Tuesday, February 26, 2013 - Send in the Clowns

I will be speaking at the Wealth Protection Conference 2013, April 5 & 6 in Tempe. It's a great conference. Click here to find out more and make a reservation.

Send in the Clowns

by Sinclair Noe

DOW + 115 = 13900
SPX + 9 = 1496
NAS + 13 = 3129
10 YR YLD -.02 = 1,88%
OIL - .42 = 92.69
GOLD + 21.10 = 1615.70
SILV + .44 = 29.53

Twice a year the Fed Chairman visits Capitol Hill. He talks to senators and the next day he talks to the House of Representatives. Today, Bernanke told lawmakers that he had done a good job and he tried to take his bows. Bernanke said Fed policymakers are cognizant of potential risks from their extraordinary support for the economy, including the possibility that it might fuel unwanted inflation or stoke asset bubbles. But, he said the risks did not seem material at the moment, adding the central bank has all the tools it needs to retreat from its monetary support in a timely fashion.

Bernanke said: "To this point, we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more rapid job creation."

When asked pointedly by Republican Senator Bob Corker about whether the Fed's easy monetary policy was contributing to competitive currency devaluations globally and laying the groundwork for inflation, Bernanke was unequivocal. He said: "My inflation record is the best of any Federal Reserve chairman in the post-war period. We are not engaged in a currency war."

 Elizabeth Warren, a Democrat, pressed Bernanke on what she said is an implicit subsidy that large banks receive in the form of lower borrowing costs from being perceived as too big to fail. Warren asked:"We've now understood this problem for nearly five years, so when are we gonna get rid of 'too big to fail?'"

Warren also asked whether big banks should repay taxpayers for the billions of dollars they save in borrowing costs because of the credit market's belief that they won't be allowed to fail, repeatedly citing a recent Bloomberg View study estimating that the biggest banks essentially get a government subsidy of $83 billion a year, nearly matching their annual profits.

Bernanke countered that Dodd-Frank financial reform rules had given regulators more power to wind down failing financial institutions, making the issue less of a concern. Bernanke said: "The subsidy is coming because of market expectations that the government would bail out these firms if they fail. Those expectations are incorrect. "

Bernanke warned the near-term spending cuts known as the sequester, which are set to take hold later this week, would threaten an already challenged economic expansion: "The Congress and the administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration, with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run."

Bernanke also addressed the labor market:"High unemployment has substantial costs, including not only the hardship faced by the unemployed and their families, but also the harm done to the vitality and productive potential of our economy as a whole."

Here is a link to video of Warren questioning Bernanke.

The main takeaway from the testimony is Bernanke downplayed the risks from the Fed’s economic stimulus campaign, describing it as necessary and effective and making clear it is likely to continue for some time. And then he told the lawmakers they need to do their part, saying: “Although monetary policy is working to promote a more robust recovery, it cannot carry the entire burden of ensuring a speedier return to economic health.”

Speaking of which: The economy is going to hell in a hand basket! The sky is falling, or airplanes will fall from the sky! The sequester is coming, the sequester is coming!

Yeah well. While President Obama warns of the dire economic impact from across-the-board budget cuts, the nation may face more serious fiscal debates in the months ahead on a potential government shutdown and renegotiation of the debt ceiling.

With just three days before the $85 billion in reductions for this year are scheduled to start, Obama and Republicans led by House Speaker John Boehner yesterday traded blame again for the impasse. The president and his Cabinet officers drew a landscape of lost jobs, long lines at airports, delays at ports and cutbacks at national parks.

There’s been no public sign of negotiations between Obama and congressional Republicans. As the administration continued laying out details of how programs used by many Americans would be curtailed, Republican governors joined their congressional delegations in accusing Obama of overplaying his hand. And it will probably take about a month before most people really start to notice the cuts. Obama said they were no less a threat to the world’s largest economy, which stalled in the fourth quarter. “The uncertainty is already having an effect,” Obama said. “Companies are preparing layoff notices. Families are preparing to cut back on expenses. The longer these cuts are in place, the bigger the impact will become.”

