Why Gold Is The Most Obvious Bull Market Of Our Generation

Moses Kim from Expected Returns makes the case for why gold is " the most obvious bull market of our generation". A lack of government prudence in fiscal matters and the debt downgrades of sovereign nations, all point to an increase in this 5,000 year old currency. See the following post from Expected Returns.

The gold explosion appears to be well underway, absolutely befuddling ignorant investors who view gold as a commodity. Do you think gold rose yesterday against every single currency because of the bullish dynamics for jewelry demand? Let's get real here- gold is trading as a currency. After all, gold has a 5,000 year history as a monetary metal. That the average person has no clue about history should have no bearing on your decisions as an informed investor since the facts never change; it is just perceptions that change.

You are currently observing the masses miss out on the most obvious bull market of our generation. How many times do gold bears have to be proven wrong before people believe in the gold story? In investing, inflexibility will get you killed. This is a bull market, stop fighting the tape!




I am telling you right now: get used to seeing perpendicular spikes in gold as shorts get stampeded by the golden horde. It is going to get ugly for gold shorts.

There is often talk in gold circles about gold manipulation at the hands of the likes of JP Morgan. Is gold being manipulated? Probably to an extent in the short run. But that doesn't concern me one bit since it is impossible to stifle a bull market driven by supply and demand in the long run. Impossible.

By manipulating the price of gold, paper shorts are implicitly betting on government prudence in fiscal matters. As someone who has studied history in times of crisis, this is a bet I would fade every single time. As anyone with a brain can see, fiscal and monetary stupidity is clearly in a bull market.

Keep this in mind: every time a sovereign nation gets a debt downgrade (Spain joined the party this morning), gold gets a tacit upgrade. Also keep in mind that investors are much more likely to be piling into gold at $2,000 than they are at $1,000. Don't ask me why- this is just how investor psychology works.

I assume most of the readers of this blog are already invested in gold. As such, I would recommend sticking a sign on top of your computer screen that says: Don't Sell, Stupid! Trust me, the coming explosion in gold will leave even the most ardent gold bugs in a state of shock.

This article has been republished from Moses Kim's blog, Expected Returns.

Exploring The Timely Topic Of Asset Bubbles

As financial reform takes center stage on Capital Hill, James Picerno discusses the timely topic of asset bubbles. Some important questions that should be explored include: whether bubbles are inevitable, whether we can stop bubbles, and whether we should stop them. See the following post from The Capital Spectator.

Everybody talks about bubbles, but what should we do about it? Before we can answer intelligently, we need to put bubbles in context. In other words, how should we think about bubbles? There's no simple answer, in part because the hyperbole surrounding the concept is thicker than honey in a beehive.

We can start by considering the argument that bubbles are something strange, something odd, something out of the ordinary. Prices that run up too far and too fast are bubbles, we’re told. The details are debatable, but presumably we all know what a bubble looks like, at least in hindsight, even if we’re reluctant to define it with surgical precision in advance.

Economist Robert Shiller in Irrational Exuberance describes a previous bubble in the stock market as “a situation in which temporarily high prices are sustained largely by investors’ enthusiasm rather than by consistent estimation of real value.”

That sounds like a rare event, although GMO's chief strategist says he's found lots of bubbles in financial history. In a video interview with the Financial Times last week, he reported that his firm identified 34 bubbles in a variety of asset classes over the years. He noted that 32 of them had since fallen back to pre-bubble levels, and that the remaining two that have yet to correct—the housing markets in the U.K. and Australia—are at risk of succumbing to the historical trend. Meanwhile, Grantham says commodities and emerging markets may constitute new bubbles in progress.

Grantham is one of the unofficial gurus on bubbleology and so we take him at his word: i.e, bubbles aren't exactly rare. In fact, they seem downright routine. Ergo, prices go up, prices go down, albeit with varying degrees of volatility within a given time period.

The concept was famously encapsulated by J.P. Morgan more than a century ago, as recounted in Jean Strouse's magnificent biography of "Jupiter," Morgan: American Financier: "Asked to predict what the stock market would do, [Morgan] replied, "It will fluctuate."

And so it shall, along with every other market. A market whose prices do not fluctuate is an unhealthy market. But how much fluctuation is too much? Or too little? The answer depends on your expectations and plans when venturing into Mr. Market's field of dreams.

For traders, there's never enough price volatility. As outlined in Edwin Lefevre's Reminiscences of a Stock Operator , the classic treatise on trading psychology, the fictional Larry Livingston (a thinly veiled front for Jesse Livermore, the famous trader of the early 20th century) tells us:

The tape does not concern itself with the why and wherefore. It doesn't go into explanations… The reason for what a certain stock does today may not be known for two or three days, or weeks, or months. But what the dickens does that matter? Your business with the tape is now--not tomorrow. The reason can wait. But you must act instantly or be left.

Such ideas are anathema to strategic-minded investors, or so-called fundamental investors who look for "value," i.e., assets trading at prices below some estimate of worth. The poster boy for fundamental investing is, of course, Ben Graham, who co-authored the bible for this approach in Security Analysis. To a value investor's sensibilities, the act of trading a la Jesse Livermore is misguided, to say the least. Wall Street Journal columnist Jason Zweig laments the view that traders are a lot that, by definition, trade first and ask questions later. In a recent article that reviews the pros and cons of financial disclosure, Zweig provides a glimpse of Graham's perspective on the subject:

Benjamin Graham, perhaps the most astute analyst Wall Street has ever produced, was once asked whether he thought disclosure was adequate. Graham replied that the quantity of disclosure "makes me ill." He added, "I don't know if there is any solution … I suppose [a prospectus] would have to say in big red-letter words, THIS [SECURITY] IS NOT WORTH WHAT IT IS SELLING FOR. I don't know if that would make any difference either … somebody [would just say], 'What the hell, it is going up anyway.'"

Traders, it seems, are irrational, or so it seems if you're a value investor. The feeling is usually mutual. If so, we've located a key source of why bubbles exist, which are premised on the idea of irrationality, which is a slippery concept depending on who you're talking to. Nonetheless, the bubble itself is widely seen as prima facie evidence of irrational decision making, or so argues the behavioral school of economics. But if bubbles are always and forever irrational, what does that say about the fairly routine arrival of bubbles? Could bubbles simply be part of the normal fluctuation in prices? In a world populated with short-term traders and long-term value investors (a.k.a. "the market"), are bubbles simply inevitable events that reflect disagreement over prices? If so, are these market debates always irrational? Or just natural?

Some economists suggest that bubbles might actually be rational at times. Summarizing one paper in this theoretical corner, Economics 2.0: What the Best Minds in Economics Can Teach You About Business and Life considers the alternative perspective on bubble study via the challenge tied to a lack of time consistency. "The estimation of what will be tomorrow's estimate on long-term price development is not necessarily consistent with today's estimation of long-term price directions," the book explains.

As example, Economics 2.0 asks the reader to imagine a point when most investors believe the market is overvalued. Yet most investors have not yet sold out of the market, perhaps because they expect further price increases, and so they buy more. "The same will occur tomorrow,

with the effect that my daily predictions for the next day's average market assessment will not be in line with my long-term forecast of the average market assessment. The discrepancy grows wider with each day, as observant investors have an incentive to "ride the bubble."

Obviously, the trend evolving this way will be prone to an abrupt reversal. Bits of innocuous public information can bring about a change in direction, for rational investors—rightfully—attach greater significance to publicly available information than to their own, private information. Only public information is meaningful for the formation of investors' average market assessment.

Yet both types of information are unreliable. For instance, an upward blip in the U.S. core inflation may be no more than a slight aberration. If financial markets function akin to Keynes's beauty contests, however, this bit of commonly available information can have very significant consequences. All investors will notice the upward move in inflation rates—and all will know that everyone else sees it, too. As a result, many investors might expect others to sell—and begin to exit their own positions as well. What caused exaggeration on the way up is now likely to cause exaggeration on the way down.

