Government Stimulus

We are a long way from really resolving the argument between the Keynesian and Austrian economic theories, despite some so-called experts proclaiming Krugman's victory this week. The discovery of the calculation error in the Reinhart/Rogoff study does little to change the overall premise that excessive debt levels impede economic growth and have, historically, led to the fall of economic empires.  All one really has to do is pick up a history book and read of the Greeks, Romans, British, French, Russians and many others. Does fiscal responsibility lead to short term economic pain?  Absolutely.  Why would anyone ever imagine that cutting spending and reducing budgets would be pain free?  However, what we do know is that the path of fiscal irresponsibility has long term negative consequences for the economy. In the meantime we can continue to ignore the long term conseqences in exchange for short term bliss.

Data are hard to deal with when your vision is on the wrong side of it. Those wanting to claim there is a recovery underway are having just this problem. These people either have no understanding of economics or they believe falsely that they can inflate “animal spirits” with their hyped reports and that will initiate a recovery. There will not be an economic recovery given the economic policies of this country. A recovery is not unlikely, I would argue it is closer to impossible if not impossible. The reasons for this position are not complicated. In short, the nation has become an out-of-control welfare state that is rapidly destroying the incentives to work or create jobs. Government policies appear designed toward this end. One doesn’t need a high IQ or  an advanced degree in economics to understand the problems. There are innumerable factors responsible for the decline of the US. These three important ones will convey why the economy is dying...

Pop quiz:

Q. What is the fiscal multiplier on $529 in government stimulus?

A. If you are Fisker Automotive, zero.

While the terminal fate of the federally-subdizied car company was no secret to anyone, there were some questions when this latest example of idiotic government "capital allocation" would get Solyndraed. The answer is now.

This week's events show that the Chinese government realises that its stimulus efforts have got out of hand and its economy is in trouble.

• When the cash runs out: Nokia to Omit Dividend for First Time in 143 Years (BBG)
• Passing Debt Bill, GOP Pledges End to Deficits (WSJ)
• Japan logs record trade gap in 2012 as exports struggle (Reuters)
• so naturally... Yen at 100 Per Dollar Endorsed by Japan Government’s Nishimura (BBG)
• Japan rejects currency war fears (FT)
• In Amenas attack brings global jihad home to Algeria (Reuters)
• Investors grow cagey as Italy election nears (Reuters)
• Mafia Victim’s Son Holds Key to Bersani Winning Key Region (BBG)
• Bernanke Seen Pressing On With Stimulus Amid Debate on QE (BBG)
• U.S. to lift ban on women in front-line combat jobs (Reuters)
• Red flags revealed in filings of firm linked to Caterpillar fraud (Reuters)
• Apple Sales Gain Slowest Since ’09 as Competition Climbs (BBG)
• Spanish Jobless Rate Hits Record After Rajoy’s First Year (BBG)
• North Korea Threatens Nuclear Test to Derail U.S. Policies (BBG)

Presenting Dave Collum's now ubiquitous and all-encompassing annual review of markets and much, much more. From Baptists, Bankers, and Bootleggers to Capitalism, Corporate Debt, Government Corruption, and the Constitution, Dave provides a one-stop-shop summary of everything relevant this year (and how it will affect next year and beyond).

Following some well-timed 'suggestions' in Natural Gas and Apple this year, the new bond guru has some rather more concerning views about the future of America. Reflecting on a dismal outlook progressing due to the fact that "Retirees take resources from a society, and workers produce resources", Gundlach has cut his exposure to US equities (apart from gold-miners and NatGas producers) noting their expensive valuation and low potential for growth. In a forthcoming Bloomberg Markets interview, the DoubleLine CEO warns we are about to enter the ominous third phase of the current debacle (Phase 1: a 27-year buildup of corporate, personal and sovereign debt. That lasted until 2008, when Phase 2 started, unfettered lending finally toppled banks and pushed the global economy into a recession, spurring governments and central banks to spend trillions of dollars to stimulate growth) as deeply indebted countries and companies, which Gundlach doesn’t name, will default sometime after 2013. "I don’t believe you’re going to get some sort of an early warning," Gundlach warns "You should be moving now."

Farce #1: “Market value” and “free markets” have become a joke.

Farce #2: Private, self-assigned, fake value is being traded for public money at 100 cents on the dollar.

Farce #3: Printed money is backed by nothing.

Farce #4: We have a “free” enterprise system dominated by monopolies that force people to buy inferior goods and services at exorbitant rates.

Farce #5: High-level financial crimes, no matter how egregious or widespread, are not being prosecuted.

Farce #6: Risk is gone. Now there is only liability borne by citizens.

Farce #7: Productivity has been supplanted by parasitism.

Today Europe awakes to yet another Eurozone summit, one at which such topics as Greece, Spain, the banking union project or a economic/budgetary union will have to gain further traction, if not resolution. In fact Greece could hardly wait and has already launched it latest 24 hour strike against austerity. The same Greece which demands a 2 year, €30 billion extension from Europe to comply with reform, a move which Europe has/has not agreed to as while the core have said yes to more time, all have refused to fund Greece with any more money. Alas the two are synonymous. As SocGen predicts unless there is some credible progress today, all the progress since the September ECB meeting, which has seen SPGB 10 Year yields decline from 690 bps to sub 550 bps, may simply drift away. And as everyone knows, there is never any progress at these meetings, except for lots of headlines, lots of promises (the Eurozone June summit's conclusions have yet to be implemented) and lots of bottom line profits by Belgian caterers. Elsewhere, Spain sold 3, 4 and 10 year bonds at declining yields on residual optimism from the pro forma bailed out country's paradoxical Investment Grade rating. In non-hopium based news, Spanish bad loans rose to a record 10.5% in August from 10.1% previously while the oldest bank in the world, Italy's Banka Monte dei Paschi was cut to junk status. All this is irrelevant though, as no negative news will ever matter again in a centrally-planned world. Finally the only real good news (at least until it is revised)came out of the UK, where retail sales posted a 0.4% increase on expectations of a 0.2% rise from -0.2%.

