Unemployment

For their sake, we hope at least the answer from the Fed is "yes." Yet it is quite ironic that the subtext of this paper is that Monetary Policy can actually fail, when, get this, people don't grasp all the nuances of monetary policy. In other words, it is not the Fed's fault when it fails - it is the people's fault: "we fi?nd evidence that the relationship between unemployment and interest rates is not properly understood by households in the lowest income quartile, and by those with no high school diploma." Cue Kartik Athreya to explain to us all why only Ph.D.s understand the complexities of monetary policy when it works, and why it is those without a highscool diploma that are at fault, when it doesn't.

Today, Rand’s fictional world has seemingly become a reality – endless bailouts and economic stimulus for the unproductive at the expense of the most productive, and calls for additional taxation on capital investment. The shrug of Rand’s heroic entrepreneurs is to be found today within the tangled ciphers of corporate and government balance sheets. The US Federal Reserve has added more than $2 trillion to the base money supply since 2008 – an incredible and unprecedented number that is basically a gift to banks intended to cover their deep losses and spur lending and investment. Instead, as banks continue their enormous deleveraging, almost all of their new money remains at the Fed in the form of excess reserves. Corporations, moreover, are holding the largest amounts of cash, relative to assets and net worth, ever recorded. And yet, despite what pundits claim about strong balance sheets, firms’ debt levels, relative to assets and net worth, also remain near record-high levels. Hoarded cash is king. The velocity of money (the frequency at which money is spent, or GDP relative to base money) continues to plunge to historic lows. No wonder monetary policy has had so little impact. Capital, the engine of economic growth, sits idle – shrugging everywhere.

Are we really in an economic recovery or is it a figment of the Fed's quantitative easing? This will be the biggest factor in the 2012 elections.

When Greece defaults, the fall-out will be much, much larger than people expect simply by virtue of the fact that everyone is lying about their exposure to Greece.

The task of the financial/political/media Status Quo is to convince Americans to overlook the abundant evidence of economic deterioration and focus on heavily juiced "evidence" of robust "growth." The game plan is this: if the Status Quo can convince you that the economy has righted itself and from here on in everything will get better and better, every day and in every way, then we will abandon financial rationality and start buying homes we can't afford on credit, cars we can't afford on credit and boatloads of stuff from China that we don't need on credit (of course looking cool is a "need," i.e. having an iPad to carry around). In other words, believing it is so will make it so. That is the essence of the campaign to stimulate "animal spirits" confidence: though the economy is actually tanking, if they can only convince us the Dow is moving to 15,000 and then on to 20,000, jobs are being created left and right and things are looking up everywhere, then the resulting piranha-like shopping-feeding-frenzy will create the expansion that is currently chimerical.

Hubris is at the heart of this. Everyone says this cannot happen – we won’t allow it. Says who? The EU says: if it is written in an agreement, it must be totally correct, unchangeable, and followed at all costs. New realities can’t intervene and no slippage is allowed. Why the Germans are so sure that they know the future is beyond me. They are fallible too, but they won’t admit it, and the Greeks can’t make them budge. Haven’t they looked around? Santorini has a different economic and social cost structure than Wiesbaden. Humanity (and common sense) seems totally lacking in the negotiations with the Greeks and a violent backlash would be totally understandable. Why the countries that have been fattening up their current account surpluses selling products to Greeks, whom they should have known were basically broke – just as they always have been – should be paid 100% on the euro is beyond me. Major losses should apply not only to sovereign borrowings but also to accounts receivable for cars, electronics, and other consumer goods. The market has not opened its eyes to the impact this Greek unraveling will have. The Eurozone will be mortally wounded and the world will suffer a significant recession – maybe as deep as 2008. European banks will lose much of their capital base and many should be bankrupt, but just as in the Lehman aftermath, the governments will try to save the banks and the banks’ bondholders, solvent or not. As the bank appetite for Eurozone sovereign paper will be decimated, austerity will probably follow shortly, followed by deflation and uncontrollable money creation. The European recession should be one for the record books.

Busy day in the economic headlines arena, with Housing Start, Claims PPI and Philly Fed all on deck. Goldman summarizes the expectations and the upwardly biased consensus.

Some of the key headlines from the just released FOMC minutes via Bloomberg, which however don't show anything out of the ordinary:

• A FEW FED OFFICIALS SAID MORE BOND BUYING MAY BECOME NECESSARY. So (1-Few) did not see it as necessary
• FOMC PARTICIPANTS SAW `GRADUAL’ IMPROVEMENT IN LABOR MARKET
• FOMC OFFICIALS SAW `MODERATE’ IMPROVEMENT IN HOUSEHOLD SPENDING
• FOMC PARTICIPANTS SAW `DEPRESSED’ HOUSING SECTOR
• FOMC OFFICIALS SAID GLOBAL FINANCIAL STRAINS POSED BIG RISKS
• FOMC PARTICIPANTS FORECAST INFLATION WOULD REMAIN `SUBDUED’
• SOME FED OFFICIALS FAVORED QE IF INFLATION FALLS, GROWTH SLOWS

The complacency of the markets is amazing given the risks at hand. I don't think I'm that smart, so is it that so many others are that stupid? It can't be, can it?

