Monday, September 10, 2012 - When the Crack Pipe Fails to Satisfy

When the Crack Pipe Fails to Satisfy

-by Sinclair Noe

DOW – 52 = 13,254
SPX – 8 = 1429
NAS – 32 = 3104
10 YR YLD +.02 = 1.68%
OIL -.30 = 96.24
GOLD – 10.50 = 1725.80
SILV - .34 = 33.44
PLAT + 2.00 = 1599.00

Consumer credit shrank by $3.28 billion in July; this marked the first declines in consumer credit in nearly a year as Americans reduced credit card debt. Now for the scary part; I read a couple of stories on this today and they described the news as worrisome for the economy. I disagree. It might be worrisome for the credit card companies; it might be worrisome for the payday loan companies; it might be worrisome for the banks and other loan sharks, but I consider it good news for consumers and the economy in general. Consumer debt does not add to productivity; it doesn't manufacture things. It's debt. It's inflationary. It's takes resources which could be applied to greater purpose elsewhere. It doesn't really matter because the Federal Reserve says they revised their earlier estimates for June, and it is likely we'll all be paying with plastic again in August – you maybe, not me.

Credit has been expanding almost continuously since mid-2010 as the country recovered from the 2007-2009 meltdown. The decline in July was the first drop since August of last year. In July, revolving credit, which includes credit cards, shrank by $4.82 billion. The data looks at declining credit as a negative because it is closely correlated to consumer spending. Of course, there is the possibility that people are buying things with something we used to call money; I know that is a farfetched notion, but I'm holding out hope.

The concept of stopping the continuous compounding of debt upon more debt upon more debt; the very idea of someone in a hole, stopping digging – this notion is completely and totally alien to the Federal Reserve. And so the Federal Reserve will almost certainly announce QE3 at the end of the week, or some version of QE3, or some new catchy name for tossing out free money to the banks, while creating mountains of fresh, new debt.

The only surprise would be if the Fed did not announce QE3 and QE to infinity; in which case the market would throw a tantrum and break things, like your 401k. The Wall Street bookies, or analysts, are putting the odds of QE3 at 99%. And then you have to believe that since the market believes the Fed will deliver QE to infinity, they have already baked it into the cake. Accommodative policy is already priced into equity and bond valuations.

We know the markets love free money, but what if the Fed announced QE and the markets were flat or even worse, their response is negative because it's already priced in. And even though the Wall Street types love free money from the Fed, businesses on Main Street aren't making investment or hiring decisions based on the idea that the Fed is holding interest rates near zero. In fact, if you want to spur capital expenditures, you might want to hint that rates will go up in the future and now is the time to make your move. At some point, the Fed's action won't be enough to make a major difference in markets; I don't think we're there yet.

Yale University professor Stephen Roach and Bill Gross, the manager of the world’s biggest bond fund at Pimco say central bank money printing is losing its effectiveness in spurring growth.

Roach says: “I’ve been negative about the U.S. ever since the Fed went to their unconventional monetary policy.”

Gross, who oversees Pimco’s $270 billion Total Return Fund, wrote in the monthly commentary posted on Pimco’s website last week: “Our credit-based financial system is burdened by excessive fat and interest rates that are too low.”

After the Fed’s first round of quantitative easing, the Bank of England announced 75 billion pounds ($120 billion) of asset purchases in March 2009, and the ECB provided 442 billion euros ($565 billion) in one-year loans to the region’s lenders in its Long Term Refinancing Operation, or LTRO, three months later. The Bank of Japan said in October 2010 it would buy 5 trillion yen ($64 billion) of government and corporate debt.

The Fed cut its overnight bank lending rate to between zero and 0.25 percent in December 2008 and has indicated it may keep it there through 2014. The ECB has reduced borrowing costs to 0.75 percent and the BOE to 0.5 percent. The BOJ lowered its target rate to about zero from 0.5 percent.

Fed stimulus has typically debased the currency. The Dollar Index tracks the greenback against six US trading partners; the index dropped 13 percent between the Fed’s announcement of $2.3 trillion in easing in November 2008 through the end of the bond buying in June 2011. That might not happen this time. The index is trading around 80.5, a fairly strong level of support. Also, we’re seeing clearer signs of diminishing returns from success quantitative-easing programs. Also, it's pretty clear that the US recovery is less than robust, you might call it tepid, you might call it a non-recovery, or you might call it something we can't call it on the radio. But the rest of the world isn't in much better shape.

The Euro-zone economies contracted 0.5 percent in the second quarter from a year earlier. Japan is struggling to overcome more than a decade of deflation and the effects of last year’s record earthquake. Bill Gross wrote on the Pimco website that central banks are agog in disbelief that the endless stream of QEs and LTROs have not produced the desired result. Yep, and junkies are amazed when the crack pipe fails to satisfy; why should the debt junkies be any different.

Gross also says new regulations requiring banks to hold more capital and increased saving by households has prevented record low interest rates from sparking the recovery central bankers anticipated. As if banks having enough money to back up their bets is a bad thing, as if households not digging a deeper and deeper hole to finance day to day consumption is a bad thing. Gross is a pretty smart guy but when a man makes his living with a hammer, the whole world looks like a nail.

