Friday, February 29, 2008

Muni Massacre

CNBC has been reporting this afternoon that several hedge funds that use leverage to invest in the municipal bond market are being forced to sell. The size of the offers are huge and prices have been marked down significantly to attract buyers. The stress in the muni market first showed up several weeks ago in the auction rate market and is now spreading to regular munis. I don't expect this is the end either; closed end funds that issued auction rate preferreds will be forced at some point to call those securities if the auction rate market continues to fail. If they are forced to pay off the preferreds they will be selling munis to cover the cost. Expect to see more selling next week.

I also suspect that at least some of the selling in stocks today is related to the muni meltdown. If a leveraged hedge fund is getting margin calls because of municipal bonds and they can't sell the bonds, they will sell what is liquid to cover the margin call. And today that appears to be stocks.

Take a look at this chart of the Municipal Bond ETF:

That's about a 7% drop in just over a month. Muni bonds are one of the safest places to invest and a drop like this in such a short period of time is unprecedented as far as I know. The muni market usually tracks the Treasury market fairly closely, but in the last week the two markets have gone in completely opposite directions. The aversion to risk being shown in the market is amazing.

Consumer Sentiment - Feb

US consumer sentiment hit its worst levels since the worst of the 1991 recession, according to the University of Michigan Consumer Survey. The survey dropped to 70.8, from 78.4 in January. The mid-February reading was 69.6, so it has improved slightly. Economists were expecting a reading of 69.4.

The index has fallen 30% since its peak in January 2007. "Past declines of this magnitude have always been associated with a subsequent recession," said Richard Curtin, survey director.

Personal Spending, Income - Jan

Nominal personal spending increased 0.4% in January, above the 0.2% expected by economists. Inflation was also higher in January, leaving real consumer spending flat for the month. Real spending on durable and nondurable goods fell, while spending on services rose.

Nominal personal incomes grew 0.3% in January, with wages and salaries increasing 0.5% in the month. Economists were expecting a 0.2% increase. After taking inflation into account, incomes rose only 0.1%. Real disposable income have grown just 1.2% in the past year.

See Full Report.

Thursday, February 28, 2008

Index Comparisons

We've updated our Index Comparison page on our website. In these studies we compare the performance of various indices over varying time periods. It's interesting to see where money is flowing in and out. Obviously, the commodity indices are vastly outperforming this year, but there are some surprises:

1. Even with the turmoil this year, emerging markets are still outperforming the US.
2. Taiwan is the best performing of the Asian markets we follow; Hong Kong is the worst.
3. Developed Europe and the EAFE are both underpeforming the US market YTD.
4. The NAREIT Residential Index and the Mortgage Index are both up for the year. The residential index was up 10.77% as of 2/25.
5. Regardless of all the talk about gold and oil, silver is the best performing of the commodity ETFs we follow, up 22.4% YTD.
6. The US Home Construction Index ETF is up 9.64% YTD.

We've also posted other interesting research on the website. Please take the time to wander around. Research Home Page

Initial Jobless Claims- Feb. 23

Initial jobless claims, first-time claims for state unemployment benefits, jumped sharply for the week ending February 23. Claims increased 19,000, to 373,000, well above the 350,000 threshold economists believe indicates a weakening labor market. Economists were expecting a number closer to 350,000.

The 4-week moving average, a less volatile and more accurate measurement, fell by 1,250, to 360,500.

See Full Report.

70s Redux?

Allan Meltzer has an editorial in the WSJ which asks if the Fed is repeating the mistakes of the 70s. His answer is yes:

Is the Federal Reserve an independent monetary authority or a handmaiden beholden to political and market players? Has it reverted to its mistaken behavior in the 1970s? Recent actions and public commitments, including Fed Chairman Ben Bernanke's testimony to Congress yesterday -- where he warned of a steeper decline and suggested that more rate cuts lie ahead -- leave little doubt on both counts.

If he's right (and I think he may be) at some point bonds are in for a big hit. The 10 year Treasury Note currently yields 3.75% while inflation is over 4%. That can't last; either inflation will come down or rates will have to rise.

Wednesday, February 27, 2008


CIBC, another former employer of mine, has a very informative piece on the possibility of global decoupling:

Regardless of whether the US is already in recession, risks
on that score are clearly rising as the housing collapse
erodes household wealth and spending, and writedownsaddled
financial institutions tighten lending standards.
The rest of the world isn’t immune to the gloom stateside.
We still, however, expect world growth to hold up at a
4.2% pace in 2008 even in the likely event that the US
picture darkens further.
Contributing to this guarded optimism is the decline in
the US economy’s global footprint in recent years. Outside
the US, the data are also still generally mixed, with Europe
cooling but Japan’s growth doubling expectations in the
latest quarter.
The US may have been the world economy’s locomotive in
the second-half of the 1990s but it hasn’t provided much
leadership for either global GDP or commodity markets
in recent years, and bad news stateside consequently
doesn’t create the same broad downside risks as it
once did. In the last three years, the so-called BRICA
economies—combining the largest emerging markets
and Middle East oil exporters—have accounted for about
40% of global growth, three-to-four times the US share
(Chart 1). Global trade patterns tell a similar story. A 6%
rise in Asia’s share of global imports since the start of the
decade, largely at the expense of the US (Chart 2), means
the latter is not as important for most areas as it was even
a decade ago (Chart 3).

I'm still not sold completely on the idea of decoupling, but I'm coming around.

I Agree with Krugman???!!!!!

I’m almost never censored at the Times. However, I was told that I couldn’t use the lede I originally wrote for my column following the 2007 State of the Union address, in which Bush made ethanol the centerpiece of his energy strategy: “Before the State of the Union address, there had been hints and hopes that President Bush would offer a serious plan to reduce our dependence on imported oil. Instead, however, he took refuge in alcohol.”
Well, anyway — the news on ethanol just keeps getting worse. Bad for the economy, bad for consumers, bad for the planet — what’s not to love?

There have been plenty of Krugman columns that the NYT could have censored; why this one?

Samuelson on Stagflation

Robert Samuelson is not my favorite economist, but this editorial at Real Clear Politics is a must read:

Naturally, no politician acknowledges the self-evident implication: that recessions, though unwanted and hurtful to many, are not just inevitable; sometimes they're also necessary to prevent the larger and longer-lasting harm that would result from resurgent inflation. Interestingly, many academic and business economists who have more freedom to speak their minds suffer the same deficiency. They treat every potential recession as a policy failure when it is often simply part of the business cycle. They thus contribute to a political climate that, focused on avoiding or minimizing any recession, may perversely aggravate inflation and lead to much harsher recessions later. The stagflation that began in the late 1960s and resulted from this attitude was indeed dreadful: from 1969 to 1982, inflation averaged 7.5 percent annually and unemployment 6.4 percent.

Samuelson points out that the Fed may be repeating the mistakes of the 70s:

Unfortunately, the Fed shows signs of overreacting to these pressures and repeating the great blunder of the 1970s. Underestimating inflation then, the Fed repeatedly shoved out too much money and credit in a vain effort to keep the economy near "full employment." Now, switch to the present. Again, the Fed has underestimated inflation. It expected the economic slowdown to suppress inflation spontaneously. But so far, the lower inflation hasn't materialized in part because, outside of housing, there hasn't been much of an economic slowdown.

I hope this doesn't mean that leisure suits will be making a comeback....

Lousy Stock Market

Stocks are in a bear market and no end is in sight. No, I'm not talking about the US stock market (via The Economist):

CHINESE investors had a rare opportunity for good cheer on Wednesday February 27th. The country’s two stock exchanges shrugged off Monday’s blues, when both indices dropped by about 4%, and gained a bit instead. Unfortunately Monday is far more typical of trading conditions in recent months in the country’s two markets, in Shanghai and Shenzhen. Despite the power of China’s interventionist government, the importance of maintaining appearances for the Olympics and the country’s relatively strong economic growth, China’s stockmarkets have been suffering from a protracted slide.

Shanghai is already down by more than a third since October last year. A fall of this severity, had it happened elsewhere, would have already prompted the word “crash” to circulate. But the collapse has sent out few tremors and little nervous talk. There are several reasons why this is so. Foremost, foreign participation in the Chinese market has been strictly curtailed. As a result global losses are limited and so news of the financial destruction that has accompanied the massive share-price losses has failed to stir interest beyond the country’s borders.

Almost exactly a year ago, the US market took a big hit that was blamed on a drop in the Chinese market. At the time, I said the two were unrelated; it would seem I was right. I wonder why this hasn't gotten more press?

Fear Itself

I think Holman Jenkins of the WSJ has been reading my essays. On February 13th, I posted an essay here called, Fear Itself. Today Jenkins has an editorial in the WSJ that echoes my thoughts:

We have nothing to fear but fear itself, a president once said, and thereupon embarked on a series of ad-libs some of which deepened and prolonged the country's depression.

Great minds think alike, right? Read the whole thing.

More Inflation

David Ranson of H.C. Wainwright & Co. Economics has an editorial in the WSJ today about commodities as a leading indicator of inflation:

The most timely figures come from the commodity markets, where prices are transparent and reflect conditions in the immediate present. Yet commentators tend to discount volatile data like energy and food prices when they assess the "underlying" rate of inflation. This is a big mistake.

Obviously, with commodity markets booming, that is not good news. Ranson provides a simple rule of thumb to estimate inflation:

There is a remarkable parallel between annual CPI inflation and the cumulative change in the price of gold measured from eight years before. A similar graph could be plotted for silver, and the parallel can also be seen in cross-section by comparing countries over time with varying degrees of currency instability.

