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Monday, July 28, 2014

The Depressing Post

I've made several attempts at this, but they are all so depressing that I end up wandering off with a headache. So now I'm just going to dump it. 

A) You may or may not have noted the Yellen (Sweet Monetary Manna Mama, aka SMMM)/Bullard-Fisher contretemps (Axis of Purported Liquidity Rationalization, aka APLR)

SMMM claims that theoretical unemployment rate masks an underlying labor slack that is very destructive to the economy, and thus rate increases will be deferred. APLR claims that conditions are such that the Fed has met its goals and must proceed quickly to raise rates while they still can. 

Who's right? First, I think the Fed really had a meeting and drew lots to distribute the Inflation Hawk suit. They're worried enough about that 4.5 T on the books that this time there were two short straws. Thus the flight of APLR falcons. We may all pause to admire their arabesques through the skies of NYC as they attempt to bring down the Black Ben Helicopters. But don't pause for too long, because it's all a play done to convince CYNK-buying financial types that WE ARE ON THIS THING WE HAVE IT UNDER CONTROL DO NOT WORRY about inflation.

Fisher may be taking his role a bit too seriously, because he mentioned the unmentionable in his July 16th speech - tailing off on reinvestment of that 4.5T. Right now they are reinvesting principal and interest proceeds, which far exceeds the theoretical QE that they are tailing off. So until they all start talking about letting that portfolio run off, they are not serious about liquidity constraints. It's just a fireworks display. 

But why are they willing to do make fools of themselves in public? They have two huge problems. They don't know how to manage either, much less the two together. 

Problem 1
This is the population-adjusted core employment graph. It's the number of the employed among the 25-54s divided by the civilian free-roaming 25-54s population. It is clear we DO have labor slack. Note that there is a considerable degree of part-time employment in there.

Problem 2 is, yea verily, like unto it, an unlovely thing cursed of G_d and man.

This is the ratio of trade receivables (cash coming in) of non-financial corporates divided by total liabilities (what they owe) of non-financial corporates. I have helpfully added the Fed Funds rate indexed on the right. These figures come from the Flow of Funds report.

In short, the Fed response has caused the acceleration of debt-loading of corporates, to the point that they are very susceptible to any increase in interest rates. Since the end of the last recession US corporates have added about 2.4 Trillion in corporate bond debt and over  2 Trillion in credit market debt.

Households have lightened up a bit, but not nearly enough. This is the equivalent graph for Households & Non-profits:

So it is clear that our reckless spending is not going to bail the corporations out, no matter how sapphire the screens get.


The implications are that households and corporations are both extremely negatively sensitive to interest rate increases. They are both extremely negatively sensitive to tax increases. They are extremely negatively sensitive to cuts in government funding.

Now note the long time period these graphs cover. Much has been made of the post WWII expansion, but the population and the business population then had relatively high cash flows in relation to liabilities, which implied that they were extremely favorably responsive to both tax rate cuts (it was a high tax environment) and interest rate cuts. 

There was a huge recession in the 50s - one of the most severe ever - and when Eisenhower was building those roads he was funding expansion. When Kennedy showed up, his tax cuts had an impressive pay back.

But now we really don't have much room for tax cuts. We don't have much room for ANYTHING. 

All of the financial machinations of the Fed have really done very little to change the long term trajectory of the US economy, which in fact they conceded already. Have you looked at their long term growth forecasts lately? This is their March projection, and here is their June projection. Compare to their June 2013 projection.

So the reason for the Fed-and-Booty Play being enacted in the skies over NYC is that they are trying to talk the markets into anticipating better rates, so that they have the room to raise them without shocking the real economy. I don't think it's going to happen, given the regime in DC.

Absorb this, and then we can go onto the ACA/economic weather forecast thing. You folks may have stronger constitutions, but there's only so much misery I can handle at one time.

Comments:
I am glad you are back posting. I don't understand much of what you write, but I am learning and very appreciative of your work.

Could you please put in a tweet button so I can tweet your posts on twitter?

