Quantitative Easing (QE) 2.0 Will Happen

According to the NY Times, since the summer, Fed officials have grown increasingly worried that the United States could slip into deflation, a decrease in prices of the kind that has bedeviled Japan since the late 1990s. The Federal Reserve has been talking about printing more money (QE) to battle "deflation". The claim of deflation is a bunch of propaganda. The stock market, food and energy, and commodities markets are all showing the inflation of QE round one.

QE 2.0 will happen, the question is when and at what cost? Maybe the Federal Reserve is waiting for a stock market crash, to start printing money. Maybe they are waiting for some strength in the US dollar, before devaluing it some more. Maybe they are waiting for a certain yield in the long and/or short term treasuries before they act. Maybe they are waiting for all asset classes to drop sharply, like what happened in 2008. Maybe they have a set date regardless of market conditions, who knows?

There are many possibilities, but one thing is for certain. There will be a QE 2.0, and as a result there will be additional inflation, and there will be lower interest rates.

Inflation Crash Course by Dr. Martenson

History Lesson from Niall Ferguson

A couple of months ago, Niall Ferguson was asked to speak at the Ninth Annual Niarchos Lecture. Niall Ferguson is a famous historian from Harvard. He has written many books like the following: The Cash Nexus, War of the World, and The Ascent of Money: A Financial History of the World. When he speaks people listen; here are some of the points of interest from his speech (most bullet points taken directly word-for-word from Niall himself):

• There is a suddenness to things when they go wrong in finance
• Canada is one country that is NOT involved with the extraordinary debt increase that most of the rest of the world is experiencing
• Crises of either war or internal politics (sometimes both), drove investors to sell bonds and therefore to drive up the yields on the bonds
• Exploding deficits to pay for the war and surging public debts caused an increase in risk in the eyes of investors
• It is striking the way in which very suddenly confidence can be lost in a country
• Ken Rogoff made the point that 90% debt-to-GDP is the threshold after which public debt tends to be associated with problems of low growth or high inflation, usually both (currently we are at 89% debt-to-GDP)
  
• Italy is much less vulnerable than Greece in the respect that most Italian debt, like most Japanese debt, is held by natives; it's not actually held by foreigners
• In the months ahead, look for debt default synonyms like repudiation, standstill, moratorium, restructuring, rescheduling, etc...Don't be fooled by the language, it still equates to debt default
  
• US treasuries are a safe haven the way Pearl Harbor was a safe haven in 1941; safe but not for much longer
• Favorite cartoon: Chinese sub threatens the US Navy. The Chinese submarine captain is says, "Turn around or we sell all our T-bills!"
• When you're spending more on your debt than on your army or your navy, it's all over as a great power
• It's not a thousand years that separates imperial zenith from imperial oblivion. It's really a very, very short ride from the top to the bottom
  

Economic Indicators

Let's review some important economic indicators, think about some questions, and draw some conclusions. Starting with Real GDP:

Number 1:

Real GDP = C + I + G + (Ex - Im) (Inflation adjusted)
where C = consumer spending - Think consumers are spending?
I = private investment - Think money is being pumped into businesses?
G = government spending - Think the government has blown all the money yet?
Ex = exports - Think we produce much in this country anymore?
Im = imports - Think we buy more US made than Chinese made products?

1st quarter of 2010 Real GDP: 2.7%
4th quarter of 2009 Real GDP: 5.6%
(source: bea.gov)

The Real GDP shows the effects of government stimulus running out. The last time we saw a nearly 3% drop in Real GDP was from the 3rd to 4th quarter of 2008.

Number 2:

M2 - aggregate of money supply in circulation.

June 2010 M2: 8,611 (in billions)
(source: federalreserve.org)

Fed Reserve uses this to determine whether to raise or lower interest rates thereby contracting or expanding the money supply. The more you have of something the less it is worth. A good analogy for those sports card collectors out there is when you open a pack of baseball cards the cards that are most abundant are worth the least (a.k.a. the commons). This is the highest M2 has been in two years, which means that higher interest rates could be coming soon.

Number 3:

Consumer confidence survey - economic sentiment of 5,000 random people
Consumer confidence index - based upon the numbers from the survey

June 2010 Consumer Confidence Index: 52.9
May 2010 Consumer Confidence Index: 62.7
(source: conference-board.org)

The consumer confidence index is used loosely to determine what consumers think of the economy. A higher number means consumers are optimistic, and that they tend to spend more.

