Thursday, May 08, 2014 - Monetary Policy Is Not A Panacea

Monetary Policy Is Not A Panacea

by Sinclair Noe

DOW + 32 = 16550
SPX – 2 = 1875
NAS– 16 = 4051
10 YR YLD + .01 = 2.60
OIL – 01 = 100.24
GOLD - .10 = 1290.80
SILV - .15 = 19.25

Stocks were mostly lower today. The closing numbers looked quiet but it was a roller coaster ride with the Dow Industrials up about 150 points. The Nasdaq also squandered early gains to finish in negative territory. The Nasdaq ended lower for a third straight session, its longest losing streak since early April. A late selloff in utilities and energy, among the best performing sectors recently, dragged the S&P 500 lower. Of 445 companies in the S&P 500 that have reported earnings, 68.2% beat expectations, above the 66% beat rate for the past four quarters. Profits are expected to rise 5.3% this quarter.

The number of people who applied for new unemployment benefits last week fell to the lowest level in a month. Initial jobless claims dropped by 26,000 to a seasonally adjusted 319,000.

The federal government had a budget surplus of $114 billion in April. That is $1 billion more than a year ago and would be the biggest April surplus since 2008. For the fiscal year to date, CBO estimates the deficit to be $301 billion, down $187 billion compared to the same period in 2013.

Retailers posted modestly higher sales in April. Results from March and April are generally viewed together because of the shifting nature of Easter, which fell about three weeks later this year and moved into April from March last year. For the two-month period, retailers reported 3.4% growth, down from 3.5% a year earlier.

Consumer credit balances increased by $17.5 billion in March to a total of $3.141 trillion. The gain was a bigger increase than the $15.5 billion expected by economists. This was the biggest month-over-month growth rate since February 2013. Nonrevolving debt like college and auto loans grew by $16.4 billion. Revolving debt like credit cards increased by $1.1 billion.

At 4.21%, the 30-year fixed-rate mortgage is at its lowest since the week of November 7, 2013, so says Freddie Mac in their new weekly report on national mortgage rates. Last week, it averaged 4.29%. A year ago, it was 3.42%. Since the housing market crashed, the Federal Reserve has used extraordinarily easy monetary policy to keep interest rates like mortgage rates low in its effort to bolster the housing market and stimulate the economy.  Lately, various housing-market metrics such as existing-home sales, new-home sales, and mortgage applications have all been flagging. Last week, we learned that the US homeownership rate was at a 19-year low, and some experts think it'll never come back.

Yesterday, Fed Chair Janet Yellen said, "One cautionary note, though, is that readings on housing activity—a sector that has been recovering since 2011—have remained disappointing so far this year and will bear watching. The recent flattening out in housing activity could prove more protracted than currently expected rather than resuming its earlier pace of recovery." That was the big takeaway from Yellen’s Congressional testimony yesterday.

Fed Chair Janet Yellen was back on Capitol Hill today for a second day of testimony. She appeared before the Senate Budget Committee.  Yellen’s favorite new line is, “Monetary policy is not a panacea.” That pretty much says it all.

There are a couple of trends that concern Yellen; long term unemployment; there are about 3.5 million workers who haven’t found a job for at least 6 months. Also, income inequality is pulling down spending and slowing the economy. Yellen would like to do something about these disturbing trends, but you know, “Monetary policy is not a panacea.”

Meanwhile, the European Central Bank was meeting to determine monetary policy for the Euroland; they decided to leave interest rates unchanged at 0.25%. ECB President Mario Draghi’s favorite line is “whatever it takes” and he’s been saying it for a couple of years. Euroland is slogging along with persistently low inflation and high unemployment. Draghi says something should be done, but he did not say what; and the ECB might address stimulus of some sort or another next month or so.

Perhaps Draghi is waiting to see how the situation in Ukraine plays out; right now the picture is smoky and very gray. Rebels in eastern Ukraine say they will proceed with a referendum this weekend seeking autonomy even though Russian President Putin appeared to withdraw his support for the vote. Putin yesterday presided over nationwide army drills, a day after he softened his tone by promising to withdraw troops from the border. The government in Kiev says a referendum would be illegal. Putin also indicated he would pull Russian troops from the Ukrainian border, but satellite images show that probably isn’t happening. The situation involving the tug of war between the West and Russia regarding Ukraine has steadily worsened over time and now involves outright economic warfare; sanctions on one side and the threat of energy shortages on the other.

Even former Treasury Secretary Tim Geithner is coming out of exile to hawk a new book. Geithner says there had been talk about nationalizing banks back in the crisis days. On the legacy of the bailouts, Geithner rejects criticism that the Troubled Asset Relief Program benefited the rich rather than ordinary Americans. And yet he acknowledges that the too big to fail banks are bigger and more dangerous than ever.

