Thursday, February 21, 2013 - the Big Coincidence

Note: I will be a speaker at the upcoming 2013 Wealth Protection Conference in Tempe, AZ on April 4^th and 5^th. Click here for details and registration information. Hope to see you there.

The Big Coincidence

by Sinclair Noe

DOW – 46 = 13,880
SPX – 9 = 1502
NAS - 32 = 3131

10 YR YLD + .04 = 1.98%
OIL – 2.23 = 92.99
GOLD + 12.10 = 1577.40
SILV + .12 = 28.78

We had a bundle of economic reports to start the day. Let's run through them. First, the CPI report, which measures inflation at the retail level, shows prices were unchanged in January for the second month. Consumer prices are up just 1.6% in the past 12 months. One striking subset of the CPI report showed energy prices dropping 1.7% in January on a seasonally adjusted basis. Of course we all know that gas prices were climbing almost every day through the month; most likely, we'll see a significant bump in the February report.

A couple of manufacturing reports showed weakness. The Philly Fed's  gauge of regional manufacturing activity fell to negative 12.5 in February from negative 5.8 in January with declines in overall activity and new orders. And Markit, a financial information services company, said its gauge of manufacturing activity dropped to 55.2 in February from 55.8. Any reading above 50 indicates expansion but the purchasing managers index showed a slower expansion, with weaker new orders and employment.

Initial jobless claims rose 20,000 to a seasonally adjusted 362,000 in the week ended Feb.16^th. The number was a smidge worse than expectations.

The Conference Board's Leading Economic Index, or LEI, rose 0.2% in January. The LEI is a forward looking weighted gauge of 10 indicators designed to signal business cycle peaks and troughs. Positive contributions came from stock prices, a leading credit index, jobless claims, building permits, and manufacturers’ new orders for consumer goods and materials. Negative contribution came from consumers’ expectations, manufacturing hours, a manufacturers’ new orders index and manufacturers’ new orders for core capital goods.

Overall, the leading indicators, and for that matter, the other economic reports, point to a relatively sound but sluggish economy.

For now, the Federal Reserve is running the economy. There are limits to their monetary policy powers, but absent any signs of intelligent life forms in Washington DC, the Fed is in charge. Yesterday, we had a glimpse into the Fed policymakers' brains. The markets were a bit rattled to learn that the masters of the economic universe were nervous about QE to infinity and beyond. QE is the Fed's experiment in buying $85 billion a month in Treasury bonds and mortgage backed securities, and flooding Wall Street with cash, in the unrealistic hope that the Wall Street crowd might spread some of the cash through the broader economy. . At the Fed's January policy meeting, some policymakers started to grouse that all those bonds were piling up on the balance sheet and the vaults were getting full, and they would have to stop buying at some point.

Wall Street's response was something like a junkie going cold turkey; shaking, trembling, and wide-eyed paranoia that the Fed would take away their free-money-fix. Of course, that's not what the Fed said; a few of them just posited the idea that maybe, someday, there might come a time when the Fed is no longer involved in the undeclared nationalization of the bond market. Then they looked around and recognized that unemployment is still high, inflation is still tame, growth is still sluggish, and the Congress likes to take razor blades and self-inflict wounds just to test their ability to feel anything.

The next self-inflicted cutting takes place March 1^st. They call it the sequester. The sequester was a result of the wrangling over the debt ceiling in the summer of 2011, when Republican leaders — who had previously passed clean debt increases 19 times under President Bush — demanded spending cuts as the price for averting a default. On the brink of default, Congress passed the Budget Control Act, which enacted immediate spending cuts and created a supercommittee tasked with striking a “grand bargain” to reduce the deficit. The Budget Control Act (BCA) of 2011, passed the House with 269 “yea” votes – 174 Republicans and 95 Democrats. In the 100-seat Senate, Democrats made up most of the 74 "yea" votes, but there were 28 Republicans in that majority, as well. Quite simply, this was both parties. Republicans walked away from the committee after refusing to consider tax increases on the wealthy, setting sequestration into motion. The sequester, which cuts from both domestic and defense spending, was designed to be painful enough that both sides would negotiate to avert it.

Congress is currently on recess until next Monday, leaving just five legislative days until the automatic cuts, known as sequestration, will take effect. The fact that Congress didn't get anything done in 1 ½ years might make you think they won't get anything done in five days. Ever since Senate Democrats unveiled their plan to avert the sequester with a mix of new revenues and spending cuts, there has been no negotiations between the Democratic and Republican leadership offices in the Senate. No discussions about any potential compromises. 

So, here's what happens if or when the sequester kicks in. Because its cuts are across-the-board, the sequester will affect most domestic programs. Jobless workers will lose access to unemployment benefits, while safety net programs for women and children and early childhood education programs will face deep cuts. The sequester will cut funding for law enforcement and border security, food safety, airline travel security, Head Start, disaster relief, and health research. Defense programs will also see reductions. These cuts will have broad ramifications for the country’s recovering economy, pushing it down the austere path Europe has followed into second recessions. Independent reports predict that sequestration would reduce economic growth by 0.6 percent over the year while also leading to the loss of 700,000 jobs. The debt limit fight that created the sequester already pummeled the recovery, and allowing these spending cuts to take effect would cause even bigger problems.

Democrats believe the real action on the sequester has yet to come, and will ramp up in earnest in March. Which means, of course, that the cuts will kick in. Democrats no longer see the sequester as sufficient to force Republicans to cave on new revenues; rather, they increasingly see the looming government shutdown deadline of March 27th as the real means for them to force a GOP surrender.

