Friday, February 28, 2014 - Tantrums

Tantrums

by Sinclair Noe

DOW + 49 = 16,321
SPX + 5 = 1859
NAS – 10 = 4308
10 YR YLD + .02 = 2.66%
OIL + .05 = 102.45
GOLD – 5.10 = 1327.70
SILV - .06 = 21.30

Broadcasting from the Renaissance Esmerelda in Indian Wells for Financial Fest Palm Springs edition.  

Remember last summer when various Fed officials floated the taper balloon? The hinted that the Fed might taper from $85 billion a month in QE asset purchases. The result: Wall Street had a taper tantrum; the yield on the 10 year note spiked up to 3%; mortgage rates shot up and made many question the strength of the housing recovery; stocks swooned as the froth escaped the market.

The tantrum didn’t last long, even when the Fed announced the actual taper. Markets treated the announcement with a yawn. Stocks resumed their climb to record highs; Treasuries settled down; the housing market, well that’s always a local story, so it depends; and the economy continued to muddle. The markets seemed to accept the idea that the economy could handle a little less Fed stimulus, after all, they gave forward guidance that interest rates would remain low until the cows come home.

In retrospect, last summer’s taper tantrum seems nothing more than a blip. Not so fast. A new paper released today before the Monetary Policy Forum in New York argues that the tantrum might portend a negative response as taper continues and as the Fed moves closer to someday raising interest rates; and it might be as simple as herd mentality. We all know the markets have been feeding on free money from the Fed, and the paper says: “Stimulus is not a free lunch, and it comes with a potential for macroeconomic disruptions when the policy is lifted.”

The longer the Fed waits to exit, the more risk there is. For example, right now the Fed is boosting the economy through guidance that interest rates will stay low a long time, but officials can’t fully control how the market will perceive it when the Fed relaxes that commitment. The trade-off is “between more stimulus today at the expense of a more challenging and disruptive policy exit in the future.”

Yellen has taken over the job of herding cats; the cats in question are her fellow Fed policymakers. Today, Federal Reserve Bank of Chicago President Charles Evans said Friday the central bank should be willing to allow inflation to go over its 2% target if that will help the economy get back on track more quickly. Meanwhile, Federal Reserve Bank of Philadelphia President Charles Plosser said:  “Most formulations of standard, simple policy rules suggest that the federal funds rate should rise very soon–if not already.”

Yesterday, Fed chair Janet Yellen broke from her prepared testimony before the Senate Banking Committee to recognize the economy has been a bit soft and, depending on data, the Fed would open to reconsidering taper, without jumping to conclusions, of course.

So, how’s the data?  In a word – weak. The Commerce Department this morning reported fourth quarter gross domestic product was worse than previously expected; revised down to a 2.4% annual growth rate from the 3.2% pace initially estimated last month, and down from the 4.1% pace of the third quarter. First quarter growth is forecast at below a 2% pace.

There were some economic headwinds in the fourth quarter: the 16-day government shutdown and the polar vortex weighed on growth but the government is open again and the weather will thaw eventually, maybe. Longer lasting moves also damped growth, including: the expiration of long term unemployment benefits, cuts to food stamps, weaker durable goods orders, and businesses working through inventory buildups in the second half, which might continue for a while. Unemployment data for December and January were surprisingly weak, and investors are focusing on the February jobs report, due next Friday, to see if the slow pace of hiring is weather-related or caused by a more fundamental downshift.

Not all data is negative. This morning the National Association of Realtors said its pending home sales index, based on contracts signed last month, rose 0.1% to 95.0 in January. The increase followed a revised 5.8% drop in December. This wasn’t a very positive report. The index fell in the West to its third lowest level since the NAR began its tab in 2001, surpassing only two months from the summer of 2007, when housing markets were beginning their free fall.

Western markets such as Las Vegas and Phoenix have witnessed some of the largest price gains as they rebound from very low levels. California markets, meanwhile, have grown much less affordable given the combination of price increases and higher interest rates. Inventories of homes for sale had been very low last year in many Western markets, but they have climbed since demand fell last fall. It’s not clear that weather can be blamed on this: the index is seasonally adjusted, and this is the West, where winters are milder. The index is now down 27% since last June, when it nearly reached a four-year high.

Also, the Thomson Reuters. University of Michigan consumer sentiment index came in at 81.6 for February, up from 81.2 in January.

And this all goes back to Fed monetary policy, and the longer the Fed stays engaged in the experimental and dangerous phase of monetary stimulus, the greater the probability of problems. One area that has already started to look bad – emerging markets. Over the past four years investors desperate for high-yielding exposure to Brazil, Mexico, Russia and Turkey, showered emerging market funds with cash. For example, Pimco’s flagship emerging market local currency fund grew to more than $12 billion from $1.5 billion. Now the inflows have turned to outflows, last year $51 billion was pulled from emerging market funds; so far this year $40 billion has flown the coup. The concern is that last summer’s taper tantrum might be followed by an emerging market bond tantrum.

The idea that a bond market tantrum, if it lasts long enough, can lead to a broader economic crisis that reaches beyond its original location is not without precedent. The debt crisis in the euro zone got its start when bond investors began selling Greek government bonds. Before long, Greece, Ireland and Portugal were getting bailed out and viability of the euro was being called into question.

As currencies like the Brazilian real and the Turkish lira have begun to wobble, the rush for the exit has become all the more hurried. Growth in these economies is already slowing down. Brazil may see economic growth below 2% this year. As investors pull money out of these funds, forcing fund managers to sell Brazilian, Mexican and Chinese bonds, interest rates will shoot up and default rates will increase in number.

And so there are concerns about another tantrum. There is precedent. Five years ago, March 9, 2009 to be precise, the stock market hit a low. Back then, the herd was heading for the exits, running for the exits, stampeding the exits. And that, of course, would have been the perfect time to buy. The Wilshire 5000, one of the broader measures of the stock market, is up about 190% over the past 5 years. Americans’ holdings of stocks have increased by about $8.8 trillion over that time.

During the same five-year period, the value of home equity has risen by about 40 percent; that’s about $3 trillion. Five years ago, at the stock market bottom, home equity, at $7.4 trillion, substantially exceeded the value of stocks owned by individuals, at $4.4 trillion. Now, stocks are about $13.2 trillion, compared with $10.4 trillion of home equity.

Five years ago, stocks looked beaten down but they roared back, much more so than home values and even more important home equity, which continued drifting down until the middle of 2012, when it finally turned upward. Home equity is still down from its peak of $12.5 trillion in 2005. At the time, stocks were $8 trillion, about 65 percent of home equity. Now, stocks are more than 125 percent of home equity.  About 5% of Americans own 60% of all individual stocks.

Household wealth for Americans still has not recovered from the downturn.  A new study rom the Ohio State University found that the mean net worth of American households in mid-2013 was still about 14 percent below the pre-recession peak in 2006. Their analysis suggested that middle-aged people took the biggest hit.