To fully understand the challenge of bubbles, one needs to consider the markets in real time. Indeed, Grantham suggests that commodities and emerging markets may be bubbles. He may be right (or wrong). To be fair, he anticipated the tech bubble that burst in 2000-2002, along with the 2008 reversal of fortunes. Other strategists offered warnings as well. But more than a few value investors went broke in the late-1990s waiting for the bubble to burst. Bubbles exist, but that doesn't mean they can be profitably exploited in real time. Identifying bubble watchers who will be right and timely, in advance, may be just as difficult as identifying the next bubble and when it's set to burst.

We may or may not be in a bubble in one or more markets as we write. If we were sure that a bubble existed, we'd go to 100% cash, wait for the correction and buy anew. In fact, there's a case for embracing this strategy, albeit modestly, in recognition that a) we're never sure if the bubble's a bubble; and b) the timing of the bubble's rise and fall is unknown.

In fact, using the word bubble to describe price changes can get us in to trouble. There's a perception that profits come easier in bubbles, either by riding them up or stepping aside when the risk a collapse seems imminent. So be it. Sometimes such analysis is timely, sometimes not. But prices will continue to fluctuate, sometimes violently. This is nothing new.

Perhaps, then, the $64,000 question is: How many bubbles do we need to see in a given time frame before we think of these events as part of the normal market fluctuation? Everyone is likely to have a different answer, which is probably why bubbles will remain a permanent fixture on the economic scene. That's not entirely bad news, as The Road from Ruin: How to Revive Capitalism and Put America Back on Top opines. Why? Bubbles tend to be linked with innovation, this new book argues.

There's a "strong correlation between bubbles and genuinely exciting advances, whether in technology or finance," according to The Road From Ruin. It's not clear, however, that bubbles can be prevented without killing the innovation. Yes, reasonable efforts to keep bubbles under control are warranted, although hammering out the details isn't easy. That's partly because no one's really sure how to prevent bubbles productively without cutting off the economy's nose to spite its face. As economist Russ Roberts has written, "We should face the evidence that we are no better today at predicting tomorrow than we were yesterday. Eighty years after the Great Depression we still argue about what caused it and why it ended." As a result, "We have the same problems in economics. The economy is a complex system, our data are imperfect and our models inevitably fail to account for all the interactions."

Meantime, because the proposed solutions du jour are ultimately political affairs, the danger of making things worse can't be dismissed.

In any case, "we may have to accept some occasional bubbles as a fact of life, human nature being what it is," advises The Road From Ruin, co-authored by Matthew Bishop of The Economist and Michael Green, a London-based consultant and writer. That's not as bad as it sounds, the book argues:

…the really nasty economic consequences tend to result not from bubbles per se but from the wrong reaction when bubbles burst, or when government actions, rather than restraining a bubble, have the effect of blowing air into it. Alas, both of these are common errors.

This article has been republished from James Picerno's blog, The Capital Spectator.

Economists Project Modest Growth Ahead For Global Economy

The IMF is cautiously optimistic of a sustainable global economic recovery and have raised their growth forecasts despite modest growth expected from mature economies. The National Association for Business Economics is also optimistic, with recent survey data suggesting that US companies are gaining confidence in the economy, indicating a potential growth in hiring ahead. See the following post from The Capital Spectator.

“The global economy seems to be recovering,” the chairman of the IMF’s Financial Committee meeting said at press conference over the weekend. "The worst is definitely behind us," advised Youssef Boutros-Ghali, who's also the Egyptian finance minister in his day job.

But most bouts of macro optimism come with caveats these days, and Boutros-Ghali's cheerful commentary was no exception. "We are not out of the woods yet," he added. "We see a strengthening of economic recovery, but we also see an unevenness in this recovery, unevenness within countries, and unevenness between countries."

Earlier in the week, the IMF revised up its global growth forecast to 4.2% for 2010 from January's estimate of 3.9%. Leading the expansion: emerging market economies, Boutros-Ghali emphasized in his Saturday chat with the press. The IMF projects that emerging nations will grow by more than 6% this year and next.

By comparison, economic growth in mature economies is expected to be relatively modest at roughly 2% to 2.5%. Not too shabby on its face. The problem is that the advanced economies need something better than average for an extended period in the wake of the Great Recession. As the IMF's chief economist, Olivier Blanchard, explained on the IMF's blog a few days ago: The 2%-plus outlook for growth in advanced economies

...is just not enough to make up for the ground lost during the recession. Output for these countries is now 7% below its pre-crisis trend, and this “output gap” is expected to remain large for many years to come. Associated with this prolonged output gap is persistent high unemployment. We forecast the unemployment rate in advanced economies to reach 8.4% in 2010, and to only decline to 8.0% in 2011.

The main factor behind this weak performance and this prolonged output gap is weak private demand. In the United States, consumers, who were the drivers of the economy before the crisis, are being more prudent. In Europe, where banks play a central role in financial intermediation, the weak banking sector limits credit supply. In Japan, deflation has reappeared, leading to higher real interest rates, and putting in danger an already weak recovery.

But while there's a risk of growth that's not quite up to the challenge in the developed world, some analysts think the hazards of a fresh round of economic contraction have diminished. "In the United States, there is a growing consensus that the risk of a double dip recession has abated which is positively impacting markets," the Blackstone Group said in a statement this past week.

In fact, it's easy to find forecasts of modest growth for U.S. GDP for the year ahead. BMO Capital, for instance, projects the U.S. economy will expand by roughly 2.5% to 3.0% at an annual pace in the coming quarters. MFC Global Investment Management expects even stronger results, albeit with that annoying caveat again:

We forecast a robust economic recovery, as job growth will drive incomes and consumer spending, which in turn fuel a resurgence of business investment. The process of rebuilding inventories, which pushed GDP growth to almost 6% in Q4 2009, is not over yet. In addition, more than half of last year’s stimulus package is still to come, while a synchronized global expansion is boosting exports.

But this is not the whole story. Another wave of mortgage defaults and foreclosures threatens renewed declines in home prices, while commercial real estate seems on the verge of a major slump. More losses for banks would only make a constrained lending environment even worse, potentially limiting the normal growth of spending.

Meantime, the always cautious, circumspect and widely followed Jeremy Grantham, chief strategist of GMO, writes in his latest quarterly letter to clients:

The economy is limping back into action, but faces some tough long-term headwinds that I collectively call “seven lean years.” Mortgage defaults in housing, steady repayments of consumer debt, and refinancings in commercial real estate and private equity, are all problems that linger, as do many others, on what is becoming a long, boring list. We may get very lucky and have a strong broad-based economic recovery.

Boring but no less relevant. The next several months are sure to be a test of the economy’s capacity from transitioning from crisis mode to something resembling stable-growth mode. The outcome will likely be determined by the prevailing winds in the labor and housing markets, both of which were crushed by the economic turmoil in recent years. In both cases, there are nascent signs of stabilization, which may be a prelude to a bonafide recovery.

One reason for thinking so comes from a new survey of U.S. companies, which are becoming more confident that the economy will grow, which inspires plans for more hiring and less firing. As the National Association for Business Economics reports today:

Job creation increased for the first time in the past two years of this NABE survey. The percentage of firms increasing payrolls rose to 22% from 13% in the January survey. The percentage of firms cutting jobs moved lower—from 28% in January to 13% in April. The share of respondents expecting their firms to add employees over the coming six months rose to 37%, up from 29% in the previous survey.

Cautious optimism seems to be the sentiment of the moment. Even assuming that's accurate, what does it mean for the market? Have stocks fully priced in the expected recovery? "If the economic recovery is slow and if unemployment drops slowly," writes Grantham, "then [Fed chairman] Bernanke will certainly keep rates very low, as he has promised in as clear a way as language permits. In that case, stocks and general speculation will very probably rise from levels that are already overpriced."

The margin for error, in other words, is getting uncomfortably thin. That doesn't mean equities won't climb higher. But the potential fallout from any negative surprises isn't getting any smaller.

This post has been republished from James Picerno's blog, The Capital Spectator.

Concerns Grow Over Spread Of Greece Debt Crisis

As concerns grow over the spread of Greece's debt crisis to other economies, Moses Kim discusses the risk of reverberations affecting the US economy. The debt crisis is already being felt in Portugal as it received a downgraded credit rating from Standard and Poor. See the following post from Expected Returns.