I think you deserve a wider audience and would like to help you get one.


cordially,

st.

 
"Show me the place in the term structure of interest rates in the United States of America that is demanding the Fed hike the rates... And it's just not there folks..."

"What is evident, though, is that the curve is suggesting monetary policy is already tightening before the Fed attempts to raise interest rates. If these conditions persist it sets the stage for a yield curve inversion at a very low level and a dangerous policy error."

Read more: http://www.minyanville.com/trading-and-investing/fixed-income/articles/yield-curve-high-quality-liquid-assets/7/28/2014/id/55613#ixzz38oF8Lee9

 
Nothing changes until supply side incentives are created to expand investment. The various crony capitalists that own the Republicans - home builder's, realtors, financial firms- won't stand for it, so more malaise is in store, as the Demcrats are even more venal and flint-hearted than the Republicans. Re-election is their game.
 
Both parties main concern beyond election is to create a permanently open door to economic immigrants, which will throw more of the lower middle to middle class people into poverty.

But who's to complain! I mean, there's always food stamps to fall back on, to keep body and soul together, and, who knows, you might suffer a tort that could be a ticket to the good life. And barring that, Paul Ryan has a nifty new safety net he's peddling that will prevent them too much discomfort: middle class existence is overrated.
 
But what about insurance companies and pension plans? Don't they need higher rates and soon? They must have a boat load of bonds that are maturing and rolling over at much lower rates.

If the insurance cos. don't get higher rates they will have to raise premiums. If pension plans don't have higher rates they have to tax the public to make up the short fall. Both are deflationary actions.
 
It is better to compare A/R-Trade with short term liabilities; even A/P-Trade.

Corporations may have lots of liquid assets and property, plant and equipment to offset total liabilities.

What is the combined equity capital of corporations? I tried to find it on FRED but I am really terrible at finding things on it.
 
But why are they willing to do make fools of themselves in public?

To quote Super Chicken, they knew the job was foolish when they took it, Fed.
 
But now we really don't have much room for tax cuts. We don't have much room for ANYTHING.

Finally someone more pessimistic than me.

We do have room for something: we can start easing up on regulatory burden. Every regulation dreamed up by a federal agency is a structural burden on the rest of the economy, piling sand on the rails of the economic railroad. ACA is a huge burden for example.

Take some of the sand off the rails and the train will move faster. But as pointed out many times before, D.C. is so arrogant (along with their lackeys in the media) they think they can put the "right" sand on the rails the "right" way to get the train moving faster. They have no evidence of such an idea ever succeeding, but slowing things down is all they know. The only thing that takes place is D.C. gets lobbied to put more sand on one set of rails than another (ACA is a perfect example of this).

The Fed is tasked with shoveling more coal into the boiler to make up for all the sand on the rails.
Now the Fed has over-stoked the boiler of the FIRE economy - the only part the Fed is connected to. Two things can happen: either the over-stoked boiler blows up or the piles of sand cause a derailment.

We already had the derailment but people down the track haven't seen the train yet so they're still piling sand. The geniuses in D.C. think they can get the train to jump back ONTO the tracks if they can just shovel more coal to keep the driving wheels going. The only way to get the train back on the track is to let it come to a natural halt and then do the heavy lifting to get the engine and cars back on the rails. But in D.C. the only heavy lifting any one understands is military.

At the very least we can tell the people down the track to stop piling sand because there's no train coming anyway.

OK, maybe I am still more pessimistic.

 
In aviation we have a saying, "Don't get caught in the coffin corner." The coffin corner is where your airplane is balanced on the edge between a stall or an overspeed. Raise the nose just a tad and you stall. Drop the nose slightly and you immediately are in mach buffet.
Stall and spin and you might be able to recover before the wings come off. Get into mach buffet with no reduction in power and you exceed the aircraft's max speed where structural soundness is not guaranteed.

It appears that the Fed is in a financial coffin corner. Raise interest rates (raise the nose) = stall and spin. Lower the nose, (drop rates and/or invest the balance sheet)= an overspeed/inflation.