In a report last June, the Federal Reserve said that net worth of Americans, which includes the value of homes, stocks and other assets minus debts, had essentially recovered since the recession of 2007 to 2009. In fact, the Fed claimed wealth was the highest it had been in nominal terms since records began in 1945.

So maybe there is something to the idea that a herd mentality could wreak havoc in the markets, it only takes a few to start a stampede, but the downturn and the recovery didn't affect all American households the same way. Much of the recovery in net worth that has occurred since the recession can be attributed to the rise in value of financial assets, such as stocks. This tends to help those who are already wealthy. This increase has occurred because of the Federal Reserve's policy of quantitative easing, which means the Fed has bought large amounts of longer-term bonds and other financial assets, boosting their prices. Without quantitative easing, we probably would show even lower levels of household net worth. But it’s a little funny to watch Wall Street throw a tantrum with any hint of a move by the Fed. And it’s a little funny to watch the Fed pretend that their policies have saved the day.  As much as the Federal Reserve might want people to believe we have recovered from the recession, the bottom line is that we haven't.

Thursday, February 27, 2014 - As She Was Saying…

As She Was Saying…

by Sinclair Noe

DOW + 74 = 16,272
SPX + 9 = 1854
NAS + 26 = 4318
10 YR YLD - .03 = 2.64%
OIL - .35 = 102.24
GOLD + 2.00 = 1332.80
SILV + .05 = 21.36

Two weeks ago, the freshly minted Fed Chair Janet Yellen appeared before the House Financial Services Committee to deliver her first bi-annual Humphrey Hawkins testimony on the state of the economy and monetary policy. She read a prepared statement and then answered questions from the Congressional representatives. The next day she was scheduled to repeat the process with senators; that didn’t happen because of a big winter storm that essentially resulted in a Snow Day for Washington DC. Today, Yellen returned to Capitol Hill to continue her testimony before the Senate Banking Committee.

Yellen began today’s hearing with the same prepared remarks from two weeks ago, but then she got to the part about the Fed’s outlook for the economy and this time she said something a little different: “Mr. Chairman, let me add as an aside that since my appearance before the House committee, a number of data releases have pointed to softer spending than many analysts had expected. Part of that softness may reflect adverse weather conditions, but at this point, it's difficult to discern exactly how much. In the weeks and months ahead, my colleagues and I will be attentive to signals that indicate whether the recovery is progressing in line with our earlier expectations.”

Now for the past few months, the Fed policymakers have been reading and repeating the same script from the playbook, that the recovery will pick up later this year and the Fed’s QE stimulus had helped make things better and jobs were coming back, and just be patient and you’ll see that everything is coming up roses and daffodils.

The rosier outlook was behind the Fed decision to cut back, or taper, its bond buying program. The Fed had been buying $85 billion per month in Treasuries and mortgage backed securities; they have since tapered back to just $65 billion a month; and they’re expected to get out of the bond buying stimulus program altogether by the end of the year, based on the idea that the economy will be able to grow without the stimulus. The clear picture of the road to recovery is not so clear anymore.

When will we get a clearer picture of the recovery? The answer is unlikely to emerge before the Fed’s policy-setting committee meets again in March. Yellen reiterated that the winding down of the Fed’s stimulus program is “not on a preset course” and “if there's a significant change in the outlook, certainly we would be open to reconsidering. But I wouldn't want to jump to conclusions here.”

Wall Street just loves to feed at the Fed’s easy money trough. The S&P 500 index has been pushing for new highs, three times in recent days it has inched to intraday highs, and today it found the force to close at a new record high.

There might have been something in Yellen’s testimony that Wall Street won’t like. Pressed by Senator Elizabeth Warren for more transparency on the regulatory from Yellen said the Fed was moving in that direction. Warren noted that the Fed rarely holds public votes on issues such as its enforcement actions taken against banks. Yellen replied: “You have raised a very important question. I do think it is appropriate for us to make changes and I fully expect that we will.”

That may not sound like much, but compared to her predecessors, it is a seismic change. Greenspan was a deregulating regulator, and Bernanke was a reluctant regulator from the Holder school of fear over collateral damage. Yellen isn’t backing down, although she hasn’t yet stepped up.

Meanwhile, Yellen pointed to what she thinks  might be the biggest problem with the economy, saying, “I think the issues of income inequality, of rising income inequality, in this country really date back many decades -- probably to the mid-eighties, when we began to see a very substantial widening of wage gaps between more-skilled and less-skilled workers, and this is a trend that unfortunately has continued almost unabated for the last 30 years."

Like her predecessor Ben Bernanke, Yellen offered a couple of the usual stock explanations for widening inequality: technological change and globalization. But those two trends didn't just abruptly get much worse in 1987, leading to the sudden spike in inequality. A Cleveland Fed study points to cuts in income-tax rates on the wealthy in 1986, directly contributing to the mid-80s spike in inequality. Further tax cuts in 1997 led to another spike in inequality and then the Great Recession came along and hammered low-income  Americans much harder than high-income Americans, driving an even bigger wedge between the haves and the have-nots. Yellen said today: "Households and segments of our population that had already been suffering stagnant or declining incomes for many years have seen the recession take a large toll."

Helping the economy grow is one of Yellen's responsibilities as Fed chair, so it behooves her to understand how to address this problem. So far, aside from identifying the start date, Yellen's thoughts on the issue aren't very encouraging. Asked what Congress could do to help, Yellen offered more stock solutions: More education and training for workers and kids. Those could help with the issues of technological change and globalization, maybe; although more education sure hasn't helped raise the incomes of low-wage workers. And that was as far as Yellen was willing to go today.

In economic news, the number of people applying for unemployment benefits rose last week to the highest level of 2014. This is not a sure sign that the employment picture is getting worse but it doesn’t show anything getting better.

Orders for durable goods fell 1.0% in January as demand tapered off for most big-ticket items except military hardware. Orders for long-lasting goods have fallen in three of the past four months, but up-and-down airline bookings are largely responsible. Aircraft orders sank 20.2% in January. Boeing received just 38 orders for new planes in January, down from a record 319 in December. Stripping out transportation orders, orders were up 1.1% and have been up in 4 of the last 5 months.

Even then, it doesn’t mean we have strong durable goods orders. Orders fell 6.7% for computers, 2.1% for electrical equipment and appliances, 1.8% for primary metals and 0.4% for machinery. That adds to mounting evidence that first-quarter gross domestic product is likely to be weak.

RealtyTrac data reports that institutional investors, defined as entities purchasing at least 10 properties in a calendar year, accounted for 5.2% of all US residential property sales in January, down from 7.9% in December and down from 8.2% in January 2013. This was the biggest one month plunge in history. It gets worse: the January share of institutional investor purchases represented the lowest monthly level since March 2012. This does not appear to be a weather related event, as some colder weather cities posted gains in investor purchases, while warm weather cities saw declines. Perhaps this will be another bit of data the Fed will consider before continuing to further taper MBS purchases.

