Wednesday, May 22, 2013 - Throwing Ben From the Chopper

Throwing Ben From the Chopper

by Sinclair Noe

DOW – 80 = 15,307
SPX – 13 = 1655
NAS – 38 = 3463
10 YR YLD +.08 = 2.03%
OIL – 1.53 = 94.65
GOLD – 6.30 = 1370.70
SILV - .16 = 22.37

Federal Reserve Chairman Ben Bernanke went to Capitol Hill this morning and that was followed by the release of the Federal Open Market Committee, or FOMC, minutes from their May 1^st meeting and that was followed with a big swing lower for stocks on very heavy volume and a big swing lower for bonds and everything was just rocking and rolling.

Bernanke was appearing before the Joint Economic Committee this morning; the gavel fell; Bernanke delivered some prepared remarks: "A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further."

So, that sounded like no tapering off of QE anytime soon. Stocks and bonds inched a little higher. Bernanke went on to say that fiscal policy continues to be a drag on the economy. Right, we've heard it before.

Then, Bernanke stressed that slowing asset purchases would not be the automatic beginning of the exit. The flow of purchases could be ramped up depending on the data. Now, the markets were trying to figure out which direction he's going.

Asked when the Fed will slow down asset purchases, Bernanke says it could come in "next few meetings”, but he won't give a date. Then he says financial stability is biggest risk of asset purchase program, but a weak economy comes with its own stability concerns. Then he says the Fed does not have to sell any agency mortgage-backed securities when the central bank exits its easy policy stance. The markets start to tank.

Is the Federal Reserve doing too much to stimulate the economy, or not enough? Many of the questions directed at Bernanke this morning were about the risks of the Fed doing too much and whether their monetary policy was hurting savers and creating asset bubbles. An equally valid question is whether the Fed is pushing hard enough, given that the economy is growing more slowly than the Fed wants it to and the jobs market remains stagnant and inflation is running well below its target.

Helicopter Ben, the student of the Great Depression willing to throw cash out of a helicopter; that Fed Chairman was nowhere to be found; replaced by a Chairman willing to stand pat despite failing to achieve the Fed’s own self-imposed targets.

Bernanke isn’t ruling out stronger action. In his testimony he said that depending on incoming data, “we could either raise or lower our pace of purchases.” But raising purchases is clearly not Plan A. As the outlook for the labor market “improves in a real and sustainable way, the committee will reduce the flow of purchases,” the chairman said, without specifying a time.

Bernanke says for the record that the Fed could do more if necessary, but he is behaving as if he believes monetary policy is at or near its limit. He testified: “Monetary policy does not have the capacity to fully offset an economic headwind of this magnitude.”

That doesn't really sound like Helicopter Ben. Has he lost his swagger? Hang on. He's saying the Fed is willing to hold on to all the Mortgage Backed Securities they've been buying, maybe just stick them in the vault and wait; that is not an acknowledgment of failure in monetary policy, but it is looking like an acknowledgment of asset bubbles.

And then we got the FOMC minutes.

The FOMC minutes showed they were still waiting for more progress before they would slow Quantitative Easing, but they were thinking about an exit plan; they discussed the old plan form 2011, debated whether it was still valid or needed updating, talked about the possibility of slowing asset purchases as early as June, that didn't fly, and then the punchline– assett bubbles.

The FOMC minutes say, in writing: "a few participants expressed concern that conditions in certain U.S. financial markets were becoming too buoyant.... One participant cautioned that the emergence of financial imbalances could prove difficult for regulators to identify and address, and that it would be appropriate to adjust monetary policy to help guard against risks to financial stability."

The big question is whether the Fed will actually have a mutiny and throw Bernanke from the helicopter and abandon super-easy monetary policy? So, let's dig a little deeper into the minutes: “Regarding the composition of purchases... ,in light of the substantial improvement in the housing market and to avoid further credit allocation across sectors of the economy, the Committee should start to shift any asset purchases away from MBS and toward Treasury securities.”

Where do we go from here? The Fed holds on to its existing asset purchases; they won't shy away from ZIRP, the Zero Interest Rate Policy; they are getting closer to using some new tools, and it's probably more than just a shift from MBS to Treasuries. What tools? We didn't really get a clue today, but we did get some acknowledgment that they recognized the limitations of the tools they've been using. So, we should be looking for new tools, or look for Bernanke to be tossed from the helicopter – it could go either way.

The latest poll of Morgan Stanley's top clients from across the world says it all. Not a single investor at the bank's Florence forum thought the world economy would rebound with any strength later this year.

Just a quarter expect a return to trend growth. Some 57pc think there will be no escape from the "twilight" conditions afflicting the western world, and 20pc expect an full-blown global recession. That is a remarkably bearish set of views. Yet the same investors are overwhelmingly bullish on stocks and property.

This schizophrenic exuberance seems entirely based on the assumption that QE and central bank largesse will keep the game going, flooding asset markets with liquidity. Indeed, 80pc think the ECB will cut rates again, and half think it will have to swallow its pride and join the QE club in the end.

Eighty percent think equities will gallop on upwards over the next year. Complacency is rife. It became very clear, and many investors were quite explicit about this, that markets are lulled by the lure of liquidity resulting from negative real interest rates and global QE. When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.