Historical CPI data in the U.S. are complicated by occasional changes in the methodology the government uses to calculate the index. In the late 1990s, one of these changes reduced the reported inflation rate significantly. But taken as a whole, the relationship suggests my following rule of thumb to estimate CPI inflation at any time: Divide the percentage change in the gold price from eight years in the past by 80, and add three. This rule of thumb has largely worked over the past several decades. In the last eight years the price of gold has risen 225%. The rule therefore comes out with an answer that puts inflation a lot closer to 6% than 4%.

Thank goodness we include commodities in all our portfolios. It's the only way I know to protect yourself from inflation. Most advisors tell their clients that stocks are the only way to beat inflation over the long run. That is true over the very long term but the only way to protect yourself in real time is to own commodities.

Low Taxes and a Budget Surplus

HONG KONG (Thomson Financial) - Hong Kong on Wednesday posted its highest budget surplus on record for the year to March and unveiled tax relief measures to spur the economy in the coming year amid rising inflation and slowing global growth.

I guess they must have really high tax rates if they're running a surplus, huh? Well, not exactly:

Tsang said the government will cut income tax to 15 percent from April from the current 16 percent, while reducing corporate profit tax to 16.5 percent from 17.5 percent.

Well then they must spend a lot less than we do, right? Um, well not exactly:

Government spending as a proportion of GDP will increase to 19.2 percent in year to March 2009 from 15.9 percent in the current year.

In the US, federal spending as percentage of GDP has averaged roughly 20% over the last 40 years. It has ranged from 15.6% in 1950 to 22.9% in 1985. It fell to 18.4% in 2000 and is now roughly 20% of GDP.

So why are so many politicians saying that tax rates have to go up to close the deficit?

Fannie and Freddie

Via Bloomberg:

Feb. 27 (Bloomberg) -- U.S. regulators removed limits on the combined $1.5 trillion mortgage portfolios of Fannie Mae and Freddie Mac, enabling the companies to increase financing for the slumping housing market.

The asset caps, imposed in 2006 after the two largest mortgage finance companies revealed $11.3 billion of accounting errors, will end on March 1, the Office of Federal Housing Enterprise Oversight said in a statement today. The agency will still require the companies to set aside reserve capital that is 30 percent more than the usual minimum.

Fannie Mae just reported a $3.55 billion loss for the fourth quarter and now OFHEO thinks its a good time to let them buy more mortgages? Yeah, that sounds like a good idea.

Blind Bernanke

Fed Chairman Bernanke gave his semi annual testimony to the House Financial Services Committee today. His prepared statement seemed to concentrate more on growth than inflation (via Bloomberg):

The Fed ``will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks,'' Bernanke said in testimony to the House Financial Services Committee in Washington.

Bernanke did acknowledge in his testimony that inflation has risen, but he still thinks that inflation will moderate as economic growth slows. It is sad that we have a Fed Chairman who still believes that growth is what causes inflation. Inflation is always and everywhere a monetary phenomenon - something over which the Fed has direct control.

Most of the questioning from the clueless Congresspersons was concentrated on questions about regulating the lending industry. In his prepared testimony Bernanke said:

During the housing sector's expansion phase, increasingly lax lending standards, particularly in the subprime market, raised the effective demand for housing, pushing up prices and stimulating construction activity.

I suppose Bernanke thinks that the problem was created by lax lending standards and a lack of oversight by his predecessor, but anyone who doesn't make a living fixing the price of credit knows it was caused by artificially low interest rates. Rather than acknowledge the obvious, Bernanke and Congress will probably come up with more regulations that will only increase the cost and reduce the availability of credit to the same sub prime borrowers politicians were brow beating banks into lending to a few years ago.

This semi annual exercise in economic illiteracy is required by law; maybe we could pass a law requiring politicians to read something by Milton Friedman or Hayek or von Mises.

How Big?

The WSJ's MarketBeat Blog has an entry on Brazil overtaking China as the largest emerging market:

Brazil edged past China to become the largest emerging market in the world, as measured by Morgan Stanley Capital International’s emerging markets index. Brazil has a free-float market capitalization of $509.10 billion and comprises 14.95% of the index; China, $481.80 billion and 14.15%, respectively, according to MSCI, FactSet and Citi Investment Research.

That's interesting I suppose, but what really caught my eye was the market cap of these countries. Sometimes I think we forget how big the US market really is compared to some of these emerging markets. As a comparison consider the market cap of some of these US companies:

ExxonMobil $484 Billion
Microsoft $264 Billion
AT&T $215 Billion
GE $343 Billion
Walmart $206 Billion

As a further comparison consider that the market cap of the S&P 500 is roughly $13 Trillion. Yeah, that's a T.

New Orders for Durable Goods - January

New orders for durable goods fell 5.3% for the month of January, after a downwardly revised 4.4% gain in December. Economists were expecting a 5.1% decline.

Although weakening demand was seen in almost every industry, much of the decline was due to a drop in the number in aircraft orders. Excluding the 13.4% drop in transportation orders, new orders fell 1.6%. Orders for motor vehicles, electronics, and machinery were also significantly weaker, with a 0.8%, 2.7%, and 1.5% decrease, respectively.

Shipments increased 1.8% in January, following two consecutive monthly decreases.

See Full Report.

Tuesday, February 26, 2008

Home Prices Down Again

WASHINGTON (MarketWatch) -- Home values in the U.S. fell 8.9% in 2007, the largest decline in at least 20 years, Standard & Poor's reported Tuesday.
The Case-Shiller National Home Price Index fell 5.4% in the fourth quarter alone, S&P said.
"Wherever you look, things look bleak," said Robert Shiller, chief economist for MacroMarkets LLC and co-inventor of the index.
Prices in 17 of 20 major cities were lower at the end of 2007 than at the beginning, with eight cities falling in double-digits. After adjusting for inflation in other consumer prices, home prices were lower in all 20 cities.
For the fourth straight month, nominal prices in all 20 cities were lower than in the previous month.
The biggest annual declines were seen in the former bubble areas in Florida and the Southwest. Home prices in Miami were down 17.5% in the past year, while prices fell 15.3% in Phoenix and Las Vegas.

There is an argument to be made that the Case/Shiller index overstates the decline in prices but the trend is certainly down. Prices overshot on the upside and they will probably overshoot on the downside so this is probably not over yet. There is still a lot of inventory out there and it will take either a drop in prices or a long time to get it back to normal


WASHINGTON (MarketWatch) -- Producer prices soared in January, pushed higher by energy prices and the biggest increase in food prices in more than three years, government data showed Tuesday.
The producer price index climbed by 1% last month, the Labor Department reported. The closely followed PPI, which measures the rate of inflation at the wholesale level, had fallen 0.3% in December after having registered a jump of 2.6% in November.
January's core PPI, which excludes food and energy prices, rose 0.4%, driven by higher drug and car prices.
Year over year, the PPI is up 7.4% -- the fastest pace since 1981. Also on an annualized basis, the core PPI is up 2.3%.

Some will say that PPI rises don't necessarily get translated to rises in the CPI, but that is a position that is becoming harder to defend. What will the Fed do if faced with a slowing economy and inflation? I don't know yet, but my guess is that they will keep inflating. What choice do they have?

If the Fed raises rates to fight inflation, they will be faced with a severe recession. That may be what the US economy really needs but the Fed has shown no desire to take that path since Volcker did it in the early 80s. It will take more than this to push them in that direction.

US Consumer Confidence

US consumer confidence plummeted again in February, with the Consumer Confidence Survey conducted by the Conference Board reaching 15-year lows. The index fell by 12.3 points, to 75.0. Economists were expecting a reading of 82.0.

The expectations index fell sharply as well, falling from 69.3 to 57.9. The expectations index is at a 17-year low.

With so few consumers expecting conditions to turnaround in the months ahead, the outlook for the economy continues to worsen and the risk of a recession continues to increase- comments from Lynn Franco, director of The Conference Board Consumer Research Center.

See Full Report.

Producer Price Index - January

Wholesales prices soared in the month of January, stirring up fears of widespread inflation and complicating matters with the Federal Reserve and its monetary policy.

The PPI climbed by one full percent in January, due in part by a jump in food and energy prices. Core PPI, which excludes food and energy due to their volatile nature, also climbed 0.4%, indicating a broad, widespread inflationary trend. Economists were expecting the index to rise by 0.4%, and the core index to rise by 0.3%.

Year-over-year, the PPI is up 7.4%, the fastest pace since 1981. Core PPI is up 2.3%.

See Full Report.

Sam Zell

Sam Zell, real estate investor extraordinaire, was on CNBC's Squawk Box this morning and had some interesting comments about the housing market and the economy in general:

The US economy will avoid recession as the housing market begins to recover this spring, according to billionaire investor Sam Zell.

Speaking on "Squawk Box" this morning, Zell attributed much of the current economic troubles to fear-mongering and politicking by Democratic presidential contenders Hillary Rodham Clinton and Barack Obama.

"Obviously what we have going on is an attempt to create a self-fulfilling prophecy," said Zell, chairman of Equity Investments Group and owner of the Chicago Cubs, Chicago Tribune, Los Angeles Times and other companies. "We have two Democratic candidates who are vying with each other to describe the economic situation worse.

"The reality is that if you live on Wall Street and you're in the credit markets the world couldn't be worse. If you're a farmer and you're getting $25 for your wheat, you're having a great time. If you're a CEO and you've got a balance sheet that's bullet-proof, you're in a great position. This whole thing is way out of control, way out of hand."

Zell said that although he doesn't try to pick bottoms in markets he believes housing has hit its nadir and will turn around this spring as inventory clears out.

