Gleanings II – 479 Compliments of Nick Rost van Tonningen Posted by John on September 28, 2012

I lived happily without a TV for the best part of a decade. But when I recently moved, cable was included in the rent. Last Sunday (September 23^rd) was Day 7 of life with TV. Until then all I had done was to rotate through various news channels (all the while disappointed it does not include al-Jazeera News) during those parts of the day that CBC Radio turns away from news & current affairs, and ‘goes artsy-fartsy”. In six days I didn’t watch a single program. Until Sunday morning. I am a huge fan of Fareed Zakaria (& his GPS program Sunday mornings on CNN). And I was in luck; for he featured Bill Clinton whom he at one point put in an awkward position when he asked him about Romney’s idea the Israeli-Palestinian issue should be just “kicked down the road”. Clinton, after reminding him he had to be careful since an election campaign is underway & his wife is Secretary of State, noted that time was likely reducing, not increasing, the probability of a two-state solution because there are growing numbers of young Jews in Israel from immigrants parents who have little or no ‘connect’ with Israel’s history & because of the high fertility rates among both the Palestinians & the extremists in Israel – in doing so Romney is likely catering to the Evangelical Right in the GOP which shares the settlers’ view that “the historical lands of Judea & Samaria”, i.e. the West Bank, belong to them, & to them only, and not to a bunch of Palestinian rag heads.

The WSJ recently had an op-ed piece by five economists, incl. the now 91 year-old former Reagan-era Secretary of the Treasury, George Schultz, that made a number of points, including

• annual federal spending has increased by about US$1TR since 2007 while revenues have changed but little. The resultant US$1+TR annual deficits have increased the average American households share of the national debt by US$55,000;
• much of the Federal debt is very short term. This has two consequences. The federal deficit this year will be US$1.2TR, but the Treasury must sell US$4TR of securities to fund it. And when interest rates go up, as they will, the cost of debt service will explode;
• the US income tax system is quite progressive with 1% of Americans paying 37% collected & 50% paying none – this is only true as far as it goes; for in 2010 personal income taxes amounted to just 40% of all federal revenues, down from 50% in 1998, as payroll taxes rose from 30% to 40% & corporate income taxes declined from 10% to 5%;
• in the last fiscal year about 75% of the Federal deficit was funded by the Fed, most of the rest by foreigners & hardly any by Americans. The Fed now owns 14% of the national debt (a larger share than even at the end of WW II) & large portions of other markets as well; and
• the banks’ reserve balances with the Fed have grown from US$8BN in September 2008 to US$1.5TR today (i.e. almost 200x); so, even with  a 0.25% interest rate thereon, the Fed is giving the banks nearly US$4BN/year (which will increase when rates rise).

It concludes by saying “we risk passing an economic, fiscal and financial point of no return. The problems are close to unmanageable now. If we stay on the current course, they will wind up being completely unmanageable, culminating in an unwelcome explosion and crisis.”

Following are comments on QE3 from three credible people :

Mohammed El-Erian of PIMCO : the Fed “doesn’t have the right tools. Expectations are too high and the Fed needs help from other government entities, but those other entities (the President & Congress) are on strike … If they don’t (cut spending) the investment theme will go from betting on Fed liquidity to positioning for the collateral damage the Fed will create”;

Philadlephia Fed’s Charles Prosser :  QE3 is unlikely to be effective as labour markets are being held back by “frictions and structural adjustments which are not issues that can be solved by monetary policy”;

Paul Volcker (who needs no introduction & who has the advantage of ‘having been there, having done that & having the T-shirt) : “Monetary policy is about as easy as it can get. Another round of QE is understandable but will fail to fix the problem. There is so much liquidity in the market that adding more is not going to change the economy.”

Bernanke is having a problem not dissimilar to that faced by his counterpart in Europe, Mario Draghi, namely that the politicians expect him to do all the heavy lifting while they pretend their noses are bleeding.

In his recent speech to the Harvard Club of New York Dallas Fed President Richard Fisher drew on his US Naval Academy Annapolis. Md. background when he described successive QEs as having the US “sailing into uncharted waters”. Despite all of the Fed’s sophistication, he said, “The truth … is that nobody … really knows what is holding back the economy … (and) nobody has the experience of successfully navigating a return home from the place in which we find ourselves … All we do know is that the system “is flush with $1.6TR in excess private bank reserves … Trillions more … on the sidelines in corporate coffers … and a significant amount  of unemployed cash … burning a hole in the pockets of money markets funds (or rather the people who own those funds?) … This begs the question : Why would the Fed provision to shovel billions in additional liquidity into the economy’s boiler when so much is presently lying fallow? … Meanwhile Congress is doing nothing to incent job creation … Indeed it is doing everything to discourage job creation (by creating & perpetuating uncertainty).” (the italics in “discourage” are his but the others, as usual, mine). He also said that the Fed would likely have been better off putting money directly into our personal bank accounts (for we would have spent it) rather than into the coffers of banks that promptly put it back  into the Fed’s (coffers) – this idea was actually mooted in Gleanings in 2009 when President Obama opted for perpetuating the Bush Administration’s flawed policies).