The way to get out of coffin corner was very carefully lowering the nose just a tad and reducing power just a tad. Go very carefully lower into more dense air where there was more spread between stall and mach buffet speeds.

The Fed cannot get out of this without some help from fiscal and regulatory action by the government. Less regulation, slightly throttling back on government spending, and steady rates until the economy picks up might, just might, get us out of the coffin corner.

Otherwise we are headed for a spin and crash (deflation) or the wings coming off (inflation).

Have I got it about right, MOM?


 
Jimmy - that is appallingly apposite.

The only comfort of this blog is that it does remind me that there is a lot of intelligence in the general population.

Just think about the fact that the Fed is contemplating raising rates when we are in this fix. It's rather frightening.
 
Joseph - these ratios are rather consistent over time, and from the POV of lending, it's not the balance sheet but the cash flow I worry about. If a company has strong cash flow and decent assets, then if the downturn occurs I can still rely on the assets in order to tide the co over cash-flow-wise. But if a company doesn't have cash flow and I am lending on the assets, then in a downturn I am going to get really hurt. I can't afford to extend, so I have to try to realize.

All-asset lending is a recipe for portfolio disaster, IMO. You may take it as collateral, but you are probably going to recover 30=50 cents on the asset dollar, at best. You end up restructuring-extending instead.

Net worth in this environment (asset inflation) is not a very reliable number. In essence the easy money campaigns have worked to inflate all such numbers, just as the flood of funny-money mortgages inflated housing values in the Aughts. The reversion to the mean is painful and means that much lending is poorly secured.

Call it the Espirito Santo effect.

The other recourse for banks is not to be the last-dollar lender, and in this respect the Fed has really helped access to money, because of covenant lite participations and rather spirited corporate bond sales. Yield-chasing means that less solid assets assume a sparkling aura.

But you are looking at a corporate culture that has often stripped companies of working capital through mergers and sales, in which liquid assets were stripped out.

Equity capital would normally be calculated as current market value of all assets - current liabilities. Is that what you are looking for?
 
Upon reflection I do think looking at A/R-Trade as a percent of equity is valuable, cash flow being the main thing as you said.

Yes, I was looking for the ratio of assets to liabilities and spent time doing this on FRED.
“Nonfinancial Corporate Business; Total Assets, Level” divided by “Nonfinancial Corporate Business; Total Liabilities, Level” shocked me. Corporate balance sheets improved leading into the great recession and I surmise helped cause it. I interpret deteriorating balance sheets with taking on more and more debt and creating credit flow – I have no idea what to call it. Improving balance sheets means reducing credit flow. Since the recovery started this ratio has been flat. That makes sense for a slow economy lacking credit growth.

I am thinking credit growth is just about everything. Economists talk about the problem being lack of Money Velocity (and even talk like one can directly affect these numbers). But MZM Velocity collapsed since 1981 and the economy had great growth since then. M2 Velocity collapsed since 1995 and the economy had great growth since then. M1 Money Velocity collapse in 2007 and after the contraction the economy has seen much improvement though slow growth. It is perverse. I think it means that stimulus has grown faster than output over the decades and we may not like what is happening if we see Money Velocity turn up.

It is like Credit Velocity – I have no idea what to call it. FRED: “Gross Domestic Product” divided by “All Sectors; Credit Market Instruments: Liability, Level”, which I search for by TCMDO (Total Credit Market Debt Outstanding). The internet complains that debt has become more and more unproductive in that it takes so much more debt to product a dollar of GDP. Well, this is because it is credit creation faster than output. It leads the output. It drives the output. The chart has stopped going down and has flatlined and we don’t like it as it means less debt creation and we have slow growth. Debt creation may be a better term than credit flow.

If debt creation is seriously inhibited then to get growth we are stuck with what Charles Kiting and Jimmy J say needs to be done. Nobody is going to like that. I am sure there will be humongous effort put into doing what is necessary to getting Money Velocity and Credit Velocity to go down, even negative if necessary before doing what should be done.

 
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