Monday, October 19, 2009
A Decade With Negative Growth
Not that posting would be very appealing even if I felt better, because everything I've got shows that under current government policies (excluding health care reform and cap and trade), we have created the overwhelming probability of a decade that will show negative GDP growth. I'd call that a depression. Depending on when the Fed changes rates (with the earlier hikes giving the most growth), it's a net over a decade of -2% to -9%. Oh, joy.
Mind you, that won't mean that you don't have some positive periods, but our current policies are building massive risks and government losses which must be funded by the taxpayers, on top of higher structural deficits, which must be funded by the taxpayers, and the inevitable result will be no jobs growth, lower net incomes for most households, and much higher taxation for higher income households. All of that would not prevent growth if it were not that both the Fed and the overall government is now wedded to zombie banks which it cannot allow to fail, and in fact is now following a policy of increasing their hidden losses instead of working them off.
It would appear we are screwed.
What's going to determine the next five years is one simple dynamic; mortgage rates have been pushed so low in a high loss environment that no sane lender would underwrite mortgages at these rates without the ability to lay off risks to the government. Now the GSEs do not underwrite all types of loans, so we have a two-tier rate schedule and an utterly dead private MBS market.
So everything is being sanitized through the government, but that is happening at the cost of very high future losses. Right now money is being slowly but surely siphoned out of the general economy through bank deposit deployment shifting steadily into Treasuries and government-guaranteed low return options, which of course has the effect of creating very low bank interest rates - rates that are below inflation rates, thus a negative real interest rate on money.
The current situation is not disputable. A cursory inspection of H.8 (Assets and Liabilities of US Commercial Banks) shows what is happening. From May to Oct 7th, on a seasonally adjusted basis:
- Bank deposits grew approximately 130 billion.
- Bank credit dropped about 325 billion.
- Bank loans and leases dropped a little under 420 billion.
- And bank credit invested in agency MBS and Treasuries grew almost 100 billion.
Of course the very high bank chargeoffs show where the missing money went - it is simply a loss. A Q2 chargeoff rate of 2.65%? That is about 100 basis points above the previous high, and it is still growing.
The money supply in circulation is being choked off. Naturally this creates an incentive to invest money in anything that would generate a cash return, no matter how small, so we have funded stock and commodity speculation.
Among the commercial analysts, there is a desperate attempt to justify current increases in stock and commodity prices, most of it completely unfounded.
Is the situation in retail improving in a structural manner? No. The wider indices show continued degeneration in pricing power.
Is the dollar declining, and are the costs of imported necessities to the US consumer rising? Yup.
Is the expected real return on sales of most consumer consumption items in the US declining? Yup.
Will that fund business investment and growth? Nope.
The net result is Japan. See Mauldin's last newsletter for a brief summary of what really happened to Japan. For two decades, there was little to no real growth in their domestic economy. Most companies invested externally, which is exactly what is going to happen to the US. This creates a situation in which you have low to no growth in wages and and consumer incomes.
The theory being presented is that external buying from manufacturers benefiting from a cheap dollar will be our way out. There are two problems with this theory. The first is that there are growth problems elsewhere in the world, especially in China. The second is that a cheap US dollar accompanied by high corporate taxation and an expensive operating environment does not create internal corporate investment. It creates external corporate investment. If we wanted to use a cheap dollar to expand the manufacturing share of the US economy, we'd need to cut corporate tax rates to about 25% max (and phase out some of the tax specials), plus assure a steady energy supply.
Ask yourself if you would expand or invest in US plant under the current environment? If you have answered yes, you do not understand business very well. The decision has apparently already been made by US manufacturers NOT to expand internally at this time. We blew through some of our magic ratio levels this summer, and restocking should be well underway (these graphs are from August):
A look at H.8 shows that C&I loans at banks have continued to drop, and we are seeing no pop at all in commercial credit for nonfinancials. Flat. "He's dead, Jim!" (to quote the good doctor). There are only the faintest indications in NACM that business credit is expanding, so the net is still down. Mind you, we are not worrying about YoYs, because prices have dropped so much. We are just worrying about the June to current trends, and those are consistently poor to declining. Now you cannot have a business expansion without using money. It does not happen. Saying that it can happen is equivalent to believing that video in Colorado was really of a space alien evincing a fascinated interest in the domestic customs of UFO enthusiasts. Only Wall Street economists are capable of such nonsense when they go In Search Of Optimism. These are the same folks who were highly reassuring about financial risks in 2007.
