Purchasing Power

Anyone Who Thinks that War Is Good For the Economy Has One Eye Covered ... And Is Only Looking At Half the Picture ...

The decoupling/recoupling we discussed earlier in the EURUSD pair seemed the biggest deal in Europe this week as the 2.5% gain is thge most in a month and takes the cross back to near 3-month highs. Not to be outdone, the VSTOXX (Europe's VIX equivalent) dropped notably and now stands at its lowest in 7 months - dramatically outperforming equity and credit markets on its way as selling vol appears the easiest trade ever (until of course your arms and legs are ripped off by a risk flare). Credit markets outperformed this week as equity underperformed - bringing the two asset classes closer into sync after last week's plunge in credit. Sovereign credit markets were mixed but clearly the high-beta compression trend has stalled as Portugal underperformed dramatically followed by Belgium with the rest generally tracking sideways (and Spain outperforming modestly). JPY weaknes balanced the EUR strength to keep the USD (DXY) from getting completely crushed on the week -1.35% (as Oil has rallied over 5%).

2012 is proving to be the 'Year of the Central Bank'. It is an exciting celebration of all the wonderful maneuvers central banks can employ to keep the system from falling apart. Western central banks have gone into complete overdrive since last November, convening, colluding and printing their way out of the mess that is the Eurozone. The scale and frequency of their maneuvering seems to increase with every passing week, and speaks to the desperate fragility that continues to define much of the financial system today.... All of this pervasive intervention most likely explains more than 90 percent of the market's positive performance this past January. Had the G6 NOT convened on swaps, had the ECB NOT launched the LTRO programs, and had Bernanke NOT expressed a continuation of zero interest rates, one wonders where the equity indices would trade today. One also wonders if the European banking system would have made it through December. Thank goodness for "coordinated action". It does work in the short-term.... But what about the long-term? What are the unintended consequences of repeatedly juicing the system? What are the repercussions of all this money printing? We can think of a few.

Something funny happened on the road to Dow Jones 13,000 - the car ran out of gas, and the driver noticed what the latest and (literally) greatest price of unleaded is...

One of the dirty little secrets of the stock market rally is that the rising corporate profits that powered it are largely phantom profits. Why are they phantom? Because they are artifacts of currency devaluation, not an increase in efficiency or production of goods and services. Though few domestic observers make mention of it, the large, global U.S.-based corporations are now dependent on non-U.S. sales for about 40% of their revenues (50% and up for many companies) and virtually all their profit growth. Overseas sales are made in the local currency: the euro, yen, renminbi, Australian dollar, Canadian dollar and so on, and the profits are stated in U.S. dollars on corporate profit and loss statements. In 2002, 1 euro of profit earned by a U.S. global corporation equaled $1 in profit when converted to U.S. dollars. That same 1 euro profit swelled to $1.60 in 2008 as the U.S. dollar depreciated against the euro. That $ .60 of profit was phantom, an artifact of the depreciating dollar; it did not result from a higher production of goods and services or greater efficiencies.

Now that the bipolar market has once again resynced general risk appetite with the EURUSD (high Euro -> high ES and vice versa), everything in the macro front aside from European developments, is noise (and the occasional reminder by data adjusting authorities in the US that the country can in fact decouple with the entity responsible for half the world's trade. This will hardly come as a surprise to anyone. In fact, the conventional wisdom as shown by Goldman's latest client poll has European sovereign crisis worries far in the lead of all macro risks. Behind it are Iran and nuclear tensions, China hard-landing, the US recovery/presidential election and the Japanese trade deficit/record debt/JGB issues. Which for all intents and purposes means that the next big "surprise" to the market will be none of the above. What are some of the factor not listed as big macro risks? According to David Kostin 'Risks that clients did not mention include late March US Supreme Court review of health care reform (implications for 12% of S&P 500); mid-year deadline to implement Dodd-Frank financial reform (14% of market); and the French Presidential election on April 22nd where polls show incumbent Nicolas Sarkozy trails opposition candidate Francois Hollande." Oddly enough, one very crucial item missing is once again surging inflation courtesy of trillions in stealthy central banks reliquification, sending crude to the highest since May 2011, and the most expensive gas price in January on record.

You're in a situation now where the rest of the world has increasingly lost confidence in the U.S. Dollar

History is replete with the carcasses of failed currencies destroyed through misguided intentional debasement by governments looking for an easy escape from piling up too much debt. James Rickards, author of the recent bestseller Currency Wars: The Making of the Next Global Crisis, sees history repeating itself today - and warns we are in the escalating stage of a global currency war of the grandest scale. Whether it ends in hyperinflation, in the return to some form of gold standard, or in chaos - history is telling us we can have confidence it will end painfully.

Make no mistake, inflation is creeping into the system in a big way. And the Fed will not raise interest rates to fight it until it’s far too late. Debt levels are simply too high for the Federal Government and US corporations, particularly the large banks which the Fed has been doing everything it can to prop up.