The idea is that the sequester isn’t as dramatic a deadline as the fiscal cliff and debt ceiling deadlines were. The sequester doesn’t have that immediate shock value. It’s not the kind of thing where people wake up on March 1st and realize it happened. It doesn’t have the sort of acute impact that the fiscal cliff or debt ceiling.

But a government shutdown will get your attention. So the month of March is when negotiations heat up, and right now it appears to be advantage Dems, because there is no other formulation of the sequester that is more appealing than the current formulation. The hit in defense spending is not worse than the hits from agreeing to non-defense discretionary cuts. The House Republican plan would not include any new taxes but it would gut Dodd-Frank Financial reform, and take away funding for Obamacare, and pretty much wipe out the first four years of the Obama administration. So, at the end of the day, the Dems like sequester better than the House Republican alternative, which offers no quarter, and so the Dems will stick to their demands for more revenue. Or maybe both sides will just sit back and see if the other side slices the razor blade too deep and bleeds to death.

And that brings us back to the masters of the economy, the Federal Reserve; they're watching the politicians make a royal mess of fiscal policy and they're thinking about how they will be forced to clean up the mess; especially when they've got a bit of a mess themselves. The cash spigot is flowing and gushing money over Wall Street banks while the Fed's own balance sheet is backed up. And the differential is getting a tad inconvenient.

Bloomberg ran an article yesterday which basically says the Fed is paying the big banks to be big and unwieldy. The larger they are, the more disastrous their failure would be and the more certain they can be of a government bailout in an emergency. The result is an implicit subsidy: The banks that are potentially the most dangerous can borrow at lower rates, because creditors perceive them as too big to fail. How much lower are the big banks borrowing costs?

A couple of economists put the number at about 0.8 percentage point. The discount applies to all their liabilities, including bonds and customer deposits. Small as it might sound, 0.8 percentage point makes a big difference. Multiplied by the total liabilities of the 10 largest U.S. banks by assets, it amounts to a taxpayer subsidy of $83 billion a year. To put the figure in perspective, it’s tantamount to the government giving the banks about 3 cents of every tax dollar collected. It's also the same amount the Fed is spending on QE 3; it's also the same amount of cuts required by the sequester. But I'm sure that's all mere coincidence.

Another way of looking at it; the top five US banks, with assets of $9 trillion, more than half the size of the US economy, aren't really making any money; the profits they report are essentially transfers from taxpayers to their shareholders.  The result is a bloated financial sector and recurring credit gluts. Left unchecked, the superbanks could ultimately require bailouts that exceed the government’s resources. Picture a meltdown in which the Treasury is helpless to step in as it did in 2008 and 2009.

Regulators can change the game by paring down the subsidy. One option is to make banks fund their activities with more equity from shareholders, a measure that would make them less likely to need bailouts. Another idea is to shock creditors out of complacency by making some of them take losses when banks run into trouble. A third is to prevent banks from using the subsidy to finance speculative trading, the aim of the Volcker rule in the US and financial ring-fencing in the UK. Another idea is to take the banks off Federal Reserve induced life support and instead use the money to pay down the deficit without draconian, meat-cleaver cuts to spending and without significant tax increases; and use the savings to grow the economy for everybody, except, of course, the five big banks.

I saw the video of Elizabeth Warren grilling regulators but this article from Time tells the rest of the story:

It's hard to find a serious critic of big banks in Washington. Senator Dick Durbin explained a few years ago that the big banks “own the place.” But there is a new kid in town. Massachusetts Senator Elizabeth Warren was sworn in in January and given a seat on the Senate Banking Committee. Warren is extremely well versed in finance. And last week, the committee held its first hearing of the new year to question regulators about the stability of the nation’s financial system, and to get a progress report on the implementation of post-crisis financial reform.

Warren stole the show, pointedly asking each member of the panel when the last time they had taken a large Wall Street bank to trial, where their misdeeds would be aired publicly. The regulators seemed completely stymied by the thought of actually going to trial and they couldn't give the senator a straight answer. You can see the video online; it's quite enlightening. The implication was, of course, that regulators are either unwilling or unable to take big banks to trial, that they rely too much on mutually agreed upon settlements as penalties for misbehavior, a slap on the wrist, and that this reluctance has created a dangerous culture of impunity on Wall Street.

But Warren’s second point is equally interesting, and perhaps more important to understanding what remains broken about the American banking system. She indicated that the majority of the nation’s big banks are “trading below book value.” The book value of a company is simply the total value of all the company’s listed assets minus its liabilities — in theory, that is, what shareholders would get by selling their company off for parts.

But most companies are worth more than book value. That’s because most firms are more than just a sum of their parts — they possess institutional knowledge, for example, that enables them to turn their employees, equipment, and intellectual property into profits. But lately, the stock market is actually valuing large banks like Citigroup, Bank of America, and JPMorgan, below the value of the company’s stated assets minus liabilities. 

Let’s take the example of Citigroup, which has a market capitalization of $135 billion. In other words, if you had $135 billion, you could buy up all the outstanding shares of Citigroup. But here’s the rub: If you actually add up the stated value of Citigroup’s assets minus liabilities, the bank should be worth at least $190 billion. Theoretically, you could buy up Citi, chop it up, and sell it for parts, and make a tidy $55 billion in profit.

Of course, in a competitive market, this shouldn’t be. Something is amiss, and Senator Warren thinks there can only be two reasons: 1) Banks aren’t being honest about the value of their assets; or 2) The market believes that large banks are too big to manage effectively. In his response, Federal Reserve Board Governor Daniel Tarullo added that regulatory uncertainty may play a role in pushing down the values of bank stocks. But are these the correct explanations?