Number 4:

Housing starts - indicates housing construction activity on building new homes/buildings, and modifying existing homes/buildings

May 2010 Housing Starts: -10%
April 2010 Housing Starts: 3.9%
(source: census.gov)

Housing starts are a large part of our GDP (about 5%). This indicator is historically volatile, but over the course of six months solid trends can be formed.

Number 5:

S&P 500 index - 500 stocks from a broad selection of industries that gives us a good indication of our economy's overall health

July 16, 2010 S&P 500 Index - 1065 points (downtrend forming)
Mar 6, 2009 S&P 500 Index - 683 points
(source: finance.google.com)

One of the best indicators of the overall economy's current health. The index is off 200 points in about 3 months. All the news about the economy's performance in all sectors and industries is factored into the price.

What are Your Conclusions?:

• What do you make of these indicators?
  
• Where do you see the economy going in the second half of 2010, if there is government stimulus, and if there is not government stimulus? (Two very different outcomes!)
• How can be bring the manufacturing base back to this country?

Union Bailouts?

President Obama is asking for $50 billion dollars worth of emergency aid for the State and local governments. For more info on this act of desperation, click the link Obama Pleads for $50 billion. According to President Obama, "the money would avoid massive layoffs of teachers, police, and firefighters". It does NOT fix anything, but rather kicks the can down the road for the next politician to deal with.

This bailout is clearly for unions, as they are not willing to accept concessions. There was a rally of Union employees recently where their chant was "raise our taxes". Here is a link to the video: Union Employees' Want Higher Taxes. You have to read the top comments associated with the video...

We cannot bailout the unions because that will NOT solve the underlying issues. The issues are as follows: union pay (far above private companies), union benefits, and of course pensions. The process will be difficult, but the sooner we fix the underlying issues the sooner we can be on the road to recovery. Regardless what the mainstream media tells you, we are clearly not in "recovery" just take a look at the foreclosure numbers (among many other economic metrics).

Preserve Your Wealth

Cash won't be King; buy and hold real assets like commodities, real estate, raw land, etc... In the near future (three years maybe sooner), you will be much more worried about preserving your wealth than making a huge profit. Here are some reasons why I think this way:

1. U.S. government expanded money supply from 500 billion in late 1990s to over 2 trillion in 2010
   
2. Warren Buffett stated “Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.”
3. $45,000 today has the same purchasing power of $5,000 in 1950
4. $5,000 held from 1913 is worth about 5 cents today
5. US debt hits a record of 13 trillion
   

US Treasury Market Looking Shaky

Take a look at the numbers below of a fairly recent 30 year US government bond auction, things are not looking good.

(Source: SeekingAlpha.com)

Out of the highlighted numbers two of them are particularly horrible; the Bid to Cover and Indirect. The bid to cover is calculated by taking the number of bids received divided by the number of bids accepted. Essentially the higher the bid to cover the higher the demand. In the bond auction community, a bid to cover of 2.0 or less is considered an auction failure, and we came very close to that.

Soft demand in a low bid to cover ratio is verified, as foreign demand for treasuries is falling. China recently sold about $35 billion worth of their treasuries, and Japan sold about $10 billion worth of their treasuries. Also, Dec 2009 was the worst sell off on record. Interest rates could be increasing in the near future at the worst possible time for the US because of the sheer amount of debt to be auctioned in the near term future.

Then the indirect number is high. An indirect bid is a bond bid that does not go through a dealer, and this is generally viewed as quantitative easing because there is no transparency in who is bidding. Nearly 30% of the winning bids came from indirect bidders. In the bond market community this is seen as the US govt purchasing more of their own debt with the intention of selling at a later time when demand is stronger.

Bond market is currently leaning more towards inflation instead of deflation. This could be largely because of the long term weakness in the US dollar. A good indication of confidence in the US dollar is shown in the price of the treasuries. If the chart was extrapolated five years in the past we would see that the current price level is what the price was in 2002.
(Source: Google Finance TLT quote)

Conclusions:
1. This decade we should see some serious inflation
2. Interest rates must rise to entice foreign buyers to take on the risk
3. This decade is going to be a horrible one for the US dollar's purchasing power; hyperinflation is probable
4. Quantitative easing will not slow down, but rather accelerate as demand lessens over time

Casino Bet With Odds In Your Favor

The money making trade (in the short term 3 - 6 months) with the odds in your favor is shorting the stock market, and profiting from the decline that could be heading our way at the end of this year and into 2010.

