Monday, September 16, 2013 - Do It Again

Do it Again

by Sinclair Noe

DOW + 118 = 15,494
SPX + 9 = 1697
NAS – 4 = 3717
10 YR YLD - .02 = 2.86%
OIL - .53 = 106.06
GOLD – 14.00 = 1314,90
SILV - .45 = 21.92

The Bank of International Settlements is a Swiss based central bank for the central banks, kind of a global clearing house. The BIS has just issued its quarterly economic review. The conclusion: it's 2007 all over again, but even worse. All the previous imbalances are still there, but total public and private debt has grown to more than 30% of GDP in advanced economies, and bubbles are forming in emerging markets. Subordinated debt has in Europe and the US has ballooned. Leveraged loans are at an all time high. The BIS said interbank credit to emerging markets has reached the highest level on record while the value of bonds issued in off-shore centers by private companies from developing nations exceeds total issuance by firms from rich economies for the first time.

So, there is more debt than ever, and a greater appetite for risk. And if the Fed raises interest rates this week there will almost certainly be a spill-over effect; global borrowing costs will rise. The international financial system is more unbalanced than 5 years ago, and there is a concern that markets can remain liquid under stress. If there is a problem with liquidity, the BIS figures there are fewer lifelines than before. The global markets, including the US, have become addicted to easy money and the

QE is essentially morphine for bankers. And while it may have been necessary as a post-crisis measure, the patient is now hooked and withdrawal could prove disorderly. Some folks consider QE as nothing more than mind-boggling fiscal profligacy, even though the national debt is shrinking, year over year. The real problem is that the money has been largely stuck with the banks, and the banks have grown bigger and more dangerously leveraged than before the crisis; yes the debt is growing slower but the stimulus didn't spread out to the rest of the economy.

And so the Federal Reserve meets this week and they are widely expected to announce the taper, or slow and steady reduction of securities purchases. Already, rates are up more than 100 basis points on the 10 year note since the mention of a possible taper. It isn't a done deal; the Fed might not taper; maybe the timing just isn't right. Fannie Mae and Freddie Mac are set to auction as much as $17 billion in mortgage bonds; that might be dumping too much supply on the markets if the Fed steps away as the primary buyer.

And to justify the taper, the FOMC will need to claim the economy is improving and doesn't really need special help. We all know better. The economy isn't dead but it isn't healthy; GDP is charging ahead like a sloth on barbiturates; the unemployment rate has dipped down to 7.3% because so many have fallen out of the labor force.

And an even nastier reality about the labor market; rates of unemployment for the lowest-income families, those earning less than $20,000, have topped 21 percent, approaching Great Depression numbers. And households with income of more than $150,000 a year have an unemployment rate of 3.2 percent, a level traditionally defined as full employment. At the same time, middle-income workers are increasingly pushed into lower-wage jobs. Many of them in turn are displacing lower-skilled, low-income workers, who become unemployed or are forced to work fewer hours.

Among households making less than $20,000 a year, the share of underutilized workers jumps to about 40 percent. For those in the $20,000-to-$39,999 category, it's just over 21 percent and about 15 percent for those earning $40,000 to $59,999. At the top of the scale, underutilization affects just 7.2 percent of those in households earning more than $150,000.

In addition to the 5^th anniversary of the Lehman Brothers collapse, this is also the second anniversary of Occupy Wall Street. You'll remember that one of the issues the protesters protested was economic inequality. One remnant of the Occupy movement is the phrase “99 percent” - that stuck. And when you combined the 99% with the 47%, that might have determined the election of 2012. The Occupy movement isn't dead; it is spreading out in smaller and more local groups, and it doesn't get much media coverage, but it left a very lasting impression, seared on the minds of the national conscience; the idea that extreme levels of inequality exist, are not acceptable, and eventually the 99% storm the gates.

To the long list of problems linked to income inequality, we can now add political gridlock. According to a new study in the Journal of Economic Perspectives, the rise and fall of income inequality is closely correlated to political polarization in the House of Representatives. Of course, correlation isn't causation—we can't say whether inequality fuels political polarization or vice versa. What we know is that income inequality is at the highest levels since the late 1920s, and the distance between the political parties is at the highest level in more than 100 years.

The president spoke at a White House event this morning pegged to the fifth anniversary of the bankruptcy of Lehman Brothers. Obama reiterated his refusal to negotiate with Republicans over the debt ceiling. And he called on Congress to “pass a budget without drama.” Saying, “I cannot remember a time when one faction of one party promises economic chaos if it can’t get 100 percent of what it wants. That’s never happened before.”

So, we have the Federal Reserve meeting this week to determine the possibility of tapering the easy money morphine from the Wall Street junkies, and the most dysfunctional Congress since the Civil War at odds with the president over whether the nation will pay its bills. And the markets started the morning with the Dow Industrials up about 170 points. And for this we can thank Larry Summers. (I never thought I would say that.) Yes, thank you Larry Summers for dropping out of the race to be the next Federal Reserve Chairman.

Past performance is not a guarantee of future results, so Summers might not have hurt the economy as Fed Chairman. Fortunately, we'll never know. But the mere threat of his becoming Fed Chairman was hurting the economy lately, by hurting stocks and bonds. His withdrawal from the race is a boon. Equity markets around the globe cheered his withdrawal this morning. Maybe Summers could keep withdrawing from Fed chair consideration until the economy recovers.

The most likely candidate to replace Bernanke is Fed Vice Chair, Janet Yellen. Also mentioned is Donald Kohn, the former Fed Vice Chair. Timmy Geithner has been part of the team reviewing the candidates; maybe he likes his own resume. There are other possibilities, and we would be well served to look beyond the usual suspects.

Speaking of the withdrawal of Larry Summers today, President Obama said: “Larry was a critical member of my team as we faced down the worst economic crisis since the Great Depression, and it was in no small part because of his expertise, wisdom, and leadership that we wrestled the economy back to growth and made the kind of progress we are seeing today.”

And in that statement there is a certain delusional innocence that is both sad and scary.

“Liquidate labor, liquidate stocks, liquidate real estate,” Treasury Secretary Andrew Mellon may or may not have told Herbert Hoover in the early years of the Great Depression. “It will purge the rottenness out of of the system.” This is what has since become known as the “Austrian” view (although most of its modern proselytizers are American): economic actors need to learn from their mistakes, “malinvestment” must be punished, busts are needed to wring out the excesses created during boom times.

Within the economic mainstream, there is some sympathy for the idea that crisis interventions can create “moral hazard” by bailing out the irresponsible. But the argument that financial crises should be allowed to wreak their havoc unchecked has few if any adherents. 

When a financial crisis hit in 2008 that was probably worse than anything the world had seen since the early 1930s, the bailout of the big banks in late 2008, was hugely unpopular. Now, the feeling is that it was necessary at the time. The Federal Reserve’s subsequent (and continuing) bailout of banks has been somewhat more controversial, but still meets widespread approval among economists. The dangerous financial-sector practices that precipitated the crisis have mostly been left in place. Far from being tamed, the financial beast has gotten its mojo back — and is winning. The people have forgotten — and are losing. Of course the reason that people so easily forget is because we averted endless waves of bank failures and a complete meltdown of the global financial system. We also didn't learn much because we were spared the full consequences. And maybe that is why we still haven't done the things necessary to achieve actual growth; maybe that's why the president still thinks Larry Summers did a great job. Maybe that's why the 99% are still important.