Zell closed the sale of Equity Office Properties last year about this time and that proved to be the top of the REIT market to the day (it was also the signal I used to liquidate most of our REIT positions) so Zell has some credibility especially when it comes to real estate. The only thing I disagree with Zell on is his take on Bernanke:

"I think he should be renewed when his term is up. I think one of the positives of the United States is having people in the position of the Federal Reserve (chairman) for long periods of time," Zell said.

"I think Bernanke's reduction in interest rates has been spot-on, because basically we're going to fix the credit markets by creating a big enough spread between the risk-free cost of capital and what's available so that greed overtakes fear and the game begins again."):

Of course, he's right about how we will fix the credit markets. That doesn't make it good policy.

Monday, February 25, 2008

Careful What you Wish For

All politicians claim to want to do something about our healthcare system. Those on the Democratic side tend toward the single payer model while those on the Republican side tend a litte more toward the market side. For those of you who believe that single payer government run healthcare is the answer, this article from the NYT is must reading:

One such case was Debbie Hirst’s. Her breast cancer had metastasized, and the health service would not provide her with Avastin, a drug that is widely used in the United States and Europe to keep such cancers at bay. So, with her oncologist’s support, she decided last year to try to pay the $120,000 cost herself, while continuing with the rest of her publicly financed treatment.

By December, she had raised $20,000 and was preparing to sell her house to raise more. But then the government, which had tacitly allowed such arrangements before, put its foot down. Mrs. Hirst heard the news from her doctor.

“He looked at me and said: ‘I’m so sorry, Debbie. I’ve had my wrists slapped from the people upstairs, and I can no longer offer you that service,’ ” Mrs. Hirst said in an interview.

“I said, ‘Where does that leave me?’ He said, ‘If you pay for Avastin, you’ll have to pay for everything’ ” — in other words, for all her cancer treatment, far more than she could afford.

Officials said that allowing Mrs. Hirst and others like her to pay for extra drugs to supplement government care would violate the philosophy of the health service by giving richer patients an unfair advantage over poorer ones.

Now that her cancer has spread, the health service is paying for Avastin. Of course, it may be too late for her. There is much more in this article that is disturbing. If you don't think the government has done a good job in other areas (infrastructure for instance) why in the world would you want the government to control the healthcare system? Please read the whole thing....

Bill Gross Channels Keynes

I have often commented here about Bill Gross' penchant for talking his book. Gross is the biggest bond manager on the planet and always seems to find a way to make his economic outlook favor the bonds he owns. Perpetually bullish is an understatement. In his latest Outlook, Gross seems to have lost his mind (and his copy of The Road to Serfdom) in praising Paul Krugman:

Economists, TV talking heads, (and yours truly) can be early or late to a party as well. I marvel at the seemingly countless number of "celebrity" experts espousing the continuation or even extension of wealthy tax cut, supply side, freer regulatory policies that have lost not only their potency but their constituency as we turn the corner into 2008. Describing these pundits as being "late" in recognizing the increasing threats that their laissez-faire ideology poses to the U.S. economy, would be more than generous. "Never" is more likely the reality. One economist, however, who while early is more than likely to guide future policy solutions is Paul Krugman, op-ed columnist for The New York Times. Long before he accepted his current assignment at the Times he was a world-respected economist at MIT, proposing revolutionary solutions for the Japanese recessionary malaise of the 1990s and writing a book in 1998 entitled The Return of Depression Economics. While his book’s title features the "D" word, the content proposed nothing of the sort, but simply referred to the fact that the crucial task of future policy would be to bolster demand as was the case in the FDR-driven 1930s as opposed to encourage supply which has been the case since the Reagan revolution. Although Krugman doesn’t comment, in my opinion, it’s not that Reagan was wrong – he was in fact brilliantly correct and timely in his supply-side revolution.

This is truly depressing stuff. What Gross advocates here are the very policies that produced the Great Depression:

The U.S. needs a Krugman "demand-based" fiscal package alright, but a $300-$500 billion permanent one, in addition to the proposed temporary package, because as mentioned in last month’s Outlook, as the system of modern day levered shadow finance slows to a crawl or even contracts at the edges, its ability to systemically fertilize economic growth must be called into question. But government writing checks for American consumers which then flow to foreign central banks is not the permanent solution; it only makes sense in the short-term as a life preserver. To provide a stable recovery path, government spending needs to fill the gap – not consumption. Public works programs, badly needed infrastructure repairs, as well as spending on research and development projects should form the heart of our path to recovery. Assistance for homeowners? That too – figure out a fiscal/regulatory way to stop the slide in housing prices and foreclosures but please – no traffic jams at the Wal-Mart checkout counter in 2009 and beyond.

These are also the same policies that produced a 15 year stagnation of the Japanese economy after their experience with bubble bursting.

Gross realizes the problem is one of monetary policy:

That pendulum, however, appears to have swung too far in the direction of the private market. But Krugman (and yours truly) was a tad early in his forecast for reversal I think, because of the failure to recognize the potency and the inventiveness of modern finance. Until recently, U.S. and therefore global demand has been driven by the ability to lower interest rates and extend credit to an increasing majority of Americans. Mortgages, auto finance, and credit cards were offered on increasingly liberal terms and continually lower yield and risk spreads because of Wall Street ingenuity and – importantly – the na├»ve endorsement of their black magic by rating services willing to sell AAAs for a fee. If you’re offered a new home with nothing down and nothing to lose, you’d take it and many Americans did. If you’re offered a new car with 0% financing for 5 years, you’d buy it and many Americans still do. Demand, as Krugman would likely retrospectively recognize, was bolstered and supported by innovative, securitized finance which in turn was nurtured by lax regulation and a belief that things could not go wrong – and if they did – that policy makers, both monetarily and fiscally oriented, would make things right. The repair, if needed, was labeled the "Keynesian compact" and it made for a deal with the American public: it would be OK to have free markets because policymakers know enough to prevent another Great Depression. Demand could always be stimulated with a combination of easy money/budget deficits. Prosperity in effect, was guaranteed.

The logical response to bad monetary policy should not be to compound the problem with bad fiscal policy. Gross falls back on the discredited policies of Keynes:

As Keynes theorized and then Krugman affirmed, when private demand falters, it becomes the responsibility of government to fill the breach. Because it likely will not do so effectively until after a new Administration is elected in late 2008, the U.S. economy and its somewhat coupled global companion will sleep walk for some time and a resumption of prosperity as we knew it will be dependent on reforms of monetary and fiscal policy resembling the 1930s more than our past decade. Better late than never.

I hope he's wrong. It was those policies, more than anything else, that prolonged the downturn that became the Great Depression. All we need is a modern version of Smoot-Hawley and we can get an exact replay. Gross even plays in that sandbox for a while but stops short of calling for import restrictions:

Some have even suggested – and with my somewhat grudging concession – that this package will help the Chinese economy more than ours. Americans will use the rebates to buy Chinese imports offered at Wal-Mart and the $150 billion will then wind its way inevitably back to Asian coffers....But government writing checks for American consumers which then flow to foreign central banks is not the permanent solution; it only makes sense in the short-term as a life preserver.

I have little respect left for Bill Gross and it is less today than yesterday.

Existing Home Sales

Feb. 25 (Bloomberg) -- Sales of existing homes in the U.S. fell last month to the lowest level in at least nine years, signaling the housing slump is deepening and will weigh on growth in 2008.

Resales declined 0.4 percent, less than forecast, to an annual rate of 4.89 million from a revised 4.91 million in December that was higher than previously reported, the National Association of Realtors said today in Washington. The group began record-keeping for this measure in 1999.

That's the big picture and of course it is not good news. However, there are glimmers - and just glimmers - in the details of the report. This report was better than expected; economists had been looking for a rate of 4.8 million. The median sales price fell 4.6% to $201,100. Falling prices will eventually entice buyers. In one other hopeful sign, single family home resales actually rose 0.5%; it was the condo market that really got killed - down 6.5%.

There are obviously still problems with the real estate market and it will be a long time before prices recover to the previous highs. From the perspective of the impact on the economy though, all we really need is for housing to stablize. We seem to be creeping closer to that point.

Friday, February 22, 2008

Free Lunch

In a conversation today about the auction rate market, a friend (who I'll refer to as The Economics Babe) made the observation that people really never seem to learn that there is no such thing as a free lunch. The auction rate market was full of free lunches as long as they lasted. Now that lunch carries a cost which The Economics Babe and I agree will be borne by all the parties involved.

The auction rate market looked like a good deal for everyone involved but especially the broker-dealers. This was not a true market. The broker-dealers who acted as underwriters were allowed to operate with little disclosure (via Bloomberg):

Regulators, who allowed the manipulation of bids and lack of information to persist even after two probes in the past 15 years, are now watching a $342 billion market evaporate at the expense of taxpayers.

Inadequate disclosure ``may have masked the impact of broker-dealer bidding on rates and liquidity,'' Martha Haines, head of the Securities and Exchange Commission's municipal office, said in an interview. ``The large numbers of recent auction failures, which are reported to have occurred due to a reduction in bidding by broker-dealers, appears to indicate those concerns were well founded.'' ....Along the way, New York-based Lehman Brothers Holdings Inc. was fined $850,000 in 1995 by the SEC for manipulating auctions conducted for American Express. Almost two years ago, 15 securities firms paid the SEC $13 million to settle claims of bid-rigging in auction-rate bonds. The banks neither admitted nor denied wrongdoing.

As usual, the brokers are the ones who benefited the most. The underwriters told issuers they could have a free lunch - long term bonds issued at the short term rate. Then they made sure they continued to collect those underwriting fees by propping up the market when there weren't enough bidders. Then they told individual registered reps they could have a free lunch too. If they sold auction rates as a money market alternative, they could get paid on cash balances that would have paid them next to nothing sitting in money market funds. Finally, clients were told they could have a free lunch by getting a higher rate than a money market with only slightly less liquidity.