Why would this be a good trade? Below are my top 3 reasons.

Reason #1:

Based on the last ten years, the "January Effect" has led to stock declines nine out of the last ten years. Much selling occurs in the final week of December and into the month of January. All this selling, causes stock prices to pull back a bit. Below is a chart to illustrate the January Effect over the past decade.


Reason #2:

As of late there has been a strong inverse correlation between the dollar and the stock market. If the dollar increases in value the stock market decreases and vice-versa. As such, the dollar has been losing much value as of late, and a short term dollar rally might be in the cards.


Reason #3:

The appetite for risk is going to lessen because of what is happening around the world. There is Dubai defaulting on their debt, which is not too significant if it was an isolated event that did not affect other parts of the world. Greece just recently received a debt downgrade from Moody's, and the Baltic area in general is experiencing many economic and social issues because of the huge deficits they have. Also, Spain just received a debt downgrade from Moody's. These occurrences are not isolated to the countries with which they happen, there will be worldwide effects from these issues with debt whether it is big or small.

US States' Budget Deficits

It is an endless cycle until we see a "real" recovery. Unemployment continues to rise, salaries and hourly rates of those who still have a job are seeing their incomes drop, and States are continuing to spend more money then they receive. More and more Americans are on food stamps, yet bankers continue to receive billions in bonuses for a job well done. States are going to have to make a choice (they might select multiple options). They will either use inflation (debasing the currency) to pay back the debt in cheaper dollars, significantly raise taxes, or default on the debt. Debasing the currency seems to be a popular trend right now for the US; I think throughout 2010 we will start to see higher taxes along with it. I would think defaulting on the debt is the last thing a State wants to do, but we could see some of this over the next few years in high risk States like California, and New York. Below are a few related articles for your viewing...

http://manyeyes.alphaworks.ibm.com/manyeyes/visualizations/state-budget-deficit-map-2010-estima

http://www.saratogian.com/articles/2009/11/21/news/doc4b0768cb81be1584614972.txt

http://www.sdnn.com/sandiego/2009-11-19/politics-city-county-government/california-budget-politics-city-county-government/california-budget-crisis-diaries-new-guess-for-state-deficit-tops-20-billion/comment-page-1

US Dollar Attacked At All Angles

Here is a summary of how the US dollar (USD) is being attacked:

• Obama Admin devaluing USD while claiming strong dollar policy

The Obama Admin's intentions are clear, they intend to devalue the dollar. They have printed enough money to increase the monetary base by over 100% in slightly over a year. Per the Telegraph UK, "America's monetary base was equal to 6% of national income, and now, after a little over a year of money printing, it's 12%". The motive is to boost US exports. More importantly we can lower the value of our huge amounts of foreign debt.

• Quantitative easing has no indication of slowing
  

The Fed Reserve continues to buy our debt with printed money, even though Ben Bernanke stated that he was going to be implementing an exit strategy to stop quantitative easing. Our government is still auctioning off record amounts of our debts across various time frames, like 1yr, 5yr, 7yr, and 10yr. The Fed Reserve still has to buy up debt on the 5yr, 7yr, and 10yr debt because there is not enough domestic and foreign demand for our debt anymore. There is still much more debt to sell (at record amounts), so I am betting that Ben Bernanke is lying to keep the USD afloat. Watch gold, silver, other commodities, and strong currencies for the indication of what the market believes.

• USD becoming popular carry trade

Since interest rates are almost at zero, investors are borrowing USD and investing in areas around the world with high interest rates i.e. Brazil with 8.75%, and Egypt with 8.25% interest rate. The carry trades are flooding the world with cheap dollars.

• Central banks dumping large amounts of USD

Global central banks are diversifying into commodities and foreign currency as a hedge against USD devaluation. According to Bloomberg, "foreign currency holdings increased by $413 billion last quarter, to $7.3 trillion". World leaders are acting on their threats to dump US dollars, and this might become more aggressive if USD value falls off a cliff.

• Tension with Chinese over Yuan and Hong Kong Dollar Peg to USD

Not only are the Chinese holding huge amounts of our debt that is being devalued, but their currencies are being devalued along with ours.

• Joseph Stiglitz's Thoughts

"A new global reserve system is needed after the global financial crisis exposed the U.S. dollar-based system as flawed and risky". "The current global reserve system is fraying. It's falling apart. The issue isn't whether we go to a new system. The question is do we do so in an orderly or disorderly way." Stiglitz's suggestion is going with a SDR via the IMF; with a basket of currencies as the world's reserve currency instead of the USD by itself.