Have you ever seen a boxer knocked out? The devastating blow is the one you don’t see coming. Mark Carney, governor of the Bank of England and head of the Financial Stability Board, an international watchdog set up to guard against future financial crises, was recently asked to identify the greatest danger to the world economy. He answered shadow banking. It is huge and growing fast, and little understood, and even less transparent. We don’t even know exactly what counts as shadow banking; basically, it refers to lending by non-bank institutions and it involves more than $70 trillion in assets, up from about $25 trillion ten years ago.

A broader definition, however, would include any bank-like activity undertaken by a firm not regulated as a bank: it could be bond trading platforms set up by technology firms, or payment systems offered by Paypal or financing offered by a retailer such as Sears, or peer-to-peer lending, or money market funds, or who knows what. At the core is the concept of credit and lending. Shadow banking fills a void left by traditional banks, which have become miserly with lending.

Yet shadow banking is poorly or non-regulated. Think of the structured investment vehicles, a legal entity created by banks to sell loans repackaged as bonds. These were notionally independent, but when they got into trouble they pulled in the banks that had set them up. Or money market funds, which seemed like a nice safe place to park cash as a stop-gap measure; they seemed conservative, nearly risk free, until they suffered a run.

Banks must now incorporate structured investment vehicles on their balance-sheets. Money-market funds must hold more liquid assets, to guard against runs. Limits on leverage have been imposed or are being considered for many forms of shadow banks. American regulators are still allowing some money-market funds to create the impression that an investor can never lose money in them. The problem for banks is that they are involved in shadow banking, either in the form of loans to shadow banks, or because the banks buy the products created by shadow banks.

One of the biggest paces for concern is China. Banks there are banned from expanding lending to certain industries, and from luring deposits by offering high returns. So they do both of these things indirectly, through shadow banks of various sorts. Some firms are setting themselves up as pseudo-banks. It is hard to imagine that all the shadowy loans to unprofitable steel mills and overextended property developers will pay off. At which point the Chinese government will likely step in a take control, but there will be a cost.

Nouriel Roubini, the New York University professor and chairman of Roubini Global Economics is known as something of an economic pessimist, and now he thinks we’re on the verge of a bubble, but not a collapse. Roubini says the Federal Reserve will keep its key lending rate low even after it lifts off from near zero, where it has rested for the few years. That slow process of normalization will keep the spigot of borrowing flowing, helping support the economy. But it will also lead to risky lending practices. Hence, a bubble is inflating that could eventually pop.

Roubini cited the return of some of the key characters associated with the period before the last financial collapse: Lots of low quality bond sales, debt without strong protections for bondholders. Roubini says: “All the risky things that were happening back in ’06 and ‘07 are back again to the same level, if not more. So we are in the beginning of a credit bubble, but just the beginning.”

Nonetheless, Roubini doesn’t see the reversal happening immediately, citing money that continues to rush into the market. For now, credit investors appear to be stuck in an uneasy equilibrium.

He’s by no means the first person to make this claim: the question of financial stability is one of the key criticisms of the Fed’s accommodative policies. Roubini didn’t criticize the central bank, so much as say that the Fed is damned-if-you-do, damned-if-you don’t.

Yeah, well, we’ve all learned that monetary policy is not a panacea.

Levitational Tools

by Sinclair Noe

DOW + 48 = 15,105
SPX + 6 = 1632
NAS + 16 = 3413
10 YR YLD - .02 = 1.76%
OIL + .99 = 96.61
GOLD + 21.80 = 1475.40
SILV - .01 = 24.05

Another day, another record high. What's behind this? Nouriel Roubini weighed in from a conference in Las Vegas. Roubini is a professor at NYU and former Senior Economist for the White House Council of Economic Advisors, and notably, one of the few economists to anticipate the collapse in the housing market. Roubini identified the levitational forces, the forces lifting the markets, on “QE, zero policy rates, more money coming into the market, not just from the US, but from other economies” as the reason behind rising asset prices.

Roubini also said: "Growth is slow. Earnings growth is also slowing down. Top line and bottom line are not as good as they used to be, but margins are high. They could correct somehow over time.” His best guess is that it could go on for a couple more years.

Why two years? Roubini says: “recent data have effectively silenced hints by some Federal Reserve officials that the Fed should begin exiting from its current third (and indefinite) round of quantitative easing (QE3). Given slow growth, high unemployment (which has fallen only because discouraged workers are leaving the labor force), and inflation well below the Fed’s target, this is no time to start constraining liquidity.”