The institutional or private equity investors have a fairly short-term view toward single family residential. In the past, many smaller investors have jumped into single family homes and added sweat equity with a long-term view towards slow and steady returns. The private equity money jumped in and jacked rent rates above market combined with unrealistically low levels of reinvestment into their projects. 

The idea was to create a liquidity event by taking the operating company public in an IPO and thus sloughing off the risk on the retail investor. That isn’t flying very high. A few deals were done; then one was pulled. The other short-term liquidity event was planned to come from securitizing rent streams. Blackstone tried that and their efforts dropped as rental income came up short just after it was launched. The market for this synthetically structured mess could be as big as $1.5 trillion, if it ever gets off the ground.

Many have anticipated that the large institutional investors backed by private equity would start winding down their purchases of homes to rent, and the January sales numbers provide early evidence this is happening. And if the institutional investors aren’t buying, then who is? Existing homeowners just swap one home for another. Normally, first time buyers would jump in and pick  up slack, but with higher prices, and higher mortgage rates, and ubiquitous student loan debt, potential young buyers aren’t.

The Treasury Department reported today that the deficit has dropped, quite a bit, from about $1.1 trillion in fiscal year 2012 to $680 billion in fiscal year 2013. That is the smallest deficit since 2008, and marks the end of a five-year stretch when the country’s fiscal gap came in at more than a trillion dollars a year.

Growth in tax revenue accounts for much of the decline in the deficit. Increases in taxes and cuts in federal spending figure strongly too, as does a surprising long slowdown in the pace of health-spending growth.

The Treasury said that revenue climbed $324 billion to $2.8 trillion between 2012 and 2013. That is growth of around 12.9 percent, reflecting both higher income rates, including higher top marginal rates and the expiration of the payroll tax holiday, and a strengthening economy. At the same time, government spending grew relatively slowly, to $3.9 trillion from $3.8 trillion a year earlier.

Wednesday, February 26, 2014 - Inequality With a Dash of Salt

Inequality With a Dash of Salt

by Sinclair Noe

DOW + 18 = 16,198
SPX + .04 = 1845
NAS + 4 = 4292
10 YR YLD - .03 = 2.67%
OIL +72 = 102.55
GOLD – 11.80 = 1330.80
SILV - .68 = 21.32

Sales of new single-family homes started 2014 with surprising strength, with January posting the fastest pace in more than five years. Home sales jumped 9.6% in January to a seasonally adjusted annual rate of 468,000, hitting the highest level since July 2008. Today’s sales news follows a string of recent reports signaling recent sputtering in the housing market. The data, to be fair, have a huge confidence interval—plus or minus 17.9% in January. That means we can’t know for certain whether sales rose or fell during the month. On a three-month average, sales rose 1.2% in January. Sometimes you have to take a look at economic data with a dash of salt.

Bank earnings jumped in the fourth quarter, but not solely because of increased net income. According to the Federal Deposit Insurance Corporation, financial institutions in the US earned a whopping $40.3 billion in net income in the fourth quarter of 2013, up 16.9% from a year earlier. More than half of the 6,812 FDIC insured institutions reported a year-over-year growth in quarterly earnings. And the portion of unprofitable banks dropped to 12.2% from 15% in the fourth quarter of 2012.

But it’s not all good news. The improvement in earnings was largely attributable to an $8 billion decline in loan-loss provisions, which is a way banks can boost the bottom line by fudging the numbers. Revenue was lower year-over-year due to slowing mortgage activity and a drop in trading throughout the industry. Mortgage activity fell 62% in the fourth quarter compared to the same period the year before for one- to four-family homes, as rising interest rates in the first half of 2013 reduced the demand for mortgage refinancings. Net Income for the full year in 2013 was up 9.6% to $154.7 billion, compared to 2012.

The Senate Permanent Subcommittee on Investigation, or PSI, has issued its report on offshore tax avoidance; the report would make Robert Ludlum flinch; it’s full of implausible cloak and dagger schemes that could never pass muster in a quality spy novel. Truth is stranger than fiction, but it is because fiction is obliged to stick to possibilities; so said Mark Twain.

The co-authors of the tax avoidance story were Senators Carl Levin and John McCain. For more than 6 years, US officials have been investigating how Americans dodged taxes by hiding assets in secret Swiss bank accounts. At a press briefing, McCain said offshore tax practices operated by Credit Suisse and other institutions had cost US taxpayers $337 billion in potential revenue, which he called “the largest amount of tax revenue lost due to evasion in the world.” He said Credit Suisse, Switzerland’s second largest bank, had “greatly profited from this infamous business model”.

According to Senator Levin, Credit Suisse’s US office used a series of intermediaries to set up a series of offshore shell companies for US clients “in order to hide their assets”. Large sums were divided into smaller ones before they were sent to the US so as not to trigger investigations by US tax authorities. The Credit Suisse crowd also set up phony visa applications to disguise their travels to meet clients. And when they did meet clients, they played the spy game, complete with clandestine exchanges of bank statements, and smuggling cash. In other words, all the actors knew they were doing something that should not be exposed to the light of day.

An investigation into similar practices at UBS, Switzerland’s biggest bank, ultimately led to the recovery of $6 billion in undeclared taxes from US customers, but investigations into the tax schemes had been hampered by the Swiss government. Instead of turning over the names of US taxpayers who have Swiss accounts like UBS did, the Swiss government has delayed requests for assistance and prevented banks from turning over information in an effort to close the door on past conduct.

According to the PSI report the tax avoidance schemes went on from at least 2001 to 2008. Over the past five years the Justice Department has obtained information, including US client names, for only 238 undeclared Swiss accounts out of the tens of thousands opened offshore. Two top Justice Officials told the subcommittee "the department is committed to global enforcement against financial institutions that engage in or facilitate cross-border tax evasion." So far that commitment has seen the Justice Department file tax-evasion related charges against 73 account holders and 35 bankers and advisors since 2009.

An investigation into Credit Suisse resulted in a deal last week between the Swiss bank and the Securities and Exchange Commission. Credit Suisse agreed to pay $197 million for servicing US clients without approval; that means the bankers traveled to the US and met with US clients - maybe 8,500 clients - and advised those clients on how to evade taxes, but they didn’t register as financial advisors. The agreement left unsettled a criminal probe into Credit Suisse and others over whether they helped Americans evade taxes. About 1,800 Credit Suisse staff worked on the accounts, but only 10 people have been disciplined and none had been fired.

McCain said: “This fine pales in comparison to the full range of wrongdoing perpetrated by the bank and its unwillingness to take responsibility for its actions immediately.”

The Credit Suisse chief executive, Brady Dougan, told the senators that he was blocked by Swiss law from disclosing the names to the US authorities. The bank's general counsel, said: "We would all face criminal indictments and possibly prison terms if we were to hand over these client names."