Yesterday, shareholders at JPMorgan Chase decided to keep Jamie Dimon as chairman and CEO. The shareholders trying to take away Dimon's chairmanship weren't trying to take the job of running JPMorgan away from him. They just wanted to give the board's oversight function to somebody else -- they didn't want Dimon being his own boss. But even this minor tweak to Dimon's job function would have been such an outrageous affront to Dimon's royal personage that he might have taken his indispensable skills away from the bank forever, causing the stock price to collapse, or so the bank told shareholders, at least in private. Jim Cramer said it publicly: "If you voted for Dimon to lose chairmanship, you voted for a lower stock."

The Office of the Comptroller of the Currency cut it's rating of the bank's management and says it need simporvement, but shareholders weren't buying it. Last weekend I heard one analyst explain that concerns about out of control trading, and the trading losses of the London Whale, and allegations of money laundering, institution wide regulatory violations, and auditors that are on the verge of throwing up their arms; for a complete list of violations, there is a report entitled “JPM – Out of Control” , which basically describes a criminal enterprise. Any way, the analyst over the weekend was saying that shareholders should forget about all that because Dimon delivers record profits, and that's all that really matters. Rather than humbling Dimon, JPMorgan shareholders have declared, loudly, that Dimon alone should hold their fate in his hands. They had better hope it doesn't go to his head.

Hurricane Sandy was the deadliest and most destructive hurricane since Katrina. It caused 285 total fatalities and was the second-costliest hurricane in United States history.

During the immediate aftermath of this act of Nature, Senators Inhofe and Coburn from the state of Oklahoma, were among many who decided to use the disaster as a political platform. They voted against a full FEMA / Army Corp of Engineer reconstruction, and repeatedly delayed votes to fund any for of rescue. The Republican Governor of New Jersey went postal against the GOP House members as well as these two Oklahoma Senators. Eventually, federal aid for Hurricane Sandy was passed. A big chunk of the Sandy emergency package replenished FEMA, which had been underfunded by the usual suspects. The Sandy relief package replenished its coffers. The votes in favor of Sandy Aid ironically funded FEMA, and it is helping with the rescue and clean up efforts in Oklahoma. Now Coburn is insisting that any federal aid to deal with the tornado in his home state must be offset by budget cuts, but he says that “as the ranking member of Senate committee that oversees FEMA, I can assure Oklahomans that any and all available aid will be delivered without delay.”

Tuesday, May 21, 2013 - Apple Gimmicks

Apple Gimmicks

by Sinclair Noe

DOW + 52 = 15,387
SPX + 2 = 1669
NAS + 5 = 3502
10 YR YLD - .02 = 1.94%
OIL - .98 = 95.95
GOLD – 18.10 = 1377.00
SILV - .49 = 22.53

It's Tuesday. The markets moved higher. It's almost inevitable. The Dow Industrials have closed higher every Tuesday this year, with the exception of January 8^th; 19 consecutive Tuesdays. No, I don't know why.

Well, today, part of the reason could be traced to the Federal Reserve. A couple of Fed heads were talking up easy money. New York Fed President William Dudley said he cannot be sure whether policymakers will next reduce or increase the amount of purchases, due to the "uncertain" economic outlook. The QE taper may end up being a QE expansion. Dudley worries about investor over-reaction to a "normalization" of policy and suggests the FOMC may need to update what it needs to see to move in that direction. Earlier, James Bullard, president of the Federal Reserve Bank of St. Louis, urged the European Central Bank to consider employing a US style quantitative easing program to counter slowing inflation and recession in the euro zone.

Tomorrow, Fed Chairman Ben Bernanke will speak before a congressional panel, the Joint Economic Committee. The minutes of the Fed's latest policy-setting meeting will be released on Wednesday afternoon. When the Fed showers liquidity, the money flows to the markets, but I can't give a good reason for the Tuesday winning streak.

There is a certain symmetry in life: fire and ice, winter and summer, darkness and light, yin and yang. And this brings us to the IRS scandal; last week we learned about the demand treatment afforded some groups by the IRS, this week we learn about the generous nature of the taxman. It's not so much that the taxman is benevolent; we all no better; but some entities demand preferential treatment; powerful, giant corporations are holding governments and citizens up for ransom; taking tax breaks and subsidies from countries in the name of competitiveness; sheltering profits in off-shore tax havens.

Google, Amazon, Starbucks, GE, Apple, and pretty much every other major corporation and the big Wall Street banks siphon off profits via off-shore entities that are sometimes no more than a mailbox on a tropical island, and they don't pay taxes like the rest of us, because if they did it would destroy their ability to be competitive.

And today, Tim Cook, the CEO of Apple, ran down the aisles of Congress and hurled his hammer at the totalitarian overlords, metaphorically speaking. Actually, Cook appeared before the Senate Permanent Subcommittee on Investigations. Congressional investigators found that some of Apple’s subsidiaries had no employees and were largely run by top officials from the company’s headquarters in California. By officially locating them in places like Ireland, Apple was able to, in effect, make them stateless — exempt from taxes, record-keeping laws and the need for the subsidiaries to even file tax returns anywhere in the world.

Apple Operations International, which has no employees but reported $30 billion in income over the four years, has not filed an income tax return in any country for the last five years, the subcommittee investigation found.

