Blowout quarter, or do US bank numbers just blow?
We are now five years into the Great Fiat Money Endgame and our freedom is increasingly under attack from the state, liberty’s eternal enemy. It is true that by any realistic measure most states today are heading for bankruptcy. But it would be wrong to assume that ‘austerity’ policies must now lead to a diminishing of government influence and a shrinking of state power. The opposite is true: the state asserts itself more forcefully in the economy, and the political class feels licensed by the crisis to abandon whatever restraint it may have adhered to in the past. Ever more prices in financial markets are manipulated by the central banks, either directly or indirectly; and through legislation, regulation, and taxation the state takes more control of the employment of scarce means. An anti-wealth rhetoric is seeping back into political discourse everywhere and is setting the stage for more confiscation of wealth and income in the future. This will end badly.
While stating the somewhat obvious - that the Fed's actions will cause 'pain' when they (try to) stop QE - when it comes from a high-ranking officer of the establishment elite (as opposed to a tin-foil-hat-wearing, BLS-exposing, HFT-undermining, fringe blog) such as Goldman Sachs' President Gary Cohn, perhaps more mainstream will begin to question the one-way path we are on. Cohn's interview on Bloomberg TV ranged from his reading habits (Greg Smith's tell-all) to the world's central bank printfest and how "we will have to go through the pains of stopping QE" and from his views of the election status quo to the global economic malaise, he does so well on the reality front - until he shovels undying praise on Mario Draghi's back for his "spectacular job" - though admits he has not solved Europe's real problems.
Economics would benefit from self-restraint in regard to the usage of mathematics. Alfred Marshall made some useful suggestions:
- Use mathematics as shorthand language, rather than as an engine of inquiry.
- Keep to them till you have done.
- Translate into English.
- Then illustrate by examples that are important in real life
- Burn the mathematics.
- If you can’t succeed in 4, burn 3. This I do often.
I hope the blowout growth in mathematics in economics is a bubble that soon bursts.
A month ago, when RealtyTrac posted their latest US foreclosure numbers for the month of August, we presented what we called was the "Foreclosure Stuffing" thesis, explaining the explicit subsidy by the banks for the housing market, whereby the entire foreclosure process has now ground to a halt, and in doing so removing millions in inventory flow from the distressed end market, forcing limited buyers to chase what supply there is, and in the process boosting prices of existing inventory higher. In other words a traditional inventory removal-based subsidy. It is therefore not surprising that today RealtyTrac reported the latest foreclosure data, and lo and behold, just as we expected, the great foreclosure collapse has taken another leg lower, with the total number of foreclosures for the month of September sliding to 180.4K, a decrease of 7 percent from the previous month and down 16 percent from September 2011, and the lowest in five years!
This October, as the presidential election nears, we witness the strange intersection of the worlds of the gambler and the policy wonk. Daily, our best political observers reference the current prices of the presidential betting market. Unfortunately, we think their lack of knowledge of gambling mechanics leads them astray. This brief introduction to betting mechanics brings us to the first uncomfortable tension between gamblers and policy wonks: policy wonks love to quote Intrade, and gamblers think it’s by far the least important and least informative presidential betting market.
Stocks popped on some bloomberg flashing red headlines from the Fed's Beige Book but quickly faded as bonds did not move. The reality - summed up in the worldcloud - is 'mixed' - for sales, for prices, for demand, for jobs:
- *FED DISTRICT BANKS SAID `CREDIT STANDARDS WERE LITTLE CHANGED'
- *FED DISTRICT BANKS SAID MANUFACTURING WAS `SOMEWHAT IMPROVED'
- *FED DISTRICTS SAID `OVERALL LOAN DEMAND INCREASED SLIGHTLY'
- *MOST FED BANKS SAID `WAGE PRESSURES REMAINED MODEST'
- *FED BANKS SAID `EMPLOYMENT CONDITIONS WERE LITTLE CHANGED'
- *FED DISTRICTS SAID CONSUMER SPENDING WAS `FLAT TO UP SLIGHTLY'
Some prefer to see the 'employment' glass half-full, some half-empty, and others see the glass smashed into a million shards on the keynesian kitchen floor. The zealousness with which the 'number' has been dismissed and praised has generated more questions than answers. Goldman's Jan Hatzius addresses the question of the pace of progress in the labor market, the reasons for the contrast between GDP and employment, the amount of slack left, and the implications for Fed policy.
As we all know, what matters isn't our nominal earnings, it's what our earnings can buy that counts. If it takes an hour of labor to buy four gallons of gasoline, it doesn't really matter if we're paid $1.60 an hour and gasoline costs 40 cents a gallon or we're paid $16 an hour and gasoline costs $4 per gallon. Ditto $16,000 an hour and $4,000 per gallon. What matters is if our hourly wage once bought eight gallons of gasoline and now it buys only four gallons. This is called purchasing power, and rather naturally the Status Quo has worked mightily to cloak the reality that our purchasing power of the bottom 95% of wage earners has been declining for decades. Until oil no longer matters, our real earnings and our economy remain hostages to the cost of oil.