In the end, all parties get what they deserve because of their greed. The underwriters will lose a steady source of income. The broker-dealers will get formal complaints when clients can't access money they need for other purposes. Brokers will be further penalized, probably by the SEC, for not properly explaining the risks of this "market". The clients will pay when they have to borrow to fund obligations for which the auction rate money was intended. The issuers (and taxpayers in some cases) will feel the pain in the form of higher rates, at least until they can refinance.

I suspect the issuers will actually pay twice. The part of the market that is failing badly now is the auction rate preferred market where leveraged muni funds borrow to purchase more bonds and pump up their dividends. If that market continues to fail, those leveraged funds may be forced to sell bonds into the same market where the issuers are trying to refinance. And that will mean higher rates than otherwise would have prevailed. Taxpayers lose again.

The lesson many people will learn from this is that Wall Street needs more regulation. That is the wrong lesson to learn. The market punishes those who forget the basic laws of economics. As the Economics Babe said this morning, "No Free Lunch", is the second thing you learn in Econ 101. There are inevitable tradeoffs in economics and if it seems like you are getting a deal too good to be true, you are probably right. All the players in this saga forgot that most basic of economic truths - and they should pay the price.

P.S. There were rumors in the market today about a potential bailout of the auction rate market. The details were murky, but if the Feds step into this market, an opportunity for everyone to learn a basic economics lesson (something that is sorely needed in this country) will be lost. A much better solution is to simply let the market work; something our politicians can't seem to bring themselves to do.

White Men Can't Dance

President Bush should have stayed least he claps in time.

Market Update

My latest market update is available at our website. Just click on the title of this post. Here's an excerpt:

On February 13th, President Bush signed the $168 billion economic stimulus package which he termed a “booster shot for our economy”. Will this rebate package prevent a recession? Well, I’ve been arguing that we aren’t in recession (more on that later) and won’t have a recession this year, but if we are headed for one, this sure won’t keep it at bay. Tax rebates have been tried in the past and have never produced the expected “stimulus”. These rebates are supposed to encourage consumer spending, but it has been shown that previous rebates were more likely to be saved than spent. And the same will likely be true of this one as well. And it’s not true savings either since the government will have to borrow the money for the rebates. Any increase in private saving will just be offset by increased government borrowing. Economic result? Zero.

Read the rest....

Here's the Helicopter

Thomas Nugent has an article at NRO titled,"Who's Flying this Helicopter Anyway?" In it he tries to dispute that the Fed has pumped up the money supply:

Now that the Fed has cut the target funds rate from 5.25 to 3 percent — a reaction to fears of an economic slowdown — the critics are out in force. The Fed, they say, has reverted to the easy-money days of the post-Y2K slowdown, when the stage was first set for the mortgage-market meltdown. They also say current Fed policy is inflationary, and to make their point they dust-off a decades-old analogy: Rather than merely tinkering with his various policy levers, they say the Fed chairman is out flying his helicopter, dumping bales of dollars on the economy.

There’s a big problem with this analogy, however. The Fed chair, be it Alan Greenspan prior to 2006 or Ben Bernanke today, has never been granted a pilot’s license.

Economists point to the monetary base as the source of the Fed’s power to increase or decrease the money supply. The monetary base has two components: currency in circulation (i.e., money in peoples’ pockets) and adjusted bank reserves. Thus, if the Fed chair were dropping dollars from on high, the act would be reflected in the statistics. There either would be a rapid expansion in adjusted bank reserves or an increase in currency in circulation.

And yet, today, neither is the case.

He uses charts of the change in the monetary base and M1 and finds no reason to believe the Fed is dropping money on the economy. I beg to differ. The best definition of money available from the Treasury is MZM and that shows a somewhat different picture:

You shouldn't cherry pick your data Mr. Nugent.

Something from Nothing

Frank Shostak, and adjunct scholar at the Mises Institute, has wonderful primer on the fallcies of Keynesian economics posted at the Mises Blog. If you ever wondered why some of us have a problem with Keynes, just read this paragraph:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course by tendering for leases of the note-bearing territory), there need be no more unemployment and with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.[2]

Why exactly would the performance of a useless activity increase wealth? This is just ridiculous. Shostak's article uses clear thinking to demolish the logic (or rather the lack thereof) of the current "stimulus" plan.

Thursday, February 21, 2008

Searching for the Silver Lining

Irwin Stelzer apparently believes, as I do, that those calling a recession may be jumping the gun:

We know three things, or think we do. The first is that credit is more difficult to come by, both for businesses and consumers. Not because interest rates are unattractive to borrowers, but because lenders have gotten pickier about whose IOUs they are prepared to accept. Second, we know that the housing sector is in almost terminal disarray, with foreclosures and inventories of unsold units rising, and prices falling. Finally, we know that the U.S. economy is, at minimum, slowing, and possibly already in recession. Hence the investment bankers' demands for "more": Ben Bernanke must cut interest rates, and the president must meet the demands of Senate Democrats to enhance the $168 billion stimulus package he signed last week.

Really? Consider each of those certainties in turn. To those who moan about a credit crisis, Warren Buffett, the legendary sage of Omaha, has this to say, "Money is available and it's really quite cheap." What he calls the "dumb money" might have stopped chasing risky investments, but cash is readily available for sound deals and to sound creditors.

He cites a few people who should know about the health of the economy - actual business people rather than Wall Street gurus and economists:

But who are we to believe--the economists and pundits who see gloom and doom, or the businessmen on the sharp end of the economy, producing and selling things? Jurgen Hambrecht is CEO of BASF, a giant manufacturer with 90,000 employees and sales of well over €50 billion, garnered by selling hundreds of thousands of products to a wide variety of industries. He tells the press that he does not foresee a U.S. recession, and that "I am glad to say that business in general does not show the panicking approach of the financial industry. . . . I am sleeping well at night." Hambrecht is not alone. Executives at General Electric, Honeywell, Procter & Gamble, Kraft Foods and the owner of this publication, News Corp, are among the many who claim that their businesses have never been better, that sales and profits are up, and that bookings are strong. The more cautious add, "so far."

Read the whole thing. He's also got a piece in there about why home prices may not be falling as much as some believe.

Pumped Up

This article from The Economist attempts to explain the continued rise in commodity prices, even as economic growth slows:

BANKERS and policymakers may be wringing their hands about the prospects for the world economy, but commodities traders, it seems, see no cause for concern. On Wednesday February 20th the oil price hit a new record of $101.32 a barrel. Soyabeans and platinum, among others, have also reached record prices in the past week. Vale, a Brazilian mining firm, has persuaded some steelmakers to pay as much as 71% more this year for its iron ore. Across the world the inflationary impact is tangible. In America consumer prices in January were up 4.3% on a year-over-year basis. Excluding food and energy, they were up 2.5%, well above the Federal Reserve’s comfort level.

The bull market in commodities is getting a little frothy and most of the reasons advanced in this article, in my opinion, don't answer the question. The answer, as with so many bull markets of recent years, lies in Federal Reserve policy. With China's currency tethered to the dollar, monetary easing in the US has the effect of pumping up demand in China. And that is driving the price of a lot of commodities higher. The article mentions another monetary policy cause at the end:

Nonetheless, the prospects for demand must have diminished at least somewhat as the world economy has slowed, and the outlook for supply has not worsened dramatically in the past few months. Hence some other factor must be at play. Many analysts blame speculation. As falling interest rates, tumbling stockmarkets and contracting house prices drive investors out of bonds, equities and property, the argument runs, there is lots of money looking for a new home. And since commodities have produced such lavish returns in recent years, and have weathered the recent turmoil relatively unscathed, they are an alluring option.

Citigroup believes that the recent rise in the oil price “is driven principally by a sharp uptick in fund flows.” Lombard Street Research sees an “iron bubble”. Others worry that America’s fiscal stimulus may cause trouble by inflating demand for commodities. In Citigroup’s cheery phrase, “the collapse of one bubble often sows the seeds of the next.”

Money flowing out of low yielding assets into higher yielding ones is called disintermediation - a fancy way of saying that individuals chase performance. I wonder how Citigroup will manage to lose money in this bubble...

Leading Economic Indicators

TThe composite index of leading indicators is used to predict the direction of the economy's movements in the months to come. The index is made up of 10 economic components, whose changes tend to precede changes in the overall economy. The ten components are:

1. the average weekly hours worked by manufacturing workers
2. the average number of initial applications for unemployment insurance
3. the amount of manufacturers' new orders for consumer goods and materials
4. the speed of delivery of new merchandise to vendors from suppliers
5. the amount of new orders for capital goods unrelated to defense
6. the amount of new building permits for residential buildings
7. the S&P 500 stock index
8. the inflation-adjusted monetary supply (M2)
9. the spread between long and short interest rates
10. consumer sentiment

For the month of January, the Conference Board reported a decline in the US index of 0.1%. The index declined for the fourth straight month, continuing its downward slope from its high back in July 2007. The index has fallen 2.0% (4.0% annualized) since that high.

4 of the components were positive for the month. The biggest contributor was real money supply. This, of course, makes a lot of sense, considering the fact that the Fed is cutting rates with the sole purpose of injecting more money into the economy. Consumer expectations as a positive component was a surprise, though, as past reports have refuted this claim. Might this be indicating a shift in the consumer psyche, from one which is solely negative to one which is preparing for a brighter future?

Stock prices and building permits were the top two negative contributors. Average weekly hours and new orders for consumer goods held steady.

See Full Report.