A second company, Apple Sales International, holds the economic rights to Apple's intellectual property in Europe, Asia and Africa. The subsidiary had $74 billion in sales income from 2009-2012 but paid less than 1% in taxes to Ireland.

The only taxes paid were on the interest earned by the cash pile and small sums in local markets. Senate investigators allege a total of $70bn has been sheltered this way in four years.

The tactic, which is legal, is possible through complex cost-sharing agreements that transfer the economic rights to the valuable intellectual property behind the iPhone, the iPad, and other products to subsidiaries outside the US.

Tim Cook told the senators: “We pay all the taxes we owe, every single dollar.” And that appears to be the case; Apple does pay a considerable amount of taxes in the US . Cook added: “We don't depend on tax gimmicks.” And that appears to be a slightly more dubious claim. Cook said he "personally doesn't understand the difference between a tax presence and a tax residence".

In a dramatic display of how threats from multinational corporations are driving down taxes across the world, Cook warned Congress that he would refuse to repatriate a total of $100 billion stashed offshore unless it acted to slash the 35% US rate. Cook said the tax rate for repatriated money should be set "in single digits" to persuade companies to bring it back. Standard tax for US profits should be, he said, in the "mid 20s". 

 Everyone "knows" that the corporate income tax is a mess. Ask any company. They pay too much in corporate income tax, face rates higher than in any other OECD country, and are just following the law when they use tax havens to keep profits eternally deferred from taxation and to perform general sleight-of-hand. There is a big difference between the headline rate of 35%, which is indeed tops in the OECD, and the effective rate of 12.1%, one of the lowest in the OECD.

Apple is not an outlier in its efforts to produce 'stateless income'; income that is taxed neither in the US nor in the countries where its foreign customers are located, but it is audacious in its tax avoidance strategies. Apple shifted tens of billions of dollars of income without even breaking a sweat. Google followed the Apple playbook by using a low-tax Irish subsidiary to avoid taxes; Google is now under investigation in the UK. Starbucks' tax dodge was so blatant British consumers began boycotting the firm until it reversed course. In the US, we aren't indignant. Today, senators talked about how they considered Apple to be a great company, even if they did have concerns about the tax thing.

We have lots of great American companies that operate in a more or less free-market system that has allowed them to thrive on publicly-funded research, infrastructure, defense, and in the case of Apple – patent and intellectual property protections. And they show their gratitude by choosing to cut their taxes in half – or actually closer to one-third despite doubling their profits, so they may hold more than $1 trillion dollars of cash off-shore, and eliminate workers rather than create jobs. Or, as one Apple executive explained: “We don't have an obligation to solve America's problems.”

Which raises an interesting question; why should America have an obligation to solve Apple's problems? Apple enjoys the protections of US laws against patent and intellectual property infringement. Apple enjoys the ability to ship its products around the world, in part because the US has the largest, most powerful military making sure the avenues of commerce aren't crowded out by pirates on the high seas or in the skies. If Apple doesn't want to pay for those protections, they shouldn't be forced to. They could just stop using those services. You don't pay; you don't get – no gimmicks in that equation.

The scandals in Washington remind us to be ever vigilant about the dangers of government overreaching its authority, whether by the long arm of the IRS or the Justice Department, but that doesn't mean that we accept anarchy. We need to remember that government does provide important services and protections, and somehow we have to pay for that. Tim Cook and Apple don't want to pay. Nobody wants to pay. I understand. And so, not much changes

By the way, the World Bank estimates the total cost for a successful attack on malnutrition would be approximately $10.3 to $11.8 billion annually. Apple alone underpaid its 2012 taxes by $11 billion, based on a 35% rate. So, we could literally put an end to hunger in this world, if Apple paid it's taxes, but you know, it's not Apple's obligation to solve the problems of the world. 

Monday, May 20, 2013 - Daily Scandals and Distractions

Daily Scandals and Distractions

by Sinclair Noe

DOW – 19 = 15,335
SPX – 1 = 1666
NAS – 2 = 3496
10 YR YLD + .02 = 1.96%
OIL + .58 = 96.87
GOLD + 33.90 = 1395.10
SILV + .66 = 23.02

I suppose we should start with the scandal du jour, since this is where most of the news has been fixated recently. I'll try to focus on how it affects the economy and the markets, but it's hard to ignore the bluster. One quote I heard over the weekend was "add Watergate and Iran Contra together and multiply by ten" to calculate the tyrannical evil of the Obama scandals.

Actually, the current scandals are not even close (I'm old enough to remember the enemies list and plumbers). I don't think the scandals are inconsequential but I think some historical perspective might help. The rhetoric without perspective might actually backfire. But what we concern ourselves with here is the economic and financial impact. And it's likely there will be limited economic impact. We've seen worse, and the markets survived and sometimes even prospered.

Remember Iran Contra? It happened to coincide with one of the greatest bull runs the market has ever seen. And remember the Lewinsky scandal? It coincided with a market that was described as irrationally exuberant; this is often attributed to gridlock in Washington, or some sort of moderation. Actually, the old idea of gridlock being good for markets, doesn't really hold water.

When one party controls both the White House and Congress – Republicans or Democrats – the markets perform about 5 times better than when the president and Congress are from opposite parties. It doesn't seem to matter for the current administration; the market is enjoying big gains, with the S&P 500 up 149% since the lows of March 2009. And when things look bad, the market goes higher.