Dougan testified before the senators: "To our deep regret, it is also clear that some Swiss-based bankers at Credit Suisse appear to have helped their US clients hide income and assets in the past… Although it was not and is not illegal for Swiss banks to accept deposits from Americans, it is absolutely unacceptable for Swiss-based bankers to help US taxpayers evade taxes or to provide them with securities advice in the US without being properly licensed."

That doesn’t exactly sound like remorse for tax evasion, as much as annoyance for not having the licenses in order.

So, now the question is what will be done. The senators said the Justice Department had decided to tackle the issue by filing treaty requests, with little success. McCain said he would be quizzing Justice Department officials about why they had not made more progress. Years and years of illegal activity; a 178 page report detailing the wrongdoing; and this on top of repeated offenses from banks that have resulted in slap-on-the-wrist fines and DPA’s, deferred prosecution agreements – which is basically an agreement that says if you break the law again you actually get punished. And the result is the banks never get punished. They break the law with impunity. This tax evasion is stealing, plain and simple.

Meanwhile the International Monetary Fund has released a new study on income inequality, and the takeaway is that income inequality can lead to slower or less sustainable economic growth, while redistribution of income, when measured, does not hurt and can even help an economy.

The IMF has traditionally advised countries to promote growth and reduce debt, but has not explicitly focused on income inequalities. In the past year, IMF Managing Director Christine Lagarde has said that creating economic stability is impossible without also addressing inequality.

According to the study: "It would still be a mistake to focus on growth and let inequality take care of itself, not only because inequality may be ethically undesirable but also because the resulting growth may be low and unsustainable."

The IMF report said countries with high levels of inequality suffered lower growth than nations that distributed incomes more evenly. It warned that inequality can also make growth more volatile and create the unstable conditions for a sudden slowdown in GDP growth.

The new study comes after several years of heated debate over the path that developed and developing countries' economies have taken since the financial crash and whether their recoveries are sustainable. Anti-poverty charity Oxfam welcomed the report, saying it shows "extreme inequality is damaging not only because it is morally unacceptable, but it's bad economics".

It added: "The IMF has debunked the old myth that redistribution is bad for growth and demolished the case for austerity. That redistribution efforts -essential to fight inequality- are good for growth is a welcome finding. Low tax and low public spending are clearly not the route to prosperity."

"We find that inequality is bad for growth ... in and of itself, and we can say that redistribution by itself doesn't seem to be bad for growth, unless it's very large."

They said the traditional view that efforts to redistribute incomes would have a corresponding and most likely detrimental effect on growth was unfounded.

"Rather than a trade-off, the average result across the sample is a win-win situation, in which redistribution has an overall pro-growth effect, counting both potential negative direct effects and positive effects of the resulting lower inequality."

Tuesday, February 25, 2014 - Dumb Luck

Dumb Luck

By Sinclair Noe

DOW – 27 = 16,179
SPX – 2 = 1845
NAS – 5 = 4287
10 YR YLD  - .05 = 2.70%
OIL - .76 = 102.06
GOLD + 5.00 = 1342.60
SILV - .07 = 21.99

Just a couple of economic reports to start. The S&P/Case-Shilller home Price Indices for December were posted today. Nationally home prices closed the year of 2013 up 11.3%, while posting a fourth quarter decline of 0.3%. After 26 months of consecutive gains, Phoenix posted -0.3% for the month of December, its largest decline since March 2011. Phoenix once led the recovery from the bottom in 2012, but Las Vegas, Los Angeles and San Francisco were the top three performing cities of 2013 with gains of over 20%.

Another sign that the housing market slowed down during the fourth quarter: Fannie Mae, the nation’s largest mortgage guarantor, saw demand for foreclosed properties dip at the end of the year. Fannie reported last week an $84 billion annual profit for 2013 on the backs of large home-price gains and a series of one-time legal and accounting benefits. The report also showed that its inventory of foreclosed homes increased for the second straight quarter as it begins to take back more properties in Florida and other states where foreclosures have been tied up in courts. The report showed that the prices Fannie received on those properties, as a share of the underlying mortgage balances, declined slightly from the prior quarter for the first time in 2½ years.

The Conference Board’s Consumer Confidence Index decreased to 78.1 in February from a revised 79.4 in January.  Fewer Americans projected business conditions would improve over the next 6 months, dropping from 80.8 to 75.7 fueling anxiety over the outlook for jobs and income that risks restraining consumer spending. The most important thing that would get consumers feeling better about the outlook is if the labor market improves more substantially. Apparently people who work feel better about the economy and are more likely to spend money than people who don’t have jobs. Who knew?

Even if you have income from work, you might still be holding tight to your coin purse. The Labor Department reports that payrolls in December and January showed the smallest back to back gains in 3 years.

White House economist Jason Furman said today the economy could be in a period of slower potential growth, a development that puts greater urgency on longer-run investments. Gains in worker productivity have eased since the recession began compared with the technology-driven improvement of the prior two decades. Without new policies, the country could face slow productivity growth similar to that recorded in the 1970s and 80s.

Weaker productivity gains during that period was offset partially by a rapidly expanding workforce due to the baby boom and more women taking jobs. Over the next two decades, demographic shifts instead will present an impediment to growth. The workforce is projected to expand at less than a third of the pace it did between 1974 and 1992 because the average American is getting older.

Furman laid out six longer-run initiatives the White House will be pushing on the economic front in the forthcoming 2015 budget:

1. The so-called “Opportunity, Growth and Security” proposal would make investments in research, job training and education beyond what’s possible under the budget framework Congress agreed to late last year. Closing tax loopholes and trimming other spending would pay for the new investments.

2. Expand infrastructure investments, ranging from roads to wireless broadband networks. The spending would create jobs in the short run, with the longer-run effect of improving business productivity.

3. Overhaul the business tax system with the long-stated goal of lowering the top rate to 28% while removing loopholes. Furman says, “By developing a system that is more neutral, corporate decision makers can act for business reasons, not tax reasons, which would create an environment in which capital will flow to the most efficient purposes.”

4. Provide universal preschool education. The investment will improve students’ performance as they advance through the education system and ultimately provide employers with higher skill workers.

5. Change the immigration system to make it easier for workers to obtain green cards and clear the way for foreign students to stay in the U.S. once they earn degrees. Immigrants will not simply expand the labor force, but engage in innovative or entrepreneurial activity that further elevates the economy’s potential.

And idea number 6:  Complete free-trade agreements with countries in Asia and Europe. Those deals would make the U.S. more attractive for foreign investment and open markets for domestically produced goods abroad.

Mt. Gox has disappeared. I know, we’re all shocked, shocked I tell you. There is nothing but a blank page on the Mt. Gox website. There was a brief notation on the website saying there might be something happening, maybe an acquisition, or something, then that disappeared and the website was blank again.