Fisher also told his audience that, when Sen Charles Schumer (D.-NY) in a recent Senate hearing told Chairman Bernanke “You are the only game in town”, the latter should have told him, rather than the usual pap, “No Senator, you and your colleagues are the only game in town … have encumbered our nation with debt, sold our children down the river and sorely failed our nation. Get your act together … get on with it. Sacrifice your political ambition for the good of our country – for the good of our children and grandchildren. For unless you do, all the monetary accommodation the Fed can muster will be for naught.” – now that would have really put the cat among the pigeons and led to a hue & cry in Congress for Bernanke’s head while in reality such advice, if followed might well have saved the legislators’ bacon since poll after poll suggests that their capsones (an old, derogatory Dutch word of Yiddish origin meaning something like ‘stupid antics’) have led to Americans’ respect for Congress being lower than a snake’s belly (Fisher is a ‘rara avis’ in Fed circles, an MBA with hands-on investment banking & money management experience in a sea of Economics Ph.Ds with backgrounds in academia and/or the Fed itself.

Karl Rove was Bush 43’s strategist & an apt observer of the political scene in the Republican camp & Joe Trippi occupies a similar position of the other side of the political divide. One source claims they can agree on only one thing, namely that Obama is leading Romney in Electoral College votes with 196 in the bag & 51 more leaning his way vs. Romney’s 159 & 32 (with 100 still up for grabs). In other words, as things stand now, Romney would have to garner almost four-fifths of the Electoral College votes still up for grabs to reach the magic 270 threshold(this makes Obama look even better than six recent polls that polled almost 8,000 people during various periods between September 15^th & 23^rd which found him, on average, ahead by 48-46 (& more so in Ohio, a key ‘battleground state’ and the very latest ones that suggest he has opened up his lead considerably more, especially in the ‘battleground states).

Americans see the middle class shrinking & getting poorer. Asked by Pew Research whom they believe carries “a lot of the blame” for this, 58% said Congress, 52% the banks, 47% the big corporations, 44% Bush, 34% Obama & 8% themselves.

A recent survey by the National Federation of Independent Businesses found that since early 2009 poor sales have been its members’ primary concern (the percentage of which doubled in the first year from 15% but since has eased off again to 20%), followed by taxes (stable at 20%) & government regulation (the percentage of which has grown steadily from 10% to 20%).

As of last weekend on the US farm scene as of last weekend, the corn harvest was 39% completed, vs. 26% this time last year & a five year average of 13% (which is not a good omen for the size of the crop), soybean prices had weakened from US$550/ton at the end of August to US$480 (on news the recent rains had come in time to do the crop some good) & the cotton crop was rated 43% Good of Excellent, vs. 29% last year.  

Prime Minister Harper is planning to correct the outrageous terms of Canadian MP’s pension plan to ‘set an example’ (& show his heart is in the right place when the polls suggest his public standing is at an all-time low?). At present MPs contribute just $1 for every $7 the taxpayers kick in. He plans  to raise that to a 50-50 split, meaning MPs’ contribution will almost quadruple, to $40,000+ out of their almost $160,000 annual stipend (that was frozen for three years in 2010) – it is a sign of how much of a rip-off their pension plan really was when henceforth it is going to take one quarter of their salary to pay for half the cost thereof; and if this passes, one should expect a move to increase MPs’ salaries to recover a significant portion of the additional amount they will be required to pay).  The Prime Minister is also proposing to extend the age of entitlement from 55 to 67 to bring it in line with the age at which he intends ordinary Canadians would become eligible for their entitlement pension programs  (all of this to be done, however, with due respect for the pension credits “earned to date” & without any retroactivity). The plan is to be rolled into another “Omnibus Bill” that will amends dozens of laws in one fell swoop (so as to avoid having to have a debate in Parliament on this specific issue).

In all the hullaballoo as to whether the proposed takeover should be allowed to go ahead of Calgary-based Nexen by CNOOC, a company controlled by a Chinese SOE (State-Owned Enterprise), one potential (unintended) consequence thereof has not gotten much attention. Namely that today 80-90% of the world’s known oil reserves under the control of SOEs & that the Alberta oil sands account for much of the remainder. So every SOE investment in the oil sands (& Nexen has some exposure there, even though the lion’s share of its current output comes from elsewhere) further solidifies the stranglehold they have on the industry. By that same token, if rumours are correct that Conoco Phillips will sell part of its stake in six Alberta oilsands properties to three Indian government-controlled  companies this would further accelerate this trend.