The explanation may come from the Federal Reserve. Weak numbers on any front are viewed as a sign that the Fed will remain accommodative as will other central banks around the world. The old adage "don't fight the fed" has really become "don't fight the feds' - as in plural. Trillions of dollars on the sidelines have to be put to work and are hungry for yield, especially from stocks. 

The trillions of dollars worth of central banks stimulus has put into play the past few years have socialized risk. The game used to be private gains and private losses. Now it's private gains and socialized losses. Businesses that have under-invested for years are beginning to capitalize on a distracted Washington using the breathing room to make new investments.

Anyway, the markets appear to be propped up, for now at least.

Remember the Libor rate rigging scandal? Several of the biggest banks were rigging Libor, the interest rate that is used worldwide for just about everything. When the Libor Scandal broke it raised the question, what else is rigged? We learned that derivatives, specifically the nearly $400 trillion dollar market in interest rate swap prices were subject to possible manipulation of the ISDA fix.

The latest revelation is oil price rigging. A review ordered by the British government last year in the wake of the Libor revelations cited “clear” parallels between the work of the oil-price-reporting agencies and Libor.

They are both widely used benchmarks that are compiled by private organizations and that are subject to minimal regulation and oversight by regulatory authorities. To that extent they are also likely to be vulnerable to similar issues with regards to the motivation and opportunity for manipulation and distortion.

Last week, the European Commission raided the offices of Shell, BP and Norway’s Statoil as part of an investigation into suspected attempts to manipulate global oil prices spanning more than a decade. None of the companies have been accused of wrongdoing, but the controversy has brought back memories of the Libor rate-rigging scandal.

The inquiry also involves Platts, the world's largest oil price reporting agency. Europeans have long complained that retail gas prices have not seemed to match wholesale prices. In fact, complaints that retail prices at gas stations were noticeably slow to fall when wholesale prices fell prompted the U.K.-based Office of Fair Trading last year to conduct a cursory inquiry into possible anti-competitive behavior in the fuel markets.Early this year, they announced that they hadn't found enough evidence to warrant a full-blown investigation. But complaints persisted.

Reuters points out that the probe may be expanding to the U.S.:

“In Washington, the chairman of the Senate energy committee asked the Justice Department to investigate whether alleged price manipulation has boosted fuel prices for U.S. consumers.

“Efforts to manipulate the European oil indices, if proven, may have already impacted U.S. consumers and businesses, because of the interrelationships among world oil markets and hedging practices,” Sen. Ron Wyden (D-Ore.), chairman of the Senate Energy and Natural Resources Committee, wrote in a letter to Attorney General Eric H. Holder Jr. Wyden also asked Justice to investigate whether oil market manipulation was taking place in the United States.”

Not only are petroleum products a multi-trillion dollar market on their own, but manipulation of petroleum prices would effect virtually every market in the world.

There's a lot riding on the price of oil, including how much money OPEC nations need to keep their governments funded. At $100 a barrel, there's enough profit to produce the oil and to fund the governments. Things get dicey around $80 a barrel; $60 dollar a barrel oil spells big problems for almost all OPEC countries.

Meanwhile, the International Energy Agency (IEA) in its Oil Market Report claimed that America's shale boom is growing even larger than expected. It's also set to have a profound effect on OPEC. OPEC is also set to produce, or have the capability to produce, a lot more oil. One main driver of that supply growth is Iraq. After a turmoil-filled decade, Iraq is coming back on line in a big way -- and could add another 3 million barrels per day to the oil mix by 2018.

So the U.S. has lots of oil, and we're producing it at an ever-growing rate. And OPEC has a lot of oil and is either producing it or sitting on it.

And what's funny is that if OPEC continues to cut supply via quotas, all it will do is help the U.S. oil boom. They'll essentially be crimping supply to boost prices... and we'll benefit. So why are prices still high? Central banks are still printing money. The Fed and the BOJ are printing away, and it's probably only a matter of time before the ECB joins in. Maybe that explains something. Then there is the fear premium. Then there is the idea that prices are rigged. Nobody wants to upset the situation, at least not right now.

The Saudis aren't happy that Iraq is coming online with about 3 million barrels a day by 2018. This could lead to a round of infighting among OPEC -- with each nation trying to eke out the most money. Frankly, the Saudis have massive incentive to see Iraq fail. The same goes for Iran. There are sanctions against Iranian oil, and that has as much to do with the price of oil as any specific act of craziness from the Iranian crazies.

The U.S. and OPEC are set to produce much more oil. And even though US and Euro demand is falling, demand from the oil-thirsty East is set to ramp up. So, we have an uneasy equilibrium in the oil markets right now.

The Federal Reserve Bank of San Francisco points out: When gasoline prices increase, a larger share of households’ budgets is likely to be spent on it, which leaves less to spend on other goods and services. The same goes for businesses whose goods must be shipped from place to place or that use fuel as a major input (such as the airline industry). Higher oil prices tend to make production more expensive for businesses, just as they make it more expensive for households to do the things they normally do.

Oil prices indirectly affect costs such as transportation, manufacturing, and heating. The increase in these costs can in turn affect the prices of a variety of goods and services, as producers may pass production costs on to consumers. Oil price increases are generally thought to increase inflation and reduce economic growth.

