Wednesday, November 21, 2012 - Of Cliffs and Helicopters

Of Cliffs and Helicopters
by Sinclair Noe

DOW + 48 = 12,836

SPX + 3 = 1391
NAS + 9 = 2926
10 YR YLD +.03 = 1.69%
OIL + .95 = 86.40
GOLD + 1.10 = 1730.20
SILV + .20 = 33.49

Israel and Hamas agreed to bring to an end more than a week of air strikes and missile attacks. A truce was declared; now we'll see if it holds. The agreement aims to halt air strikes that have left more than 150 people dead in Gaza and rocket attacks that have killed five Israelis. Israel has hit more than 1,500 targets, and Palestinians launched more than 1,400 missiles.

Secreatary of State Hillary Clinton said that she welcomed the accord and expressed hope it will “move us closer to a comprehensive peace.”

“In the days ahead, the United States will work with partners across the region to consolidate this progress, improve conditions for the people of Gaza, and provide security for the people of Israel,” she said.

The accord says that Israel shall stop all hostilities on the Gaza Strip, land, sea and air, including incursions and targeting of individuals. It also says that “all Palestinian factions shall stop all hostilities from the Gaza Strip against Israel, including rocket attacks and attacks along the border.”

Israeli Prime Minister Netanyahu thanked President Obama and Egyptian President Mohamed Mursi for their work to end the violence. There was tremendous US pressure on the Egyptians, who in turn pressured Hamas to accept terms which are not set in stone, including it seems regarding the Gaza blockade. The Obama administration has now placed itself as the guarantor of the agreement’s terms, including the halt in rocket attacks, and they are probably going to be tested very quickly.

Volume was light today due to the impending Thanksgiving holiday. NYSE trading volume finished about 30% below the 10-day moving average, near one of the lowest volume days of the year. From the early morning until the equity market closed, S&P 500 futures traded in a narrow 5.5 point range.

Because of the Thursday holiday, the weekly jobless claims report was released a day early. The Labor Department showed a decline to 410,000 weekly claims, down from last week's claims that saw a revision up to 451,000 from 439,000. Other data showed manufacturing picked up at its quickest pace in five months in November, while the Thomson Reuters/University of Michigan's final reading for November showed the consumer sentiment index improved only slightly from the previous month. The focus will likely turn to retailers on Friday as analysts try to assess how strong the holiday shopping season will be this year.

Overnight, equity futures dropped a sharp 1% after European finance ministers announced that they had not reached a definitive deal on the funding gap that is currently facing Greece. While there was progress made, no final deal was reached. However, the wording of the press release suggested that the overall basics of the deal were agreed upon, but the mode of payment was not. The next opportunity to come to a final agreement comes next Monday at another emergency meeting of EU finance ministers. Also in Greece, additional news headlines surfaced that the Troika of Greek creditors were taking another look at the proposal of a Greek debt buyback or lowering interest payments on bailout loans.

There has been disagreement among the ministers and the IMF on how to make Athens' debt manageable. The eurozone ministers are in favor of giving Greece an extra two years, to 2022, to bring its debt down to 120 percent of gross domestic product from the 176 percent forecast for this year. The IMF has resisted such an extension.

Agreement on this issue is needed for the group of creditors to pay Greece the next batch of its rescue loans, expected to amount to $57 billion. Greece needs the money to avoid bankruptcy. Greece has been relying since 2010 on international bailout loans, under terms supervised by the so-called troika - the IMF, the European Central Bank and the European Commission, which is the 27-country European Union's executive branch. Two weeks ago, Greece's coalition government narrowly succeeded in passing a $20 billion package of budget cuts, tax increases and reforms in order to secure the latest loan payment.

The question of debt sustainability is as important as it is divisive: If Greece's debts can't be reduced to a level where the country can afford to pay them, the billions of euros in bailout loans given to Greece will have been wasted. One of the reasons Greece is not expected to reduce its debt to 120 percent of GDP by 2020 is that its austerity program of spending cuts and tax hikes is hurting the economy, which faces a sixth year of recession in 2013.

Japan's exports continued to fall for the fifth straight month. Japan is faced with slowing demand from its main trade partners China and the US as well as continued slowdowns from Europe. Yesterday, the Bank of Japan declined to ease further despite increased calls for monetary stimulus from Japan's opposition party.

Tomorrow US markets will be closed for the Thanksgiving holiday. On Friday, US markets will be open for a half day, closing at 1:00 p.m. ET. There will be no economic data from the US on Friday. 

Time won't stop for the rest of the world, however. The rest of the world will issue economic reports, and then Monday, we'll get back to the novella that is the fiscal cliff. What is it about fiscal policy that brings out the crazy?

Which brings us to the fiscal cliff; or slope, which is more accurate and avoids creating the false impression that all is lost come January 1. The tax increases and spending cuts in place promise to repeat the mistakes of the UK and the Eurozone by pivoting too fast and too hard into the realm of fiscal austerity.  A solution to the fiscal cliff means smoothing the path to fiscal consolidation (optimally, with no austerity in the near term, but I don't see that as an outcome). Why? Because the parameters of the debate have already been determined. Just listen to what former Federal Reserve Chairman Alan Greenspan says:

All of the simple low hanging fruits have been picked and the presumption that we are going to resolve the big issue on spending by making a few little twitches here and there I think is a little naive. If we get out of this with a moderate recession, I would say that the price is very cheap. The presumption that we will solve this problem without paying I think is grossly inappropriate...I think the markets are getting very shaky. And they are getting shaky because I think fiscal policy is out of control. And I think the markets will crater if we run into any evidence that we cannot solve this problem.

If markets are shaky, they are shaky because participants recognize the recessionary impact of this level of fiscal austerity and they don't like it.  Market participants want Congress and the President to do exactly what Greenspan claims is impossible, minimize the impact of spending cuts. We need to find a cure for the crazy that some fall into whenever the topic is fiscal policy.

It was 10 years ago today that Mr. Bernanke gave his speech titled “Deflation: Making Sure ‘It’ Doesn’t Happen Here” as at the time some “expressed concern that we may soon face a new problem, the danger of deflation or falling prices” as reported inflation rates were low at the time as the economy was in its post stock market bubble malaise. In the speech he said, “US dollars have value only to the extent that they are strictly limited in supply. But the US Government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at essentially no cost. By increasing the number of US dollars in circulation, or even by credibly threatening to do so, the US government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper money system, a determined government can always generate higher spending and hence positive inflation.”

He then went on to ironically say, “Of course, the US government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).” The CRB index proceeded to rally 159% over the following six years and gold, on that day in 2002 at $317.60, has ‘only’ risen 444% since. We have now 10 years of economic results and the attached debt due to the Fed’s attempt to avoid deflation after the 2001-2002 stock market bubble popping induced recession.

Anyway, that speech ten years ago today, earned Bernanke the nickname, Helicopter Ben.

Yesterday, Bernanke spoke to the NY Economic Club and in a question-and-answer session, Bernanke warned that Fed policy could not protect the economy if it goes over the cliff. “I don’t think the Fed has the tools to offset that,” he said. That's not exactly true. He still has a printing press. He still has a helicopter.