It would appear that a lack of trust in bank accounting is one culprit for the discrepancy. In a recent cover story for The Atlantic magazine, Frank Partnoy and Jesse Eisenger examined Wells Fargo’s annual report. They found that the vast majority of the assets on Wells Fargo’s books are securities like derivatives and mortgage-backed securities which aren’t traded often or on public markets. These securities are difficult to value, and therefore banks must use estimates when putting together their financial reports. But Partnoy and Eisenger claim the complexity and incentives to hide risk, causes big-bank financial statements to be effectively useless.

Barry Rithotz, CEO and director of equity research at Fusion IQ, commenting upon the article summed up investor’s skepticism in the banking sector succinctly:

Banks are essentially opaque black boxes; banks have purposefully concealed what’s on their balance sheets . . . they are not merely complex, but actually deceptive; investors have no idea what they are buying when they own one of the behemoth money centers like Citigroup, Bank of America, Wells Fargo, or JP Morgan.

So it would seem Senator Warren is on to something when she accuses large banks of being dishonest about the value of their investments. Warren isn’t accusing large financial institutions of outright fraud. These institutions are following the letter of law, and complying with accounting rules from the Financial Accounting Standards Board. But accounting isn’t an exact science, and given enough resources, firms can avoid conforming to the spirit of these rules while still technically being in compliance.

You don’t need to take Warren’s word for it. Just take a look at the bank’s stock prices and decide for yourself. Bank representatives may argue that the $55 billion discrepancy between Citigroup’s market capitalization and book value are due completely to the fear that regulators will increase capital requirements, but does this explanation really pass the smell test?

Regulatory uncertainty may be a factor, but ultimately investors don’t understand what these banks have on their books — and don’t want to be holding the bag when we eventually find out. Remember when we almost had a global financial meltdown in 2008; financial institutions froze, in part because they didn't know the counterparty risk, what the other bankers had on their books. They still don't know, and you don't know, and the regulators don't know.

In a scenario like that, what could go right?

Wednesday, February 20, 2013 - Seeds of Change

Seeds of Change

by Sinclair Noe

DOW – 108 = 13,927
SPX – 18 = 1511
NAS – 49 = 3164
10 YR YLD - .01 = 2.02%
OIL – 2.28 = 94.82
GOLD – 40.50 = 1565.10
SILV - .87 = 28.67

We may be seeing the seeds of change. Today, the Federal Reserve released the minutes from the January 30 meeting of the Federal Open Market Committee. The minutes reveal that several FOMC policymakers think it might be time to shake things up, vary the pace of their $85 billion dollar per month bond purchase program. According to the minutes, the debate “emphasized that the committee should be prepared to vary the pace of asset purchases, either in response to changes in the economic outlook or as its evaluation of the efficacy and costs of such purchases evolved.”

The minutes of the FOMC meeting states: “Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound. Others pointed to offsetting factors, and one noted that losses would not impede the effective operation of monetary policy.”

The Fed  at its January meeting decided to continue buying $45 billion a month of Treasuries and $40 billion in mortgage- debt without setting a limit on the duration or total size of the purchases. Policy makers also affirmed their pledge to keep the target interest rate near zero “at least as long” as unemployment remains above 6.5 percent and inflation is projected to be no more than 2.5 percent. And the Fed's balance sheet has grown to more than $3 trillion and will likely grow by another $1 trillion this year, and the policymakers are getting nervous; maybe not so nervous, just prudently checking to make sure they're not painting themselves into a corner.

The bond market might already be influencing Fed confidence; there is a fairly significant pattern of reaching for yield behavior emerging in corporate credit. One concern is that the Fed might trigger instability in the financial markets when it starts selling bonds. As long as the Fed continues their QE to infinity and beyond, bond-buying program, the equity markets feel like they have a bid underneath it, a safety net. And the Fed isn't going to pull the safety net in the face of sequester and a possible debt ceiling shutdown. It would be good to see a stimulus plan that does more for Main Street than Wall Street, but that is not what the Fed does. A new report shows the bankers are flush with cash and unwilling to lend it out. The biggest banks are lending the smallest portion of their deposits in five years. The average loan-to-deposit ratio for the top eight commercial banks fell to 84% in the fourth quarter from 87% a year earlier.  Putting more of the unused money to work could boost profit and help turn around the economy, but the banks are stuck, kind of like the Fed itself.

And the latest inflation report will do nothing to alter the Fed's stimulus plans. The Labor Department reports inflation on the wholesale level is tame; over the past 12 months the increase in producer prices is just 1.4%, barely changed from the prior month. A couple of interesting points: Energy prices fell a seasonally adjusted 0.4%, but the index failed to capture the surge in gasoline costs that started shortly after the new year began. Higher fuel costs are expected to show up in the February PPI report. Also, the cost of food increased 0.7%. Cold weather in the West was the blame. Vegetable prices were up 39%.

And that brings us to the curious case of Vernon Bowman, a 75 year old farmer in Indiana. A few years back, Vernon bought some soybean seeds; as far as he knew they were just soybean seeds; he planted the seeds, and then saved seeds from the resulting harvest, which he planted, grew, and harvested yet again. Vernon did this for about 3 years. It sounds like the very definition of farming. Monsanto calls it patent infringement. They sued Vernon. A federal judge ordered Vernon to pay $84,000, and an appeals court upheld the decision. Yesterday, Vernon went before the Supreme Court to argue that he had a right to replicate the seeds.

At issue is whether patent rights extend to seeds and other entities that can "replicate themselves beyond the first generation.” The justices realize that the case is bigger than that. The Software Industry lobbying group weighed in on the case of Bowman v. Monsanto. A legal rule eliminating patent protection for 'self-replicating' seeds that had the same result with respect to temporary copies of software programs would facilitate software piracy on a broad scale. But there is a difference between seeds and software, and the most basic question is whether anyone, or any corporation should be able to control a product of life.