Oil price increases can also stifle the growth of the economy through their effect on the supply and demand for goods other than oil. Increases in oil prices can depress the supply of other goods because they increase the costs of producing them. In economics terminology, high oil prices can shift up the supply curve for the goods and services for which oil is an input. One major area that could feel the pinch is agriculture, and the prices of the food we eat.

There are some important scandals, just don't get distracted.

Friday, May 17, 2013 - Squirrel

Squirrel

by Sinclair Noe

DOW + 121 = 15354
SPX + 17 = 1667
NAS + 33 = 3498
10 YR YLD +.08 = 1.95%
OIL + .83 = 95.99
GOLD – 25.70 = 1361.20
SILV - .43 = 22.36

Record highs for the Dow and the S&P 500; marking the fourth consecutive week of gains. For the week, the Dow gained 1.6%, the S&P 500 gained 2%, and the Nasdaq was up 1.8%. The S&P 500 is up about 13% year to date.

Someone asked me yesterday if I intended to talk about the scandals in Washington; you know, the Benghazi scandal, the IRS scandal, and the Associated Press scandal. I suppose we can talk about that if you want.The issue I might address right now is, what does all the scandal-mongering mean for the economy?

Well, we could look to the Clinton years, which continued to perform handsomely, but I think that had more to do with the dot.com boom than with Clinton's proclivity. Greenspan warned about irrational exuberance while fostering policy that just pumped the markets to higher highs. Not so different really from Bernanke's warnings about excessive risks while continuing with QE to infinity and beyond.

The market has been profiting from the indulgences of the Fed's easy money, and the Chairman seems more worried that Congress will busy itself with more fiscal austerity in the form of quick-timed spending sequesters and additional tax increases than he is about inflation from easy money. Unspoken is the fear certainly in the Fed quarters and lurking in the markets' subconscious that Congress will go even further and again set up another credit-rating political cliffhanger over the debt ceiling extension.

Maybe, the politicians can pull themselves away from their compulsive partisanship to recognize that the deficit is getting better. The Congressional Budget Office revise its budget projections. The short-term deficit, in particular, is way lower; $200 billion lower; or a $643 billion deficit for 2013 rather than an $845 billion deficit. That should be really big news, just not this week. Both sides of the aisle could take credit for that, but it barely gets a nod. Congress is distracted, like a dog in the presence of a squirrel.

And the longer they keep up their nonsense, the less time they have to meddle with the economy; which might not be such a bad thing. No time to come up with a Grand Bargain on Social Security and Medicare; no time to figure out entitlement cuts; nothing but gridlock through the hazy days of summer.

For a business community that constantly begs for certainty, maybe they would enjoy a lazy summer of slow, steady growth without the distractions from Washington. Fed Chairman Bernanke has begged for Congress to come up with fiscal policy that might help grow the economy, but would probably be happy to see Congress stop stepping on the economy's tail with it's austerity obsession. The politicians are clueless about the economy and they could only screw things up.

Case in point; last week the US House passed the Full Faith and Credit Act, which quickly gained the nickname “Pay China First Act”. The supposed purpose of the act is to prevent default on the public debt as a result of the debt ceiling.

The idea was the act prioritizes the financial obligations of the US government, and authorizes the Secretary of the Treasury to meet only the highest priority obligations when at the debt ceiling; that is how the act is described by its own authors, since the head of the resolution contains the description, “A bill to require that the Government prioritize all obligations on the debt held by the public in the event that the debt limit is reached.”

The act seems to have been designed to provide the Secretary of the Treasury with an alternative mechanism for paying off public debt and meeting Social Security obligations once the government has reached the statutory debt limit. But the new mechanism cannot be applied directly to other government spending commitments, and so Congress would still apparently have the ability use the debt ceiling as a tool for shutting down other government payments and forcing the executive branch to accept further spending cuts.

But remember the politicians are not real strong on economics and it appears this act would provide the Secretary of the Treasury with the power to meet all US spending obligations, and effectively eliminate the debt ceiling as a serious political and operational consideration going forward.

The act specifically authorizes the Treasury to issue “obligations … to pay with legal tender”, the principal and interest on the obligations described in subsection 2(b). Now, an obligation is just another debt instrument. So the act basically permits the Treasurer to issue IOUs to pay the principal and interest on public debt. It permits the Treasurer to redeem conventional government debt obligations – all of the usual bills, notes and bonds the government issues, and that count against the debt subject to the debt limit – with a new kind of debt obligation.

Basically, the Treasury could write IOU's and put them in the Treasury coffers to reduce the debt, and then issue fresh bonds to raise cash to pay for whatever they want to pay for.

Squirrel.

The one thing that has roiled the markets lately is talk of the Federal Reserve tapering off Quantitative Easing. While the economy has shown signs of improvement, it is still a long way from a strong economy. Inflation remains under control, so that's not a problem. Unemployment is still a problem, so that's reason to increase stimulus, not taper off. Several regional Fed presidents have weighed in recently, and yesterday, Fed governor Sarah Bloom Raskin raised the possibility that rising inequality may restrain growth for years to come.

In a speech delivered in Washington, Raskin said: “In my view, the large and increasing amount of inequality in income and wealth, which has been an ongoing development for decades, may have exacerbated the crisis. More research is required to determine whether it may also pose a significant headwind to the recovery from the crisis for years to come.”

