUR/JPY - 6 Year Low
CAD/JPY - 13 Year Low
GBP/JPY - Record Low
NZD/JPY - 8 Year Low

The most significant moves have been in the British pound, which fell to a 23 year low against the US dollar and in USD/JPY, which fell to the lowest level in 13 years. Comments from former Fed Chairman Volcker triggered a wave of risk aversion that led to a technical break in the currency market. He said “we are in serious recession, with no end clearly in sight.” Although there is no question that the US economy is in trouble, by saying that there is no end in sight means that there is no hope which coming from the chairman of Obama’s newly formed Economic Recovery Advisory Board is significant. By saying that he does not an end to the recession is certainly not good advice. Treasury Secretary Nominee Geithner expects an Obama economic stimulus plan to be released in the next few weeks but unfortunately Volcker’s comments overshadowed the prospect of a stimulus plan. Yesterday’s sharp sell-off made investors nervous but Volcker’s comments pushed them over the edge.
We are continuing to see flight to safety into the US dollar and Japanese Yen. Investors are looking to hide in the lowest yielding currencies.

We also had comments from ECB President Trichet and SNB President Hildebrand. Trichet defended the ECB’s monetary policy and said they haven’t decided if 2 percent is the lowest level for rates.

Intervention by Swiss National Bank?

The Swiss franc collapsed after SNB Hildebrand said that the central banks is considering selling francs to halt the currency’s gains. With interest rates already at 0.5 percent, they have no room to ease monetary policy. Therefore they may have to resort to fixed rate currency intervention.

This post can also be viewed on kathylien.com.

Welcome President Obama: Now About The Economy...

Yesterday was basically one big party, everyone it seemed was excited to welcome in our new President. Now the party is over and it is time for Obama to get to work, and he had better act fast. The economy is struggling mightily and Americans expect, albeit a tad unfairly, that Obama's administration is going to be able to fix the problem. James Picerno from The Capital Spectator paints a dreary picture for the economy over the coming months, while holding out some hope for a recovery, in his blog post below.

Today is the first full day of President Barack Obama's administration and, as everyone knows, the new commander in chief has his work cut out for him. With a fresh start before us in Washington the question on the home front remains: What's up (or down) with the economy?

In broad terms, the answer is obvious, and the numbers only lend statistical support. Clearly, tough times lie ahead, with the next 6 months or so looking set to be the toughest. But how does that square with our proprietary measure of U.S. economic activity (CS Economic Index), which bounced sharply higher in November, the last month with the full compliment of data pieces for calculating this benchmark? What's more, based on preliminary data for December, the November bounce looks set to hold.

Alas, the rise is something of an illusion for the time being since only two factors out of the 17 in our economic index are driving the bounce skyward. Granted, the pair is on steroids trying to bring aid and comfort to the ailing economy. Statistically, the changes in those two factors are enough to push the entire index upward. Even so, those two lone bullish factors alone, unfortunately, aren't likely to spark a recovery of any substance for the foreseeable future. Looking out later in the year offers some hope, but first let's talk about the immediate future.

The two factors doing all the heavy lifting in our economic index are money supply and the interest rate spread. Both were in overdrive in November in terms of generating pro-recovery fuel to an otherwise shrinking economy. The rate spread was particularly bullish, although the growth-oriented bounce from money supply was robust too. Collectively, the pair overwhelmed the negative energy elsewhere in the economy, at least when measured on an average basis.

By rate spread we're talking of the difference between the yield on the 10-year Treasury Note less the effective Fed funds. Thanks primarily to the dramatic fall in Fed funds in November, which continued in December, the rate spread widened sharply and thereby moving definitively into positive territory, which generally is a bullish signal for the economy. Why? Because a positive sloping yield curve—rates are higher as bond maturities lengthen—historically accompanies economic growth. By contrast, a negatively sloping yield curve—rates fall as maturities lengthen—is a sign of distress/economic contraction.

Based on the rate spread, this measure went negative in July 2006 and stayed negative until February 2008, when the spread moved back into positive territory. Looking back, it turns out that the recession warning posed by the arrival of a negative yield curve in mid-2006 was an accurate forecast of an approaching recession, which officially began in December 2007.

Fast forward to November 2008 and the rate spread is telling us that it's now in high gear as an economic stimulus. That is, short rates are extremely low relative to long rates—despite the fact that long rates are also bouncing around at historically low absolute levels. Based on this measure alone, one might be bullish on the immediate future, assuming this was a normal cycle. But as we know, the times are anything but normal and so even the unusually bullish stimulants coming from the money supply and interest rate factors aren't yet dispensing their usually pro-growth influence. The reason is that the negative drag from everything else is, for the moment, still too much to overcome. Indeed, the lagging and coincident factors in our broad economic index are either flat lining or still declining.

The good news is that at some point all the monetary stimulus will take root and promote expansion. All the money has to go somewhere and eventually it'll go into corners of the economy other than banks accounts and T-bills. Banks will one day lend and businesses will borrow. In addition, now that the Obama administration is at the helm, we expect a fresh round of fiscal stimulus to compliment the monetary efforts now running at full speed.