For most of this country's history, and for most of all history, seeds have been a part of the public domain - available for farmers to exchange, save, and modify through plant breeding and replanting. Through this process, farmers developed a diverse array of plants that could thrive in various geographies, soils, climates and ecosystems. But today this history of seeds is seemingly forgotten in light of a patent system that, since the mid-1980s, has allowed corporations to own products of life.

One of Monsanto's arguments is that when farmers save seed from a crop grown from patented seed and then use that seed for another crop, they are illegally replicating, or "making," Monsanto's proprietary seeds instead of legally "using” the seeds by planting them one time, and then buying more seeds from Monsanto for each subsequent crop. Farmers who buy the seeds must generally sign a contract promising not to save seeds from the resulting crop. Vern Bowman thought he found a loophole when he bought undifferentiated seeds.

The reach of Monsanto’s theory, is that once that seed is sold, even though title has passed to the farmer, and the farmer assumes all risks associated with farming, that they can still control the ownership of that seed, control how that seed is used.

What makes these seeds different? They are known as Roundup ready seeds; they are resistant to glyphosate, the weed killing ingredient in Roundup herbicide spray. The Roundup Ready soybean seed is now grown by more than 90 percent of the 275,000 soybean farms in the US. There is an old saying: Mother Nature bats last.

One of the interesting side effects, which the Supreme Court will probably not pay attention to, is the side effects of Roundup Ready soybeans. Last month, Farm Industry News reported that more than 61 million acres of US cropland is infested with glyphosate resistant weeds; Super weeds that no longer can be sprayed away with Roundup. In response, farmers resort to more soil-eroding tillage operations to combat the weeds, and they turn to more toxic chemicals. Based on data from the USDA, as much as 26% more pesticides per acre were used on genetically engineered crops than on conventional crops. The agrochemical companies are responding with even more chemicals, while accepting none of the liabilities.

The farmers don't have much choice. Ten agrochemical companies now control two-thirds of global commercial seed for major crops. The high adoption rate of genetically engineered seed is largely because the companies have stopped offering conventional seed. Over an 11-year period, the cost per acre of planting soybeans has risen a dramatic 325%. At a certain point, farmers will recognize the economic advantage of avoiding genetically modified seeds, but by then, the GM seeds will be ubiquitous.

So, the case of Bowman v. Monsanto went before the Supreme Court, and the justices will issue an opinion later this year, and that opinion will likely set precedent for patent law. I have no idea what they will decide. Farmer Bowman's lawyers argued a point known as the exhaustion doctrine, or first sale doctrine; this is a concept that limits the extent to which patent holders can control an individual article of a patented product after an authorized sale. Under the doctrine, once an unrestricted, authorized sale of a patented article occurs, the patent holder’s exclusive rights to control the use and sale of that article are exhausted, and the purchaser is free to use or resell that article without further restraint from patent law. Note, however, that under current law, the patent owner retains the right to exclude purchasers of the articles from making the patented invention anew, unless it is specifically authorized by the patentee.

The exhaustion doctrine was always limited to the particular article sold, a new crop of soybeans, three or four crops removed might be considered an entirely new article. Justice Breyer made a reference to a 1927 opinion by Justice Oliver Wendell holmes, in which Holmes sought to justify the forced sterilization of a woman with mental disabilities. “Three generations of imbeciles are enough,” Justice Holmes wrote.

Justice Breyer said: “There are three generations of seeds. Maybe three generations of seeds is enough.” Breyer was, of course making a lawyerly joke, but it brings up the question: what's next? Can a corporation control the entire food chain? Can we have patents on human genes? What is the appropriate role of ownership and control over the very elements of life?

I'll be speaking at the Wealth Protection Conference April 4. Click here for info.

Tuesday, February 19, 2013 - Never more

Nevermore 

by Sinclair Noe

DOW + 53 = 14,035
SPX + 11 = 1530
NAS + 21 = 3213
10 YR YLD +.02 = 2.03%
OIL + .70 = 97.11
GOLD – 5.20 = 1605.60
SILV - .54 = 29.54

So, stocks have been moving higher, up for 7 weeks; the S&P 500 index is at a five year high. Every story I read talks about optimism in the markets. What that really means is that we're almost back to where we were in October 2007. Five years of risk and heartburn and having money tied up, and we're back where we were. WooHooo!

There's merger fever in the air. Last week we heard the announcements on USAirways and American Airlines, plus Berkshire Hathaway and 3 Brazilians buying an enormous quantity of ketchup. This week, the rumor du jour is Office Depot merging with Office Max. And when the M&A fever subsides, there is the stock buyback fever, the anti-dilution thrill that comes from watching corporate management buy high.

Of the 391 companies in the S&P 500 that have reported fourth quarter earnings results, 70.1 percent have exceeded analysts' expectations, compared with a 62 percent average since 1994 and 65 percent over the past four quarters. Fourth-quarter earnings for S&P 500 companies have risen 5.6 percent.

Of course, there is an ominous feel to this market rally, like a nasty black raven over the gate screeching out “Nevermore.” And this coincides with the impending sequester, which Congress will deal with, using all their energy and diligence, next week, after they get back from vacation. The purpose of the sequester was to threaten something so unthinkable that the two parties would come together to agree on an alternative, but the only thing they can agree on is vacation time. President Obama returned for a three-day golf holiday in Florida and he used the bully pulpit this morning to take a few jabs at the legislative branch in a White House auditorium surrounded by blue-uniformed emergency responders to illustrate some of the jobs threatened if the cuts were to take effect; Mr. Obama warned that military readiness and vital domestic services would be hurt “if Congress allows this meat-cleaver approach to take place.”