As stocks sell off and sovereign debt ratings drop, people are starting to realize how tenuous this economic recovery is. Debt crises rarely occur in isolation; in fact, they are quite "contagious." When the debt crisis spreads to the U.S., you will see some real fireworks. From Bloomberg:

Portugal had its credit rating cut two steps by Standard & Poor’s as contagion from Greece’s debt crisis spreads through the euro region.

S&P lowered its long-term local and foreign currency ratings to A- from A+, it said in a statement today. The outlook is negative, the company said.

The extra yield investors demand to hold Portuguese bonds over German bunds surged to 265 basis points today, the most since at least 1997, as the government struggles to convince investors it can cut its budget deficit. Portugal, whose economy has barely grown for a decade, had a shortfall of 9.4 percent of gross domestic product last year, the fourth-highest in the euro-region.

Portugal may have the fourth highest deficit to GDP ratio in Europe, but it lags the U.S, whose deficit to GDP ratio sits at 9.9%. With government spending increasing at a torrid pace, we're well on pace to surpass 10% this year. Of course all the headlines are focused on the problems in Europe, which is quite comical if you ask me.

Commodites are down across the board, including crude oil, which is down over 2% as we speak. But gold is mysteriously bucking the trend in commodities and is rising on the news of Portugal's debt downgrade.

Flight to quality, anyone?

This article has been republished from Moses Kim's blog, Expected Returns.

Why Seasonally-Adjusted Housing Data Brings False Hope

While the mainstream news media outlets have reported widely on the seasonally adjusted housing data as evidence that the real estate market and economy are recovering, a closer look reveals the weak areas of the housing market. Given the poor market performance in the housing market over the past three years and the substantial number of US mortgages in distress, many industry analysts agree that seasonally-adjusted housing data are less reliable indicators of market trends at this time. See the following post from HousingWire.

“I can’t explain myself, I’m afraid, sir, because I’m not myself you see.”

“It would be so nice if something made sense for a change.”

– Alice, in Lewis Carroll’s Alice in Wonderland

Let’s start with what’s clear right now—the simple fact is this: our nation’s housing markets have gone mad. Up is down, and down is up, and quite literally so. I’d not be surprised, in fact, to run into a Mad Hatter having a tea party in front of his dilapidated house (that he hasn’t paid the mortgage on for years, of course).

And that’s just the point. Our nation’s housing data has more in common with Alice in Wonderland than it does with anything resembling reality right now. And my thinking here isn’t the figment of a misguided perma-bear attitude, lest some readers mistake my stance: I, for one, am rooted firmly in reality. Housing will recover and return to strength. It must.

But not yet.

In fact, the disconnect between housing reality and the Wonderland we’re all now living in was the subject of a formal note last week from researchers at Standard & Poor’s. Like me, they were vexed to see that seasonally-adjusted housing data has looked so positive, while the unadjusted data looked far less so.

Most media outlets, after all, have been trumpeting the positive, seasonally-adjusted data as proof of recovery.

Here’s an example: the raw S&P/Case-Shiller data found a -0.2% dip in home prices in January (using the 10 city index), yet the seasonally-adjusted data reported by most media outlets showed a 0.4% increase month-over-month. This sort of dichotomy has been apparent for some time—and not just within the S&P/Case-Shiller data, either.

Consider the insight of Gluskin Sheff Chief Economist David Rosenberg:

“Now it would be one thing if January was an unusually weak seasonal month for home prices deserving of an upward skew from the adjustment factors; however, from 1998 through to 2006, they rose in each and every January and by an average of 0.6%.

“But what happened is that home prices collapsed in each of the past three Januarys — by an average of 1.8%, or a 25% annual rate. And, seasonal factors typically weigh the experience of the prior three years disproportionately so what looks like steady gains in housing prices may be little more than a statistical mirage.”

In other words, the disparity between adjusted and unadjusted data suggests that seasonal statistical corrections are doing more than simply correcting for any seasonal effects—especially if you believe that the underlying seasonal patterns of the housing market have been significantly disrupted by what statisticians would call “exogenous” variables. (That is, something other than seasonality.)

In its note, the S&P/Case-Shiller Home Price Index Committee suggested that foreclosures and “other market dislocations”—code speak for extraordinary mortgage market support from the Fed, as well as a substantial tax credit program for consumers—have affected home prices beyond what would normally be seen by seasonality. “[W]e believe that current market conditions are making the seasonally-adjusted data less reliable indicators,” the committee said.

“[T]he Committee believes that, for the present, the unadjusted series is a more reliable indicator and, thus, reports should focus on the year-over-year changes where seasonal shifts are not a factor.”

Welcome to Wonderland, indeed.

So, for now, we see builders swinging their hammers again a little bit more, pushing March housing starts up 20.2 percent from one year ago—those numbers coming fresh off of an all-time record low in new housing starts in February. And we see that existing home sales soared in March, too, up 6.8% as borrowers rushed to claim a tax credit before expiration. Is this what recovery looks like? Only if you believe this is reality.

I tend to see reality in terms of a not-so-hidden overhang of distressed mortgages that must eventually be dealt with—7.9 million, at last count. And whether through short sales, or the tried-and-true foreclosure to REO pipeline, there are undoubtedly millions of such homes yet waiting to enter the nation’s available housing supply.

Likewise, we are seeing vacant housing units reach a record, as well, hitting 19 million in the first quarter of this year according to data released Monday morning by the Commerce Department. Depending on whose estimate you believe, that adds another 1.5 to 2 million excess housing units that will undoubtedly constrain upward movement in home prices.

Is there anyone out there that really believes that an unavoidably increasing and likely substantial supply of homes will somehow drive home prices upward further this year? Perhaps only those that live in Wonderland.

This post has been republished from HousingWire, a mortgage and real estate news site.

Chinese Government Has Strong Incentives To Keep Property Prices High

Housing prices in China have risen dramatically over the last several years, creating booming real estate markets in the country's major cities and other areas. While its clear that the Chinese real estate market is in a bubble, it may be some time before the market declines since China's government has substantial financial incentives to allow the current market to continue. See the following article from The Mess That Greenspan Made.

A couple of reports today about the housing bubble in China must make some Americans long for the days of condo parties and Hummers about five years ago, this story in the LA Times no doubt spurring memories for hundreds of thousands of Angelinos whose lives have taken a decided turn for the worse since the housing bubble burst here.

Hundreds of miles inland from the booming real estate markets of Beijing and Shanghai, an unlikely property fever is gripping this middling industrial outpost.

Rows of half-completed apartment buildings rise over former farmland, each crowned with yellow construction cranes that seem to outnumber trees in parts of this dusty city of 5 million residents.

Taxi drivers boast of owning multiple flats for investment. Billboards hawk developments with names such as Villa Glorious and Rich Country. Frenzied crowds pack sales events with bags of cash, buying units that exist only on blueprints. Average home values in Hefei soared 50% last year.

China’s real estate rush, once confined to leading cities, has spilled into the hinterlands with a ferocity reminiscent of American expansion into exurbs like the Inland Empire.

The “bags of cash” are unique to China – that certainly wasn’t the case for the housing bubble in the U.S. – but we had our share of 50 percent property price increases. It was a flood of Southern California buyers that played a big role in pushing prices up by about that much in Las Vegas and Arizona at the height of the boom.

Cameraman Xi Zhou in the Times story notes that after a paper gain of 60 percent on his first purchase, he’s ready for more, though he appears to have stiff competition. XI notes, “For people of my generation, property is all we talk about. I felt a lot of pressure to buy because the longer I didn’t, the more likely I wouldn’t be able to afford anything.”

As was the case in the West, real estate sales people are adding to the excitement, in Andy Xie’s Bloomberg commentary today, one bubbly sales girl prodding potential buyers to take the plunge in suggesting, “You should buy two. In three years, the price will have doubled. You could sell one and get one free.”

Now, that sound like a plan and even the maids are coming down with real estate fever.

“My maid just asked for leave,” a friend in Beijing told me recently. “She’s rushing home to buy property. I suggested she borrow 70 percent, so she could cap the loss.”

It wasn’t the first time I had heard such a story in China. Some friends in Shanghai have told me similar ones. It seems all the housemaids are rushing into the market at the same time.

There are benefits to housekeeping for fund managers. China’s housemaids may be Asia’s answer to the shoeshine boy whose stock tips prompted Joseph Kennedy to sell his shares before the Wall Street Crash of 1929.