Current Trade Deficit Thoughts

According to the latest trade deficit numbers of the US Bureau of Economic Analysis, "total US exports in July 2009 were $127.6 billion and US imports were $159.6 billion". In the short term, imports have increased by $7 billion over June 2009, and exports increased by about $3 billion over the same time. Typical of the US, we are consuming much more than we are producing. "The gap between US imports and exports grew by 16%, the most in a decade" per Bloomberg.

Here is the breakdown of some important US trade numbers via the US Census Bureau Foreign Trade Statistics:

US trade deficit increased by approximately:
$4 billion with the European Union to $8 billion
$2 billion with China to $20 billion
$1 billion with Canada to $2.2 billion
$1 billion with Germany to $3.2 billion
$500 million with Venezuela to $2.3 billion
$200 million with Japan to $3.9 billion

Obviously the US trade surplus is increasing at a slower rate, here are our top six trade surpluses (numbers are approximations):
$1.3 billion with Hong Kong
$1.1 billion with Netherlands
$950 million with Australia
$870 million with Belgium
$787 million with United Arab Emirates
$500 million with Singapore

The good news is that the US trade deficit at $32 billion has decreased by over half since hitting a monthly record of $65 billion in July 2008. Since the US dollar has been weak lately, our exports have potential of increasing because they will be more competitive in global markets. On the other hand, we are losing many of our manufacturing jobs and the workforce is still contracting, so even if other countries want to purchase our products, what volume of products will we have to sell? We will see what happens to the trade deficit for August.

Since the US has had a trade deficit for a prolonged amount of time, the difference is essentially debt. The larger the debt is the more likely it is for investors to believe that demand for our products is decreasing. As such, I believe if the deficit continues to get larger it is likely to have a negative effect on the stock market. Less buying of our goods from other countries hurts producers in the US and their respective company's stock market values. Investors like Peter Schiff realize there are few investment opportunities domestically, that is why he invests a large percent of his assets overseas and in commodities. I myself think we are headed for a 'W' shaped stock market pattern where we are near the top, and within a short period of time (six months or sooner) we will have a pullback in the market.

Stock Market Gains Created By Government Bailout Monies

If you have been following the stock market closely since March 2009, you would be able to draw the conclusion that the gains of the stock market are not based on solid economics. I think what we are seeing is what market analysts call a 'dead cat bounce'. Per Bob Chapman, "there is low volume in the overall market and short covering", which typically infers a bear market and lower market prices. In addition, the market is pricing in the future economic strength that we are suppose to have, and this is simply not possible with a weak dollar. You cannot have a weak dollar, and a strong economy. Also, there is no such animal as a jobless recovery, especially when our economy is fueled by 70% spending. What's more is that the savings rate among Americans is increasing quickly, so the people that do have money are saving more and spending less. The latest government numbers showed that Americans were saving approximately 7% of their income on average, versus 0% of their income on average a year ago. This is the highest our savings rate has been since 1994. Based on the graphics below, I would conclude that people across all generations are saving more and making less.

New Subscribe Features

I have added new subscribe features to the website. The subscribe feature will notify you of updates when I post. You have two options: to subscribe in a reader, or subscribe by email. If you subscribe in a reader you can view updates in a reader of your choice, and it seems to be quicker than the email option. If you subscribe by email it is much slower, I receive emails about 10 - 12 hours after the post is published.

Credit Derivatives Still Forcing Banks to FDIC Takeover

A flavor of a credit derivative is a pool of mortgages that are packaged up into securities called Mortgage Backed Securities (MBS). No one knows just how large the MBS market is in total, but according to the Bank of International Settlements the total value of the credit derivative market is approximately $500 trillion. Warren Buffett said it the best when he stated back in 2002 that "derivatives are financial weapons of mass destruction". These financial weapons almost brought down the entire financial system in the US back in September/October 2008, and they are still doing damage today.

Here we are about a year later, how is the financial sector doing? Associated Press noted that as of August 21, 2009; "81 institutions have failed, which is the most since 1992 at the height of the savings-and-loan crisis". The Guaranty Bank with about $10 billion in assets failed this past weekend, which is the 10th largest financial institution to fail in US history. Wall Street Journal noted that, "Guaranty's woes were caused by its investment portfolio, stuffed with deteriorating securities created from pools of mortgages originated by some of the nation's worst lenders". Next question is what is the scope of this problem...