President Obama went on to say: “These cuts are not smart, they are not fair, they will hurt our economy, they will add hundreds of thousands of Americans to the unemployment rolls. This is not an abstraction — people will lose their jobs.”

President Obama tried to call the Republicans’ bluff in his State of the Union Address. “Deficit reduction alone is not an economic plan,” the president said. He didn’t come out against deficit reduction. He said it should not be given a higher priority than economic growth. There are many reasons why it is important to reduce the national debt. Short-term economic growth is not one of them.

The best chance of avoiding the sequester appears to be a miniature, watered down bill that might kick the can. Meaningful legislation by the deadline appears hopeless. And it is not good for the economy. It would hurt. It would slow growth. The market might look askance, right as we bump up on resistance. Funny how that times out.

Alan Simpson and Erskine Bowles, the Washington budget sages behind the ubiquitous Simpson-Bowles plan, have released a new version of their old plan to cut the federal deficit by trillions of dollars. The plan includes cuts to Medicare and Medicaid, “reforms” to Social Security, chained CPI, and the elimination or reduction of various tax deductions. Notably, many of the most significant cuts seem to fall on programs which benefit seniors. In the report, Simpson and Bowles argue that “the aging of the population represents a significant driver of our growing debt.”

All told, the new Simpson-Bowles plan is distinguishable from the old Simpson-Bowles plan largely by the fact that it sets a higher benchmark for how many cuts are needed.

The new $2.4 trillion figure seems to come from a recent report by the Committee for a Responsible Budget, the umbrella organization for Simpson and Bowles’ pro-cuts lobbying group, Fix the Debt, which is comprised of large corporations that want to Fix the Debt by having someone else pay, but still retaining their corporate loopholes. In the report, the Committee for a Responsible Budget calls cutting only an additional $1.5 trillion “dangerous,” because “it would leave no margin for error, would result in slower economic growth, would leave little fiscal flexibility, and would have little chance of stabilizing the debt beyond the ten-year window.”

“For these reasons,” the report goes on, “we believe the debt must be not only stable, but on a clear downward path by the end of the decade.”

The nation’s economy shrank in the last quarter of 2012. Economists attribute it to cutbacks in defense spending in anticipation of the sequester. More cutbacks will give us exactly what the country doesn’t need right now — austerity. Of course, we dealt with a fiscal cliff to start the year, and all that uncertainty amounted to nothing more than a can of beans. The markets seemed to love it. More precisely, the Federal Reserve was so worried about the fallout that they juiced the markets, and pushed us to an outstanding January. This is apparently the third mandate: jobs, inflation, juiced equities. They're batting .333, which is great for baseball; lousy for economics.

How long can the Fed keep the markets happy in the face of zany politicians? Longer than you might guess. Tomorrow, we'll hear the Fed's minutes from the last FOMC meeting, but don't expect any revelations. One possible topic that might have been discussed: backlash from paying billions of dollars to commercial banks when the time comes to raise interest rates. The growth of the Fed's balance sheet means it could pay $50 to $75 billion a year in interest on bank reserves at the same time it makes losses and has to stop sending money to the Treasury. Yep, that will be a topic for the FOMC.., someday.

(Wolf Richter had this on the latest corporate welfare queen) The sequester is scheduled to kick in on March 1. An artificially constructed national disaster, it would threaten everything from national security to preschool programs for low-income kids. It would cause hundreds of thousands of jobs to evaporate, or whatever. So, as the drama with all its lurid theatrics was playing out in Washington, Facebook filed its first 10-K annual report with the SEC, containing its financial statements for 2012 along with a host of small-print footnotes which presumably no one would ever look at. But the recalcitrant nonpartisan research and advocacy group, Citizens for Tax Justice, took a look anyway.

And it found “an amazing admission”: despite $1.1 billion in pre-tax profits from its US operations in 2012, Facebook didn’t pay any federal or state income taxes in the US—in fact it will collect net tax refunds totaling $429 million.  Facebook is relying on a single tax break in our glorious corporate tax-dodge code to obtain its negative tax rate: the deductibility of executive and employee stock options. It cut Facebook’s federal and state income taxes by $1.03 billion last year—but that was just part of it. As Facebook said in its footnote under “Share-based Compensation,” on page 68 of the 10-K: “during the years ended December 31, 2012, 2011, and 2010, we realized tax benefits from share-based award activity of $1.03 billion, $433 million, and $115 million respectively.”

Another $2.17 billion of this US tax break is carried forward. To rub it in, COO Sheryl Sandberg giddily pointed out during the earnings call that the company “ended the year with a total of $5.8 billion in NOL, net operating loss, tax loss carry forwards created by stock compensation”—to be used in future years.

Given Facebook’s anemic “profits” in the US, it’s unlikely that it will have to pay federal or state income taxes anytime soon. Instead, taxpayers will have to continue showering tax refunds on what has become the cutest, coolest welfare queen of them all.

On its financial statements, Facebook claimed that it had a federal tax liability in 2012 of $559 million, that it would somehow pay $559 million in taxes in the coming year. But the number was wiped out by its infamous footnote on page 68 of the 10-K. And suddenly, that “federal tax liability” of $559 million had, like so many things on financial statements, no graspable relationship to reality.

Unknown hackers infected the computers of some Apple workers when they visited a website for software developers that had been infected with malicious software. The malware had been designed to attack Mac computers. The same software, which infected Macs by exploiting a flaw in a version of Oracle Corp's Java software used as a plug-in on Web browsers, was used to launch attacks against Facebook, which the social network disclosed on Friday. Twitter, which disclosed that it had been breached February 1 and that hackers might gave accessed some information on about 250,000 users, was hit in the same campaign. It's possible that hundreds of companies, including defense contractors, had been infected with the same malicious software. This is apparently different than the Chinese hacking attacks. Today, a security company issued a detailed report that places the Chinese hacks at the very doorstep of the Chinese military.