Mt. Gox, once the world's biggest bitcoin exchange, abruptly stopped trading today. Several other digital currency exchanges, including Bitstamp and BTC-E, issued statements attempting to reassure investors of both bitcoin's viability and their own security protocols.

Bitcoin investors deposit their holdings in digital wallets at specific exchanges, so the Mt. Gox shutdown is similar to a bank closing its doors - people cannot retrieve their funds. Released in 2009 by an anonymous creator known as Satoshi Nakamoto, the Bitcoin program runs on the computers of anyone who joins in, and it is set to release only 21 million coins in regular increments. The coins can be moved between digital wallets using secret passwords.

While Bitcoin fans have said the technology could provide a revolutionary new way of moving money around the world, skeptics have viewed it either a Ponzi Scheme or an investment subject to potential fraud or just a bad idea. Bitcoin was supposed to be a new, subversive alternative to a financial system that had been exposed as fragile, dangerous and too big to fail in the financial crisis of 2008. If you’re confused by what that is supposed to be, don’t worry, you are still sane; the bitcoin world is the crazy one in this story.

Tokyo-based Mt. Gox began as a venue for trading cards; the name stands for Magic the Gathering Online Exchange. No, I did  not make that up. Mt. Gox had surged to the top of the bitcoin world, but critics, from rival exchanges to burned investors, said the digital marketplace operator had long been lax over its security. Mt. Gox halted withdrawals earlier this month after it said it detected "unusual activity on its bitcoin wallets and performed investigations during the past weeks." The move pushed bitcoin prices down to their lowest level in nearly two months.

This morning, Mt. Gox CEO Mark Karpeles told Reuters in an email: "We should have an official announcement ready soon-ish. We are currently at a turning point for the business. I can't tell much more for now as this also involves other parties." He did not give any other details.

A document circulating on the Internet purporting to be a crisis plan for Mt. Gox, said more than 744,000 bitcoins were "missing due to malleability-related theft", and noted Mt. Gox had $174 million in liabilities against $32.75 million in assets. It was not possible to verify the document or the exchange's financial situation. If accurate, that would mean approximately 6 percent of the 12.4 million bitcoins minted would be considered missing.

But at the same time that the news about Mt. Gox was emerging, a New York firm announced plans to create an exchange that could draw the world’s largest banks into the virtual currency market for the first time. It could still happen, or not. This might be the death knell for bitcoin, or not. Imagine the lunacy of a private entity, printing money out of thin air, thinking that people would accept it as real currency, despite having no inherent value, based on nothing more than the beneficence of the issuer; subject to meltdown and freeze up, where massive amounts of value just disappear in the blink of an eye. The whole idea is the height of lunacy; unless, you’re the Federal Reserve of course.

There is more to it of course. A sovereign government that issues its own “nonconvertible” currency cannot become insolvent in terms of its own currency. It cannot be forced into involuntary default on its obligations denominated in its own currency. It can “afford” to buy anything for sale that is priced in its own currency. It might be able to buy things for sale in foreign currency by offering up its own currency in exchange, but that is not certain. If, instead, it promises to convert its currency at a fixed price to something else (gold, foreign currency) then it might not be able to keep that promise. Insolvency and involuntary default become possible. This seems to be where bitcoin failed; the convertibility part, or at least the part where you could actually buy something with bitcoin.

Speaking of the Fed and failure. Last week we finally saw the transcripts from the Fed from back in the crisis year of 2008. Now, Tim Geithner has a book coming out, titled “Stress Test”.  Geithner has a number of attention-grabbing takeaways. Among them: “We saved the economy from a failing financial system, though we lost the country doing it,” he writes in the book, due out May 13. Geithner led the Federal Reserve Bank of New York at the onset of the meltdown. He served as the Obama administration’s top economic official from January 2009 until January 2013.

On the book’s website, Geithner says: “We made mistakes, it was messy, and the damage was devastating and long-lasting. And yet, at the moments of most extreme peril, the United States was able to design and execute a remarkably effective strategy.” Actually, what we’ve been learning from the transcripts of the Fed in 2008, is that the remarkably effective strategy was more like a drunkard managing to survive a stroll through a landmine; i.e., persistence and dumb luck.

Monday, February 24, 2014 - Wine and Neurosis

Wine and Neurosis

by Sinclair Noe

DOW + 103 = 16,207
SPX + 11 = 1847
NAS + 29 = 4292
10 YR YLD + .01 = 2.75%
OIL + .64 = 102.84
GOLD + 10.50 = 1337.60
SILV + .11 = 22.07

The S&P 500 hit a new high today; topping out at 1858; surpassing the intraday high of 1850 set back January 15^th, and finishing at 1847.61, just below the record high close of 1848.38, again from January 15. So, we couldn’t hold on to a record close, but it was tempting. The S&P was banging up against resistance, briefly floating above the ceiling and into new, rarified air. And we would all love to be on that rocket, if it really is going to soar. Patience, patience.

Now, we know that fundamentals, the news of the day, only offers justification for movement, and we know that the fundamentals can also prove to be contrary indicators. Still, the best explanation I’ve heard today for the enthusiasm is the recent M&A activity has created something of a halo effect. There has been quite a bit of merger action. Consider: RF Micro Devices will merge with Triquint Semiconductor in an all stock deal announced this morning, last week was news of Men’s Warehouse upping its offer for Joseph A. Bank conditioned on Bank dropping its bid for Eddie Bauer, Actavis is buying Forest Laboratories, Comcast buying Time Warner Cable in a deal to create the world’s biggest consumer complaint, and Facebook buying WhatsApp.

And suddenly everybody wants to catch the M&A fever. Maybe that explains new market highs, maybe not. What we haven’t seen is an improvement in the economy; blame it on the weather if you wish, but it’s hard to find demand. Households, businesses, governments are all holding onto their money; meaning supply outweighs demand. Another way to look at this is when demand increases, buyers bid prices higher, or you have too much money chasing too few goods, and the result is inflation, and this is usually a sign of an expanding economy. But prices are not inflating.  We saw the CPI and PPI reports last week and what we have is disinflation or perhaps just stagnation; and the economy is just muddling along.

Of course, there are multiple causes of inflation; you might see supply decrease and cost of production increase, and that could push prices higher; this is known as cost-push inflation; you might see demand increase while supply remains constant or drops, and that pulls prices higher; this is known as demand-pull inflation. The Fed has hoped that by throwing money into the banking system, they could increase demand. That hasn’t happened, and so the Fed is backing away from their monetary stimulus scheme and they are cutting back QE.

Last Friday we saw the transcripts of the Fed’s deliberations from 2008, and it revealed policymakers were largely in the dark about the impending meltdown; they were in the dark about how the markets would respond to stimulus; they were in the dark about where and why and to whom they should apply stimulus – they really missed the mark on that count; they were in the dark about how economic models could miss changes in conditions; they were in the dark about the consequences of a meltdown; they are still in the dark to this very day.