Another friend recently vacationed in the southern island- resort city of Sanya in Hainan province and felt compelled to visit a development sales office. Everyone she knew had bought there already. It’s either buy or be unsocial.

Pretty amazing stuff, that is, for 2010…

What’s so interesting about the China property bubble are the perverse incentives for government land sales. That was always part of the housing bubble in the U.S., but not nearly to the extent seen now in China as Xie explains.

When it comes to interested parties, Chinese governments are knee-deep in the bubble. They get all the money from land sales. Land values have risen to half of the development cost. In hot spots, land costs more than the development — the governments want to collect the future price gain immediately.When properties are sold, transaction and profit taxes kick in. Developers pay more levies to the governments than they earn. When developers finally book their earnings, they must put it to work, as good Wall Street analysts would recommend, so they buy land. As land prices are much higher, their measly earnings aren’t enough, so they have to borrow. The governments get all their earnings and debt repayments. Can you blame them for boosting the market whenever it slips?

Xie makes the point very clearly that, while China property markets are clearly in a bubble, that bubble may not meet its pin for some time to come.There are a number of powerful forces at work, not the least of which is the Chinese government that may not be so keen on popping this bubble despite their recent moves to limit lending.

This article has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

How A Chinese Yuan Increase Could Destroy US Jobs

Some analysts believe that a revaluation of China's currency will actually result in a negative impact on US job creation since it will raise manufacturing costs for US firms and harm US competitiveness in most markets (except China). Other analysts dispute this view, stating that the loss of US jobs as a result of higher China manufacturing costs would be small and that in fact, a 10% increase in China's currency valuation would result in a modest increase in US jobs. See the following post from Economist's View.

An argument that revaluation of the renminbi/renembi won't have much effect on jobs in the US:

Will Chinese revaluation create American jobs?, by Simon J Evenett and Joseph Francois, Vox EU: Many in the US are pushing China to revalue the renminbi. Will that create US jobs? Traditional Keynesian analysis associates higher exports and lower imports with more jobs, but today’s world is more complex. Chinese parts and components feed into US firms’ global competitiveness. This column says a dearer renembi would boost the competitiveness of US exports to China but reduce US competitiveness everywhere else. A revaluation may be the right policy for other reasons, but its impact on US jobs is far from clear.

Undervaluation of China’s exchange rate is central to the debate on the right global policy mix in the aftermath of the economic crisis. Estimates of the undervaluation vary (from zero to 40%, Cheung, Chinn, and Fuji 2010) along with the reasons for focusing on the renembi:

* The IMF expresses concern about persistent capital account imbalances and asymmetries between surplus and deficit countries, with concern that imbalances contributed to past global financial instability and could so in future. The IMF also calls an exchange rate appreciation “essential” for China’s domestic macroeconomic situation (IMF 2010).
* Senior Brazilian and Indian officials call upon their Chinese counterparts to revalue the renminbi to mitigate competitiveness concerns.
* In the US, some call for revaluation as a means of redressing the bilateral imbalance with China and quickly creating US jobs.

In this column, we focus on the last issue; that is, whether it is realistic to expect a US jobs bonus to follow a Chinese revaluation. ...

With extensive global supply chains and outsourcing, a modest Chinese revaluation will ... raise costs for US firms and thus harm US competitiveness everywhere except in the Chinese market. This cost-raising effect mutes the current account improvement and, by our estimates, may result in 424,000 jobs losses in the US.

Findings such as these call for a rethink of aggressive foreign trade policy towards China, not just by the US but all those nations that supply and source parts and components to and from China as part of global supply chains.

And, rebuttal:

Estimating the effect of renminbi appreciation on US jobs: A comment on Francois' China result, by William R. Cline, Vox EU: Would appreciation of the renminbi actually destroy US jobs? This column discusses recent estimates that find that making intermediate inputs from China more expensive would hurt US global competitiveness. It argues that the direct effect of an improvement in the US trade balance would create far more jobs than might be lost to more expensive intermediate inputs.

In a recent study, Francois (2010) estimates that if China appreciated the renminbi by 10%, the US trade balance would rise by $100 billion but the number of US jobs would decline by 430,000. He uses a computable general equilibrium (CGE) model to make this calculation. He allows for below-full capacity and sticky wages so that it is possible for a change in the external balance to affect the level of employment. The paradoxical negative sign on employment as a consequence of the currency correction stems from the model specification that emphasizes induced losses of jobs throughout the economy that result as a consequence of the increase in costs of intermediate inputs imported from China and used in the US economy. Francois argues that the gain of employment in exports and import substitutes would be too small to offset the loss of jobs in the general economy; hence the net loss of 430,000 jobs. This column examines whether these results make sense. ...

This exercise suggests that something appears to have gone wrong in the Francois calculations. A reasonable approximation of his two opposing effects suggests that the 10% RMB appreciation would create 320,000 jobs from the US trade balance improvement and eliminate only 32,000 jobs from the induced effect of higher intermediate input costs to US manufacturing. ...

Even if the effect on US jobs is small, we should still care about the effect of China's currency policy on other developing countries. That's where China's currency policy is likely have the greatest effect in terms of shifting the location of manufacturing employment.

The effect of the policy on global imbalances and the potential impact on financial stability is also of concern. However, given the IMF's behavior toward countries that needed help in the past, it's hard to be critical of the desire to establish a reserve fund as insurance against having to turn to the IMF for help. That's why giving countries such as China a larger role in determining IMF policies could help with currency alignment problems. With a credible change in IMF policy, countries could get the help they need when troubles arise at a smaller cost than it takes to build up large reserve balances.

This article has been republished from Mark Thoma's blog, Economist's View.

What Will The Fed Do With $1 Trillon Worth Of Bad Assets?

While the Fed and Washington are boasting of the economic recovery underway, some analysts point out that the recovery is the result of an unprecedented level of government intervention that ultimately has resulted in the Fed acquiring more than $1 trillion worth of bad mortgage securities. With its bloated balance sheet, the Fed is in a difficult position to try and figure out a realistic strategy for unloading these toxic assets without undermining the delicate economic recovery. See the following post from Expected Returns.

While talks of an economic recovery reach a deafening crescendo, questions still abound about the sustainability of a recovery driven by unheard of government intervention. The Fed has become the buyer of last resort for toxic waste that had no place on the balance sheet of private institutions. To think that the market can absorb these toxic securities is dubious at best. From the WSJ, Fed to Discuss Mortgage-Bond Sales:

The Federal Reserve has acquired more than $1 trillion worth of mortgage-backed securities in the past 15 months. At their policy meeting in the coming week, Fed officials will try to decide how and when to get rid of them without jarring financial markets and the nascent economic recovery.

The Fed's thinking on interest rates is straightforward. The recovery has gained traction but hasn't been vigorous or long lasting enough to warrant raising them soon; after its Tuesday and Wednesday meeting it is likely to repeat its signal that rates will stay low for an "extended period."

The more challenging issue will be agreeing on a long-term plan to shrink a balance sheet bloated to $2.38 trillion—more than double precrisis levels—according to Fed insiders.

Sales of mortgage-backed securities aren't likely soon. It is also possible that the Fed won't signal its intentions on the matter in its post-meeting statement Wednesday. But markets are on edge because its mortgage bonds holdings are so large. At $1.1 trillion in holdings of mortgage debt guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae, the Fed owns roughly a fifth of all these outstanding instruments.

Based on the preceding chart, it's obvious the Fed's focus has been on housing. While sales have perked up leading into homebuyer tax-credit expiration, keep in mind that we are making comparisons based on historically low levels. Celebrating a tax-credit induced rise in housing sales is like a student celebrating going from an F to a D, but only after cheating from his buddy. You cannot analyze complex markets statically without taking into account the variables that generate data points.

The Fed's Dilemna

"If they sell the assets, it is clearly going to have a pretty big impact on the long end of the bond market, depending on how they do it, when they do it, and the speed at which they do it," said David Zervos, bond market strategist with Jefferies & Co.

Even if they reach a consensus, many officials want to stay flexible to avoid locking themselves into a course they might need to change later. "It seems to me neither necessary nor advisable to decide upon a single game plan that will be announced in advance and rigidly implemented," said Daniel Tarullo, a Fed governor, earlier this month.