As to the oil sands generally, the bloom seems to be coming off the rose a bit for a variety of reasons. Costs have risen, & are continuing to rise, rapidly. Fracking is both making the oil price outlook a bit less bullish and causing companies to reallocate capital to shale oil development where the payoff is more immediate. The industry may be waking up to the fact that there is little use in producing oil where there are no pipelines to take it to markets. All this is starting to let some of the air out of the fiscal balloon of the Alberta government (which just announced that it now expects this year’s budget deficit to be triple its forecast six months ago.

In the seemingly endless European financial saga one important fact has been largely overlooked, namely the fiscal position of the so-called “sub-national” (i.e. local) governments. In this respect Spain is in a class by itself, with their indebtedness being fully 50% of the total tax base, vs. Portugal’s 20%, Ireland’s 17%, Italy’s 8%, Germany’s 7%, the US’ 5% & France’s 2% – this, by the way, also reflects the division of powers between the two levels of government, the higher the rate, the greater the power of the local -, vis a vis the central-, governments.

In China workers are becoming more aware of their rights, and demanding better pay & working conditions even as the economy is slowing. And, in the absence of a safety valve in the form of legitimate means to make their grievances heard, this is creating a pressure cooker environment in which the only option is to ‘take to the streets’. Thus the China Labour Bulletin, which tracks strikes & labour protests, reported a monthly average of 29 such incidents in the first eight months of this year, up from 11 in the same year-earlier period (last weekend’s riot by 2,000 workers at the 79,000-worker manufacturing ‘campus’ in Taiyuan, Shanxi Province, of Taiwan-owned Foxconn, a major supplier of components to Apple, started as a drunken fight between two workers which security guards sought to quell with such extreme force that it quickly escalated to the point where it took 5,000 riot police to restore order – Foxconn employs 1.1MM workers in its plants across China & it was at this very same site that it installed  safety netting around its plant walls last year to catch workers trying to commit suicide by jumping of its roof.

Only in Canada, you say? An Edmonton police officer defrauded his employer by something like a quarter of a million dollars over a period of half a dozen years. A lower court judge sentenced him earlier to time served plus house arrest because he had readily confessed when confronted with the facts, had made full restitution, had done so out of love for his wife (to pay for her fertility treatments) & because he was a police officer. Recently this sentence was overturned on appeal & upped to 18 months in the slammer on the grounds that the judge had made serious errors in judgment, among others by giving him credit for seeking to accommodate his wife’s wishes for having a child (‘having children is not an entitlement’) & treating him more leniently because he was a police officer (‘they should be held to a higher, not lower, standard, lest the police lose their credibility’) – Thank God there are at least some judges left with common sense, even though in practical terms this won’t make much difference since he was given full credit for time already served & will be given more time off for good behaviour.

 GLEANINGS II – 479

Thursday September 27^th, 2012

QE INFINITY : UNINTENDED CONSEQUENCES (Thoughts from the Front Line, John Mauldin)

• While QE3 had been widely anticipated, few had expected “open-ended” quantitative easing with the Fed not only continuing ‘Operation Twist’ but buying US$40BN/month  in agency mortgage paper for as long as “the outlook for the labor market does not improve substantially”; in other words, Bernanke plans to pump US$500BN/year into the system for some time to come (onto a Fed balance sheet that already has ballooned to US$1.5TR), despite growing numbers of economists saying more QE may do more harm than good).
• When Greenspan held rates at an abnormally low level for a long time, its unintended consequence was a housing boom & a debt leveraging bubble (& before that, as a sort of dress rehearsal, the dot.com boom?). So what might be the unintended consequences of this initiative (that some now refer to as “Quantitative Easing Infinity”)?
• While Bernanke won’t be pinned down as to what “acceptable unemployment” levels are, the Minnesota Fed President, who used to be hawkish but now has turned dovish, says that in his view it is 5½% provided inflation remains < 2.25% (which begs the question as to what be “acceptable” once inflation exceeds that level). Doing the math, achieving his target would take at least three years of uninterrupted 3+% GDP growth. But that oversimplifies matters since for official purposes one is not deemed to be unemployed if not actually looking for work; so making provision for the ‘true’ rate of unemployment it may take as much as nine years to achieve his target.

Just about every political decision (& the FOMC’s decision-making is now more political than financial) is later found to have had ‘unintended consequences’. As to real unemployment, the current 31-year low participation rate of 63.50% (down 0.20% MoM & 0.60% YoY, and 3.70% from its recent  early 2008 high) suggests that at least 4MM people are no longer looking for work & that, had they been included, July’s unemployment rate would have been 10.5% not 8.3%.