A certain flavor of econometric model dominates conventional portfolio management and financial analysis. This model can be paraphrased thusly: seasonally adjusted economic data such as the unemployment rate and financially derived data such as forward earnings and price-earnings ratios are reliable guides to future economic growth and future stock prices....If this model is so accurate and reliable, why did it fail so completely in 2008 when a visibly imploding debt-bubble brought down the entire global economy and crashed stock valuations? Of the tens of thousands of fund managers and financial analysts who made their living off various iterations of this econometric model, how many correctly called the implosion in the economy and stock prices? How many articles in Barrons, BusinessWeek, The Economist or the Wall Street Journal correctly predicted the rollover of stocks and how low they would fall? Of the tens of thousands of managers and analysts, perhaps a few dozen got it right (and that is a guess--it may have been more like a handful). In any event, the number who got it right using any econometric model was statistical noise, i.e. random flecks of accuracy. The entire econometric model of relying on P-E ratios, forward earnings, the unemployment rate, etc. to predict future economic trends and future stock valuations was proven catastrophically inadequate. The problem is these models are detached from the actual drivers of growth and stock valuations.

UBS' economics research group do not believe that Greece is saved but hope that it is at best ring-fenced. In an excellent Q&A follow up, Stephane Deo and his team address the role of the EFSF, the IMF package and its austerity measures, the ECB's participation, and finally the likelihood of the PSI being successful and its fallout. As Greek 2Y yields break 200% (obviously price is the critical part but these yields are stupendous) and bridge loan discussions appear for the March 20th maturity, perhaps UBS view of the IMF 'walking away' is more credible if they manage to ring-fence a recap of the banking sector. We would be surprised if contagion was contained and, as we have seen before, that risk leaks out somewhere and unintended consequences (or unknown unknowns) tend to pop up just when we least expect them. Perhaps the FT's note this morning (which incidentally confirms the everything that Zero Hedge warned about almost a month earlier) that deadlines are slipping rapidly is the bright yellow canary in the Piraeus coal-mine as 'time is running out' for a solution here very quickly (as seemingly is the desire).

• Europe ushers in the recession: Euro-Area Economy Contracts for the First Time Since 2009 (Bloomberg)
• Greek conservative takes bailout pledge to the wire (Reuters)
• China Pledges to Invest in Europe Bailouts (Bloomberg) - as noted last night, the half life of this nonsense has come and gone
• Japan's Central Bank Joins Peers in Opening the Taps (WSJ)
• EU Moves on Greek Debt Swap (EU)
• EU Divisions Threaten Aid For Greece (FT)
• Athens Woman facing sacking threatening suicide (Athens News)
  
• King Says Euro Area Poses Biggest Risk to UK’s Slow Recovery (Bloomberg)
• Sarkozy to Seek Second Term, Banking on Debt Crisis to Boost Bid (Bloomberg)

While the government propaganda machine chugs along and tells us to move along, there is nothing to see in the plunging labor participation rate, it is just 50 year olds pulling a Greek and retiring (fully intent on milking those 0.001% interest checking accounts, CDs and 3 Year Treasury Bonds for all they are worth - they are after all called fixed "income" not "outcome") there is more than meets the eye here. Yet while we will happily debunk any and all stupidity that Americans actually have the wherewithal to retire in droves as we are meant to believe (with the oldest labor segment's participation rate surging to multi-decade highs), there is a distinct subset of the population that migrates from being a 99-week'er to moving to merely yet another government trough - disability. Art Cashin explains.

These January jobs numbers make the Obama administration look good, at least relative to how it’s looked in the previous 12 months. However, they’re not reflecting as positively on two of Obama’s primary support groups: Wall Street and the US Federal Reserve.

There had been some hopes for Greece following the Q3 GDP number which slowed the decline in the country's economy when it dropped by just 5%, following drops of 8% and 7.3% in Q1 and Q2. These may have to be doused following a report that Q4 GDP came in at a disappointing -7%. As Athensnews reports: "The country's economic slump is headed towards a record annual plunge close to 7 percent in 2011, the fourth consecutive year of a deepening recession.  After an official confirmation by the Hellenic Statistical Authority (Elstat) on Tuesday that GDP dropped 7 percent year-on-year in the fourth quarter of 2011, the economy has shrunk by an average of 6.8 percent.  The latest quarterly contraction followed a slight slowdown of the depression in the preceding quarter, with GDP shrinking 5 percent due to the customary seasonal surge of tourist revenues in the summer." The full year drop was a record 6.8%, compared to the expected 6% projected in the 2012 budget. No comment there.