So right now, we don't seem to have a carrying wave of growth of any sort. Normally, a neutral is a positive for growth because people try to find a way. But in the current situation, this is not so. For one thing, stimulus this year did provide some boost, some of which is due to expire. Another unpleasant truth is that state and local governments are running into deep funding problems, and are being forced to raise taxes and fees plus cut spending, which is a very broadspread negative vector. Finally, small businesses are cutting employment and shutting down at a very high rate. Because these businesses account for such a big part of the jobs base, this is an unfortunate development which will have widespread effects. The businesses shutting down are not just restaurants and independent retail, but service businesses such as welders, mechanics, HVAC etc.
CR has written about his worries for 2010, and that is worth a read as well.
No ten year forecast is worth anything, because public policy changes in response to experience. There are public policy responses which could restore real growth, but there are also public policy responses which could make the situation worse.
It's worth noting that over the last six weeks many economists have shifted toward a more negative outlook.
That has a certain Weimar ring to it...
Impressive feat given the fever I must say.
I thank you very much for the education, and wish you a quick recovery.
I also believe I serve as a wonderful example of how to almost kill yourself by not taking this stupid flu seriously. I am much improved, but I should have figured this out sooner.
I'm not sure the stock market is over-priced. Sure, by traditional measurement, but traditional measurements don't really factor in runaway inflation. The best analyses I've seen demonstrate that the market is moving inverse of the dollar and positively correlated with foreign investment flows. Basically, our trading partners are shoveling their dollars into equities and dollar-denominated commodities as fast as we pay them for their products.
Is that a bad deal on their part? Maybe not, if our future looks like Weimar and Argentina. Or even just like Jimmy Carter. At least they're likely to own something at the end of it all.
"Sure, by traditional measurement, but traditional measurements don't really factor in runaway inflation."
I would highly encourage you to read (or reread) Warren Buffett's shareholder letters from the 1970s.
I believe that the stock market will lose a lot of investors a lot of money if there is runaway inflation. While the stock market would most likely rise in nominal terms, I doubt very strongly that it would rise fast enough to keep up with inflation. As near proof, I merely point to the 1970s.
"As inflation intensifies, more and more companies find that they must spend all funds they generate internally just to maintain their existing physical volume of business. There is a certain mirage-like quality to such operations." - Warren Buffett, 1980 Shareholder Letter
"For inflation acts as a gigantic corporate tapeworm. That tapeworm preemptively consumes its requisite daily diet of investment dollars regardless of the health of the host organism. Whatever the level of reported profits (even if nil), more dollars for receivables, inventory and fixed assets are continuously required by the business in order to merely match the unit volume of the previous year. The less prosperous the enterprise, the greater the proportion of available sustenance claimed by the tapeworm." - Warren Buffett, 1981 Shareholder Letter
Corporations can't tolerate heavy inflation any better than individuals can. Inflation is a tapeworm. No good can come from it.
As more near proof, consider this. If inflation is causing serious pain to individuals, then imagine the pain that runaway inflation AND a lack of customers would do. As just one concrete example, if there was runaway inflation then I would expect to see MANY restaurants go out of business.
I can't speak for others of course, but I eat out a lot less since I turned bearish in 2004. Unless the government chooses to offer a "cash for burger" program then runaway inflation is certainly NOT going to change my behavior.
I agree, the stock market is not the best hedge against inflation for individual U.S. citizens. I was pointing out that the primary driver of the run-up in the market has been foreign exporters faced with a large positive dollar account. They're trading pieces of paper for a piece of the pie. I'm not willing to say that the stock market is overvalued from that point of view.