If you've been behind the wheel recently, you already know gasoline prices are up. The national average price for regular gas rose to nearly $3.75 a gallon. Retail prices have gone up for each of the last 33 or so days.  prices rise near the end of winter every year. As refineries switch to summer blends to reduce smog, they shut down units and work on maintenance. Traders worry there won't be enough supply, so they start bidding up prices. This time around it's happening a few weeks earlier than typical. One reason is refiners are catching up on maintenance and repair work they weren't able to do late last year because Hurricane Sandy.

Friday, 15 February, 2013 - February 15th - An Historic Date

February 15th - An Historic Date

by Sinclair Noe

DOW + 8 = 13,981
SPX- 1 = 1519
NAS – 6 = 3192
10 YR YLD +.01 = 2.01%
OIL – 1.23 = 96.08
GOLD – 24.30 = 1611.10
SILV - .60 = 29.90

Today marks the 10^th Anniversary of the largest single coordinated protest in history. Roughly ten to fifteen million people (estimates vary widely) assembled and marched in more than six hundred cities: as many as three million flooded the streets of Rome; more than a million massed in London and Barcelona; an estimated 200,000 rallied in San Francisco and New York. From Auckland to Vancouver to the streets of New York and Los Angeles—and everywhere in between—tens of thousands came out, joining their voices in one simple, global message: No to the Iraq War.

And there it was. We failed. Slightly more than a month later, the U.S. was shocking and awing its way through Iraqi cities and Saddam Hussein’s defenses and bedding in—though it didn’t know it yet—for a near decade-long occupation. The protests, which by any measure were a world historic event, were brushed aside. The UN Security Council was bypassed. Congress rubber stamped the war. The media was little more than a puppet. The U.S. spent nearly a trillion dollars on a pre-emptive war that didn’t need to happen and a nation-building exercise that has achieved only fragile, uncertain gains. Far from a “Mission Accomplished,” the American adventure in Iraq has become a cautionary tale of hubris and poor planning.

February 15^th was a global day of protest; the biggest ever.

For the week, both the Dow and Nasdaq fell 0.1 percent while the S&P rose 0.1 percent in its seventh straight week of gains, a period during which the index rose 8.4 percent. The last such seven-week run was between December 2010 and January 2011.

Wall Street dealmakers are off to a busy start to 2013, as some of corporate America’s most recognizable names have become involved in multi-billion-dollar mergers and acquisitions. Check this article from Christopher Matthews: Just yesterday, American Airlines and US Airways announced they would be merging in an $11 billion deal, to form the world's largest inconvenience, or airline.

Private equity firm 3G and Warren Buffett‘s Berkshire Hathaway announced a $28 billion joint acquisition of  food conglomerate H.G. Heinz. That private euqity firm is from Brazil. American private equity firms look for something much sexier than ketchup. The Brazilians are looking for profit.

And these two deals follow hard upon $24.4 billion leveraged buyout of Dell by private equity firm Silver Lake Partners and the firm’s founder, Michael Dell.

US companies have spent $219 billion on mergers and acquisitions so far in 2013, a sharp increase from 2012, when firms spent just $85 billion during the same period. And US firms are on pace to have the biggest year in M&A activity since 2000.

While all this activity will be surely benefit shareholders of acquired firms — as well as lots of Wall Street investment bankers — what does it say about the health of the economy? Since the late 19th century, mergers and acquisitions have tended to come in waves, spurred by the availability of credit, changes in government policy, or bursts of private-sector innovation. Deregulation, for instance, motivated a wave of mergers in the airline industry in the 1970s and the consolidation of the banking industry in the 1990s. But perhaps the most important factor in motivating these bursts of M&A is economic conditions, particularly the strength of the stock market. Mergers in particular are often financed with stock, and high stock values give companies the resources with which to make purchases.

But the stock market has been doing pretty well for a few years now, with the S&P 500 up more than 138% since its bear-market lows of 2009. So why are we only now seeing the first glimmer of an M&A boom?

Surely one reason is that today’s market is heavily fortified by quantitative easing. The Federal Reserve has taken unprecedented action to keep interest rates low in both the short and long term, and those efforts have kept stock prices high despite the weak economy. In other words, given central bank stimulus, a rising stock market isn’t quite the indicator it used to be. We can see this in GDP growth figures as well.

In addition to predicting M&A activity, the stock market is also considered a leading indicator of economic growth, meaning increases in GDP generally follow bull markets.  This is because stock prices reflect investors expectations for a company’s future income. A high stock price today represents investors’ belief in big profits tomorrow. Taken in the aggregate, a surging stock market index is a predictor of increases in GDP down the line.

But, just as we’ve seen the link between rising stock prices and M&A severed, the huge gains we’ve seen in stock prices since 2009 have also not been followed by robust economic growth. Again, this is probably because Fed action has done more to promote stock price increases than economic fundamentals. But this is exactly why we should be encouraged by this fast start to M&A activity in 2013, especially if it keeps up in the coming months. It may mean that recent stock market gains are once again reflecting confidence about future profits, and not just central bank stimulus.

What makes this plausible is the fact management won’t seek out — and boards won’t sanction — expensive acquisitions if they’re not confident about future growth. And given the fact that corporate profits have been strong while unemployment remains high and wage growth stagnant means the corporate sector will eventually have to start spending if economy is to recover fully.