Initial Jobless Claims- Feb 16

First-time claims for state unemployment benefits declined by 9,000 in the week ending February 16, the Labor Department reported. Total number of filings were349,000, compared to an upwardly revised 358,000 the previous week. Jobless claims were revised from a decrease of 9,000 to an increase of 1,000 in the week ending February 9.

The report on the health of the labor market was worse than expected. Economists had expected claims to fall to 345,000 for the past week. The 4-week moving average, a less volatile measure which smoothes out any discrepancies, like a strike or weather-related incidents, rose by 10,750 to 360,500. Readings consistently higher than 350,000 is usually indicative of a weakening labor market, which tends to point to a recession.

See Full Report.

Wednesday, February 20, 2008

Residential Construction- Jan

Housing starts for the month of January rose slightly, by 0.85%, to a seasonally-adjusted annual rate of 1.01 million. This data follows a downwardly revised 14.8% decline in the previous month. Economists' estimates were in-line with the Census Bureau report.

Single-family housing starts fell by 5.2% in the month, but starts on buildings with two or more units rose an astonishing 22.3%.

Regionally, the Northeast and the Midwest were hotspots for housing starts, with an 18.9% and 12% gain recorded for each. The South and the West, where the housing boom was the biggest, saw a decline of 2.9% and 6.2%, respectively.

Building permits, a sign of future construction, fell 3.0% in January. Permits fell to 1.08 million, its lowest level since November 1991.

See Full Report.

Consumer Price Index- Jan

US consumer prices continued their rise into the new year, as inflationary pressures maintained its grip on the economy and on the individual's wallet. Consumer prices rose a seasonally-adjusted 0.4% in January. The gain was mostly attributed to a 0.7% rise in both food and energy prices. Economists were expecting a 0.3% gain.

Core CPI was also up an alarming 0.3% for the month. Since core CPI strips out the more volatile measures of energy and food, a gain of 0.3% is not a good sign. Prices paid for medical care rose 0.5%, while prices for apparel were up 0.4%. Education and communication costs were up 0.4%

In the last year, the consumer price index is up 4.3%, while the core CPI is up 2.5%.

See Full Report.

Tuesday, February 19, 2008

That's a Downer

LONDON (Reuters) - It's no fun at parties, but when it comes to investing being depressed just might help.

Fund managers, like so many of us, consistently think they are smarter than they are and that their ideas are of an unusually high quality. And to keep thinking these reassuring thoughts, they ignore evidence that contradicts their beliefs while paying rapt attention to data or news that confirms their own biases.

But not the depressed, whom multiple research studies have shown to have a more accurate and realistic view of their own abilities and insights, according to James Montier, a strategist at Societe Generale who specializes in behavioral finance, the study of how emotion and thinking patterns influence economics and investment.

If they have "more accurate and realistic views" of themselves and they're depressed...well maybe they have reason to be depressed? I guess that isn't the point, but I found this idea interesting. I think they've got the wrong emotion though. Why couldn't one have a realistic and skeptical view and also be happy? I've spent a lifetime as a skeptic and I'm generally happy with my life. I'd like a flatter belly...hell a six pack...but that would involve working out which isn't at the top of my list of favorite activities. But I'm happy anyway. I have a realistic view of the likelihood that I will work out regularly. And I'm skeptical that if I start a workout program that I will stick with it. I'd like to think I'm a pretty good investor too... or is that just my unrealistic view of my own capabilities? Damn, I hope not. Now that would be depressing.

The emotion that best describes a good investor I think is...well...actually a good investor is emotionless - at least when it comes to investing. Investing shouldn't have anything to do with emotion except to determine when other investors are acting emotionally so one can take advantage them. Otherwise, it is best to maintain a passion only for knowledge and information. The information is only useful if one has the knowledge to interpret it and act without emotion or bias. I'm not sure why Societe Generale needed a behavioural economist to tell them that. Maybe their money would have been better spent on a decent trade surveillance system.

McCain and the Fed

John McCain, presumptive nominee of the Republican party, has said that he doesn't understand economics and in this interview with Bloomberg, he proves it.

Feb. 17 (Bloomberg) -- Republican presidential candidate John McCain said Federal Reserve Chairman Ben S. Bernanke should have been quicker to cut interest rates to try to avert a recession.

``I personally would have liked to have seen those rate cuts earlier,'' McCain said today on ABC's ``This Week with George Stephanopoulos.'' ``That doesn't mean I want him fired, it doesn't mean I've lost confidence,'' McCain said.

I don't know how many times I have to repeat this but the cure for excessive credit is not more credit. While that may seem apparent to the average person, politicians (and the Fed for that matter) just don't seem to get it.

McCain does go on to say some things I agree with:

He said Bush allowed $35 billion in funding for pet projects, called earmarks, to be included in the budget over the last two year, money McCain said he would have cut.

McCain also pledged not to raise taxes if elected.

``No new taxes,'' McCain said. ``I could see an argument, if our economy continues to deteriorate, for lower interest rates, lower tax rates, and certainly decreasing corporate tax rates, which are the second-highest in the world.''

McCain said he also supports reducing government spending.

``Spending restraint is why our base is not energized,'' he said. ``Spending restraint is why we are having to borrow money from China.''

I'd love to see some spending restraint and lower taxes, especially corporate taxes. Unfortunately, I think the odds of that are pretty low, no matter who is elected.

Friday, February 15, 2008

Consequences of a Weak Dollar

WASHINGTON (Reuters) - U.S. import prices rose 1.7 percent in January, powered by higher prices for oil, while export prices increased 1.2 percent, the largest rise since January 1989, a U.S. government report showed on Friday.

All those people out there that believe we can devalue the dollar and close the trade deficit, here's the evidence of why that will never happen. Import prices are rising faster than export prices and we still import more than we export. Basic math tells me that closing the trade gap through a devalued dollar will be almost impossible. The volume rise in exports required to offset the rise in import prices is just too much to overcome. The only way to close the trade deficit is to reduce the volume of imports while maintaining (or increasing) the volume of exports. That won't happen through trade restrictions - what partner will allow us to restrict their exports to us while welcoming our exports to them?

The better question is why should we want a trade surplus? It seems such a simple thing; we should want to sell more stuff than we buy - but concentrating on the trade deficit as a measure of that is ridiculous. If we sell more stuff than we buy - as a country - that would imply that we are consuming less than we produce and are therefore saving and investing the difference. That's good. But does it matter whether we sell our stuff to foreigners or to our own citizens? I submit that it makes no difference whatsoever and therefore the trade deficit is meaningless. What matters much more when talking about deficits is the budget deficit of our government. That is real money that must be borrowed. A trade deficit in and of itself does not imply indebtedness.

International Capital Flows

The Treasury Department released its monthly report on cross-border financial flows for December today. Here is a quick recap-

Net foreign purchases of long-term U.S. securities were $69.1 billion. Of this, net purchases by foreign official institutions were $35.8 billion, and net purchases by private foreign investors were $33.3 billion.

Of the $69.1 billion, 48% was invested in US equities. What does it mean? Do foreign investors believe US stocks are now cheap enough to further invest in? Maybe...

Foreign holdings of dollar-denominated short-term U.S. securities, including Treasury bills, and other custody liabilities increased $34.2 billion. Foreign holdings of Treasury bills increased $15.5 billion.

Monthly net treasury international capital flows were positive $60.4 billion. Of this, net foreign private flows were positive $8.4 billion, and net foreign official flows were positive $52.1 billion.

In a nutshell, foreigners are stockpiling on short and long-term US securities, and have been for years. Year-over-year, net foreign purchases of long-term US securities were more than $1 trillion, while foreign securities purchased by US residents were a negative $223.5 billion.

Read Full Report.

US Industrial Production

US industrial production (output of the nation's factories, mines, and utilities) gained 0.1% for the month of January, following an upwardly revised gain of 0.1% in December. The news, released by the Federal Reserve today, was in-line with what economists had expected.

Of the three major industry groups, utilities output increased 2.2%, while output at mines decreased 1.8%. Manufacturing output remained the same.

In the past year, industrial production increased 2.3%.

See Full Report.

January Import/Export Prices

US import prices for the month of January rose a larger than expected 1.7%, with rising oil and food prices accounting for most of the gain. Economists were expecting an increase of 0.4%.

Petroleum prices increased 5.5% in January, and have increased a staggering 66.9% over the past year. Imported food prices rose by 3.1%, the largest gain since March 2005.

US export prices, meanwhile, rose 1.2% for the month, the most since January of 1989. This was helped by record prices for food and agricultural products. In January, agricultural export prices rose 5.0%, while food and beverage export prices increased 5.6%. Over one year, export prices are up 6.7%.

See Full Report.

NY Fed Manufacturing Report

The Empire State Manufacturing Survey is a monthly economic report put together by the Federal Reserve Bank of New York detailing business conditions in the region. For the month of February, the report points towards a substantial slowdown in NY manufacturing activity.

The general business conditions index fell 21 points, to a negative 11.7 reading. Anything below zero indicates contraction in the business sector. The new orders, shipments, and employment indexes all fell into negative territory as well. The prices paid index, up for a second consecutive month, is at a one-year high.

Read Full Report.

Thursday, February 14, 2008

Auction Rate Securities, Part II

I posted an article earlier about the auction rate market failures. Today I spoke with the bond traders at Fidelity about the possibility of purchasing some of these securities. One example was a bond issued by a hospital in Colorado Springs that was available at a rate of 10%. The ultimate maturity on these bonds is 2030 and while the bonds are insured by AMBAC, the underlying credit is A-. 10% for A- rated long term tax free bonds is a damn good deal. I also talked with a doctor client in Colorado who is familiar with the hospital. It is a relatively new 200 bed hospital owned by the city.