So, we’re back to the basics of supply and demand. Throwing money at Wall Street does not increase demand; it does increase mergers and acquisitions and stock buybacks and executive bonuses. And that creates a feverish frenzy among Wall Street traders looking for the next big buyout. Anyway, we hit a high but we couldn’t hold onto it. You can celebrate that record with wine and neurosis.

If you are trying to trade these markets, don’t get caught up in the M&A fever. Follow the trend, not the fad. This means that you will not hit the tops and bottoms in the market. In other words, you will not be exactly right on any given trade; you will be a little late on any given entry and exit, but you will let the technical data, the price action tell you when to buy or sell. You won’t predict where the market is going but rather follow the market. If it sounds a bit stressful, it is. But you have to ask yourself if you want to be right or if you want to be profitable. Or maybe that’s not the question at all. Maybe you should be questioning why you are in the market at all.

If you can make it through a weekend without checking the stock quotes, you might consider not checking the quotes for a week. So says Warren Buffet.

Mere mortals should not try to outsmart the stock market. That’s what Warren Buffet is saying, or writing in his upcoming annual letter to investors. Buffet writes:  "The goal of the nonprofessional should not be to pick winners -- neither he nor his 'helpers' can do that -- but should rather be to own a cross section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal."

Buffett thinks the best course of action is to take almost no action. Stick to what you know, which is probably nothing. Buy a basket of 500 stocks, a smattering of bonds, and forget about it for the next 100 years or so. Treat investing this way and you'll actually beat the experts in the long run.

Buffett takes a few shots at the hedge fund managers and the newsletter writers and the talking heads on CNBC and similar outlets. Buffett writes: “Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits -- and, worse yet, important to consider acting upon their comments," Buffett writes, adding: "In the 54 years [partner Charlie Munger and I] have worked together, we have never forgone an attractive purchase because of the macro or political environment, or the views of other people."

So sayeth the Oracle of Omaha, and he’s right, of course; unless you didn’t get out at the top and prices are collapsing and you’re wondering whether to eat your losses or buy more, and remembering that you don’t have quite the balance sheet of Warren Buffett.

Meanwhile, Defense Secretary Chuck Hagel today outlined a modest proposal to deal with spending caps ahead of the formal budget presentation next week. Hagel has laid out how he will cut spending. The Department of Defense plans to reduce the size of the Army to between 440,000 and 450,000 soldiers, he said. The Army is currently about 520,000 soldiers and had been planning to draw down to about 490,000 in the coming year.

A reduction to 450,000 would be the Army's smallest size since 1940 - before the United States entered World War Two - when it had a troop strength of 267,767, according to Army figures. The Army's previous post-World War Two low was 479,426 in 1999.

The Defense Department is in the process of reducing projected spending by nearly a trillion dollars over a 10-year period. A two-year budget deal in Congress in December gave the Pentagon some relief from the budget cuts, but still forced it to reduce spending in the 2014 fiscal year by $30 billion. The Pentagon's budget for the 2015 fiscal year is $496 billion, roughly the same as in 2014 but still lower than had been projected last year. There would also be cuts to some spending on equipment, but Hagel argues the cuts would be more draconian and less strategic if executed under sequestration.

Hagel also announced a series of steps to try to reduce the Defense Department's military and civilian personnel costs, which now make up about half of its spending. While Congress voted to undo cuts to military retiree benefits on February 12, some cuts will still be made to compensation, however the new recommendations do not cut pay. Hagel said the department would slow the growth of tax-free housing allowances, reduce the annual subsidy for military commissaries and reform the TRICARE health insurance program for military family members and retirees.

Hagel cautioned that reducing Army troop levels would increase the risk involved in protracted or simultaneous ground operations, as the US saw during the wars in Iraq and Afghanistan. Hagel said: “As a consequence of large budget cuts, our future force will assume additional risks in certain areas.”

Hagel also raised the specter of disaster if Congress does not reverse sequestration cuts to the military that would set in at deeper levels two years from now.

“Sequestration requires cuts so deep, so abrupt, so quickly, that we cannot shrink the size of our military fast enough. In the short-term, the only way to implement sequestration is to sharply reduce spending on readiness and modernization, which would almost certainly result in a hollow force - one that isn’t ready or capable of fulfilling assigned missions.”

“In the longer term,” Hagel went on, “after trimming the military enough to restore readiness and modernization, the resulting force would be too small to fully execute the president’s defense strategy.”

This is a major change in defense spending and a bit of a gamble in a midterm election year. Defense advocates in both parties will debate the merits of closing bases and idling factories and what benefits must be honored for the troops and their families. And there will be people arguing for cutting the deficit yet arguing for more defense spending.

This is not going to be easy, but to maintain a little perspective, in 2013 the US spent about $680 billion on our military, which works out to 4.4% of GDP. We spend more than any other country. We have about 5% of the world population but we account for 39% of the world military spending. The cutbacks would still leave us spending more than any other country by a long shot. The plan calls for downsizing so we can fight one land war, not two, at the same time. Maybe we could avoid war for a while and really save some money. 

Friday, February 21, 2014 - Grab Tight and Hope for the Best

Grab Tight and Hope for the Best

by Sinclair Noe

DOW – 29 = 16,103
SPX – 3 = 1836
NAS – 4 = 4263
10 YR YLD -.02 = 2.73%
OIL - .50 = 102.25
GOLD + 3.10 = 1327.10
SILV + .03 = 21.95

Sometimes you just grab tight and hope for the best. There is a deal in the Ukraine. Ukraine's opposition leaders signed an EU-mediated peace deal with President Viktor Yanukovich. Under pressure to quit from mass demonstrations in Kiev, Russian-backed Yanukovich made a series of concessions, including a national unity government and constitutional change to reduce his powers, as well as announcing an early presidential election this year. The Ukrainian parliament then voted to revert to a previous constitution, which essentially stripped Yanukovich of some powers, sacked his interior minister blamed for this week's bloodshed, and amended the criminal code to pave the way to release his arch-rival, jailed opposition leader and former Prime Minister Yulia Tymoshenko.

The deal was mediated by the foreign ministers of Germany, Poland and France, and appears to have been a victory for Europe in its competition with Moscow for influence. The European envoys signed the document as witnesses, but a Russian envoy did not. And just because a deal has been signed it doesn’t mean it will be easy. Protesters remain encamped in Kiev's central Independence Square, where approximately 77 activists had been killed over the past week. There were some celebrations but many of the demonstrators were skeptical that Yanukovich could be trusted.

Ukraine still has problems. The country is deeply divided between Russian sympathizers and the opposition which supports the European Union. The country is broke and facing default. They are dependent on Moscow for energy imports. Putin promised $15 billion in aid after Yanukovich turned his back on a far-reaching economic deal with the EU in November, but now Russia is holding back to see how things play out. The devil is in the details but for this moment in time, they are trying to give peace a chance.