According to the FDIC, there are about 9,400 banks in the US. About 15% of these banks are involved to some degree with MBSes. In addition, banks have to deal with their losses in the commercial real estate market, which I outlined in the Commercial Real Estate Conditions article. Remember when the government performed financial institution stress tests earlier this year? There was much controversy on how that was done, and the results were largely skewed. Shortly thereafter, the Weiss Research Firm did their own more fair and much less criticized stress tests. Out of the nineteen banks stress tested, "seven institutions -- JPMorgan Chase & Co., Citigroup, Wells Fargo & Co., Goldman Sachs Group, GMAC LLC, SunTrust Banks, Inc., and Fifth Third Bancorp are at risk of failure". Let's see how the continuing domino effect of bank failures plays out later this year and into next.

State of The Job Market and The Consequences

The most recent unemployment number is 9.4% as of the end of July 2009 despite a ~250k job loss. This is an improvement over the previous month's unemployment number of 9.5%, how can this be? The unemployment rate is determined by dividing the number of unemployed by the number of people in the labor force. The only way the unemployment number can contract is by shrinking the labor force, and that is exactly what the Bureau of Labor Statistics' unemployment number reveals. One last note on unemployment is that people who are unemployed are looking for work for a much longer period of time. According to EconomPic, 50% of the people whom are unemployed will be searching for work an average of approximately 15 - 27 weeks. This is certainly not good news for the various States' unemployment insurance programs, and it could not be at a more difficult time for most States.

The past 18 months or so have been tough on the job market, and it is no surprise that the amount of people on food stamps has broken a record. In October 2008, there were approximately 31 million Americans on food stamps. Currently, 34 million Americans are on food stamps, and the number is rising. About one in nine Americans are using food stamps.

Consumer spending accounts for about 70% of the United States economy. Is it any surprise that consumer spending has fallen the most it has in almost 30 years? According to Bloomberg, purchases slid 2 percent since the peak at the end of 2007 -- the most since a 2.4 percent decline in the 1980 recession. Not many people in our country have discretionary spending funds, so how easy is it to get some credit nowadays? Banks are maintaining their strict lending policies, and most people are not taking advantage of HELOC. According to the Federal Reserve, consumer credit (covers most common forms of credit like home loans, college loans, credit cards, etc.) is contracting at a 5% annual rate. Financial institutions are still hoarding all the bailout monies to improve their damaged balance sheets. In this country, we have to get to a point where the bailout money is enough for these financial institutions, and they can start lending again.

Commercial Real Estate Conditions

According to the Fed, the commercial real estate (CRE) market size is $6.5 trillion, versus the residential market size at about $10 trillion. Although the size of the CRE market is smaller than the residential market in property value, this does not lessen the impact on our economy as the market becomes flooded with empty CRE space that cannot be sold. Take a look around your local community, and see all the lease signs up for businesses that could not make it through this depression.

The CRE impact from Wall Street to Main Street. Morgan & Stanley lost $1.2 billion. Regions Financial lost $912 million. There are many more losses, too many to mention but none larger than these. Take a look at the financial stocks, and see how many financial institutions blame their losses on the collapsing CRE market.

CRE property values are down by almost 50% since the 2007 peak. Too much supply and not enough demand. Good news is that we are bound to hit a bottom in the CRE market soon!

Bernanke Is Right - Weak United States Dollar Not Going Anywhere

In a recent PBS interview, Bernanke stated that "a strong dollar will come when we have a strong economy". How do I understand this statement? A weak dollar is here, and it is going to be here for awhile until we can turn this economy around. A strong economy will attract foreign investors, and this is what we need in the United States for a strong dollar.

How has our economy been doing lately? According to the Bureau of Economic Analysis, "our Gross Domestic Product (GDP) has decreased by over five (5) percent in the first quarter of 2009". The United States unemployment rate per the Bureau of Labor Statistics is at about 10%, which is probably lower than it really is. What is made in this country anymore? Take a look at the product(s) you buy and find out where it is made. You might have a difficult time finding a product made in the good ole' US of A. According to BBC news, "nearly two million manufacturing jobs have been lost in the US in eighteen months".

There is hope though! If the US can lead the world in "green" innovations, maybe we can start producing our "green" goods and revitalize our manufacturing sector.