Raskin’s comments are among the most forceful to date from any current member of the Fed’s seven-person Board of Governors regarding wealth, income inequality, and how dynamics in household wealth may be impeding growth and prolonging the realization of a full-fledged recovery

Between 1979 and 2007, inflation-adjusted, pretax income for households in the top 1 percent more than doubled, while middle-income households experienced earnings growth of less than 20 percent, according to Congressional Budget Office data. A recent survey by the Fed found that households in the top fifth of annual income owned 72 percent of the total wealth in the economy in 2010, while those in the bottom fifth owned just 3 percent.

Maybe this is the excessive risk Bernanke has been harping on lately.

Here's your weekend reading list:

From the Guardian: A Look at How Apple will petition Washington for a Tax Holiday and what history tells us about tax holidays.

Matt Taibbi continues to dig up wrongdoing by banksters; Everything is Rigged

Thursday, May 16, 2013 - What's Next For the Fed

What's Next For the Fed

by Sinclair Noe

DOW – 42 = 15,233
SPX – 8 = 1650
NAS – 6 = 3465
10 YR YLD - .08 = 1.87%
OIL + .95 = 95.25
GOLD – 6.60 = 1386.90
SILV + .10 = 22.79

The Labor Department reports the consumer price index dropped 0.4% in April from March, the biggest monthly drop since December 2008. The main reason the index fell was that gas prices plunged 8.1 percent. Excluding the drop in fuel costs, prices were largely unchanged. For the 12 months that ended in April, overall prices rose 1.1 percent — the smallest year-over-year increase in 2½ years. Excluding volatile energy and food costs, “core” prices ticked up 0.1 percent last month. Core prices have risen only 1.7 percent in the past 12 months. That’s below the Federal Reserve’s 2 percent inflation target. Yesterday, we reported that wholesale prices declined last month.

Inflation is not the problem right now; it might be a problem at some point down the road, but not now.

John Williams, the San Francisco Fed president gave a speech in Portland and he indicated that the Fed's Quantitative Easing program can be reduced soon, and that the whole program may be halted this year. He pointed out the pace of job growth has picked up since the program was launched in September, with an average pace of job growth of 200,000 over the last six months.

Williams said: “Assuming my economic forecast holds true and various labor-market indicators continue to register appreciable improvement in coming months, we could reduce somewhat the pace of our securities purchases, perhaps as early as this summer. Then, if all goes as hoped, we could end the purchase program sometime late this year.”

Williams was open to the idea of ramping up bond purchases if the economy slows down.

So, let's go back to the Federal Reserve's dual mandate of price stability and maximum employment. Right now, prices are stable; even a little bit of disinflation based upon this week's producer-price index and consumer-price index. No need to taper off.

On the maximum employment side of the mandate, the Fed set a target of 6.5% unemployment, which is still a long way from it's mandate of maximum employment. One of the reasons the unemployment rate has dropped to 7.5% is because the participation rate has dropped; fewer people are considered to be in the labor pool. The economy has been adding about 200,000 jobs per month, on average, over the last six months. We know that many of those jobs are temp jobs; many are part-time jobs; many are lower paying jobs. But they are net new jobs. The problem is that 200,000 jobs is not enough to lower the unemployment rate, unless a lot more people fall out of the labor market.

This morning, the Department of Labor reported initial claims for unemployment increased 32,000 to 360,000.

So, why do we have all this talk of tapering off from QE?

In order for QE to work, rather than just inflate asset prices, there needs to be viable investment opportunities that create productive jobs in the short, medium, and long term. Infrastructure would qualify as filling the bill, but not just building bridges to nowhere. And this is the flawed premise of QE, according to a recent speech by Dallas Federal Reserve President Richard Fisher: “by driving rates to historical lows along the entire length of the yield curve, investors will rebalance their portfolios and reach out to riskier assets, providing the financial wherewithal for businesses to increase capital expenditures and reengage workers, expand payrolls and regenerate consumption. Rising prices of bonds, stocks and other financial instruments will bolster consumer confidence. The CliffsNotes account of this play has the widely heralded “wealth effect” paving the way for economic expansion, thus saving the day.”

Fisher went on to add: “Until job creators are properly incentivized by fiscal and regulatory policy to harness the cheap and abundant money we at the Fed have engineered, these funds will predominantly benefit those with the means to speculate, tilling the fields of finance for returns that are enabled by historically low rates but do not readily result in job expansion.”

There are a few problems here. Cheap money does not encourage speculation. Cheap money encourages prudent lending. If you can only get a small rate on your loan, you are more likely to make certain that loan will be repaid. This is why triple-A rated corporate bonds pay less than junk bonds. This is also why the residential housing mortgages written in the past two years are a much better vintage than the mortgages written in 2005. High rates encourage speculation. The risk is not in the low rates, but rather that the low rates push prudent potential lenders to seek higher returns elsewhere, like in the stock market.

The result, and it must be scaring the Fed, is that we are headed for a speculative bubble. If you always do what you've always done, you'll always get what you've always gotten. The Fed actually has some history with bubbles. The next time you read that a new era has dawned, that the old rules of economics don't apply, and that some asset class or other that’s been rising steadily for a while now is certain to keep on to infinity and beyond; that's just wrong. It really is that simple.  