Let's take this a step further; with inflation running at about half the Fed's target, it might be argued the Fed has room to ramp up its already aggressive quantitative easing. The Personal Consumption Expenditures price index, or PCE, is the Fed's favored measure of inflation; it is currently at a 3 ½ year low of 1.0%. If the Fed target is 2%, with an upper limit of 2.5%, then they need to do more to move the inflation meter. Right now, they expect inflation to be lower than their target, and unemployment to be unconscionably high, so the Fed's own framework says that they need to take more stimulative action.

There is an argument that economic growth might pick up later in the year, but there are other arguments that we still haven't felt the full weight of the sequester. Government agencies may begin to freeze hiring more broadly, rather than just furloughing, and that will weigh on monthly payroll gains; government-dependent businesses will need to make greater adjustments.

Because money is a public monopoly, when the monopolist restricts supply by not running a sufficient deficit, it creates excess capacity in the economy, as evidenced by high unemployment. The downside is the deficit, which can result from lower taxes or increased government spending, whatever your politics prefers. But policies aimed at reducing the deficit are doomed to keep an economy depressed.

The Federal Reserve has already stated that fiscal policy is restraining growth and so the argument is not whether the Fed will exit QE anytime soon but rather whether the Fed will expand QE anytime soon. We're not hearing this debate but I think this is what the market is telling us. It might be nice to see some fiscal policy that could stimulate growth, but we know that Congress moves like a slow motion sloth unless it involves gutting the STOCK Act. You'll remember that they jumped at the opportunity to eviscerate key sections of the legislation that required disclosure of financial transactions by politicians and their staff prohibiting insider trading.

Americans for Tax Fairness, a coalition of 280 organizations, has "identified 10-year budgetary savings of $2.8 trillion simply by limiting or eliminating a plethora of high-income and corporate tax loopholes." Congress is busily revising the tax code as we speak but how many of those loopholes and other perks like credits and deductions do you bet will go away? Not many if the lobbying industry has anything to do with it.

Here's a quick and easy loophole that should be closed; remember last week, when Apple announced announced the largest corporate bond offering ever - $17 billion. And remember that Apple's balance sheet as of March 30 shows $145 billion in cash? Why would they borrow $17 billion when they have all that cash sitting around.

Apple may be lagging a little when it comes to technological innovation but they are pioneers in tactics to avoid paying taxes to Uncle Sam. To distribute the cash to its owners would force it to pay taxes. So it borrows instead to buy back shares and increase its stock dividend.

The borrowings were at incredibly low interest rates, as low as 0.51 percent for three-year notes and topping out at 3.88 percent for 30-year bonds. And those interest payments will be tax-deductible. Isn’t that nice of the government? Borrow money to avoid paying taxes, and reduce your tax bill even further. It's legal.

Apple can get away with paying little tax in the United States relative to the profits it makes, thanks to what is known as “stateless income,” in which multinational companies arrange to direct the bulk of their profits to low-tax or no-tax jurisdictions in which they may actually have only minimal operations. The United States, at least theoretically, taxes companies on their global profits, but taxes on overseas income are deferred until the profits are sent back to the United States.

The company makes no secret of the fact it has not paid taxes on a large part of its profits. They come right out and say they are generating significant cash offshore and repatriating this cash will result in significant tax consequences. Apple did pay about $6 billion in federal income taxes last year, but the borrowing scheme will help them avoid about a $9 billion dollar tax bill. There is something ridiculous about a tax system that encourages an American company to invest overseas rather than in the US.

Of course, we could close that loophole. Companies would owe taxes on profits when they made them. There would be, of course, credits for taxes paid overseas, but if a company made money and did not otherwise pay taxes on it, it would owe them to the United States. After it paid the taxes, it could move the money wherever it wished without tax consequences.

While big business is able to game the system, small business is being destroyed by it.  The Economic Collapse Blog reports “the percentage of Americans that are working for themselves has never been lower in the history of the United States.”  The decline in the number of startup jobs per 1000 Americans has dropped from 11.3 under the first President Bush, to 7.8 under President Obama. The percentage of new entrepreneurs and business owners dropped by 53 percent between 1977 and 2010. Entrepreneurs, who take risks, innovate and, when they succeed, hire people; small businesses, the backbone of the economy, seem to be being killed off in the US economy.  It does not portend well for the future.

The time to focus on jobs and inequality is now, but don’t hold your breath. The political agenda in Washington, DC shows no sign of even considering sensible policies. So, for now the best hope of economic growth comes from the Federal Reserve and their loose monetary policy, which will probably become super-loose, especially when faced with super-stupid fiscal policy. The Fed probably has some more tools in their tool-belt. They have room to be much more aggressive, just look at the example of Abenomics and the Bank of Japan. The real question is whether the Fed has any tools in their tool-belt that might actually spread the wealth beyond Wall Street.