Guessing when all this will produce some measurably positive change in the economy proper is the great question. Given the depth and magnitude of the economic headwind, we're not expecting much for the first half of this year, perhaps longer. Even when signs of growth, or at least stabilization emerge, they're likely to be tenuous, slipping temporarily back into negative territory and keeping everyone on pins and needles.

Recovery worth the name is going to take time, and perhaps a fair degree more time than we've come to expect over the past generation, when growth returned fairly quickly after a downturn.

As such, strategic-minded investors should pace themselves and use the next several quarters productively to restructure their portfolios for the day when the storm passes. As we'll discuss in more detail in the February issue of The Beta Investment Report, the ongoing economic and financial turmoil is wrenching but it also offers substantial opportunities for dynamic asset allocation strategies.

That said, the next several months are undoubtedly going to be rough, replete with surprises, false starts and lots of noise in the markets. Economically speaking, there are still a number of big unknowns lurking in the near-term future too. Investors should brace themselves for more volatility, and at the same time prepare to take advantage of it.

Risk management, in other words, has never been more important, or potentially more rewarding.

This post can also be viewed on capitalspectator.com.

Buying A New Home? You Better Be Careful...

Just in case you needed one more thing to worry about, a recent article published in the New York Times should have you thinking twice about buying a home in a new subdivision. The article is titled, “Banks Foreclose on Builders With Perfect Records.” The article talks about how banks are starting to do such things as call for extra collateral from builders—even if they have never missed a payment—essentially dooming them to failure. If you have purchased or are planning to purchase a home in a new subdivision that has not yet been completed, this could be horrible news for you.

Builders rely heavily on credit to function, and now that credit is being restricted even for the best borrowers, builders are in serious trouble. According to the New York Times article, already we have seen more than 20,000 builders nationwide go out of business. Before the carnage is finished, the total will likely swell to more than 50,000, according to Ivy Zelman, a housing analyst quoted in the article. That total would represent more than half of all U.S. builders. So why exactly should new home buyers be worried?

When you purchase a home in a new subdivision, part of the purchase price is based on community features and factors. The subdivision might have a nice park for the kids, or just great, overall family appeal. These are things that sell people on wanting to move into that particular neighborhood. The problem in new subdivisions is that typically people buy homes before the community is finished. If the builder were to go out of business, it is possible that the community might not be finished for a long time, if ever. Not only is it possible that early homebuyers might not ever see the clubhouse that they were promised, or that neighborhood park, but they may also be forced to look at partially built, rotting homes for a few years. In case you didn’t connect the dots already, that means that resell values of existing homes in those communities are likely to plummet.

The worst part about this is that these buyers could be completely blindsided. It doesn’t even matter if they went so far as to make sure that the builder looked financially sound and was current on payments to the bank. The banks are so scared about the collapsing real estate market—especially in the sun belt region—that they are prematurely foreclosing on these builders right now. If the banks are prepared to go to these dramatic lengths, regardless of payment history, who knows what they will do next? It seems that as a homebuyer, you can only protect yourself by paying for nothing but what you see. Don’t bother looking at the master plan with the salesperson. Just walk outside, look around and ask yourself whether this house is worth its price, even if nothing else gets finished. If it isn’t: Move on.

They Better Use This $350 Billion Better Than The Last $350 Billion

Many people are bitter about the way the first $350 billion in TARP funds was used. Some feel that Paulson flat out lied and deceived them. The money wasn't used for what he said it was going to be used for, and now it appears as if we have little if anything to show for it. So why do we want to give them another $350 billion to waste? Mark Thoma takes a look at a recent article by John Berry which looks to address this very question in his blog post below.

John Berry isn't sure that politicians will be willing to provide additional help if the $700 billion in TARP money falls short of what is needed to stabilize the banking system:

Bernanke Tells It Like It Is, Some Don’t Listen, by John M. Berry, Commentary, Bloomberg: This may be as close as we’re going to get to a Fed chairman labeling some in Congress as irresponsible.

Sure, Federal Reserve Chairman Ben S. Bernanke was typically careful with his wording in a Jan. 13 speech in London. ... After explaining how the world economy “is critically dependent on the free flow of credit,” Bernanke issued his challenge: “Responsible policy makers must therefore do what they can to communicate to their constituencies why financial stabilization is essential for economic recovery and is therefore in the broader public interest.”

Three days after that speech, 33 of 39 Republican senators ignored Bernanke’s warning and voted against releasing the remaining $350 billion in Troubled Asset Relief Program money. (So did eight Democrats...) Fortunately, that left enough supporters, mostly Democrats, to clear the release of the much-needed money.

Too many senators shrugged their shoulders at Bernanke’s wise words. OK, perhaps they didn’t like the way Treasury Secretary Henry Paulson had jerked them around... Or maybe they didn’t like something else about the program.