So while high profile M&A deals are often times more about CEO empire building than creating real shareholder value, this boom may be a positive sign for the economy nonetheless. It may finally be that rising stock prices are actually telling us something about the real economy around us — and perhaps more important, that corporate leaders are finally feeling frisky once again.

The Group of 20 is meeting this weekend and they are acting like they won't throw Japan under the bus; in other words, they say they won't target Japan over policies that have weakened the yen. The yen initially fell on a draft communique prepared for G20 leaders at their meeting in Moscow. The draft omits part of this week's Group of Seven statement declaring fiscal and monetary policy may only be used for domestic economic aims. The yen has reversed early gains and is now the weakest major currency on reports the language of the G20 statement may differ from that of the G7 countries. The G20 is expected to urge members to avoid competitive devaluation, but not echo the G7 view that exchange rates should not be a target of policy. That's a new phrase: “competitive devaluation”.

Federal Reserve Chairman Ben Bernanke said the United States is acting in line with the position of the G7 nations by using domestic policy tools to boost growth and reduce unemployment.

A new study published by the Government Accountability Office says the 2008 financial crisis cost the US economy more than $22 trillion. The GAO report says: "The 2007-2009 financial crisis, like past financial crises, was associated with not only a steep decline in output but also the most severe economic downturn since the Great Depression of the 1930s." The agency said the financial crisis toll on economic output may be as much as $13 trillion -- an entire year's gross domestic product. The office said paper wealth lost by homeowners totaled $9.1 billion. Additionally, the GAO noted, economic losses associated with increased mortgage foreclosures and higher unemployment since 2008 need to be considered as additional costs.

The GAO report concludes that an ounce of prevention is worth a pound of cure: "If the cost of a future crisis is expected to be in the trillions of dollars, then the act likely would need to reduce the probability of a future financial crisis by only a small percent for its expected benefit to equal the act’s expected cost."

In other words, Wall Street and its many allies and lobbysists have been complaining about the cost of regulation and reform but they never mention that it was Wall Street’s reckless investments and trading that caused the biggest financial collapse since the Great Crash of 1929 or the trillions of dollars in costs they inflicted on our country. That economic wreckage can still be seen from coast to coast in unemployment, foreclosed and underwater homes, lost retirements and educations and so much more.

Another quarter of data shows that the austerity solution has not been working in Europe. A deepening recession in the 17-nation eurozone revealed evidence that the problems of the single currency’s crisis-hit periphery were spreading northwards to affect monetary union’s core economies of Germany and France.

Despite an easing of financial tensions in the second half of the year, gross domestic product in the members of the monetary union dropped by 0.6% in the final three months of 2012, a heftier decline than the markets had been expecting. The US grew by 2.2% in 2012 and Japan by 1.9%, while GDP in the eurozone contracted by 0.5%.

The Treasury Department said Friday that foreign holdings of U.S. Treasurys rose 0.3 percent in December from November to $5.56 trillion. It was the 12th consecutive monthly gain. China, the top foreign holder, increased its holdings 1.7 percent to $1.2 trillion. Japan, the second largest holder, boosted its investment 0.2 percent to $1.12 trillion.

Demand kept rising in December even as Congress approached a deadline to raise the government's $16.4 trillion borrowing limit. In January, Congress approved a measure to temporarily suspend the borrowing limit until May 19. That has allowed the government to take on more debt while the debate continues.

 Remember how Congress managed to delay the fiscal-cliff and debt-ceiling fights? That's right, they kicked the can down the road. What's left of that mess, a big round of spending cuts called "sequestration," takes effect on March 1 and will shave about $85 billion from government spending this year, with more to come in the years ahead. And it is almost universally agreed that sequestration would hurt the economy if it happens; it would nip potential growth in the bud; just nip it. And the economy is, how do you say, not so good! In fact, it shrank in the fourth quarter of 2012.

When the going gets tough, the wimps leave town. Congress has recessed, and the recess is scheduled to end with four full days to fix the sequestration problem. They couldn't fix it in two years, but they have four days to clean it up after their vacation. A new survey indicates that 94% of Americans have no problem with Congress taking a vacation right now, as long as they all take a vacation together on a Carnival Cruise.

Thursday, February 14, 2014 - Helicopter Money

Helicopter Money

by Sinclair Noe

DOW – 9 = 13,973
SPX + 0.98 = 1521
NAS + 1 = 3198
10 YR YLD - .03 = 1.99%
OIL + .36 = 97.37
GOLD – 7.20 = 1636.40
SILV - . 33 = 30.55

A reminder I will be speaking at the 2013 Wealth Protection Conference April 5th. To register or for more information, please visit: www.buysilvernow.com

or click here.

Happy Valentine's Day.

The G-20 meets this weekend. Currency devaluation will be a major topic. There is a race to devalue currencies, with the payoff being more exports for the winning or losing country. The winner in the race to the bottom looks to be the UK; over the past five years, the pound sterling is the weakest major currency. London's role as a financial center made in vulnerable to the banking problems, and then the government imposed austerity measures, making a bad situation far worse. Since the end of last year the pound has weakened dramatically against all other major currencies, apart from the yen. The British and Japanese currencies seem to be falling for similar reasons. Those countries’ economies have experienced almost no growth since 2009, and their governments are becoming increasingly desperate to end this long-term stagnation.

This past week, saw some important speeches that were largely overshadowed here in the US by the State of the Union address. The Bank of Japan's Shinzo Abe announced monetary expansion should directly finance record breaking public investment programs. The other big speech came from Adair Turner, chairman of Britain's Financial Services Authority; and this speech is now being called the “helicopter money” speech. Ellen Brown has done an excellent analysis of Turner's speech and I have a link at my blog. Turner's idea of helicopter money is a bit different than Ben Bernanke's. Although both involve throwing bags of money out of helicopters, Bernanke's chopper never hovered anywhere except directly over Wall Street.