I didn't buy this issue today because there are more disruptions to come. A large part of the auction rate market are preferreds issued by closed end muni funds. These funds borrow in the auction rate market and purchase long term bonds with the proceeds. If they can't get funds at the auctions, they will be forced to liquidate part of their portfolio. We may be able to find bargains in the straight muni market soon.

There is nothing wrong with this paper. The problem is that the underwriters who routinely bought anything that didn't get purchased at auction are now constrained and cannot support the market. I know of at least two firms that have told their brokers that auction rates cannot be purchased. So we're going to have some forced selling by the leveraged muni closed end funds and brokers are being told not to bid at the auctions. There is a lack of liquidity in the market. Those who can provide some liquidity will be able to find major bargains. I'll be looking at closely at these for clients in the next few weeks.

BankUnited's Blacklist

The South Florida Business Journal is reporting that BankUnited has blacklisted some condo projects:

Interested buyers looking for mortgages to buy units in Miami's Opera Tower, Everglades on the Bay or Four Ambassadors shouldn't bother approaching BankUnited. The Miami-based bank has included them on a list of 191 condo projects it won't write loans for.

The Business Journal obtained a list of "non-permissible" projects used internally at BankUnited (NASDAQ: BKUNA) and updated as of Jan. 14. Most of the forbidden properties were in Miami and were added at the last update. It wasn't clear who at the bank wrote the list, but the author stated a reason for almost every project declared off-limits.

If BankUnited won't lend on condos in these projects and other lenders follow suit, these projects will likely fail. Banks that lent to developers on these projects are about to own some condo towers. Its just another step toward the bottom of this market. This happened in the 80s as well and there were bargains for years. It'll probably take even longer this time.

Government Math

But administration officials are counting on a lift this summer from the $168 billion economic stimulus package that Congress passed last week and from the Federal Reserve’s recent decisions to reduce short-term interest rates....

Mr. Lazear rejected proposals by Democrats to offer an additional 13 weeks of unemployment benefits, for a total of 39 weeks, to people who lose their jobs. He said it would be unprecedented to extend jobless benefits at a time when the unemployment rate is only 5 percent, and he predicted that the stimulus package would create an additional 500,000 jobs this year.

$168,000,000,000/500,000 jobs = $336,000/job

And this is a stimulus plan? Just goes to show how much politicians want to avoid a recession in an election year.

The Investment Slowdown

Stephen Moore doesn't think the economic "stimulus" package will work because it targets consumers rather than investors. Hmm, where have I heard that before?

Yesterday, President Bush signed into law a $170 billion bipartisan "stimulus" package of tax rebate checks and housing subsidies to try to steer the economy clear of recession. The ink is hardly dry yet and Democrats are now agitating for a second "stimulus," in the form of infrastructure spending and welfare payments such as food stamps and longer unemployment benefits. All of this government check-writing is on top of the $3 trillion the federal government is already scheduled to spend this year.

Unfortunately, neither of these "free money" stimulus plans are likely to solve the nation's economic woes -- just as a similar economic rescue package of tax rebates and spending programs failed in 2001, the last time the economy slid into recession.

The current mortgage meltdown closely resembles what happened after the technology industry bubble burst at the end of the Clinton years. What Congress failed to understand, now as then, is that America is suffering from an investment slump driven by falling asset values, not a Keynesian consumption drought.

He points out the effects of the second of Bush's tax cuts which were targeted to capital:

The investment tax cuts had two positive effects on the economy. First, almost from the day the tax cuts were enacted the stock market capitalized the value of the lower taxes on corporate profits and capital gains. Within months, the Dow Jones Industrial Average rose nearly 10%. And, we now know, the investment slump was converted into an investment boom. Business capital spending, down 4.8% in 2001 and 6.1% in 2002, surged in 2004 by 7.4% and in 2005 by 9.5%. It was this investment spurt that financed job and GDP growth in recent years. In short, what we experienced was a classic supply-side recovery.

And he quotes Michael Darda about what may be inhibiting capital investment:

Why is investment declining? One explanation is that firms and investors know that there is a tax hike on the way when the Bush tax cuts expire in 2010. "The two big negatives for investment loom on the horizon," says economist Michael Darda, "higher tax rates and higher inflation due to easy money." Mutual fund data from the fourth quarter of 2007 confirm that a weak dollar and the risk of higher taxes are pushing capital overseas.

As Moore points out in the last paragraph, Say's Law tells us that consumption is dependent on production, not the other way around. Maybe someday politicians will learn but I'm not holding my breath.

Contrarian Indicator

Now here's the first really cheerful news we've heard from the stock market in quite a while: Big institutional money managers are miserable.

They are fearful, unhappy, and hoarding cash in case the market collapses still further. That's according to the latest monthly Merrill Lynch survey of fund managers world-wide.

"Fund managers and asset allocators are the most risk averse in more than seven years," reports Merrill on Wednesday. "A net 41% of fund managers say that they are overweight cash -- a level last seen in the aftermath of the '9-11' terrorist attacks. … Investment time horizons have almost shrunk back to extremes last seen in March 2003, while the number of investors adopting risk-averse investment strategies has hit new highs."

Merrill calls this "an unprecedented combination of high cash levels and low risk appetite."

This is a pretty good contrarian indicator. If these guys are sitting on cash, that means they've already sold. From a contrarian standpoint that means a lot of the big money is already out of the market - and will have to get back in at some point. This isn't a timing indicator though; there is no way to know when they'll start buying or what will trigger it.

Jobless Claims

Jobless claims for the week ending February 9th fell for the second consecutive week. Claims fell by 9,000, to 348,000, from an upwardly revised 357,000. The 4-week moving average rose 12,000, to 347,250. It's the highest level since October 2005.

John Ryding, the chief US economist for Bear Stearns, marked 375,000 as recession territory for the 4-week moving average. Anything above 350,000 usually signals weakness in the labor market.

US Trade Report - December

The US trade deficit decreased by 6.9% in December, according to a report released by the Commerce Department today. It fell to $58.8 billion, the largest monthly drop in the deficit since October 2006. Economists expected a number closer to $61.6 billion.

Exports rose 1.5%, to a record high of $144.3 billion for the month of December. Imports, on the other hand, decreased $2.2 billion, or 1.1%, to $203.1 billion. Imports dropped for the first time in 4 months, suggesting a slowdown in consumption.

For the year, the US trade deficit fell by 6.2%, to $711.6 billion, from a record $758.5 billion in 2006. We haven't seen a decline in the trade deficit since 2001.

See Full Report.

Auction Rate Securities

The auction rate security market has seized up and investors who bought these securities as cash equivalents are discovering that they own securities they don't understand and can't get rid of:

When M. Brian and Basil Maher sold their family's shipping business last July for more than $1 billion, they quickly put the money in a safe place.

Or so they thought.

The two brothers handed much of it to Lehman Brothers Holdings Inc. with marching orders to make only the most conservative, cashlike investments. Within weeks, however, they had lost access to more than a quarter-billion dollars.

"We didn't think we were taking risks," says Brian Maher, 61 years old. "We read about all the troubles in the credit markets and said, 'I'm glad we're not invested in that stuff.' It turns out, we were."

What are auction rate securities? Auction rates are long term bonds with variable interest rates that reset at regular auctions. As such many brokers and investors considered them short term cash equivalents. Unfortunately, these securities have long term maturities and if no one shows up for the auction, holders are left with long term securities.

Why do brokers sell these securities? That's simple; brokers make almost nothing on money market funds; usually only a few basis points. Auction rates allow brokers to increase their income on cash holdings to about 25 basis ponits. In the case cited in this WSJ article, because of the amount of money involved, it is a signficant difference.

I expect to see more cases like this as clients discover that brokers are not acting in their client's interest but rather their own. The Maher's have filed a claim against Lehman:

In their claim, the Mahers are demanding their $286 million back from Lehman, along with interest, and are seeking punitive damages of up to an additional $857 million.

As for what they learned about investing, "It's about trust," says Brian Maher. "We entrusted our money to Lehman believing them to be looking out for our best interests."

The mistake the Maher family made is brilliantly exposed in that last sentence. Brokers are not looking out for your best interests. As a Registered Investment Advisor, I have a fiduciary duty to my clients. Brokers have no such responsibility.

Wednesday, February 13, 2008

Fear Itself

The first paragraph of FDR’s first inaugural address contains the famous line about fear:

“I am certain that my fellow Americans expect that on my induction into the Presidency I will address them with a candor and a decision which the present situation of our people impel. This is preeminently the time to speak the truth, the whole truth, frankly and boldly. Nor need we shrink from honestly facing conditions in our country today. This great Nation will endure as it has endured, will revive and will prosper. So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance. In every dark hour of our national life a leadership of frankness and vigor has met with that understanding and support of the people themselves which is essential to victory. I am convinced that you will again give that support to leadership in these critical days.”

I read this entire speech today and another quote comes to mind:

“The more things change, the more they stay the same.”

I have no idea who first uttered that phrase but I’m almost certain it was a reference to politicians. The politicians of today would feel perfectly comfortable debating economic policy in 1933. The solutions offered for our current economic problems are not materially different than those offered by FDR in this first of many speeches as President.

Faced with an economic slowdown at a perilous time, an election year, our current day politicians feel, as FDR did, that “this nation asks for action, and action now”. And so they have enacted an economic “stimulus” package that promises, as FDR’s programs did, an economic recovery “by engaging on a national scale in a redistribution”. The current redistribution differs only in details from the plan put forth by FDR to end the Great Depression. The myth that government can redistribute resources in our economy and cause growth is apparently one that has endured for many generations.