And of course many of their constituents, who have their own financial and job worries as the economy falls deeper into recession, indeed are furious that banks that created the crisis are getting help when it seems ordinary people aren’t.

They aren’t going to be any happier... In all probability, $700 billion won’t be enough. ... At some point, politicians are going to have to stop pandering to their constituents and show leadership by explaining why the economy can’t survive without a banking system.

If more is needed, they are going to have to do more than that, this time they need to articulate a plan that makes sense. Because if they are going to do what Paulson did with the first round and never really explain how the plan is supposed to work, jump back and forth between plans, say a plan are dead and then revive it - maybe - and act haphazardly when banks are in trouble so that nobody knows quite what to expect, then there are better uses for the money.

This post can also be viewed on economistsview.typepad.com.

Spain, The Latest Country To Have Credit Downgraded

Spain has become the latest country to have their credit rating downgraded. Next in line could be Portugal and Ireland. As a country, having ones credit downgraded is a huge blow to the economy. Most countries today rely heavily on borrowing to keep their economies moving along, and when credit ratings fall, borrowing costs go up, sometimes dramatically. For Americans this might seem like a European problem, and nothing for us to worry about, but with each new bailout, and with every trillion added to the deficit, the potential for the U.S. to have their credit rating downgraded is increased. That is still an afterthought at this point, but if it were to happen the results would be catastrophic. Kathy Lien takes a closer look at the latest credit rating downgrades in her blog post below, and attempts to answer the question: "What does it mean to have your credit rating downgraded?"

This morning, Standard and Poors downgraded the sovereign debt rating of Spain from AAA to AA+. With Greece’s rating downgraded last week and Ireland and Portugal on credit watch negative, this could be the beginning of more downgrades.

Therefore it is important to consider what it means for a country to have their credit rating downgraded:

To have your credit rating downgraded means higher costs of borrowing. The Euro is slipping as we are seeing an exodus out of Spanish bonds because some global funds are mandated to invest only in AAA debt. A credit rating reflects the risk of default. Therefore a lower credit rating means that a country is at greater risk of defaulting on their debt.

On a local level, we expect investors to shift their money out of Spanish debt and into countries with a higher credit rating such as Germany or even outside of the Eurozone. Spanish Bond prices have dropped significantly since the beginning of the year, driving yields higher. The gap between the interest rates on German and Spanish bonds have hit the highest level in 10 years, reflecting the sharp divergence in economic performance. Talk of Spain leaving the Eurozone is irrelevant because their cost of borrowing would skyrocket if they chose to do so. I think that there is a greater chance the countries being downgraded will be kicked out of the Eurozone.

This post can also be viewed at kathylien.com.

An Increasingly Popular Alternative To Layoffs

Companies in the U.S. laid off over 2 million jobs in 2008, but another expense cutting measure which is less often utilized also saw a major increase. A growing number of companies are choosing to cut pay rather than cutting jobs. Layoffs are typically preferred over pay cuts because among other things firms are afraid it might lead to an exodus of top workers. However, in this job market that isn’t a big worry. The last time there were nominal pay cuts was back in the Great Depression according to Price Fishback, an economic historian at the University of Arizona, as stated in the Wall Street Journal.

Because they remove spending capital from consumers while fostering additional fear and uncertainty, pay cuts are bad for the economy just as layoffs are. By now, practically everyone knows someone who has been laid off or had a salary cut, and even if one believes that one’s job is secure, the threat of a pay cut is encouragement to spend less. That said, though pay cuts will always be painful—especially if they become more widespread—they are still preferable over layoffs for consumers and the economy. After pay cuts, workers still have a source of income and don’t need to claim unemployment, which saves taxpayer dollars.

The inauguration is tomorrow, and I’ve never before seen this amount of anticipation for a new President. The state of the economy has brought a great deal of excitement, as many Americans believe that Obama is the man to rescue us from this recession. The thinking seems to be that once Bush is out of the White House and Paulson is out of the Treasury, all will be well. It is great to get excited, and Obama just might be the man to bring us out of this economic darkness, but people should remember that these things take time. Obama isn’t a miracle man, and he isn’t going to magically fix the economy. There is a lot wrong with the economy and there is a huge amount of work that needs to be done. We can hope for a quick turn around, but don’t expect it because it is not likely to happen that way.

Why The "Bad Bank" Is A Bad Idea

There is a lot of momentum gaining right now behind the idea to create a so called, "Bad Bank." This bank would be set up by the government and would be used to take toxic debt off of the balance sheet of the banks like Citigroup and Bank of America. Paul Krugman thinks this "Bad bank" is simply a bad idea. Economics Professor Mark Thoma revisits Krugman's article in his blog post below.

Are policymakers about to take another wrong turn?:

Wall Street Voodoo, by Paul Krugman, Commentary, NY Times: Old-fashioned voodoo economics — the belief in tax-cut magic — has been banished from civilized discourse. The supply-side cult has shrunk to the point that it contains only cranks, charlatans, and Republicans.

But recent news reports suggest that many influential people, including Federal Reserve officials, bank regulators, and, possibly, members of the incoming Obama administration, have become devotees of a new kind of voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking.