Meanwhile the city of Detroit is looking for a fresh start. You might hear that the city of Detroit officially filed for bankruptcy today; that’s not quite accurate. The state appointed emergency financial manager, Kevin Orr filed a bankruptcy plan with the courts. And that’s just the beginning of the strangeness that is Detroit.

To begin the process of restructuring and exiting Chapter 9 bankruptcy, the city of Detroit filed documents with the court outlining its restructuring plans; who might get what, and an idea of what the city might look like after it pays what it can.

Orr proposed 34% cuts to the pension checks of general city retirees and 10% to police and fire retirees, and they would lose cost of living adjustments, and it’s dependent on the city’s two independently controlled pension boards agreeing to support the plan of adjustment. The city has about 24,000 retirees. The city proposed paying about 20% to 30% of its retiree health care liabilities to a newly created trust fund.

The city proposed paying secured bondholders 100% of what they’re owed, while unsecured general obligation bondholders would receive 20%.The significant haircut for general obligation bonds now declared to be unsecured debt likely will upset participants in the $3.7 trillion municipal bond market, where general obligation bonds have traditionally been considered a safe bet for investors. A deal to end costly interest-rate hedges was not included in the plan, but there should be a plan for that within a few days.

The plan also calls for the city to invest about $1.5 billion over 10 years to improve public protection, restore services and reduce blight, including tearing down abandoned houses.

The judge overseeing the city’s bankruptcy, Steven Rhodes, must approve the restructuring plan before it can be finalized. This is likely to involve a fierce court battle with creditors over several months. Again, the devil is in the details, different parties will be upset; but the basic plan appears to be: fewer debt collectors, fewer murders, and fewer abandoned homes.

How will things work out for the Ukraine or for Detroit? We don’t know. In times of crisis, sometimes you just grab tight and hope you don’t get thrown off the horse. That appears to be the game plan of the Federal Reserve as the economy and financial markets collapsed around them in 2008. Today the Fed released transcripts of the Fed policy makers from 2008, when everything hit the fan. The one thing that becomes quickly apparent from the transcripts is that the Fed was not prepared for the meltdown and they were in no way certain about the best response.

As then-Fed Chairman Ben Bernanke said during an emergency conference call on Jan. 21, 2008: "We were seriously behind the curve in terms of economic growth and the financial situation." And so at that meeting, they cut the Fed Funds discount rate target by three-quarters of a percent. Twelve days earlier they had called another emergency meeting and made no change to interest rates. Nine days later, on January 30, they cut rates another 50 basis points.

Then at their September 16, 2008 meeting the Fed left interest rates unchanged, even though Lehman Brothers had just collapsed and insurance giant AIG was in the grips of a crisis that threatened to bring down the whole financial system. By the end of 2008, the Fed had made eight rate cuts, leaving its benchmark short-term rate on Dec. 16 at a record low near zero. It remains there today.

At the September meeting, many Fed officials were far more worried about inflation risks than about the risk of an economic collapse and depression. The word "inflation" occurs 129 times in the Sept. 16 transcript; the word "recession" was uttered just five times. ("Laughter" is noted in the transcript 22 times.)

Lehman fallout was unclear. The day after Lehman declared bankruptcy, Fed officials still didn't have a handle on what the long-term effect would be on the economy. Dave Stockton said: "I don't think we've seen a significant change in the basic outlook. We're still expecting a very gradual pickup in GDP growth over the next year."

Several Fed officials congratulated themselves on the controversial decision to deny funding for a potential acquisition of bankrupt Lehman Bros. The move, however, significantly worsened the crisis. Former Kansas City Fed chief Thomas Hoenig said: "I think what we did with Lehman was the right thing because we did have a market beginning to play the Treasury and us, and that has some pretty negative consequences as well.” And St. Louis Fed chief James Bullard said: "By denying funding to Lehman suitors, the Fed has begun to reestablish the idea that markets should not expect help at each difficult juncture."

And if they were unsure of the effect of the Lehman collapse, they totally misread the failure of Bear Stearns. In April, just after the collapse of Bear, Bernanke seemed to think the worst had passed, saying: “I think we ought to at least modestly congratulate ourselves that we have made some progress," he said. "Our policy actions, including both rate cuts and the liquidity measures, have seemed to have had some benefit. I think the fear has moderated. The markets have improved somewhat." Actually, it was just the calm before the storm. Then at the September 16 meeting, Bernnake made the mistake of self-congratulation once again, saying: “I think that our policy is looking actually pretty good.”

Janet Yellen, the new Fed Chairperson, seemed to grasp the gravity of the situation more than most of her colleagues. At an Oct. 28-29 Fed meeting, Yellen noted the dire events that had occurred that fall. With a nod to Halloween, she said the Fed had received “witch’s brew of news.” Yellen went on to say: “The downward trajectory of economic data has been hair-raising, with employment, consumer sentiment, spending and orders for capital goods, and homebuilding all contracting.” Market conditions had “taken a ghastly turn for the worse,” she said. “It is becoming abundantly clear that we are in the midst of a serious global meltdown.” Yellen had downgraded her economic outlook and was predicting a recession, with four straight quarters of declining growth. She was right about that, even if no one was sure what to do about it.

Maybe they were just tilting at windmills, as Philly Fed President Charles Plosser suggested, saying: “I don’t think that anything that we do today — cutting the funds rate 50 basis points or whatever — is going to make the next couple of months in terms of the overall economy any less painful.”

They thought they should get more regulatory powers in return for bailing out the banks. Richard Fisher, head of the Federal Reserve Bank of Dallas, said in a March 2008 conference call:  "I am just a little worried about being taken advantage of here. The question is, what do we get in return, and how do we make sure that, since we are not the regulator of these dealers, there is indeed discipline?" Of course it turns out there was no discipline. The big banks are now bigger and riskier than ever.

At times they were overwhelmed. At the September 16 meeting a Fed economist said: "We did receive a great deal of macroeconomic data since ... last Wednesday. We didn't seem to get any of it right, but it all netted out to just about nothing."  And everybody had a good laugh.

Eventually, Bernanke seemed resigned to his limitations. In October of 2008, he was asked about the future direction of rates and he answered: “I feel rather unconfident about predicting the path of rates six months in the future, because I’m not quite sure what is going to happen tomorrow at this point.”

To be fair, even though they made a bunch of mistakes, the global financial system did not collapse. Sometimes you just grab tight and hope for the best. 