"The consensus view was that QE3 was going to send the stock market to the moon. Yet the peak level on the S&P 500 was 1,465 on September 14th, the day after the FOMC meeting. The consensus view was that the lagging hedge funds were going to be forced to play some major catch-up and take the stock market to the moon too. Surveys show that the hedge funds have already made this adjustment...Q3 EPS estimates are still coming down and now stand at -3% YoY from -2% at the start of October....this is the first time the Fed embarked on a nonconventional easing initiative with the market overbought and with profits and earning expectations on a discernible downtrend. Not only that, but the fact the pace of U.S. economic activity is still running below a 2% annual rate, which is less than half of what is normal at this stage of the business cycle with the massive amount of government stimulus, is truly remarkable. Keep an eye on the debt ceiling being re-tested — the cap is $16.394 trillion and we are now at $16.119 trillion. This is likely to make the headlines again before year-end — the rating agencies may not be taking off much time for a Christmas break."

As we patiently await tonight's much-anticipated debate - and its zinger-ful diatribe of tax, spend, save, borrow, jobs, jobs, jobs word bingo - we thought this perfectly succinct clip dismissing the myth of how government stimulus leads to economic growth was particularly pertinent. Professor Antony Davies provides evidence, via empirical data from 1955, that there is no connection between federal spending and economic improvement - and as we have repeatedly noted - it merely adds to government debt. From the 'magic' of the Keynesian multiplier to the eyes-wide-shut view of spending creating jobs while ignoring the taxing-borrowing-printing nature of that spending. Government doesn't create jobs, it 'moves' jobs; as three years of stimulus spending has left us with ~8% unemployment and $4.6tn more debt.

Even now, after the Chinese economy has consistently disappointed everyone, we still get the impression from market participants that it will all be fine in the end, because the Chinese government know what they are doing, and all they need is to let the floodgate of money open. Whenever a bad data point comes out, the market interprets that as more easing ahead, and it will most certainly save the economy. If only running the Chinese economy is that easy. Every growth engine of the Chinese economy is failing, and there is only one thing which can sustain these failing engines for longer, which is government stimulus, and whether the government is actually willing to deploy massive stimulus that is questionable.

Most people know that during this year's Coachella festival, Tupac made a surprising appearance, if not in the flesh for obvious reasons, then in hologram form. What fewer people know is that the firm that created Holo-Tupac is special effects producer Digital Domain Media, which after years of failed attempts to do so, finally went public in November with Roth Capital as underwriter (there is now an Urban Dictionary definition for 'Rothed') at a price of $8.50 (well below the preliminary range of $10-12/share) and at a time when its burn rate was well above 50% of revenues, and which filed for bankruptcy hours ago. In other words, the company destroyed over $400 million in market cap in under 10 months. What is known by very few is that this is yet another public equity disaster of this administration: as filed in the bankruptcy Affidavit, "the Company has worked closely with State and local government authorities in Florida to execute economic stimulus contracts designed to create jobs and stimulate Florida’s economy. As of the Petition Date, the Company had contracted to receive a total of approximately $135 million in such government stimulus financing, including $19.9 million in tax credits. This financing consists of cash grants, land grants, low-interest financing, and tax incentives." In other words, in addition to the government's remarkable track record in the alternative energy field, public equity is now in the digital movie studio subsidization business. End result: bankruptcy, of a publicly funded company, shortly after IPO and sadly the realization that US capital markets are now so broken that the combination of private and public funding can sustain a company for less than one year.

Over the weekend, we pointed out that the old mechanism for the People’s Bank of China to expand its balance sheet and create base money has been broken by new funds flow pattern, and it will sooner or later require some sort of large scale asset purchases programme a.k.a. quantitative easing to offset the impact of the broken mechanism (after other tools such as cutting RRR reach their limits). However, we also mentioned that as the private sector is currently quite overstretched and will start the deleveraging process (if they have not already started), and that would render traditional monetary tools useless, and quantitative easing ineffective. And that would necessitate deficit spending at both local and central government levels. If we have read the social mood correctly that China might be more pro-austerity than pro-Keynesian, and if policymakers indeed share that view, then the consequence in the near term could be rather grim. The delay in stimulus as well as the small size of it so far has already done damage, if you like. The economy is already on course to a hard landing.

When we wrote Part I of this paper in June 2009, the total U.S. public debt was just north of $10 trillion. Since then, that figure has increased by more than 50% to almost $16 trillion, thanks largely to unprecedented levels of government intervention. Once the exclusive domain of central bankers and policy makers, acronyms such as QE, LTRO, SMP, TWIST, TARP, TALF have found their way into the mainstream. With the aim of providing stimulus to the economy, central planners of all stripes have both increased spending and reduced taxes in most rich countries. But do these fiscal and monetary measures really increase economic activity or do they have other perverse effects?...  The politically favoured option of financial repression and negative real interest rates has important implications. Negative real interest rates are basically a thinly disguised tax on savers and a subsidy to profligate borrowers. By definition, taxes distort incentives and, as discussed earlier, discourage savings.... The current misconception that our economic salvation lies with more stimulus is both treacherous and self-defeating. As long as we continue down this path, the “solution” will continue to be the problem. There is no miracle cure to our current woes and recent proposals by central planners risk worsening the economic outlook for decades to come.