To explain..., let me describe ... a hypothetical bank that I’ll call Gothamgroup, or Gotham for short.

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.

So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope ...[of] a government bailout.

Why would the government bail Gotham out? Because it plays a central role in the financial system. ... Gotham has to be kept functioning. But how can that be done?

Well, the government could simply give Gotham a couple of hundred billion dollars... A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to ... the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.

The current buzz suggests ... policy makers aren’t willing to take either of these approaches. Instead, they’re reportedly gravitating toward ... moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” ... “The aggregator bank would buy the assets at fair value.” But what does “fair value” mean?

In my example, Gothamgroup is insolvent... The only way a government purchase of that toxic waste can make Gotham solvent again is if the government pays much more than private buyers are willing to offer.

Now, maybe private buyers aren’t willing to pay what toxic waste is really worth... But should the government be in the business of declaring that it knows better than the market what assets are worth? And is ... paying “fair value,” whatever that means,... enough to make Gotham solvent again?

What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense...

Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. ...Gothamgroup and its sister institutions are already ... utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.

Unfortunately, the price of this retreat into superstition may be high. I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal — and that we’re about to get another financial rescue plan that fails to do the job.

This post can also be viewed at economistsview.typepad.com.

Most Americans Support New Stimulus Proposal

House Democrats released the latest version of a new stimulus package meant to turn our struggling economy around. Most notably, the stimulus package swelled from $775 billion to $825 billion with a proposed $550 billion in spending and aid to states and $275 billion in tax cuts, according to CNNMoney. Despite the large price tag, Americans are generally perceived to be on board with the plan, according to a recent Wall Street Journal/NBC News poll. 43 percent of the people surveyed called the plan a “good idea,” while 27 percent said it was a “bad idea.” The remaining portion had no opinion either way.

The most pressing concern for the people surveyed was unemployment, followed by the federal budget deficit which came in at a distant second. 63 percent of the surveyed individuals felt that government spending should be the biggest priority of the bill, while 33 percent felt that tax cuts should be the main catalyst.

It would be interesting to compare this current poll to how people felt about these priorities prior to the last stimulus package. I have a sneaking suspicion that more people would have been in favor of tax cuts back then. Because those didn’t work as planned, people are turning to a different strategy to fix the problem.

President-elect Obama is enjoying unprecedented support for his plan and his administration as Americans look to him to get us out of this mess, but if Obama’s stimulus plan doesn’t get succeed, it will be interesting to see how quickly that support wanes. President Bush once had the highest approval rating ever (90 percent in September 2001), and now has the second lowest approval rating ever, only bested by Richard Nixon after the Watergate scandal. The American people are ready for results, and Obama may learn, as George W. did, that opinions can change drastically and quickly.

Consumer Prices Fall 0.7 Percent

The latest CPI report showed that prices fell 0.7 percent in December. While this likely will have people worried about deflation, that isn't the problem yet. To fully understand what is happening with the CPI numbers one must look closer at the underlying data. Tim Iacono from The Mess That Greenspan Made attempts to weed through the information and provide some insight for us in his blog post below.

The Labor Department reported that consumer prices fell 0.7 percent last month but rose 0.1 percent during all of 2008. As is the custom, the monthly figures use seasonally adjusted data while the annual inflation rate gets the non-seasonally adjusted variety.
Interestingly, as indicated in the chart above, the seasonally adjusted data now shows a 0.1 percent annual decline in prices.

And you know what that means...

DEFLATION!!

No not really.

A 0.1 percent decline in the Consumer Price Index would be better characterized as follows:

DEFLATION!!

The big red bold type should be reserved for real deflation as was seen in the 1930s, not the Japan style "baby-deflation" where the enlarged font really only serves one purpose - to give governments and central banks license to print money at astronomical rates to once again forestall the inevitable end of another system of pure fiat money.

They always end badly ... but, the current one still has a ways to go.

Don't confuse an energy-induced downward spike with deflation as your grandparents or great-grandparents knew it - they are entirely different things. And they will still be entirely different things in the months ahead as lower energy prices push CPI-inflation lower. Remember, this summer we'll be comparing last year's $4 gasoline to something about half the price.

You can see just how much tumbling energy prices affected overall inflation last year. Shown below are the monthly and yearly changes across all CPI categories - many prices continued to rise through 2008, notably food (up 5.8 percent), education (up 3.6 percent), and medical care (up 2.6 percent).
And yes, amid all the talk of deflation and plunging home prices, owners' equivalent rent (the consumer price index substitution for the cost of home ownership) continued to rise, up 0.1 percent in December and 2.1 percent higher than where it began the year.

Maybe some day, some brave young economist somewhere will successfully challenge what others haven't had the gumption or common sense to object to - how owners' equivalent rent has made a laughing stock of the government's consumer price index (it accounts for nearly 25 percent of the headline inflation number) and, in the process, greatly contributed to the worst financial crisis since the Great Depression.