FDR’s redistribution involved a movement of people from cities back to the farms and “definite efforts to raise the values of agricultural products and with this the power to purchase the output of our cities.” FDR sought to redirect capital – in this case human capital – to areas that produced a lower return on that capital. Today, our politicians seek to redirect capital from producers to consumers in the mistaken belief that the path to prosperity is to be found through consumption rather than investment.

The Great Depression has been blamed by many on faulty monetary policy, most notably by the current Chairman of the Federal Reserve. Monetary policy is said to have been too accommodative in the 1920s and too restrictive in the 1930s. Mr. Bernanke has endeavored to do his part to prevent a repetition of those faulty policies by cutting interest rates aggressively. However, even FDR realized that there is a faulty logic at work here:

“Faced by failure of credit they have proposed only the lending of more money.”

Our economy, much like the one of 1933 America, is at a crossroads. Years of excessively accommodative monetary policy has produced a society that believes, as Ludwig von Mises said that “more credit expansion is the only remedy against the evils inflation and credit expansion have brought about”. If the US continues down this path to a virtual debtor’s prison, there will come a time when monetary policy is no longer effective in limiting the periodic slowdowns that are a necessary part of a healthy economy. When that happens we will face a decision much like the one that faced America and FDR in 1933.

Monetary policy had a great deal to do with getting us into the economic mess that became the Great Depression. However, it was governmental interference in the normal functioning of the economy that prolonged that routine economic contraction into the Great Depression. Speaking of economic recovery FDR said: “It can be helped by preventing realistically the tragedy of the growing loss through foreclosure of our small homes and our farms. It can be helped by insistence that the Federal, State, and local governments act forthwith on the demand that their cost be drastically reduced. It can be helped by the unifying of relief activities which today are often scattered, uneconomical, and unequal. It can be helped by national planning for and supervision of all forms of transportation and of communications and other utilities which have a definitely public character. There are many ways in which it can be helped, but it can never be helped merely by talking about it. We must act and act quickly.”

It is this idea that government must act to generate economic growth that we should fear. Just as FDR did in the early phase of the Depression, our politicians want to protect citizens from the consequences of their bad economic decisions. There is real pain involved in the unwinding from the excessive debt that plagues our economy, but the blame for that pain lies not with the businesses that merely followed the economic incentives provided by the Federal Reserve. The blame for that pain should be placed squarely on the shoulders of Alan Greenspan and his successor at the Federal Reserve. Sharing the blame should be politicians who enact policies solely because they fear the retribution of voters. Neither the Fed nor the Congress is acting in our best interests. They are acting in their own best interests, consequences to the long term health of our political economy be damned.

The US economy is a resilient system that depends on innovation and the creative destruction that is inherent in capitalist systems for growth. Left alone, the US economy will recover from the current credit crunch because we are a nation of optimists who find opportunity even in times of economic distress. A Federal Reserve that confronts every economic downturn with a dose of monetary elixir merely short circuits the process. Likewise, fiscal policy aimed at anesthetizing the public to the economic cycle merely prolongs the pain.

The only thing we have to fear is fear itself. Fear of capitalism. Fear of the normal economic cycle. Fear of ending our addiction to debt. Fear of allowing investors to face the consequences of their risky actions. Fear of the competitive nature of free trade. Fear of immigrants who come to this country with a work ethic we seem to have forgotten. If, and only if, we can overcome these fears will we reform our dysfunctional monetary system and start to repair the damage done to our economy.

January Retail Sales - Good news!?!?

Retail sales in January rose more than expected, up 0.3% for the month, after declining 0.4% in December. Economists had expected a drop in sales by 0.3%. Excluding the purchase of autos, retail sales were still up 0.3%, in line with expectations.

Auto sales rose a surprising 0.6% for the month, while gas purchases rose 2.0%. If you exclude both from the calculation, retail sales remain unchanged. Clothing, food and beverage, and health and personal care stores also reported strong sales.

Every other category was in the red. Hardest hit were department stores (-1.1%), building materials (-1.7%), and electronics and appliance stores (-1.0%).

See full report.

No Laffing Matter

Arthur Laffer deconstructs the "stimulus" package on the pages of the WSJ this morning. He thinks it will do more harm than good and explains it in a way that anyone can understand. Taking money from a group that saves and invests and giving it to a group that is likely to spend it sounds good for the short term but the longer term effects are negative.

But even though the income effects net to zero, the substitution effects accumulate, and they accumulate in a most unpleasant way. This should be obvious to even a person untrained in economics. Ask yourself why not a $40,000 rebate per person, indexed for inflation of course, if a $600 rebate is so good. Heck, why don't we give rebates equal to GDP, so that everyone who doesn't work and doesn't produce receives everything, and all those who do work and do produce receive nothing?

GDP would go to zero in a New York minute if workers and producers got nothing for their work effort. And, as fate will have it, any rebate will reduce output because it reduces incentives to produce output. The larger the rebate, the greater the reduction in the incentives to work and the greater the reduction in output. It's as simple as that. This $170 billion rebate camouflaged as economic stimulus will deal a serious blow to the economic health of the country.

But there's also collateral damage. Few in Congress understand or care. They think their actions either don't matter or that they would see a positive impact from their actions if only they did more. If the economy worsens and when their political sensors become alarmed, they'll up the dose, and goodness knows just how far this vicious cycle will take us. A quick glance back at the 16 years of presidencies of Lyndon Johnson, Richard Nixon, Gerald Ford and Jimmy Carter should give you pause. Whenever you observe bipartisan cooperation, hold on to your wallet and run to the basement.

I never watched That Seventies Show because I lived through that miserable time. I don't think I'll like the sequel any better than the original.

Tuesday, February 12, 2008

GM Earnings

NEW YORK ( -- General Motors posted better-than-expected financial results for the latest quarter, but indicated that its efforts to shave costs are not behind it as the automaker offered lucrative buyouts to 74,000 employees - its entire U.S. hourly workforce.

The nation's largest automaker reported improved fourth-quarter results from its overseas auto operations, which helped to balance out continued losses at its North American plants. But problems at finance unit GMAC, of which it still owns 49%, coupled with large charges taken in the third quarter related to tax credits, left GM with a company record $38.7 billion net loss for 2007.

If you strip out all the charges, GM reported a profit for the quarter. Is it possible that GM has actually turned the corner? GM is desperately trying to cut costs but the union contracts make it very expensive. And the cost cutting is just a survival technique. Ultimately, GM will need to design cars that people actually want to drive - something they haven't been particularly successful at lately.

That's Too Bad

TORONTO (Reuters) - A major outage hit BlackBerry users in North America on Monday, cutting off wireless e-mail for everyone from busy executives to political campaign staff on the eve of three U.S. presidential primaries.

The problem, which BlackBerry owner Research In Motion described as a "critical severity outage" affecting users in the Americas, once again raised concerns about the stability of the e-mail service 10 months after a widespread crash last April.

I must admit to a little schadenfreude about this. How fricking important do you have to be that you can't wait to get to your computer to check your email? Maybe blackberry users will actually be able to engage in a conversation - at least for a while.

Buffet's Offer to Bond Insurers

CNBC is reporting that Berkshire Hathaway's new bond insurer is offering to reinsure municipal bonds for the existing bond insurers. There are no details available yet about the deal, but this seems a better deal for the investors in insured munis than the bond insurers. MBIA and the other bond insurers are in trouble because of CDOs they insured that are turning out to be basically worthless. Their muni bond business has always been solid. A muni bond insured by MBIA is now trading as if the insurance didn't exist (who really thinks MBIA could pay off in the case of a default?) so existing owners of those bonds would certainly benefit. How the bond insurers themselves would benefit is a little more murky. I'll post more details when they become available.

You really have to give Buffet credit on this. He's a hell of a businessman. He set up this company after the bond insurers got in trouble and if they fail, he will get all future business in the muni bond insurance business. By making this reinsurance offer he is attempting to get some of the existing business as well. Investors will push the bond insurers to accept but if I were them, I'd pass. Why give away their good business? If they accept, they will have written their own death sentence.

Monday, February 11, 2008

France's Second Largest Bank to Sell Shares At A Discount

Societe Generale, France's second largest bank, will raise $8 billion by selling stock in a rights offer, with the purpose of replenishing working capital. A rights offering involves the raising of capital by giving existing shareholders the right to purchase new shares in proportion to their holdings. In this case, shareholders can buy one share for every four held. The shares are usually priced at a discount to market price. SocGen stock is being sold at a 39% discount to the February 8th closing price, much higher than what analysts had expected.

Is SocGen in dire need? Well, after a $7.16 billion trading loss from one, lone, rogue trader, and a $3 billion write-down linked to risky US mortgage-backed securities, it just might seem that way. The bank's corporate and investment banking units reported a loss of $3.2 billion in all of 2007, compared to a gain of $3.4 billion the previous year. Net income for 2007 fell to $1.4 billion from $7.5 billion in 2006.

Pierre Flabbee, from Kepler Equities in Paris, described the rights issue "a matter of life or death" to the survival of the company. Ouch.

A Change In The Dow Jones

The Dow Jones Industrial Average, one of the most closely watched stock indices in the US, is adding two new components to reflect changes in the US economic structure. Bank of America, symbol BAC, the world's biggest bank by market cap, and Chevron Corp, symbol CVX, one of the largest oil companies in the world, will be added to the 30-member index of blue chip stocks. This is the first change in the Dow Jones Industrial since 2004.

The tobacco company Altria, symbol MO, and diversified manufacturer Honeywell International, symbol HON, were both removed from the index to make room.