Thursday, February 20, 2014 - Searching for Inflation

Searching for Inflation
by Sinclair Noe

DOW + 92 = 16,133
SPX + 11 = 1839
NAS + 29 = 4267
10 YR YLD + .02 = 2.75%
OIL + .02 = 102.86
GOLD + 12.10 = 1324.00
SILV + .29 = 21.92

The Conference Board’s Leading Economic Indicators rose 0.3% in January following no change in December. Over the six months through January, the LEI rose 3.1%. The LEI tracks 10 indicators designed to signal business cycle peaks and troughs. In the most recent report, 5 of the 10 indicators were positive, including a drop in jobless claims and a pickup in factory orders; on the negative side, declines in building permits and hours worked. Meanwhile, the Conference Board’s index of coincident indicators, a gauge of current economic activity, rose 0.1 percent for a second month. Overall, the leading indicators point to moderate expansion once the nation gets past inclement weather, with the caveat that consumer demand needs to pick up. No surprises in that report.

The Consumer Price Index rose 0.1% in January after a 0.2% gain in December. The CPI measures prices at the retail level. The core rate, excluding food and energy prices, also rose 0.1%. Over the past 12 months, consumer prices were up 1.5%, and the core CPI was up 1.6%. Energy costs increased 0.6% from a month earlier and were up 2.1% over the past 12 months. Food costs rose 0.1%. Gains in the cost of hotel rooms, medical care and rents were mostly offset by declining costs for new and used cars, clothing and airline fares.

Yesterday, Fed policymakers released the minutes of the January FOMC meeting and we learned they had expressed concern about inflation being too low. Some participants wanted an “explicit indication” in their annual statement on policy goals that prices persistently above or below their 2 percent inflation target would be “equally undesirable.”

Prices are about to move higher, at least for food. It’s pretty simple; the state that produces the most vegetables is going through the worst drought it has ever experienced. Just consider the statistics regarding what percentage of the produce you eat is grown in California: 99% of artichokes, 44% of asparagus, 66% of carrots, 50% of bell peppers, 89% of cauliflower, 94% of broccoli, 95% of celery, 90% of lettuce, 83% of spinach, 33% of tomatoes, 86% of lemons, 90% of avocados, 84% of peaches, 88% of strawberries, and 97% of plums.

If fruits and veggies don’t fill your plate, you’ll want to take note that the US cattle herd is now the smallest it has been in 63 years. The drought in California and also Texas means that there are fewer cows, as ranchers in the West sell off their livestock because grazing land has dried out and buying feed is prohibitively expensive. And you can’t just snap your fingers and have a cow ready for market; it takes a couple of years. The lower supply means higher prices; offsetting the supply is lower demand; nearly 40% of Americans say they eat less beef today than 3 years ago.  Ground beef prices were up 5% for the past year. Chicken prices up more than 18% in the past 3 years, and bacon up 23% in the past 3 years.

If there is any good news on the food front, the US Department of Agriculture today reported that corn, soybeans, and wheat prices should be lower over the next 12 months.

Anyway, no inflation on the horizon in today’s CPI report. And the reason is not just what is happening in the USA. Goods inflation is exposed to global trade. When China was flooding the world with low cost goods in the 1990s and 2000s, it put immense downward pressure on consumer goods prices and held down the overall U.S. inflation rate. Unlike the 1990s and early 2000s, the latest downdraft in goods inflation is likely being driven not so much by an influx of cheap goods produced by low-cost emerging market labor, but by a slowdown overseas driven by over investment in emerging markets during their boom. An acceleration of global growth is probably a necessary condition for headline inflation to accelerate.

That’s just a small part of the inflation picture. The service sector makes up a larger part of the US economy these days. Services inflation is highly exposed to domestic housing and the cost of domestic labor. In other words, rent and wages. The owners’ equivalent rent index had been rising at a steady pace through most of 2012 and 2013, with 12-month percent changes hovering around 2%, but toward the end of 2013, the pace picked up. By January OER was up 2.5% compared to year-ago levels. That’s not a hot pace for housing costs but it bears attention. Meanwhile, wages have been flat for what seems like forever, and that means there is no demand to push prices higher, at least for services. For that matter, we may be setting up a divergence between wages and rents. You can’t push rents higher unless people earn enough wages to pay the rent.

The Federal Reserve Bank of New York has issued a paper on why people are having a hard time finding a job. The old excuse was “structural unemployment.” The new excuse is a decline in “job matching efficiency.”

The White House budget to be released early next month will propose $56 billion in new spending on domestic and defense priorities and drop a proposal that was included in last year's budget as a way to attract Republican support; a plan that would have cut Social Security benefits based on a “chained CPI”. The budget would aim to reduce the emphasis on austerity that has been the preoccupation of American politics for the past four years.

A White House official said President Obama decided to release a budget that fully represents his "vision," rather than to continue to pursue a fiscal agreement, because Republicans have refused to engage in good-faith negotiations over the nation's top priorities.

The new budget is due March 4.

The protests in the Ukraine have escalated into gun battles between police and anti-government forces. The death toll has climbed to 75. Three hours of fierce fighting in Kiev's Independence Square, which was recaptured by the protesters, left the bodies of over 20 civilians strewn on the ground. Nearby, President Viktor Yanukovich was meeting with a EU delegation trying to broker a political settlement. For now, there is no agreement.

Increasingly, we’ve seen big banks involved in commodity markets, and an interesting idea was recently tossed out by Theodore Butler regarding the origins of the 2008 crash. I don’t know if it is true but it’s an interesting story.

You’ll remember that Bear Stearns imploded six years ago; JPMorgan took it over as the doors were closed. It was an unprecedented fall. As Butler said: “The cause was said to be a run on the bank as nervous investors pulled assets from the firm. Bear Stearns was said to be levered by 35 times, meaning it had equity of $11 billion and total assets of $395 billion. This is a very small cushion if something negative suddenly appears… Since Bear had a significant presence in sub-prime mortgages and that market was in distress, it is assumed the fall of the firm was mortgage related. That may be true, but there was no general stress in the stock market through mid-March 2008 reflecting a credit crisis. Was there instead some specific trigger behind the company’s sudden collapse?”

One idea is that Bear Stearns was short the silver market. The exact holdings haven’t been established but the 4 largest short traders in silver was at an extreme level of more than 300 million ounces; triple the long positions, and Bear Stearns was the largest short in COMEX gold and silver contracts.

The day of Bear Stearns demise coincides with historic high points in gold and silver. “Gold prices rose from under $800 in mid-December 2007 to $1,000 in mid-March 2008, a gain of more than $200. Silver prices rose from under $14 in mid-December to $21 when Bear Stearns failed on March 17, 2008. That was a gain of $7. This was the highest price for silver and close to the highest price of gold since 1980. Obviously, a $200 rise in the price of gold and a $7 rise in the price of silver is not good if you are the biggest gold and silver short…. Bear Stearns had to come up with $2.7 billion because gold and silver prices rose sharply in the first quarter of 2008 and the company bet the wrong way. That it couldn’t come up with all the margin money for the losses in gold and silver, is the most visible reason it went under.”

We can’t say with certainty that this is what happened to Bear Stearns, but it is probably more than mere coincidence that JPMorgan ended up acquiring Bear, and really, it makes  sense, and at the very least it’s a great story.