This post can also be viewed at themessthatgreenspanmade.blogspot.com.

Forecasting The Current Recession

We all know that the current economic conditions are unlike anything we have ever seen before. This was a large reason why it took the folks responsible for identifying recessions so long to make the official announcement. It is very interesting to hear their reasoning behind the delay, and even to understand how these things are tracked to begin with. James Picerno from The Capital Spectator interviewed one of the officials that helps make these determinations which helps shed some light on the topic. You can read more about it in his blog post below.

Forecasting cyclical turning points in the economy (and inflation) is job one at the Economic Cycle Research Institute (ECRI), a New York consultancy. In fact, it seems to do so rather well, or at least it has in the past. Notably, ECRI has earned some well-deserved praise in recent years for correctly predicting the 2001 recession.

But the current downturn has been a little trickier. True, ECRI was warning of trouble in late-2007. Even so, the firm held out hope that a recession might be sidestepped. As discussed in a November 2007 report, ECRI explained that "the leading indexes are not yet in a recessionary configuration, thus a recession can still be avoided." Alas, it was not to be. With the clarity of hindsight, we know that the recession began in December 2007, as per NBER's official (albeit 12-month lagged) dating of the downturn's start.

To be fair, ECRI was advising that a downturn was possible well ahead of December 2007. Today, the firm counsels that the recession is well entrenched and that economic contraction looks set to roll on. "The bad news is that the recession is going to continue for the next couple of quarters, and we know that objectively from the leading indexes," says Lakshman Achuthan, managing director of ECRI and co-author of Beating the Business Cycle: How to Predict and Profit from Turning Points in the Economy.

In an interview earlier today with The Capital Spectator, Lakshman talked of recessions, how we got into this mess and the outlook for, one day, better times. If you have a taste for the ugly details of the business cycle, read on…

Lakshman, ECRI did a nice job of predicting the 2001 recession. Were you ahead of the curve this time?

No, we were much more coincident, for a whole host of reasons. We said a recession was unavoidable in early March 2008. The reason we held out some hope that the recession could be forestalled was because of a weird confluence of events going on at the end of 2007 and early 2008 with respect to inventories—manufacturing stuff in the U.S. economy.

Typically recessions are kick started in many examples by a big inventory overhang that, all of a sudden, in sort of a Wile E. Coyote moment, give way and the floor falls out from under manufacturers. They realize that they have way too much inventory and they stop [producing]. That's how a lot of recessions tend to start.

But not this time.

No, it didn't happen that way. There was very little inventory and so we didn't have that kind of downturn in the economy. That gave policymakers the briefest window of opportunity to maybe push [the recession] off. But they weren't that worried and thought they had things pretty much under control. And we had growth abroad that was still drawing on U.S. manufacturers and so there was a widely held belief that we didn't have to worry about [recession] and that we were managing the home price decline and the emerging credit crunch quite well.

The economic cycle has in fact been some sending false signals, or certainly misleading signals in recent years, or so it seems. Inflation, for example, was running hot in the first half of 2008. But by the end of the year, deflation seemed to be the big threat.

Yes, it's been very schizophrenic. For example, the assumption in many models was that home prices couldn't go down; now the assumption is that they can't go up. All along the way there were plenty of prognosticators saying extreme things. Today there are some expecting a depression while others are expecting things to rebound in the second half of this year.

Looking back, you can see how this recession was set up. Certainly oil was part of the reason. We started to have oil spikes in 2005, and every year since then, through early 2008, we had oil spikes. Every time you had an oil price spike, someone warned of recession. When you had the housing market downturn begin in 2005, and you combine that with an oil spike, a lot of people saw recession.

But those were false signals, at least for a few years after 2005.

Right, and instead what we saw was that the economy accelerated to a four-year high with the growth rate in 2007. That's kind of an inconvenient fact. We actually grew faster than Europe in 2007. This wreaked havoc with all kinds of assumptions that decision makers had taken. In fact, the acceleration in 2007 may have lit the match for a lot of this credit stuff.

How so?

Because decision makers in the fixed-income markets and other markets were looking for a recession in 2007, but it never happened. You had the expectation on Wall Street, at Merrill Lynch and Goldman Sachs, for instance, of a 75-to-100 basis point rate cut by the Fed. And then one day in early June those two houses, which have a lot of followers, abruptly turned on a dime and said they didn't think there would be any rate cuts in 2007. What this did was immediately wreak havoc with all of the models pricing subprime credit groups, where the assumption was that rates would go down and so those instruments would maintain their credit ratings. The minute you took out the rate cuts, the guise fell away and everyone started running away from subprime debt very quickly. And that continues today.

So you had a housing price downturn that began in 2006 and then morphed into a credit crunch in 2007. These are massive things that take time to resolve. But they don't in and of themselves mean that you must have a recession. Our indicators were saying, yeah, things were bad, but it wasn't a guaranteed recession.

When did things take a turn for the worse in terms of triggering a real economic contraction?