Fed staff in the coming week will present models to forecast how different approaches to reducing the portfolio might play in markets. But some officials worry that they have little experience selling assets and can't rely exclusively on models to predict how markets will react. That—and a worry about disturbing the vulnerable housing market—has top officials inclined to proceed gradually and cautiously, at a predictable pace.

I can tell you right now that the Fed's models will end up being way too optimistic. Remember the models that took skewed historical housing data (because of Mr. Greenspan and negative real interest rates) and predicted never-ending rising home prices? If your inputs are out of wack, your outputs won't come out clean.

The most realistic scenario is for housing to stagnate as mortgage originations dry up. While this won't result in an utter collapse in housing, it does suggest further declines lie ahead. Investors should tread cautiously; markets are currently trading based on a strangely familiar speculative fever.

This post has been republished from Moses Kim's blog, Expected Returns.

Obama Pits Main Street Against Wall Street

President Obama employed populist rhetoric over substantive discussion to cast banks and Wall Street as the primary villains as he worked to ramp up support for the Democrats proposed bank reform and regulation bill. Glenn Hall from The Street states that by turning the financial industry's profits into greedy indictments, the President overstated his case that Wall Street and Main Street are at odds with one another; on the contrary, the bullish market has created value for numerous IRAs and 401Ks held by the citizens of Main Street. See the following post from The Street.


President Obama is totally overstating the MainStreet vs Wall Street conflict to scare Congress into passing new banking regulations.

"Some on Wall Street forgot that behind every dollar traded or leveraged, there is family looking to buy a house, pay for an education, open a business, or save for retirement," Obama said Thursday in New York.

That's got a nice populist ring to it, but it's not that simple. What about the value to MainStreet from all the money flowing into 401Ks and IRAs courtesy of a bank-led bull run in the markets?

I'm sure Obama understands the nuances, but they aren't politically expedient. It's far more effective in Washington to have clear villains.

So Obama's SEC delivered Goldman Sachs' (GS) head on a platter with its fraud charges last week.

It doesn't matter that the SEC's case against Goldman is lame, the public has been put on notice that banks can't be trusted.

With the stage set, Obama is now in New York today, taking the fight straight to Wall Street. Just when it looked like Congress might waste a good crisis (as Rahm Emanuel, Hillary Clinton and other Obamanistas have become fond of saying), Obama is putting on a full-court press against banks.

IMF Bank Proposals Face Hurdles (Forbes)

Obama's timing is deliberate, arriving in New York just after the banks started getting good press with headlines like "Morgan Stanley's (MS) Trading Business Delivers" and "JPMorgan's (JPM) Success Raises Stakes".

Even the oft-maligned poster child for the financial crisis, Citigroup (C), posted a surprise profit.

Obama took the opportunity to turn those profits into indictments, saying that "until this progress is felt not just on Wall Street but Main Street we cannot be satisfied. Until the millions of our neighbors who are looking for work can find jobs, and wages are growing at a meaningful pace, we may be able to claim a recovery - but we will not have recovered."

Sure, Obama offered a few bones to the bankers and struck the occasional conciliatory note such as his concluding remarks that "ultimately, there is no dividing line between Main Street and Wall Street. We rise or we fall together as one nation."

But Wall Street really served as the backdrop for Obama's populist appeal to rally MainStreet and remind members of Congress that an election is coming and they don't want to be on the wrong side of this debate.

Obama knows how to work a crowd -- and after today's speech in New York, he has put bank reform back on America's agenda.

This article has been republished from The Street, an investment news and analysis site.

Several Players Caused The Financial Crisis

While many are focused on figuring out who to blame for last year's banking crisis, the real question should be on how the bubbles could have been avoided. Wall Street's greed, politicians desire to promote faux prosperity for the purposes of maintaining a happy and passive electorate, and individuals own desires for the trappings of prosperity - despite their lack of ability to afford it - are all to blame for the current disastrous state of the US financial system. See the following post from The Mess That Greenspan Made.

One look at yet one more story about how the world should assess and assign blame for the ongoing financial crisis, this one appearing over at the Wall Street Journal Real Time Economics Blog the other day titled No Resolution in Sight in Fed Blame Game, has belatedly brought me to the conclusion that, for years now, nearly everybody has been asking the wrong question about blame for the financial crisis.

Of course there was no one person or one group that was primarily responsible for the financial crisis - clearly it took many players to cause a mess as big as the one that we now have on our hands.

Yet, that’s the question that everyone seems to want answered in recent years.

Who caused it?

Which individuals, what organizations?

If ever there were a good example of a group effort, the housing and credit market bubbles and their inevitable demise were surely it and seeking to find the one group that was most responsible is really an exercise in futility because no one fits that bill.

Ultimately, it’s not a very productive exercise either, save for the astonishingly consistent repetition by the nation’s central bank that low interest rates were not to blame. That, by itself, speaks volumes about where we are in the process of understanding what has happened since 2008 and fixing it.

Maybe a better question to ask is, who could have prevented it or stopped it?

After all, there is merit to the argument that capitalism is, by its nature, prone to bubbles, so, maybe it would be a good idea to learn how to stop them.

What individual or group had it in their power to prevent the financial market meltdown but, for whatever reason, chose not to?

Who’s to blame for allowing it to get so bad?

While one could argue that these two are the same question – who caused it versus who could have stopped it – for all practical purposes, the list of candidates for the former is far bigger than the latter and, without doubt, the answer to second question is far more important for the future, that is, if anyone in government or industry is seriously interested in preventing this sort of thing from happening again, something that appears to be in question given the progress on financial market reform so far.

In the West, the powers that be may already understand – either consciously or subconsciously – that financial bubbles are about all that’s left to offer the masses the illusion of prosperity, actual prosperity now seeming to slip further and further from our collective grasp with each passing year.

Consider how many aspiring retirees who resisted the temptation to sell their stocks a year ago may now be looking at their investment portfolio thinking that, maybe, just maybe, things really are turning around?

Despite the growing fears that, at this very moment, policymakers are in the process of blowing more bubbles, a shrewd 401k investor might now understand that the nation’s economic problems can only be postponed – not fixed – and that they just might be postponed long enough for them to cash out in another year or two with a decent retirement stash.

It’s become clear to millions of Americans that the Washington-Wall Street connection isn’t really working in their interests anymore (if it ever did) and that, perhaps, neither group has any real interest in real reform because they know it will be the end of business as they’ve come to know it.

Pretending to fix problems in Washington while remaining loyal to vested interests on Wall Street seems to be a much surer way to extend and enrich careers, respectively, and little else seems to matter.

Casting aside the unpleasant possibility that, in the end, it may be pointless to ask a better question about who to blame for the financial crisis, let’s go ahead and try anyway.

Realistically, who could have or should have prevented the financial crisis?

Wall Street? Sure, if you just fell off the turnip truck

The folks on Wall Street could have kept things from getting out of hand, but why would they? Especially the biggest firms who, as we’ve all learned, are too big to fail. Had they eschewed the madness that was business as usual during the middle of the last decade they may have gone out of business for lack of business. Motivated by earning good bonuses – not by doing good deeds – precludes this cast of characters from doing anything that will not fatten the bottom line and that includes putting the firms very existence in jeopardy.

It’s really as simple as that and that includes the rating agencies.

Every business wants happy customers or it knows the customers will go elsewhere – that includes Goldman Sachs if you’re John Paulson or Moody’s if you’re Goldman Sachs.

Over the years, Wall Street firms have proved that they’ll do everything they can to earn a buck, coming right up to that line separating what’s legal and what’s not and sometimes even crossing it.

Realistically, no commercial entity on Wall Street should be expected to do what is prudent rather than what will make the firm boatloads of money (as long as it’s legal) and anyone who thinks they would or should is naive.

Washington? Why? Faux prosperity has never worked better

Priority number one for anyone in or headed to Washington as an elected official is to remain an elected official, so, it shouldn’t come as too big of a surprise that, when homeownership rates were soaring back in the 00’s and a hundred million or so American families were getting rich beyond their wildest dreams, Congress and the White House would err on the side of taking credit for the prosperity rather than questioning its durability.