Turner's recommendation was supported by a 75-page paper explaining why handing out newly created money to citizens and governments could solve economic woes globally and would not lead to hyperinflation. Government-issued money would work because it addresses the problem at its source. Today, we have no permanent money supply. People and governments are drowning in debt because our money comes into existence only as a debt to banks at interest. We are completely dependent on the banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money, we are prosperous; if not, we starve.

In the US monetary system, the only money that is not borrowed from banks is the “base money” or “monetary base” created by the Treasury and the Fed. The Treasury creates only the tiny portion consisting of coins. All of the rest is created by the Fed.

Most of the money the Fed creates is electronic rather than paper. We the people have no access to this money, which is not turned over to the government or the people but goes directly into the reserve accounts of private banks at the Fed.

It goes there and it stays there. Except for the small amount of “vault cash” available for withdrawal from commercial banks, bank reserves do not leave the doors of the central bank. In a modern monetary system there is absolutely no correlation between bank reserves and lending. Banks do not lend “reserves”. Whether commercial banks let the reserves they have acquired through QE sit “idle” or lend them out in the internet bank market 10,000 times in one day among themselves, the aggregate reserves at the central bank at the end of that day will be the same.

Banks do not lend their reserves to us, but they do lend them to each other. The reserves are what they need to clear checks between banks. Reserves move from one reserve account to another; but the total money in bank reserve accounts remains unchanged, unless the Fed itself issues new money or extinguishes it.

The base money to which we have no access includes that created on a computer screen through “quantitative easing” (QE), which now exceeds $3 trillion. That explains why QE has not driven the economy into hyperinflation, as the deficit hawks have long predicted; and why it has not created jobs, as was its purported mission. The Fed’s QE money simply does not get into the circulating money supply at all.

What we the people have in our bank accounts is a mere reflection of the base money that is the exclusive domain of the bankers’ club. Banks borrow from the Fed and each other at near-zero rates, then lend this money to us at 4% or 8% or 30%, depending on what the market will bear. Like in a house of mirrors, the Fed’s “base money” gets multiplied over and over whenever “bank credit” is deposited and relent; and that illusory house of mirrors is what we call our money supply.

The only thing quantitative easing is doing is to help banks increase the liquidity of their portfolios by getting rid of longer-dated and slightly less liquid assets and raising cash. Turner's helicopter money idea apparently involves credit creation by the central bank for productive purposes in the real, physical economy. It would involve the government printing money, much like the colonial scrip in pre-Revolutionary War America or the “greenbacks" of Abraham Lincoln's time.

The threat of price inflation is the excuse invariably used for discouraging this sort of “irresponsible” monetary policy today. The inflationistas argue that when the quantity of money goes up, more money will be chasing fewer goods, driving prices up.

What this theory overlooks is the supply side of the equation. As long as workers are sitting idle and materials are available, increased “demand” will put workers to work creating more “supply.” Supply will rise along with demand, and prices will remain stable.

True, today these additional workers might be in China or they might be robots. But the principle still holds: if we want the increased supply necessary to satisfy the needs of the people and the economy, more money must first be injected into the economy. Demand drives supply. People must have money in their pockets before they can shop, stimulating increased production. Production doesn’t need as many human workers as it once did. To get enough money in the economy to drive the needed supply, it might be time to issue a national dividend divided equally among the people.

Increased demand will drive up prices only when the economy hits full productive capacity. It is at that point, and not before, that taxes may need to be levied—not to fund the federal budget, but to prevent “overheating” and keep prices stable. Overheating in the current economy could be a long-time coming, however, since according to the Fed’s figures, $4 trillion needs to be added into the money supply just to get it back to where it was in 2008.

The Federal Reserve has lavished over $13 trillion in computer-generated bail-out money on the banks, and still the economy is flagging and the debt ceiling refuses to go away. If this money had been pumped into the real economy instead of into the black hole of the private banking system, we might have a thriving economy today.

Would Turner's helicopter money scheme work? It already has – in Iceland. Iceland was a failed financial system, and after they failed they started fresh. They introduced currency controls. Thye let their banks fail. They provided support for their poor. They did not introduce austerity measures. Four years later, Iceland is enjoying recovery and prosperity. Iceland's president summed it up nicely: “ Why do we consider the banks to be the holy churches of the modern economy? The theory that you have to bail out banks is a theory about bankers enjoying for their own profit the success and then letting ordinary people bear the failure through taxes and austerity, and people in enlightened democracies are not going to accept that in the long run.”

Maybe Turner's speech is the “emperor's new clothes moment, where people realize the financial rulers are suffering from a delusion that doesn't have to be humored. Turner argues that a virtually surefire method of stimulating economic activity exists today and that politicians and central bankers can no longer treat it as taboo: Newly created money should be handed out to the citizens or governments of countries that are mired in stagnation and such monetary financing of tax cuts or government spending should continue until economic activity revives. The idea that the government can't provide enough money to keep the economy humming along on the road to prosperity is as absurd as the idea that a carpenter doesn't have enough inches to build a house.

We need a permanent money supply, and the money must come from somewhere. It is the right and duty of government to provide a money supply that is adequate and sustainable. It is also the duty of government to provide the public services necessary for a secure and prosperous life for its people. As Thomas Edison observed in the 1920s, if the government can issue a dollar bond, it can issue a dollar bill. Both are backed by "the full faith and credit of the United States." The government can pay for all the services its people need and eliminate budget crises permanently, simply by issuing the dollars to pay for them, debt-free and interest-free.