And for now, the markets are freaked out, traders and analysts still think there will be a compromise within the next 30 days or so.

Looming even larger than the March 1 start of the automatic spending cuts is a potential government shutdown if Democrats and Republicans can’t agree on a stopgap funding measure by March 27, the date that current government funding expires. Without a deal in Congress that Obama would sign, government spending would halt.

In the battle over the sequester, Boehner has maintained his pledge not to entertain any new tax revenues. President Barack Obama and Democrats have called for a resolution that consists of both spending cuts and increased revenue, such as closing corporate tax loopholes and implementing the Buffet rule to raise taxes on billionaires.

During a news conference, Boehner showed no signs of hedging. "The president says we have to have another tax increase in order to avoid the sequester,” he said. "Well, Mr. President, you got your tax increase. It’s time to cut spending here in Washington."

So, don't expect a sequester deal. Sen. Ron Johnson (R-Wis.) said House Speaker John Boehner (R-Ohio) would lose his speakership if he agrees to new tax revenues to avert the across-the-board spending cuts that are set to kick in on March 1.

Much of the motivation for deficit reduction, a goal shared by policy makers across the political spectrum, is the belief that deficits consume the nation’s seed corn. That is, deficits represent negative saving. Because saving is presumed to be the key determinant of long-term real economic growth, deficits deplete the supply of saving and thus reduce growth. There are many problems with this analysis. One is that it assumes that all government spending is consumption. In fact, much of it consists of investment. the federal government will invest $550 billion this year in physical capital (buildings, equipment), research and development and human capital (education). This includes grants to state and local governments for these purposes.

It is perfectly reasonable to finance long-lived capital projects with borrowing. Because the benefits will accrue over many years, it would be silly to treat things like highways as if they were consumed within a single year for budget purposes.

Unfortunately, the federal budget is silly in this respect. It treats investment spending the same way every other budgetary item is treated – as if it were consumption with no long-lasting benefits for the nation.

An unfortunate consequence of this budgetary convention is that reducing federal investment is viewed as beneficial if it reduces the deficit. Moreover, it is often easier to cut investment spending than consumption, just as homeowners suffering from an income loss may find that deferring maintenance or planned improvements is the easiest way to conserve cash.

Many economists say they believe that the best thing the federal government can do to raise the long-term economic growth rate is increase infrastructure spending. It would have the double benefit of mobilizing idle resources, especially unemployed workers, while low interest rates permit capital projects to be financed very cheaply. One main barrier to achieving this double benefit is the confusion between investment spending and consumption spending, which is distorted by the way the budget is presented and the way we calculate saving.

Meanwhile, Italy's politics have almost literally become a clown show. The front-runner, who had teamed with the former European Central bank technocrat, did not do well in yesterday's election. Go figure. Beppe Grillo, the clown comedian did well, his movement was the top vote getter, even though he didn't win, and even though or perhaps because he is not a politician, he is not particularly wise, he does not have a permanent tan, he does not own the entire telecommunications industry in Italy, he is no a shameless unrehabilitated whoremonger, and he is not a Goldman Sachs puppet, (which may be a bit redundant). The Italians failed to do the responsible thing and vote for austerity. Go figure.

Italy is doing what Greece was (quite understandably) too small, too afraid and too vulnerable to do which is to say, collectively, “up yours” to austerity, technocracy and cronyism. And yes, they probably won't get away with it. Italian party chiefs began jockeying to forge a coalition of rivals and head off a second vote as a political vacuum of at least a month loomed.

The Five Star protest movement of comedian Beppe Grillo looked likely to emerge as the biggest single party in the lower house. The scourge of bankers and corrupt elites, Mr Grillo has campaigned for a return to the lira and a restructuring of Italy’s $2 trillion public debt.

The conservative bloc of ex-premier Silvio Berlusconi looked poised to win the senate, coming back from the political grave with vows to rip up the EU’s austerity plans and push through tax cuts to pull Italy out of deep slump. The majority of Italians have clearly voted against the Brussels consensus. That is a damning indictment. But if they can't come up with a coalition, look for another technocrat to be installed to run things until they figure it out.