Why ruin a good thing even if you suspected it was all going to come crashing down?

In parts of the country around 2005, state and local governments weren’t citing the dangers of a housing bubble, they were railing against the “affordability crisis” where ordinary people couldn’t afford ridiculously priced housing and, instead of questioning whether home prices were too high, they looked for ways to make the monthly payment on these ridiculously priced houses manageable.

When hundreds of millions of people become wedded to the idea that rising asset prices are in the national interest, it makes little sense to think that the nation’s leaders would do much to stop those asset prices from rising, regardless of the consequences.

Individuals? Why? Faux prosperity has never felt better

At the rate we’ve been having asset bubbles over the last 10 or 20 years, it might be a good idea to start teaching high school students about them and, perhaps, the damage that they cause will be mitigated in the future. A good place to start would be to make these two books required reading in about 10th grade:

* Extraordinary Popular Delusions & the Madness of Crowds by Charles Mackay
* Manias, Panics, and Crashes: A History of Financial Crises by Charles Kindleberger

Absent this sort of common sense advice about how to avoid owing $300,000 on a house that is only worth half that amount, there is little hope that individuals will be able to avoid being pummeled by asset bubbles let alone prevent them from occurring or stop them in their tracks.

Joe Sixpack will never really understand those loan documents he’ll keep on signing and the allure of a 25 year-old mortgage broker making a half million dollars a year by burying Joe Sixpack in a loan he can’t really afford is far too powerful to resist. Besides, prosperity – however fleeting – is better than no prosperity at all.

Regulators? Maybe, but remember who they work for

Some might think that one of the policy objectives of the Federal Reserve is financial stability, but it’s not. Yes they talk about it a lot – especially in the last couple years – but, as clearly stated in the Federal Reserve Act, their objectives are limited to prices, employment, and interest rates. Yes, they watch what goes on in banks’ balance sheets but, as we’ve learned the hard way in recent years, that’s not where the real action is.

With the unstated (but widely acknowledged) additional responsibility to protect and, if necessary, bailout the biggest of the big banks, they should not be expected to bring an end to any sort of activity that benefits their owners and, at this juncture it is important to remember that the Fed is owned by the banks … literally.

The big banks will get rescued if they run into trouble, so the Fed’s position is “let ‘er rip”.

Fed chairmen who don’t do the banks’ bidding don’t last very long and those who do stick around forever – you have to look no further than former Fed chairmen Paul Volcker and Alan Greenspan.

As for the other hodgepodge of regulators in Washington, they’ll continue to trail badly the financial innovation occurring on Wall Street and will always prevent the last crisis from happening again, all of which will do nothing to prevent the next crisis.
Nobody? Unfortunately, you’ve reached the correct answer

If there is one thing that can be learned from the events of the last few years and more recent efforts to institute meaningful financial reform, it is that the system, as currently designed, is incapable of fixing itself.

Sure, there will be lots of nice speeches, in fact President Obama is making one today right there in New York, and there will be contrition from many Wall Street professionals but, in the end, the symbiotic relationship between Washington and Wall Street simply has too many incentives that are far too powerful for mere mortals to resist.

We may as well resign ourselves to even bigger and more damaging asset bubbles and financial crises in the years ahead with the next one likely already in its gestation phase.

In the West, that’s about the best we can hope for.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

When Will Global Debts Reach The Tipping Point?

Even as the global economy begins to recover, a new IMF report warns that growing sovereign debt could create a new global financial crisis. One of the largest threats to the potential new crisis is the level of underperforming private assets that have been transferred to the public sector, creating long-term debt obligations for many countries. See the following post from The Capital Spectator.

We’ve heard it before, but the IMF is telling us again: there’s a lot of debt sloshing around in the global economy, and more is on the way. The question before the house: At what point will ballooning deficits reach the financial tipping point? Whatever the answer, we seem to be moving closer to that hazardous peak. That doesn't mean we're destined to reach it, but the alarm bells are now ringing loud and clear.

“The global financial system and the world economy are slowly regaining their health, thanks in large part to unprecedented interventions by governments,” the IMF advises in its newly published Global Financial Stability Report. “But the sharp rise in government debt during the economic crisis from already elevated levels helped create… the newest threat to the financial system: growing sovereign risk.”

A chart from the report summarizes the trend. The ratio of sovereign debt to GDP in the G7 countries is approaching 120%, which is near a 60-year high. "Some sovereigns have also been vulnerable to refinancing pressures that could telescope medium-term solvency concerns into short-term funding challenges," the IMF advises.



Sovereign risk has been a topical subject of late, including on these digital pages, such as a look earlier this month at new red ink commentary from the Bank for International Settlements. In broad terms, the IMF essay doesn't really bring anything new to the table, although it certainly adds a powerful voice to the mounting list of alarms issued from economists and other observers of the macro scene.

The core issue, the IMF asserts, is that "the biggest threats have moved from the private to the public sectors in advanced economies. Governments not only took on many of the bad assets from private institutions but due to the recession face continuing heavy borrowing needs for the next few years."

In another graphic from its report, the IMF contrasts recent trends for several macroeconomic risks. As the chart below shows, the IMF counsels that sovereign credit risk has worsened since last October—in sharp contrast to the otherwise improving state of the macroeconomic environment.



The good news is that the "the world economy is recovering from the global crisis better than expected," the IMF advised in another report, which was published today. That's no small trend in generating the cash flow needed to pay down the world's rising debt load. "In its latest World Economic Outlook (WEO), the IMF said among the advanced economies, the United States is off to a better start than Europe and Japan," according to a statement. "Among emerging and developing economies, emerging Asia is leading the recovery, while many emerging European and some Commonwealth of Independent States economies are lagging behind." The new WEO projects that world economic growth this year will 4.2%, up from the predicted 3.9% in January. And the U.S. will grow by 3.1% in 2010, up from the 2.7% forecast from earlier this year, according to the IMF. But even amid this encouraging outlook, the statement added that "sovereign risks in advanced economies could undermine financial stability gains and extend the crisis." The forces of light and dark are headed for battle.

"When investing abroad, it's always important to look at the country's sovereign rating," writes Randy Epping in The 21st Century Economy--A Beginner's Guide. "Usually, a sovereign government is almost always a better credit risk than a company in that country. This is because the government, in theory, will always be the last to go bankrupt." But perhaps This Time is Different.

This article has been republished from James Picerno's blog, The Capital Spectator.

30 States Take Out Loans To Pay For Unemployment Benefits

California and more than 30 other US states have taken out loans to pay for jobless benefits. With repayment of these loans starting in 2011, many of these cash-strapped states have raised unemployment insurance taxes - further discouraging employers and potential employers from adding new jobs to the economy. See the following post from Expected Returns.

California takes down the prize for being the state with the worst finances, followed closely by abut 40 other states. States are starving for cash, which will result in higher taxes and cuts in services. States can't even come up with the cash to insure millions of unemployed Americans who are watching this apparent economic recovery unfold from the sidelines. From Reuters, California leads in borrowing for jobless benefits:

The Golden State has borrowed $8.8 billion so far to cover jobless benefits during a recession where the national unemployment rate crested above 10 percent. It is not alone. More than 30 states have had to take out similar, albeit smaller, federal loans to keep their unemployment benefit systems afloat.

Their combined debt tops $40 billion and the U.S. Labor Department expects 40 states to be in debt to the federal government by year's end, underscoring the labor market's problems in the deepest recession since World War Two.

To give cash-strapped states a break, the federal economic stimulus program enacted last year suspended interest on the loans to states for two years. Without an extension, interest payments resume next year and Washington could raise payroll taxes on employers in delinquent states if loan balances remain outstanding.

State leaders fear that would derail a jobs recovery which they need so employers replenish bare state coffers and enable states to repay the unemployment loans.

States will have to start repaying loans to the federal government in 2011 at around 5% interest. This is money that is coming directly from states budgets at a time of crisis. One must question how long states can defer the repayment of debt into the future before a crisis unfolds.

Rising Taxes Guaranteed

By 2012 employers in 25 states, including California, New York and Texas, could face rising federal payroll taxes if unemployment loans remain outstanding, which analysts expect they will, said Rich Hobbie, executive director of the National Association of State Workforce Agencies.