We started to get a real recession risk in the second half of 2007. Our weekly leading index peaked in June 2007, about six months before the recession actually began in December 2007. In fact, by December 2007, our weekly leading index had plunged to its worst reading since the 2001 recession. However, because of these inventory issues I mentioned [there was an expectation that] maybe we would be able to buy a little bit of breathing room. That didn't happen. You saw the recession begin at the end of 2007. All the dead bodies started showing up in 2008 as the recession turbocharged the housing downturn and credit crisis.

What's the outlook now?

The outlook remains recession. Retail sales, the Fed Beige Books, industrial production, jobs growth—these are all coincident indicators and they confirm that we're in the most severe recession in the post-World War II era. This was forecast by our weekly leading indicators. Our leading index had earlier fallen to a 60-year low. So it's not a surprise that the coincident indicators are now weak.

What has changed in very recent weeks is that the leading indicators have begun to stabilize. I'm not suggesting that there's an imminent recovery ahead, but it is notable that we've gone from minus 30% growth rates to minus 25%, minus 28% or so. I suspect this is largely related to hope. We have a new year. We also have a new administration and some new stewards of the economy. There's talk of a new stimulus plan. The leading index may be showing there's some pause to this sharp decline. However, an objective reading of the index doesn't yet show a sustained recovery. That would require a very persistent and pronounced rise in the leading index for us to make that kind of forecast. What we know objectively is that the first two quarters of 2009 are going to be recession quarters.

The longest previous recessions were 16 months each, in the early 1970s and early 1980s.

If we date the current recession's start to December 2007, that suggests that we'll soon match the previous recessions' 16-month time frames. Does that mean we'll be getting close to the end of the current downturn later this year?

Saying at this point that the recession will end in the second half is really a coin toss—no one really knows. We don't know because the leading indicators haven't turned up yet. The bad news is that the recession is going to continue for the next couple of quarters, and we know that objectively from the leading indexes. The good news is that the leading indexes can't see that far. A lot of it is going to depend on, for example, the stimulus debate. If the stimulus is three times the proposed size and it happens quickly, then that's one extreme and so there's probably a chance of some kind of bump in the second half of 2009. On the other hand, if the stimulus is delayed, or adjusted down, maybe there's less chance.

Keep in mind that the recessions of the early 1970s and early 1980s were also international recessions. The number of countries in recession around the world today is the broadest we've seen since World War II. It's broader now than it was in the 1970s and 1980s in terms of the diffusion and pervasiveness of the recessions globally. That informs our view of what may happen in the U.S. There's a linkage: The broader the recession, very often the longer it is.

This post can also be viewed on capitalspectator.com.

Division Mounts Among Fed Officials

The swelling balance sheet at the Federal Reserve is causing problems in more ways than one. One Fed official, Philadelphia Fed bank president Charles Plosser, recently went public with his objections against current Fed policies. Plosser’s main objections concern the ballooning balance sheet and the apparent endlessness to the madness. Fed chief Ben Bernanke doesn’t think that the balance sheet is a problem, but Plosser does, and he is ready to take his argument to whoever will listen. The following are excerpts from a MarketWatch article that detail some of Plosser’s concerns:

“Plosser said that the growth of the Fed's balance sheet was a key metric. ‘It is not appropriate to ignore quantitative metrics in this new policy environment,’ Plosser said.”

“Fed officials who pay attention to the money supply believe that the Fed's current policy of printing money never ends well and the danger of inflation is very high. They believe the Fed must withdraw the stimulus before there is any sign of inflation or it is too late.”

“Plosser also argued that the Fed has put its independence at risk by buying long-term assets. He worried that some "interest groups" will try to use political persuasion to stop the Fed from selling these longer-term assets even if the central bank has decided it makes sense.”

“‘We will need to have the political fortitude to make some difficult decisions about when our policies must be reversed or unwound,’ Plosser said. Bernanke said that he would watch this situation closely but didn't expect it to be a ‘significant problem.’"

Plosser isn’t the only one expressing concerns. William Poole, who recently left his position as president of the St. Louis Fed, has also been outspoken about issues with current Fed policies. The following are experts from a MarketWatch article:

“Poole said the expansion of the Fed's balance sheet is unprecedented and research suggests that a surge of inflation is sure to follow. ‘I would say if the policy is not reversed, there is a high probability that the unpleasant risk (of inflation) materializes,’ Poole said in an interview.”

“‘I believe that the Fed should set a hard number—a target that they take seriously for the overall size of the balance sheet,’ he said.”

“Poole said he was very concerned that the Fed could simply lend money to anyone, without constraint.”

“In the Soviet Union and Eastern Europe during the Cold War era, economies were inefficient because they had a soft-budget constraint. If a firm got into trouble, the banking system would give them more money, Poole said. The current situation at the Fed seems eerily similar, he said.”

"’What is discipline—where are the hard choices—when does Fed say our resources are exhausted?’ Poole asked.”