Between the IMF's European growth expectations and deleveraging needs, it seems reality is sinking in a little in Europe. All equity indices are closing red today with Spain and Italy worst and banks underperforming. The most interesting feature we noticed is that once again - now the seventh day in a row - European sovereign spreads have deteriorated notably from the US day-session open to the European close. Spain and Italy 10Y bond spreads are 15 and 8bps wider (only) on the week but notably Spanish and Italian equities are down 3.2% and 2.8% respectively this week. EURUSD is practically unch at the EU close - up 60 pips from overnight weakness.
As if we needed further confirmation of the un-reality of Friday's BLS data, the JOLTS data just printed with the largest two-month drop in ten months (and the first two-months-in-a-row of falling job openings this year). Of course this is data for August and the unemployment rate was for September - which we are sure makes all the difference...
There should be three objectives for a well-functioning monetary system: i) internal balance, ii) allocative efficiency and iii) financial stability. The international financial and monetary system (IFMS) has functioned under a number of different regimes over the past 150 years and each has placed different weights on these three objectives. Overall, this recent Bank of England paper finds that today’s 'fiat' system has performed poorly against each of its three objectives, at least compared with the Bretton Woods System, with the key failure being the system’s inability to maintain financial stability and minimize the incidence of disruptive sudden changes in global capital flows. There is little consensus in the academic literature, or among policymakers, on what are the underlying problems in the global economy which allow excessive imbalances to build in today’s IMFS and/or which impede the IMFS from adjusting smoothly to counteract these imbalances. Critically though, while the fiat money system we are currently does indeed exhibit lower GDP growth volatility (by design), it has dramatically more incidents of banking and currency crises than under a Gold Standard.
If your predictions are wildly out-of-whack with reality, you need to change your approach. Jared Bernstein and Christy Romer Administration predictions have been an unmitigated disaster. Not only did the real figures not match up to the advertised ones, but they are also much worse than the baseline expectations. Romer and Bernstein appear to have both severely under-estimated the depth of the crisis, and over-estimated the effectiveness of the stimulus package. Obama might talk about spreading the wealth around, but the aggregate effect of the policies pursued during his administration have squarely benefited large corporations and the financial sector, and not the middle class or small business. Is reinflating financial bubbles and pumping up corporate profits Obama’s idea of recovery? The money isn’t trickling down, and small businesses and the middle class are more in debt than they were before the crisis started.
While yesterday it was the sovereigns who suffered the wrath of the IMF's wholesale growth outlook downgrade (unbeknownst to Christine Lagarde), today it is the turn of the financial sector (which is increasingly being blurred with the former in a world in which central banks are used to both backstop bank liabilities and fund endless public deficits, unafraid of the consequences in a closed loop fiat world in which defection is, so far, impossible) to be greeted by a cold dose of reality emanating from the IMF's "Global Financial Stability Report" especially as pertains to Europe's insolvent banking system. The most notable finding of said report is the admission that the IMF was only kidding when it said six months ago, in April of this year, that the worst case outlook now has European banks deleveraging to the tune of $3.8 trillion through the end of 2013, or over the next 14 months: now this number is 18% higher, or a gargantuan $4.5 trillion (12% of bank assets). This is how much debt Eurobanks will need to shed in a "weak policies" case in which Europe continues to delay implementing fiscal reform, aka austerity, as per Figure 2.14. Even the baseline (and this being the IMF it means it has zero chance of happening) scenario is not much better, at a revised $2.8 (7.3%) trillion in deleveraging. The reason for the increase is due to "lower expected earnings, higher losses linked to worsened economic conditions, and greater funding pressures on banks."
With the market seemingly oblivious to the dismal reality of the fiscal-cliff (from a priced-in perspective) in the same way as equities trade at four-year highs while earnings are at three-year lows; it is perhaps useful to get a grasp of the maelstrom that awaits congress as they begin to tackle the fiscal-cliff on November 12. As we discussed here, the downside potential is considerable with complacency high and just as Goldman expects no real progress to be made until December (at the earliest), the market (i.e. a correction) may be the only lever to move our political elite from their respective higher ground. While talk will be of 'grand bargains', we, like Goldman, remain skeptical that any broad reform package will be completed and instead some short-term extension may be achieved. The following Q&A explains how that sausage could be made in all its gory detail. (e.g. Q: Can Congress actually put together a "grand bargain" fiscal agreement in the short time available? A: It is difficult to see how.)