"They can't completely solve their problems in the near term," Hobbie said. "If we have eight years of sustained growth as we had back in the 1980s then the states have a shot of repaying their loans."

In order to raise cash, states have raised unemployment insurance taxes. The net effect is that employers are even more wary to hire new workers, which makes the unemployment situation even worse. Taxes are bound to increase, although the proper response in this situation would be to cut spending dramatically. But we know this isn't going to happen.

This post has been republished from Moses Kim's blog, Expected Returns.

More Sovereign Default Risk May Be On The Horizon

As the developed economies of the US and other countries continue to accumulate levels of debt not seen since WWII, the IMF has warned that there is the danger of higher interest rates and slower growth that could threaten global economic recovery. As the debt crisis in Greece demonstrates, unless other countries stop increasing their entitlement spending, it is only a matter of time before they, too, will have to take drastic measures to avoid currency devaluation. See the following post from Expected Returns for more on this.

From the Washington Times, IMF: Mounting debt threatens global recovery:

Historic levels of government debt in the developed world could throw the global financial system back into crisis and clear plans are needed to bring it under control, the International Monetary Fund said Tuesday.

In one of its first broad surveys since the recent recession gave way to renewed growth, the agency said that "sovereign risk" -- the chance that sovereign nations have racked up so much debt they won't be able to borrow enough money to pay their bills -- is now perhaps the central threat to the global financial system.

Governments in the United States and across Europe have accumulated levels of debt not seen since World War II as the recession crimped tax receipts, spending rose on entitlement programs, and emergency measures were put in place to support the economy.

The staggering debt levels in developed economies will be of concern in the years ahead. To put it plainly, it's time to pay the piper for years of debt accumulation. Investors will have to reasses whether current yields are justified in light of the risk of currency devaluation. Current yields are more a function of speculation and direct government intervention than fundamentals. In the end, fundamentals always win.

Gold at $1,140 dollars suggests that sovereign debt remains an issue for investors. The simple-minded will tell you gold is a bubble; the truth is, gold is the canary in the coal mine signalling sovereign debt concerns.

Interest Rates Rise, Death Spiral Begins

"The crisis has lead to a deteriorating trajectory for debt" among developed countries, which could cause higher interest rates and slower growth and weaken the broader financial system, the IMF said. Government debt could "take the credit crisis into a new phase, as nations begin to reach the limits of public sector support for the financial system and the real economy."

The most acute government debt problems are currently in Greece, whose government is negotiating a rescue plan with the IMF and other European nations but has already had to cut social benefits and raise taxes.

"Greece is a wake-up call" for the rest of the developed world, IMF's head of capital markets, Jose Viñals, said at a briefing about the report.

The debt crisis in Greece is just the tip of the iceberg. Time will tell if the Greek economy can recover with the austerity measures imposed upon them. If the potential bailout of Greece follows the pattern of previous IMF bailouts, then the Greek economy is in a lot of trouble. The Euro will come under pressure as the larger European economies follow the path of Greece to default. When Greek debt is trading hundreds of basis points above German debt, you have to start questioning the sustainability of the Euro.

The high yields on Greek debt underly how sovereign risks dictate interest rates, not increasing economic activity. Make no mistake about it: when long-term interest rates in America rise, it will be because of sovereign debt.

Americans should get used to the death spiral Greece finds itself in. Higher bond yields will redirect government revenue to creditors, which weakens the budget position of Greece. The Greek government will raise taxes further in a knee-jerk response, leading to more civil unrest and a stagnant economy. Global players will be searching for a complicated solution to this never-ending crisis when the solution is rather simple. It's called stop spending, stupid.

This article has been republished from Moses Kim's blog, Expected Returns.

Does Extended UI Benefits Increase Unemployment?

Despite the common idea that extending unemployment benefits will result in the unemployed lasting for longer periods of time, recent data analysis indicates that extending unemployment insurance benefits has only a modest effect on the rate of unemployment. While there are always a few who will seek to take advantage of government programs, there can be a good case made that extended benefits are needed during the severe labor market downturn. See the following article from Economist's View.

Republicans have been worried that extensions to Unemployment Insurance are causing higher levels of unemployment, but Rob Valletta and Katherine Kuang of the San Francisco Fed say those worries are unfounded.

Extended Unemployment and UI Benefits, by Rob Valletta and Katherine Kuang, Economic Letter, FRB SF: Unemployment duration, or the amount of time that an individual remains unemployed, reached new historical highs in 2009. The spike in unemployment duration is among the most compelling indicators of the severe economic dislocation caused by the recent recession. At the same time, however, following congressional legislation that temporarily extended eligibility for unemployment insurance (UI) benefits, the maximum period for UI claims also reached new historical highs. As of late 2009, individuals in most states were eligible for up to 99 weeks, or nearly two years, of UI benefits, well above the normal limit of six months. The question arises whether this extended availability of UI benefits has contributed to a lengthening of unemployment spells because jobless workers are staying in the labor force longer in order to continue collecting benefits. Such a dynamic could raise the unemployment rate. However, analysis of data on unemployed individuals decomposed by their reason for unemployment, which affects their eligibility for UI, suggests that extended UI benefits have had a relatively modest effect. We calculate that, in the absence of extended benefits, the unemployment rate would have been about 0.4 percentage point lower at the end of 2009, or about 9.6% rather than 10.0%. ... It is not surprising that the disincentive effects of UI would loom small in the midst of the most severe labor market downturn since the Great Depression. ...

When I was a kid in school, I can remember how mad I'd get when the misbehavior of one one or two people would cause the whole class to lose privileges. I hated that.

No matter how hard we try to stop it, people are going to find ways to take advantage of government programs. There will always be one or two people in every "class" who will misbehave, and people opposed to programs will turn them into very public examples of how these programs fail. But these few examples shouldn't stop us from doing the right thing and helping all the people who use these programs as intended, people who rely upon them when, say, they lose jobs due to a poor economy.

The problem isn't lazy workers taking advantage of government programs as some would have you believe. Job openings are few and far between, and until that changes workers will continue to have difficulty finding employment.

This article has been republished from Mark Thoma's blog, Economist's View.

Anecdotal Data Suggests Consumers Spending Mortgage Money On Goods

Paul Jackson from HousingWire defends his observation that many defaulting homeowners are likely spending their mortgage payments on consumer goods instead. Despite the lack of data to prove this claim, several economists have surmised that this could be a trending behavior. See the following post from HousingWire.

A few weeks ago I pondered out loud if millions of troubled homeowners, without the burden of a monthly mortgage payment, were instead spending their money on other things — and if that might explain at least some of the recent strength in consumer spending.

Wow, did that ever open a can of worms.

I’ve since been called brilliant or stupid, not to mention pretty much everything in between. The idea has made it into the mainstream pretty quickly, with economists of the likes of Robert Shiller of the S&P/Case-Shiller Home Price Index and Mark Zandi over at Moody’s Economy.com telling CNBC the idea has some merit. Those of you attending the REOMAC conference last week (a real estate show for those specializing in residential default management) might also have also heard economist Christopher Thornberg of Beacon Economics talk about the idea, as well.

Others have somewhat predictably panned the idea that distressed borrowers are contributing to either retail spending or consumer spending figures, with well-known financial commentator Barry Ritholtz over at the Big Picture blog taking me to task for suggesting that deadbeat borrowers were having any impact at all. Ritholtz called the idea “ass backwards,” and suggested that I needed to consider “doing actual research.”

Ritholtz’s opinion notwithstanding, I stand by the idea, although I think some additional clarification is warranted. In my original column, I highlighted a case study published over at the excellent Calculated Risk blog about a HAMP application at a large servicer, and implied that the spend-happy profile was more than just a single, deviant case.

What I didn’t do was explain why I believe this to be true. Ritholtz, for one, bases most of his objections on the premise that I “never bothered to ask” the guest poster at Calculated Risk — code-named Shnaps — if the HAMP applicant in question was an outlier, as he believes the case to be.

What Ritholtz doesn’t know (ironically enough, because he didn’t ask) is that Shnaps and I have spoken at length and numerous times about this very issue. I also speak to numerous other servicers (beyond just Shnaps’ current employer) on a regular basis, as part of running this media platform.