Bernanke seems content to continue on the current path, but it should at least be a little concerning that the opposition inside the Fed is becoming more vocal. I would venture to guess that there are others that oppose Bernanke, but they do not have the guts to stand up publicly against him. If things continue to worsen, it will be at least interesting to see how much the opposition ranks swell.

Retail Sales Dissapoint: Impact On Dollar

As expected December retail sales disappointed as more consumers cut back spending thanks to the ailing economy. According to currency expert Kathy Lien, the U.S. will likely see very weak fourth quarter GDP numbers which will lead to the USD falling against some major currencies. But some other currencies have major problems of their own that could counteract this latest poor showing from the U.S. economy. See Kathy Lien's full analysis in her blog post below.

For the 6th month in a row, US consumers have cut back spending. The December consumer spending data tells us that retailers had a very tough time this holiday shopping season. Consumers reduced their spending by 2.7 percent but if you take out year end deals in the auto sector, retail sales actually fell 3.1 percent, the largest decline in at least 16 years. The Grinch really stole Christmas this year and no one is happy about it. Lower gasoline prices continued to drive down gas station receipts, but weaker spending was seen across the board. The worry now is that more retailers will be forced to file for bankruptcy protection and the latest consumer spending reinforces those fears. With more than 1 million Americans out of work in the last 2 months, concern about job security lead to more nimble shopping over the Christmas holidays.

Import prices dropped for the fifth month in a row, but by less than the market had expected.

Expect fourth quarter GDP to be very weak. Retail sales is one of the primary inputs to GDP and the sharp drop in consumer spending suggests that GDP could have fallen as much as 4 percent. The dollar should continue to weaken against the Japanese Yen but the Euro has its own host of problems. There are reports that Ireland may call in the IMF if the economy weakens. This is yet another reason why the ECB could cut interest rates on Thursday.

This post can also be viewed on kathylien.com.

There Is No Need To Worry About Deflation

Deflation is certainly a hot topic of late, but is it really something we should be worrying about? Deflation is a scary thing, don't get me wrong, but according to some experts the U.S. isn't about to enter into a deflationary spiral. Government officials have shown no qualms about printing money as needed, and it is likely that they will print us out of any deflationary pressure. Tim Iacono from The Mess That Greenspan Made looks a little closer at this concern in his blog post below.

An article by Rich Toscano and John Simon of Pacific Capital Associates makes a very good case for why an extended period of CPI-deflation is highly unlikely in the U.S.

The motivation of policymakers is summarized nicely in this paragraph:

There is a powerful combination at work. Mainstream economic pundits, academics, and policymakers are united in their opinion that deflation must be prevented. They are providing a theoretical justification for highly inflationary policy, and right or wrong, this justification is widely accepted as truth. Meanwhile, from a politician's standpoint, inflation is a far more viable and easy path than deflation. This combination of real-world incentive and theoretical justification induces our monetary and fiscal leaders to overwhelmingly favor an inflationary outcome.

And with a pure fiat money system, where the whole idea of printing up hundreds of billions (if not trillions) of new dollars is quickly becoming the consensus "lesser of two evils" in how to best avoid another Great Depression, it all really boils down to whether or not they'll be successful.

They will.

Who knows what the world will look like when they're done, but they will be successful.

The entire piece is well worth a look, particularly the discussion of nine counterpoints, one or more of which have "deflationists" so excited at the moment:

- Pushing on a String
- Japan
- Lost Financial Asset Wealth
- Credit Deflation
- Debt Defaults
- Recessions
- Foreigners Won't Let Us Inflate
- The Fed Doesn't Want Inflation or a Dollar Crisis
- The Fed Will Reverse Course

The conclusion is as follows:

We in the United States have been dumping our dollars into the world for years and we continue to do so. We owe a staggering amount of foreign debt denominated in dollars and we are gearing up to borrow even more. Our legislators and the stewards of our currency are rabidly hostile to deflation -- they are hostile, in other words, to the idea of the dollar gaining purchasing power. They have shown via word and deed that they will do whatever it takes to prevent deflation from taking hold. When deflation is viewed as even a remote possibility, there are effectively no limits to the amount of money the government can create nor to what they can do with that newly minted money.

Under these circumstances, we just don't believe that the dollar is going to gain purchasing power in any sustainable way. The current deflationary storm could continue for a while yet, but the longer it goes on, the more violent and severe its reversal is likely to be.

Deflation is a choice within the current monetary regime. It is a choice that our government has shown it will not make. There are serious long-term risks inherent in our dysfunctional monetary system, to be sure -- but deflation isn't one of them.

The next look at the Labor Department's Consumer Price Index is due on Friday and the year-over-year reading as of November - the commonly accepted, definitive measure of "inflation" in the U.S. - printed at a lowly 1.1 percent.

It is possible that, with energy prices that have continued to plunge through the mid-December reporting period combined with a few other falling prices elsewhere, we'll get our first negative inflation number since 1955.

Just wait to you hear how acceptable the idea of "printing money" becomes then.