The problem is that the Fed has been passing out cheap money to speculators and gamblers. And now they're shocked, shocked I tell you, to discover that the speculators are gambling with the cheap money. Speculation demands high rates as compensation for high risk, but the Fed has been passing out super-low rate money to the most high risk players.

And the banksters continue with their rotten ways. They take the zero-interest money from the Fed and they screw anybody and everybody they can. Today a case in point.

In 2006, Congress passed the Military Lending Act, which was designed to prevent predatory lenders from targeting men and women in uniform. But a new report from ProPublica and Marketplace entitled Beyond Payday Loans suggests aggressive lenders have merely shifted tactics and are still very actively going after military personnel.

Rather than a loophole, installment loan companies and so-called payday lenders have found huge gaps in the Military Lending Act. The Military Lending Act set a national interest rate cap of 36 percent APR (annual percentage rate) for loans to military members and their families (excluding mortgages and auto finance loans).

The Act covered three specific types of loans: payday loans (short-term, due in one lump sum after a borrower’s payroll check clears); car-title loans; and tax refund anticipation loans. Further, the loan-terms covered were restricted: 91 days or less for a payday loan, 181 days or less for a car-title loan.

As a result, lenders are offerings payday loans, which typically have annual percentage rates over 400%, with a duration of five months instead of three. Same is true of auto-title loans, which are secured by the vehicle’s title and typically have rates above 100%.

And yes it is the banksters that back the payday lenders, or in many cases the big banks are the payday lenders, through a different division of the company. QE and the other tools of the Fed have not cleaned up some of the worst abuses in the system.

Today, the International Monetary Fund weighed in, claiming the Quantitative Easing by the Fed, and the ECB, and the Bank of Japan had helped to stabilize financial markets and push asset prices higher. The IMF figured that: “While additional unconventional measures may be appropriate in some circumstances, there may be diminishing returns, and benefits will need to be balanced against potential costs.”

Maybe it is time to ask whether the Fed has been effective in its policy over the past five years. Yes, the Fed policy helped avert a global financial meltdown. Yes, the Fed policy prevented the collapse of the biggest banks. Yes, the Fed policy was a part in turning around massive job losses and helping bring down unemployment in a less-than-robust manner. No, the Fed hasn't done much to regulate the financial institutions that caused the problems in the first place. The Fed doesn't seem to believe in regulation; which is kind of like a Pope that doesn't believe in religion.

The Fed hasn't been particularly successful in its mandates. Perhaps the time is coming where they need to change the tools they're using. Maybe it is time to break away from Quantitative Easing, which mainly helps the banks, and maybe they need to start using tools that will promote a healthy economy, with maximum employment – not just a target of 6.5% unemployment – and help people find productive employment. And then they could use their regulatory tools to help ensure financial stability in what has become a casino market.

One of the better moves the Fed could consider is to open up low interest rates to entities other than the member banks; this probably exceeds the Feds generally accepted role, but not the technical limits of its tool box. Infrastructure investment still looks like the best, least speculative way to achieve the dual mandate. Imagine a country with a continental railroad - like what Lincoln did, or an nationwide highway system – like what Eisenhower did, or a country that develop science to the point we could fly to the moon – Kennedy and Johnson. Now imagine a country that is energy independent.

The time is coming for the Fed to move beyond Quantitative Easing, and this is why we've been hearing about tapering off. QE is not as effective as it once was, and it has never been as effective as it should have been. So, maybe a change is coming. The big question is where they go next.

Wednesday, May 15, 2013 - Have Another Cookie

Have Another Cookie

by Sinclair Noe

DOW + 60 = 15275
SPX + 8 = 1658
NAS + 9 = 3471
10 YR YLD - .01 = 1.94%
OIL + .18 = 94.39
GOLD – 33.30 = 1393.50
SILV - .82 = 22.69

More record highs on Wall Street. We celebrate with milk and cookies, and remembrances of the days of rice and beans and tins of tuna. Record highs are fleeting, almost ephemeral. I know the trend is your friend; don't fight the Fed; a rising tide lifts all boats; yada, yada. Why is this starting to feel like an asset bubble?

Stock Traders Daily did a comparison of quarter to quarter earnings and revenue growth rates for the S&P 500 and the Dow Industrials: “For the past two consecutive quarters, the Dow Jones Industrial Average has had zero growth. In fact, this quarter revenue growth declined by 2.65% (25 companies reporting thus far) and earnings have barely budged. Last quarter, there was negative earnings growth with revenue growth less than 1%, and since the third quarter of 2010, the EPS growth rate for the Dow has been declining steadily.”

So, the growth rate is at zero and the prices keep going higher. Don't worry, have another cookie; after 13 years in the market, you should be back to break even.

Meanwhile, the National Association of Home Builders/Wells Fargo housing-market index rose to 44 in May from 41 in April. The NAHB says builders are noting an increased sense of urgency among potential buyers as a result of thinning inventories of homes for sale, continuing affordable mortgage rates and strengthening local economies. Have another cookie.

Wholesale prices dropped in April. The producer-price index declined by a seasonally adjusted 0.7% to mark the biggest drop in more than three years. Wholesale prices over the past 12 months are up just 0.6%. In April, the cost of fuel fell 2.5%, led by a 6.0% drop in gasoline prices. Electricity and home-heating-fuel costs also eased, though natural-gas prices posted the biggest increase since mid-2008.