In addition to the Federal Reserve FOMC meeting we'll be watching the news out of Europe. Stocks declined earlier today as Greek Prime Minister Antonis Samaras was meeting officials from the nation’s creditors after failing to secure agreement from coalition partners on spending cuts. Meanwhile, Greece’s Democratic Left leader said that no decision had been made on the cuts required to obtain further aid for the country’s bailout, and that poorer citizens must be protected from austerity measures.

The German Constitutional Court will rule on the legality of the Euro-bailout fund. Also, Mario Draghi, the president of the European Central Bank still has to sort out exactly what the next steps are for the Euro-zone under his whatever it takes, unlimited conditional support, bond-buying scheme. If nothing else, Draghi has kicked the can into the politicians' court; he can claim he did his part and now it is up to the politicians and the German courts.

George Soros made his fortune betting on currencies in the midst of economic crisis in the UK; Soros says: “Lead or leave: this is a legitimate decision for Germany to make. Either throw in your fate with the rest of Europe, take the risk of sinking or swimming together, or leave the euro, because if you have left, the problems of the eurozone would get better.”

And while the Germans deliver their verdict, the Dutch will also take to the polls for national elections. The Netherlands economy is fairly strong but it has been slowing and the Netherlands is not an island, despite all the canals, it is feeling the slowing effects of the Euro-crisis.

The Dutch and the Germans have been part of the northern countries demanding austerity by the southern or peripheral countries, but now that the Dutch are feeling the slowdown, the idea of austerity becomes less appealing. While the Dutch generally still see the benefit of fiscal responsibility and financial sustainability, more and more people doubt that now is the best time to try to reign in the deficit as it is becoming clear that the cutbacks deepen the crisis rather than solving it.

Since 2008, the internet collective known as Anonymous has hacked the CIA, the Sun newspaper, the Church of Scientology, the FBI, the Arizona Department of Economic Security, Visa, Mastercard, and a host of other large corporations, sparking a global police crackdown last year. For a period in 2011, LulzSec – an offshoot of Anonymous, the internet"hacktivist" collective who came to prominence around the time of the Wikileaks affair – wreaked a trail of chaos across the web. Their actions ranged from the transgressive – they had taken down the CIA's website and hacked into Sony's database and released more than a million user names and passwords. Then they hacked PBS television after they aired a negative documentary about Julian Assange. LulzSec hacked into their website and replaced the homepage with an article about Tupac Shakur, "Tupac Still Alive in New Zealand" (I have long suspected Tupac was living in New Zealand). Then, during the Arab spring, members of the group hacked and defaced Tunisian and Egyptian government sites. One hacker (later discovered to be a 16-year-old London schoolboy), allegedly wrote a webscript that enabled activists to circumvent government snooping.

Thousands and possibly millions of websites hosted by GoDaddy.com went down today, causing trouble for up to 5 million small businesses. A Twitter feed that claimed to be affiliated with Anonymous said it was behind the outage, but this couldn't be confirmed. Another Twitter account, known to be associated with Anonymous, suggested the first one was just taking advantage of an outage it had nothing to do with. Maybe they were hacked, maybe GoDaddy just screwed up on their own. GoDaddy was a target for hacktivists early this year, when it supported a copyright bill, the Stop Online Piracy Act. Movie and music studios had backed the changes, but opponents say they would result in censorship and discourage Internet innovation. And GoDaddy sided with the censors.

The US Treasury Department said it will sell $18 billion of American International Group Inc., slashing its stake in the New York company by more than half and making the government a minority shareholder for the first time since the financial crisis was roaring in September 2008.

At JPMorgan directors are considering lower 2012 bonuses for Chief Executive Jamie Dimon and other top executives in the wake of a multibillion-dollar trading disaster. But they also are grappling with the question of how to do that without drastically reducing the executives’ take-home pay. More than 93% of Mr. Dimon’s $23 million in compensation last year came from either stock- or cash-based bonuses. Citigroup’s board, meanwhile, is expected to decide this fall how to fine-tune next year’s compensation plan to win broader support among investors. One thought is if an executive loses billions of dollars in reckless trades, maybe they don't deserve a bonus.

Transocean Ltd. and the Justice Department have discussed a $1.5 billion settlement that would resolve federal claims over the company's role in the 2010 rig explosion that led to the nation's worst offshore oil spill.

Transocean said in a regulatory filing that several issues, including the possible time period for payment, must be resolved before a deal can be completed. A Justice Department spokesman declined to comment. Transocean owned the Deepwater Horizon drilling rig, where 11 workers died in an April 2010 explosion triggered by a blowout of BP's Macondo well. Transocean also says it rejected settlement offers earlier this year from BP and a group of private attorneys for Gulf Coast residents and businesses.

Transocean was once a US company, but now they're headquartered in Switzerland. They are involved in deep-water ocean oil drilling and apparently Switzerland offered, easy coastal access.