Earlier today we got another indication that Europe's recession will hardly be a "technical" or "transitory" or whatever it is that local spin doctors call it, after the European December Industrial Output declined by 1.1% led by a whopping 2.7% drop by European growth dynamo Germany, which slid by 2.7% compared to November (which in turn was a 0.3% decline). This was worse than the Greek number which saw a 2.4% drop, however starting at zero somewhat limits one's downside. Yet even as the German economic decline accelerated, German ZEW investor expectations, which just like all of America's own consumer "CONfidence" metrics are driven primarily off the stock market, which in turn is a function of investor myopia to focus only on nominal numbers and not purchasing power loss - a fact well known to central bankers everywhere - do not indicate much if anything about the economy, and all about how people view the DAX stock index, which courtesy of the ECB's massive balance sheet expansion, has been going up. And if there has been any light at all in an otherwise dreary European tunnel, it has been the dropping EURUSD, which however has since resumed climbing, and with it making German industrial exports once again problematic. Which in turn brings us back to the primary these of this whole charade: that Germany needs controlled chaos to keep the EURUSD low - the last thing Merkel needs is a fixed Europe. It is surprising how few comprehend this.

To be happy is to be confident. And at least until the recent past, in America to be confident, meant to have purchasing power, which pretty much always, at least for the bulk of the population, meant to lever up, i.e., to take on debt and to spend it on worthless crap. Well, as we reported earlier this week, in December the US population literally jumped head first right back into the credit frenzy, experiencing the largest jump in unadjusted consumer credit since the peak of the credit bubble. however, very much contrary to naive interpretations that this would reignite the economy, as Lance Roberts explained, and as Charles Hugh Smith confirmed showing plunging gasoline usage, it merely indicated that with savings again at record lows, US consumer have no choice but to dig deep into their credit card stash merely to pay for staples, and non-discretionary spending. And one hardly is happy when one purchases a roll of toiler paper (not to be confused with US Treasurys - there is far less than 15.4 trillion pieces of toiler paper in the world) on credit. Sure enough, as the following chart from John Lohman demonstrates, the recent (mini) reincarnation (because it will last at most a month or two) of the consumer credit bubble has done absolutely nothing for consumer confidence. In fact, today's UMichigan data showed a decline in confidence. Which shows  all one needs to know about just what the true state of the US consumer is...

For the last thirty years economic policy makers have been in the business of promoting asset prices higher through easy credit. Global policy makers are meddling in markets so that the economies they feel responsible for can achieve what seems to be a consensus objective of muddling through. A policy of meddling to muddle, if you will. QBAMCO's critical 'inflation' insights, and Tourette's-ridden ranting, reflect the simple realities of what real-world consequences occur when policy makers succumb to the perceived political imperatives of perverting economic data. In this combined note, Brodsky and Quaintance scrub away at the misconceptions related to inflation, raise doubts as to the incentives of central banks to share the true loss of their currencies' purchasing power with the public, and extend this to try and get a truer sense of money, inflation, and real value today - all of which seem grossly misunderstood, despite our best efforts, in the marketplace. Simply put, they point out that, "It should not be considered acceptable to be in a profession – as a political economist, policy maker or investor – in which self-delusion has become a necessary requirement for success and perpetuating that delusion is harmful to the broad economy over time. Yes, but the “public good” you say? Ah, but for how long?"

As I reminded you the other day, Ben Bernanke isn't worried about inflation. That's good to know, but what are some other facts that we can look at to determine where prices and / or purchasing power are headed. Two indicators that are relevant to this topic are core inflation (everyone's favorite to point to, since it excludes those pesky inflationary items food & energy), and income.

Rising consumer credit means more consumption which leads to stronger economic growth.  Let me explain.  Individuals go to work to produce a good or service for which they are paid a finite amount of money for.  With that income they pay taxes which leaves them with discretionary income from which to live on.  Pay the rent, utilities, insurance and healthcare, food, clothes and put gas in the car and that pretty much consumes the majority of the paycheck.  Today, the situation is quite different and a harbinger of potentially bigger problems ahead.  The consumer is no longer turning to credit to leverage UP consumption - they are turning to credit to maintain their current living needs. Take a look at the chart of personal consumption expenditures (PCE) versus total consumer credit.  Notice in the past year as consumer credit rose you saw an increase in PCE.  In the last two months consumer credit has exploded higher but there has been virtually NO increase in PCE levels on a month over month basis.  Retail sales during the Christmas shopping season we disappointing and this was even with a large decrease in gasoline prices. This situation becomes even more apparent when we begin to look at the longer term trends of real disposable incomes, consumer credit and personal saving rates.

Mohamed El-Erian, CEO and co-chief investment officer of bond fund giant PIMCO, said investors should be underweight equities while favoring "selected commodities" such as gold and oil, given the fragile global economy and geopolitical risks. Over the long term gold will reward investors who own gold as part of a diversified portfolio. Trying to time purchases and market movements is not recommended – especially for inexperienced investors.  New research from Credit Suisse and London Business School entitled ‘The Credit Suisse Global Investment Returns Yearbook 2012’ continues to be analysed by market participants. The 2012 Yearbook investigates data from 1900 to 2011 and looks at how best to protect against inflation and deflation, and how currency exposure should be steered. The chief findings are that bonds do well in deflation and benefit from currency hedging, and equities are not a perfect inflation hedge, but benefit from international diversification.  The report shows that gold offers a timely inflation hedge and long term holders of gold should expect a positive correlation to inflation – gold is one of only two assets since 1900 to have positive sensitivity to inflation (of 0.26). Only inflation-linked bonds had more - 1.00, as expected. By contrast, when inflation rises 10%, bond returns have fallen an average 7.4%; Treasuries fell 6.2%, and equities lost 5.2%. Property fell by between 3.3% and 2%. Importantly, gold managed to increase its value across both extreme inflationary and deflationary scenarios. The academics from LBS analysed 2,128 individual years in 19 major countries (1900-2011), finding gold rose 12.2% in the most deflationary years - when average deflation was 26%.