The word "deflation" (and, by inference, the threat of another Great Depression) may become President-elect Obama's most powerful tool in convincing Congress and hundreds of millions of Americans that "debasing the currency" has become our national duty.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

U.S. Exports Continue Their Downward Trend

Last year, while the U.S. dollar was down, manufacturers were joyfully experiencing one of the the loan bright spots in the U.S. economy, increased exports. Oh, how things can rapidly change for the worse. The latest trade report showed that U.S. exports were down again, for the fourth consecutive time. Is there any bright spots left in the economy? If so they are hiding pretty well. James Picerno from The Capital Spectator looks closer at the latest trade report in his blog post below.

The trade boom is fading. That's no great surprise, given the weakening state of the global economy. But the slippage in export-related activity comes at an especially challenging moment for the U.S.

Exports remained a bright spot for the U.S. economy last year. As other areas weakened in 2008, the American export machine bucked the trend. It was a timely boost, offering some hope that the approaching recession might be mitigated and perhaps even sidestepped altogether.

The high point came in last year's second quarter, when real (inflation-adjusted) export activity soared 12.3% on an annualized basis while GDP advanced 2.8%. That took some of the sting out of the drop in durable goods spending and a growing sense of unease otherwise in the GDP trend. In the third quarter, the export boom slowed but remained robust, rising 3.0%, in sharp contrast to the 0.5% decline in GDP.

The long-suffering dollar was no small advantage for juicing exports. As the greenback declined, the price cuts on American goods and services became increasingly attractive to foreign countries. Then in July 2008, the dollar began to rally. Although the U.S. Dollar Index has been trading in a range recently, it's still up sharply from its summer lows.

It was a tempting notion to think that exports would save us, although we warned last summer about expecting too much from the trend. "There's a limit to how much economic gain any nation can enjoy through a weakening of its currency," CS wrote in July. "Devaluation may offer short-term benefits, but the U.S. can't devalue its way to prosperity for very long."

The dollar's recent strength at the moment surely isn't helping U.S. exporting activity, nor is the credit crisis or the general economic turmoil blowing through economies around the world. Few analysts expected the fourth quarter GDP report to deliver anything other than a negative number. Today's trade update for November only strengthens that forecast. Exports dropped nearly 5.8% last month, the fourth consecutive montly decline.

No one will be shocked by the trend, although it's a humbling reminder that the economy has nowhere to hide. Employment, consumer spending, and so on have each fallen victim to the ill winds of recession. Exports are no exception. As we discussed on Friday, this is the eye of the economic hurricane and, as a result, all news from the dismal science is likely to be discouraging news for the time being. Not forever, but for a few quarters at least. Time moves slowly when you're waiting for a bottom.

This post can also be viewed on capitalspectator.com.

Fix Housing First: A Plan For Another Real Estate Bubble

Recently a coalition of homebuilders, real estate agents and other housing stakeholders have come together to formulate a plan to fix the economy. For the purpose of making their plan known, they have even created a website: fixhousingfirst.com. They proclaim that the main reason that the economy is so down right now is because the real estate market is being battered. After all, the problems began when housing values started to fall and foreclosures mounted, which exposed troubled mortgage-backed securities. So naturally, if we hope to fix this financial crisis, then we must address the most glaring problem first and foremost, right?

“So what is their big plan,” you ask? To create another housing bubble of course!

Their plan, as written on the website, is outlined below:

1. Enhance the initial Home Buyer Tax Credit:
• Eligible purchases: Primary residences between April 9, 2008, and December 31, 2009.
• Credit amount: 10% of home price capped at 3.5% of FHA loan limits (geographically dependent) — ranging between approximately $10,000 and $22,000.
• Eliminate the recapture — a true tax credit [Here they are referring to the repayment of credit described above. In the previous housing bill there was an interest free loan for first time homebuyers of $7,500.]
• Monetization: credit available at time of closing.
• Available to all home buyers and not just first-time home buyers.
2. Couple the enhanced tax credit with a below market 30-year fixed-rate mortgage for home purchases
• 2.99% rate available for contracts closed between now and June 30, 2009.
• 3.99% rate for contracts closed between June 30, 2009 and December 31, 2009.
3. Continue foreclosure prevention measures to keep people in their homes, help stabilize home prices and bolster the economy.

Restated, they want taxpayers to pay the down payment for homebuyers and subsidize their mortgage payments as well. What would the net effect of this be? Housing would all suddenly become much more attractive and people would buy, pushing prices up. This is exactly what they say will happen, and is what they are striving for. The trouble is that it is an artificial boost to housing prices, which will inevitably lead to another housing bubble. Housing just isn’t worth what it currently costs. That is the simple truth, and a truth that we all need to grasp. Once the subsidies are gone, housing prices will once again fall until they hit their true value point.

If we are looking for a solution to temporarily get us out of this mess, I think this is certainly one plan that will help with that. However, to me it seems like a waste of time and money when in the end we are ultimately going to return to the same place we were before. This plan is not sustainable in any way shape or form, and should not be seriously considered. Then again what did one expect to see from a plan constructed entirely by home builders, real estate agents and other housing stakeholders?