Since their point of view is apparently the dominant point of view for a while, the stock market is not overvalued. That will change eventually, as it always does.
Since nearly half of typical recovery hiring comes from small business, you can just forget about seeing any significant improvement in employment any time soon should those policies become law.
What I have seen in the last month is the worst overall indicators since 1984, when I began tracking such things. The large amount of items coming up for sale (rare and uncommon items), and the prices (high) are completely out of line with the number of buyers (virtually none). This is coming out of a 1 year period of an intensely positive index, largely because of fears of the brave new noble laureate leader and what plans he might have for folks who cling to such items troglodytes favor. This pattern of large offerings with virtually no buyers indicates a sharp pull back in the economy. The fact that rare items are being offered indicates that folks need to get cash and are selling off treasured items. The prices being out of line with demand indicates that it is just dawning on folks that the economic decline will be long lasting and have not yet prices their items at a rate which will induce sales. Buyers seem to either have no cash or are waiting on better prices.
Based on that index, hard times are here for what was previously the burger class.
"Now laugh if you will..."
I certainly won't laugh at your gun show index. I've got my own version (said somewhat tongue-in-cheek).
I call it the "Pawn Shop TV Show Index". The index sat at 0 for centuries and is just now exploding in value.
"Long before banks, ATMs and check-cashing services, there were pawn shops. Pawning was the leading form of consumer credit in the United States until the 1950s, and pawn shops are still helping everyday people make ends meet. PAWN STARS takes you inside the colorful world of the pawn business."
I saw a piece by Bianco Research today with the breakdown of job losses by goods vs. services.
So, in the 1982 downturn, service job losses accounted for around 3% of the total -- 97% was goods.
In 1991 and 2001, services jobs were up to around 17% of losses.
The number for this recession? 50%. This number begs important questions. Are we losing service jobs for structural or cyclical reasons (guess!)? And, will service jobs return as quickly as goods-producing jobs did in the history of post-War recessions (that's a hard one!)?
The Fed thinks zero rates will reverse this structural adjustment in the service sector. Good luck with that. It will only succeed in raising gas prices.
It is the small businesses that concern me. Some of the ones that are going are markers for severely constricted money circulation. Welders? Come on! Car repair isn't doing well either - it seems like a lot of people can't afford to pay.
From MTS, the YoY chg for Aug in SS taxes was -2.86. September -4.34%
We're hitting the wall.
WIET in Sept was down something like 7%. Through Oct 16th it's more like 9%.
Service businesses are highly dependent on money circulation!!! You can't have velocity drop like this and not have a huge impact in services. What will survive are businesses like electricians, plumbers, car repair and so forth, but a big chunk of discretionary replaceable services will just quietly amble offstage, which will then circulate into another round of B2B services. Nothing like being a bookkeeper and having 1/3rd of your client base go out of business.
For the icing on the cake, just take a look at the Baucus bill, and those taxes due to take effect next year.
Everyone with government jobs or pensions is living in a bubble. They don't see it, they've got no clue, and of course the Beltway crowd associates with like, so they have no idea what's really happening.
It's over. It is now too late to prevent another downturn - the aim should be to lay the foundations for a subsequent rebound. But no one in charge is watching the ball - they're all staring at the gals in the stands who just stood up and lifted their shirts.
"David - it's mostly structural."
"It's over. It is now too late to prevent another downturn..."
It's the horror story that never ends.
"The most merciful thing in the world, I think, is the inability of the human mind to correlate all its contents." - H.P. Lovecraft
"Doubt of the real facts, as I must reveal them, is inevitable; yet if I suppressed what will seem extravagant and incredible there would be nothing left." - H.P. Lovecraft
"Then the shadows began to gather; first little furtive ones under the table, and then bolder ones in the dark panelled corners." - H.P. Lovecraft
Sorry. I'm clearly not known for my motivational speeches. ;)