AS CLINTON SOUNDS INTEREST RATE ALARM, DOES CONGRESS THINK IT’S FOR REAL? (NBC News, Tom Curry)

• He warned on CBS’ Face the Nation on September 23^rd that “If interest rates were the same today as … when I was president, the payment on the debt … would go from $250 billion to $650 billion” (i.e. to almost the same level as the current US$670BN Pentagon budget). He then went on to say that Congress & President Barack Obama “can’t let that happen” & must strike a deal on reducing deficits and the debt. While conceding the US economy is currently anemic, he continued “when the economy starts to grow again and people start borrowing again, and banks starts loaning money to small businesses and not just to big ones, interest rates will go up, because there will be more competition for money.”

His warning is spot on : the yield on 10-year UST’s currently is in the 1.75% range, so their holders  for all intents & purposes get a yield of zip in real terms. No matter what the Bernank’s promises, the fact is that this is way below its 6.00% 60-year average & its 4.75% 30-year average. But he should have stopped there; for the banks have already started growing their small business loan book,  the big corporations are sitting on so much cash they don’t need the banks, & the pressure for higher interest rates won’t come from the demand side but, far more powerfully, from the supply side, i.e. from lenders refusing to play the Fed’s “unusually low interest” game any longer.    

CEO OUTLOOK GROWS GLOOMY (AP)

• The Business Roundtable said on September 26^th that its quarterly survey of CEO sentiment shows that only 29% plan to increase hiring over the next six months, down from 36% in its June survey, and only half what it had been in early 2011 (which had been the highest since it had initiated the survey in 2002). Jim McNerney, the Chairman of the Roundtable & CEO pf Boeing, said CEOs were worried about the pending “fiscal cliff”, the budget cuts & tax increases that, unless Congress acts during the “lame duck” session  between Election Day & yearend, will kick in automatically on January 1^st.

This assumes, & not unreasonably so, that Congress won’t be able get its act together long enough to ‘kick the can down the road” once again before then.  

U.S. HOUSING, CONFIDENCE ON CORRECTIONAL FOOTING (Reuters, Leah Schnurr)

• In July house prices rose for the sixth month in a row, albeit not as much as expected, nor as much as in the month before. Still, Paul Diggle, Property Economist at Capital Economics, & Larry Kantor, Head of Research at Barclays Capital, reflected the view of many of their ilk when the former opined that “even with the broader economic recovery struggling to gain traction, the housing recovery is sustainable” & the latter that “housing will give a stronger boost to the US economy in 2013 as steadily rising prices give Americans comfort the housing crash is past &  may deter people from renting.” Nevertheless, there remain many who warn that a number of hurdles remain, incl. tight lending standards, large numbers of underwater owners & many foreclosures still in the pipeline.
• And the Conference Board’s Index of Consumer Confidence was up 7 points MOM to 70.

This seven point jump seems hardly warranted by events in  past 30 days; and in going public with this  number, the Board’s spokesman took the opportunity to point out that really positive consumer sentiment doesn’t kick in until the Index hits 90 & that there are still “more pessimists than optimists out there.” And elsewhere it was reported that in August the median household income was down 1.1% (to a level 5.7% below what it was when the current recovery got underway).

BACON ON THE BRINK (NP, Tristin Hopper)

• A UK group, the National Pig Association, has come out with a warning that skyrocketing prices for soybeans & corn (& to a lesser extent other grains?) have already begun to dramatically shrink European pig herds. This came less than two weeks after Canada’s second-, & fourth-, largest pig producers filed for creditor protection.
• Although pork is scorned by Muslims, Jews & Rastafarians (& some fundamentalist Christians) total annual global pork consumption is in the 100MM tonne range (i.e. 15kg/33 lbs per capita) “because the Chinese eat so much” (of it).  Canada is the world’s third-largest exporter, shipping out $2.6BN of pork products annually, most of it to the US & Japan. While one Manitoba swine breeder expects pork prices by next summer to be the “highest in history”, it is unlikely to ever completely disappear from store shelves; consumers will just have to get used to laying more for their bacon & sausages.

If pork prices head North, can chicken (& eggs) be far behind? And…? And …? The way the hog industry works, the immediate effect of such downsizing is to have a depressing effect on prices because the normal supply is augmented by animals that otherwise would have been kept for breeding purposes (in the case of hogs this may last, albeit increasingly less so with the passage of time, for as long as 8 months, i.e. the conception-to-slaughter interval. But after that the hammer will come down with a vengeance. And the way the system seems to operate, once significantly higher prices are locked into it, they tend to be sticky on the downside, even if next year we were to have corn coming out of our ears.

BARAK BACKS POSSIBLE PULLOUT FROM WEST BANK (G&M, Josef Federman)