Here’s the truth: as unfortunate as it may be, there are in fact many mortgage holders in distress that do fit the spending profile at issue here; but precisely how many? No one really knows, since there isn’t any real data on it. The sense I get from the servicers and loss mitigators I’ve spoken with thus far is that “spending the mortgage” is already quite prevalent among aged delinquencies and in certain geographic locations, and is becoming even more common over time as the number of mortgages “held up” in the default pipeline continues to grow.

One servicing employee I spoke with this past week told me the following: “It feels almost like one in two [hardships] I see, someone in a household has lost a job or seen a cutback and the old income level is gone. It used to be that we would see a track record of attempting to adjust spending habits, going through savings, loading up credit cards, the usual. Not now. Now, I see more where they [the household] decides the minute the job is lost that so is the mortgage, and other spending keeps on going.”

I think most Americans, too, if they look at their own neighborhoods, will likely know of someone that may be in default on their mortgage — and yet can be seen spending heavily on consumer goods. In our neighborhood, for example, I can think of one household defaulting for strategic reasons that just purchased a brand new car. I know I’m not alone on this, either.

The point here is that truth, as with most things, most often lies somewhere in between two extremes: not every defaulted mortgage holder is out spending money that might have gone to a mortgage payment or rent, of course. Our nation’s jobless rate is through the roof, and as a result many good people simply don’t have a job (or enough of one) to pay their mortgage.

But the majority of households in the US are now also dual-income — 80% or so of married households, last I checked, and married households represent roughly 50% or more of all households in most states. So the loss of a job for many certainly will constrain household income, but doesn’t necessarily push it all the way to zero.

With that in mind, consider that the ratio of total debt payments to monthly gross income is at a median of 77.5% for those borrowers successfully obtaining a modification through HAMP, according to Treasury data. Housing expenses alone represent 44.8% of monthly gross income for this group (prior to modification). And these DTIs apply to the successful HAMP applications; you get one guess to figure out what these ratios look like for the millions more that do not qualify.

It doesn’t take a PhD in economics to see a few key points here. For these households, the non-shelter Maslow basics — food, clothing, and so forth — are able to be met with 22.5% of available monthly gross income.

A household facing loss of income can, therefore, rationally lop off 77.5% of its expenses by simply choosing not to perform on its consumer debt, and/or lop off 44.8% of its expenses in one fell swoop simply by defaulting on the mortgage (and still meet household shelter needs, for free). It’s quite possible, in fact, that doing so is often more than enough to offset whatever loss of income is being experienced by many households.

Retail and food spending for March 2010 came in at $363.2bn, up 1.6% from $357.5bn in February. That’s an increase of $5.7bn, month-over-month. I threw around a rough figure of $3.7b per month as the “delinquent spending” figure in my original column (using admittedly back-of-the-napkin math), but have since seen other estimates above that number.

All of my years of studying econometrics did manage to teach me one very important lesson: Economics isn’t always about whiz-bang analysis of data. At the end of the day, that data is supposed to capture meaningful behavior — which is what ultimately gives any analysis its context. In this case, we have ample evidence of how households are behaving, even if it’s the sort of anecdotal and qualitative evidence that quants tend to discount.

In a nascent and fragile economic recovery, choosing to ignore anecdotal evidence simply because it isn’t “rigorous enough for real analysis” is a great way to miss an important trend.

This post has been republished from HousingWire, a mortgage and real estate news site.

Is The Window Of Opportunity Closing For Gold Investment?

Moses Kim writes that the Goldman Sachs fiasco will further undermine the public's confidence in financial institutions and government, fueling the next bull run for gold. While many investors view gold as risky at its current price, Kim believes that explosive gains are in the future. See the following post from Expected Returns.

The latest SEC investigation of Goldman Sachs has brought down most asset classes, including gold. Of course this makes no sense whatsoever, since the secular bull market in gold is driven by factors outside Goldman's packaging of esoteric securities to unsuspecting investors. However, short-term moves often defy logic, and it is the job of the long-term investor to block out day-to-day noise.

Technically, gold is consolidating once again after failing to sustain a breakout above $1,160. Support lies at $1,130 and $1,100. Below $1,100 support lies between $1,070-$1,080. Gold is still trading above its 30-day moving average, so the technical damage of Friday's sell-off was minimal.



On a fundamental basis, the sell-off on Friday was a dream come true. Keep in mind the rhythm of bull markets- consolidation, breakout, consolidation, breakout. As a long-term investor, prolonged periods of consolidation are to be welcomed with both hands. A basic rule of technical analysis states that the magnitude of the breakout is proportional to the period of consolidation. Viewed in this light, gold bugs should be praying for an extended consolidation period.

Now let's think logically for a second about the repercussions of increased regulatory scrutiny of financial institutions. Although most people with a brain know that Government Sachs has been operating a crime syndicate for years, there are obviously people who live in a constant state of oblivion. As more allegations of wrongdoing come to light, the general population will lose confidence in financial institutions and the government, since the government failed to identify fraud as it was happening. This is all to be expected in a cyclical move from paper assets to hard assets.

Gold will benefit from the growing distrust of the government. We are in the middle of a long-term cyclical bull market in gold, and the truly explosive moves lie ahead. Patience and discipline are the name of the game moving forward.

Gold is still flying under the radar and investors are still hesitant to buy. The window of opportunity to accumulate is closing, so investors should be focused on accumulating right now. However, how many people will actually buy at these levels? We all know most people have trouble buying gold above $1,000 dollars since it is so "expensive." Ironically, these are the same people who will be waiting on lines around the block at gold shops to buy above $2,000 dollars. Human nature is a funny thing.

This article has been republished from Moses Kim's blog, Expected Returns.

Wall Street Giants Fight For Freedom To Take Risks

Stanley Bing rails against opponents of financial regulation in this satiric article from The Street. While there is a good argument that over regulation can stifle innovation and investment, there are some behaviors on Wall Street that should clearly be limited. See the following post from The Street.

Discouraging news from Washington today. It seems like the enemies of the benign free marketplace are set to triumph over the protectors of the right of every American to get hosed by an unregulated banking industry.

Yesterday it was revealed the Lehman Brothers, before it coughed up other people's money and died, used an alter-ego called Hudson Castle, which it controlled, to conceal its debt and associated risk.

This is the kind of thinking that will be cruelly squashed if these foes of unrestricted creativity get their way in Congress. The signs are increasingly grim in this regard .

The Wall Street Journal reports this morning that "Wall Street giants... had been pressing hard in recent days to dilute provisions of the bill that would change the rules for derivative trading. But the Obama administration, which has made this one of its priorities for the financial-regulatory bill, has pushed back hard and appears to be succeeding. "

Naturally, the protectors of our economic growth in the Republican Party are doing their best to stand fast in the fight for the under-regulated marketplace. In doing so, these courageous voices for liberty represent the interests not only of Goldman Sachs(GS), JPMorgan Chase(JPM) and Morgan Stanley(MS), the firms who have been leading the financial freedom-fighters from the right flank, but for all who value license over restraint, unfettered access to profits by the strong, and the creative spark that has fueled the American dream for those already quite wealthy.

Those who are with these imperiled interests -- the time is now to stand up! To take the flag from their failing grasp and raise the standard high!

If you believe in the right of financial institutions to sell you derivatives that are insufficiently capitalized, stand up!

If you believe that people who have money should be able to offer loans to anybody, regardless of their ability to pay them back, repackaging those loans until it takes a forensic accountant to figure out who owns them, speak!

If you believe in the right of those who hold your money to move around loans as if they were assets and assets as if they were debt, be counted!

If you believe that the creativity of Wall Street should be a force for enormous gain for those who know how to manipulate the tools of investment capital, and that their prodigious wealth will somehow reinvigorate our stalled economy, speak up now or forever hold your peace!

If you yearn for the days where somebody could offer you 20% per year on your money without being investigated by the SEC, when all the operations in Washington were run by proponents of freedom and economic liberty, find your voice!

The ship of state is sailing. We are heading into a dark Sargasso sea of rationality, responsibility and constraint, and soon it will be too late. Speculators of the world, unite! We have nothing to lose but our chains!

This post has been republished from The Street, an investment news and analysis site.