The price of food, meanwhile, fell 0.8% in April after jumping by the same amount in March. Vegetable prices plunged 10.6%, with the cost of squash, lettuce, celery and cucumbers all taking a dive. Meat prices also fell. Cookie prices were not included in the report.

The muted rate of inflation at both the producer and consumer levels gives the Federal Reserve more leeway to keep interest rates low and continue with QE. So, the talk about tapering off of QE might make more sense if the Fed was actually getting closer to its targets of 6.5% unemployment or 2.5% inflation. They aren't close.

The Federal Reserve Bank of New York reports households reduced debt during the first quarter by 1 percent to the lowest level since 2006. Household debt fell to $11.2 trillion in the first quarter compared with a peak burden of $12.7 trillion in the third quarter of 2008. Consumers reduced debt by $110 billion after increasing their borrowing by $31 billion in the fourth quarter of 2012, while delinquency rates fell across the board. Student debt bucked the trend, rising to a record $986 billion.

Households in the first quarter improved their debt payment patterns as delinquency rates on mortgages fell to 5.4 percent from 5.6 percent, on home equity loans to 3.2 percent from 3.5 percent, on credit cards to 10.2 percent from 10.6 percent and on student loans to 11.2 percent from 11.7 percent. One way to look at this is that reducing debt results in a better vintage of debt. Student lending has surpassed credit cards, auto loans, and home equity loans, and is now the largest form of consumer debt after mortgages.

Last week, Fed Chairman Ben Bernanke said “the Fed could push banks to maintain a higher leverage ratio, hold certain types of debt favored by regulators, or other steps to give the largest firms a ‘strong incentive to reduce their size, complexity, interconnectedness.’

“The Fed chairman acknowledged growing concerns that some financial companies remain so big and complex the government would have to step in to prevent their collapse and said more needs to be done to eliminate that risk.”

And Fed Governor Jeremy Stein said pretty much the same thing; and Fed Governor Daniel Tarullo also picked up on the talking point.

James Kwak raised a vital question about these talking points: Too-big-to-fail banks enjoy implicit subsidies and impose externalities on the rest of us; therefore those subsidies and externalities should be priced; and then those banks can decide whether they want to absorb those costs or make themselves smaller. 

Here’s what they are saying: Too-big-to-fail banks are too big and complex and pose a systemic risk to all of us; therefore they need to become smaller and less complex; and the Fed will tweak the regulations until they become smaller and less complex.

What’s remarkable about this? These three men—probably the three most important on the Board of Governors when it comes to systemic risk regulation (as opposed to monetary policy, for example)—all say that they know that the megabanks are too big and complex. They all say that accurate pricing of subsidies and externalities is not an end in itself.* They all say that the goal is smaller, less complex banks.

If the goal is smaller, less complex banks, why not just mandate smaller, less complex banks? Why beat around the bush with capital requirements and minimum long-term debt levels? Those tools might be appropriate if you think huge, complex banks should exist but you want to make them safer. But if you’ve already concluded that banks need to be smaller and less complex, then they’re just a waste of time.

They also betray a frightening naivete regarding corporate governance. The theory is that higher capital requirements, for example, will lower banks’ profits, which will upset shareholders, who will eventually force the board of directors to eventually convince the CEO to break up his empire. This scenario, unfortunately, depends on the premise that American corporations are run for the benefit of their shareholders, which is only roughly true, and even that often requires long, expensive, and messy shareholder activist campaigns.

Instead, there’s an obvious solution: rules that limit the size and scope of financial institutions. But Bernanke has ruled out “arbitrary” size caps in favor of his cute regulatory dial-tweaking.

Again, Bernanke’s position might be defensible if he wasn’t already sure that today’s banks are too big and complex. Then it might make sense to tweak the incentives and see how the market reacts. But if he knows they are too big and complex, he should eliminate that risk in the simplest, most direct way possible. If he’s not sure how much smaller and simpler banks need to be, he can do it in steps: set one set of size and scope limits, see what he thinks about the outcome, and then set another set of limits if he’s still unhappy.

To use a crude analogy, let’s say we’re concerned about guns on airplanes. Ben Bernanke thinks, like I do, that guns on planes present an unacceptable risk to the safety of air travel. But his approach is to charge a $100 fee for anyone who wants to bring a gun onto a plane. If people keep bringing guns on board, he’ll raise the fee to $200, then $300, and so on until people stop. The sensible, obvious solution is to just ban guns on planes. But that would be “arbitrary.”

It is theoretically plausible that one should simply price the subsidies and externalities and then let the market determine whether big banks provide enough societal benefit to offset the costs they impose on the rest of us. But that is not what Stein, Tarullo, and Bernanke are saying.

Meanwhile, Attorney General Eric Holder was speaking before the House Judiciary Committee hearing today on another subject, but he was asked about comments he made back in March about the idea that the big banks are too big to jail. He said his comments were misconstrued and he added that there is “no bank, there’s no institution, there’s no individual who cannot be investigated and prosecuted by the United States Department of Justice.”

And that was the straightest answer he gave in testimony today. Have another cookie.

Meanwhile, a few years ago, I wrote a book about breaking up the too big to fail banks; Eat The Bankers: The Case Against Usury: The Root Cause of the Economic Crisis and the Fix