Friday, February 08, 2008

Back to the Future

Larry Kudlow, not one of my favorite commentators because he's so partisan, has an article at NRO with some good thoughts on monetary and fiscal policy. He starts by bucking up Bernanke:

Bernanke has taken a lot of criticism in the last year, and I think much of it is undeserved. Wall Street claims that he’s an isolated academic, unaware of the real-world difficulties of sagging capital markets, slumping stock prices, and slowing growth. But he moved aggressively once he saw the credit problem develop last summer. And new information obtained under the Freedom of Information Act reveals how he has been meeting with leaders in business, finance, and government all along. He has talked with John Chambers, the CEO of Cisco Systems, Sam Palmisano, the head of IBM, JPMorgan’s chief Jamie Dimon, former Senate banking head Phil Gramm, and international central bankers Jean Claude Trichet and Mervyn King. The street was wrong about Bernanke. He’s been on top of the situation. He took remedial action and the economy will be the beneficiary faster than people think.

But this is the part that really caught my eye:

At some point, the entire corporate tax structure should be thrown out, along with all the murky K-Street tax-earmark loopholes that litter the IRS code. We need to broaden the tax base and lower marginal rates. This is the key to maximizing future economic growth on the supply side. Without strong tax-reform measures to expand the production of goods and services, further Fed money injections are only demand-side “solutions” that will surely inflate prices and depreciate the currency.

Back in the 1970s, policymakers in Washington were obsessed with increasing aggregate demand, but they forgot about aggregate supply. Today’s short-term-stimulus rebate package is a throwback to that era. It’s not economic stimulus; it’s political stimulus. Congressmen up for reelection are trying to “do something” in response to primary-season exit polls that say Americans are totally unhappy with the economy. But these rebates are budget busters. And how will Congress attempt to pay down $400 billion in budget deficits? Higher tax rates, of course. And then we’ll really be back in the 1970s.

Kudlow wants fiscal policy to take all the blame for a depreciating currency but surely the Fed at least shares the blame. Of course, Kudlow is right about fiscal policy. The rebates are a waste of money; they won't stimulate the economy and they will add to the deficit and debt.

Explanation for Low Jobless Claims

Randall Forsyth has an interesting article on the low level of jobless claims, something I've cited here as being inconsistent with a recession. The argument is that the self employed, such as real estate brokers and mortgage brokers, are independent contractors and therefore not eligible to file for unemployment benefits.

That's important because the self-employed have become an increasingly large portion of the U.S. economy, and not just because of the E-bay entrepreneurs that Vice President Dick Cheney is fond of citing.

During the housing bubble, the army of mortgage brokers and realtors swelled. The barriers to entry into those fields are minimal. As the former head of mortgage operations of a major New York bank once told me, a mortgage broker is a used-car salesman with a better suit. (Apologies to used-car salesmen.)

In any case, thousands of people began to earn a living by getting a slice of the housing boom. But even when they went to work for a mortgage or real-estate firm, they remained independent contractors, not employees. That meant that they weren't on firms' payrolls (and not counted in the establishment survey of the monthly employment report.)

Their independent-contractor status also precludes their receiving unemployment benefits. The legions of freelancers extend beyond the salesmen and saleswomen who raked it in during the housing boom to those did the honest work in the construction trades, from electricians to carpenters, who worked for contractors (also entrepreneurs.)

Many of this corps that swelled and prospered during the housing bubble are out of work. But they can't file for unemployment insurance.

If the economy is in recession this would seem to explain the low level of jobless claims. Anectdotal evidence would seem to support this thesis as well. We all know someone who was a mortgage broker or real estate broker that is now struggling. You can also include other self employed individuals who benefited from the housing boom as well. What about the personal trainer with real estate related clientele who now can't afford the luxury of a personal trainer?

The counter argument is that many of the people who entered the real estate business during the boom were just looking for extra income. Real estate was more of a hobby than an actual career, a way to supplement income from other sources. That isn't true in all cases of course, but it is certainly true of some portion. Maybe they'll go back to selling used cars...

Buttonwood Says....Nothing

The Buttonwood column at the asks if the stockmarket is a presenting a buying opportunity. And answers the question with a resounding....uh....well they don't actually have an opinion. First BWood says sentiment is pretty negative...or not:

One approach is to look at sentiment. The best buying opportunities occur when investors are most gloomy. Unfortunately, sentiment is hard to measure decisively. At the end of January, bears outnumbered bulls by nearly 19 percentage points in a survey of the American Association of Individual Investors. That sounds pretty depressed. But Richard Bernstein of Merrill Lynch points out that Wall Street strategists are recommending a much higher weighting in equities than they did for much of the 1990s.

Then he says valuations are cheap...or not:

There are, broadly speaking, two schools of thought. The optimists argue that shares are not expensive relative to either trailing or prospective earnings and are very cheap relative to government bonds. The pessimists argue that corporate profits are historically inflated and could have a long way to fall as the economy subsides.

Finally, BWood says it is this uncertainty that explains why markets are so volatile. Duh.

This uncertainty helps explain why markets have been so volatile lately. It is tempting to believe the economic and credit problems are a short-term blip and that Wall Street will be rescued by the Fed as it has been so often before. But every time that view seems about to take hold, something happens to make investors fear a more sinister possibility: that years of debt-financed growth are finally unravelling and that the Anglo-Saxon economies face as bleak a decade as Japan did in the 1990s. The market may not hit bottom until that fear recedes.

There was a time when I couldn't wait to receive my latest copy of The Economist and the first thing I did when it arrived was read the Buttonwood column. Not anymore.

This Can't be Good

The WSJ has an article about credit card delinquencies that sounds fairly ominous. Apparently, folks are not paying their bills on time:

The result could be a sharp pullback in consumer spending that would further weaken the slowing U.S. economy.

Such a pullback may already be taking shape. Yesterday, the Federal Reserve reported an abrupt slowdown in consumers' credit-card borrowings. In December, Americans had $944 billion in total revolving debt, most of it on credit cards, a seasonally adjusted annualized increase of 2.7%. That was off sharply from seasonally adjusted growth rates of 13.7% in November and 11.1% in October. And it reflects the volatility in consumers' spending habits as economic growth sputters.

Oh my goodness. People aren't getting deeper into debt fast enough. Whatever will we do?

Something Sort of Positive

In my never ending quest to find anything positive about the economy, I found this blog entry by Greg Ip at the WSJ about a service sector index constructed by ISI. Their index did not show the plunge that the ISM survey did:

Not so fast, says ISI Group. The New York brokerage firm has its own service sector index that it puts together from weekly surveys it conducts of auto dealers, homebuilders, shopping guides, credit card companies, airlines, banks, restaurants, wine & spirit wholesalers, temp employment companies, trucking companies, shipping companies and commercial real-estate companies. While it has been trending down, it didn’t show the abrupt plunge in January that the ISM’s index did: the four week average has slipped to 46.5 in early February from 47.1 at the end of January and 48.5 at the end of December.

“We think the risk of recession is high, but the data in aggregate are not consistent with a US recession right now,” says economist Oscar Sloterbeck, who runs the surveys at ISI. Unemployment insurance claims aren’t high enough, the manufacturing ISM index is at 51 instead of recession levels of 41, the firm’s own diffusion index is still above recession territory and “the Company Surveys in aggregate aren’t low enough.” –Greg Ip

Okay I know it's thin gruel but at least it's not as negative as the ISM survey.

Thursday, February 07, 2008

Now That's a Central Bank

After an FOMC policy meeting, the committee releases a statement which is usually less than a page in length. The public then spends the next few minutes trying to figure out exactly what the hell they really mean. By contrast, consider the European Central Bank. The President and Vice President of the ECB hold a press conference at which they read a very detailed statement - and then take questions! And what a statement. If Europe ever gets the rest of its economic house in order, they will be a force to be reckoned with. A few outtakes from the latest post meeting statement:

On the basis of our regular economic and monetary analyses, we decided at today’s meeting to leave the key ECB interest rates unchanged. This decision reflects our assessment that risks to price stability over the medium term are on the upside, in a context of very vigorous money and credit growth. The current short-term upward pressure on inflation must not spill over to the medium term. The firm anchoring of inflation expectations over the medium and long term is of the highest priority to the Governing Council, reflecting its mandate.

They are actually more concerned about inflation than a slowdown in growth. Imagine that, a central bank worried about inflation!

That said, uncertainty about the prospects for economic growth is unusually high and the risks surrounding the outlook for economic activity have been confirmed to lie on the downside. Risks relate mainly to a potentially broader than currently expected impact of financial market developments on financing conditions and economic sentiment, with negative effects on world and euro area growth. Further downside risks stem from the scope for additional oil and other commodity price rises, concerns about protectionist pressures and the possibility of disorderly developments due to global imbalances.

That part in bold is a direct jab at the US and it's reckless central bank.

Risks to this medium-term outlook for price developments are confirmed to lie on the upside. These risks include the possibility that stronger than currently expected wage growth may emerge, taking into account high capacity utilisation and tight labour market conditions. Furthermore, the pricing power of firms, notably in market segments with low competition, could be stronger than expected. At this juncture, it is therefore imperative that all parties concerned meet their responsibilities and that second-round effects on wage and price-setting stemming from current inflation rates be avoided. In the view of the Governing Council, this is of key importance in order to preserve price stability in the medium run and thereby the purchasing power of all euro area citizens. The Governing Council is monitoring wage negotiations in the euro area with particular attention. Indexation of nominal wages to the consumer price index should be avoided. Finally, further rises in oil and agricultural prices, continuing the strong upward trend observed in recent months, as well as increases in administered prices and indirect taxes beyond those foreseen thus far pose upside risks to the inflation outlook.

With respect to fiscal policies, a discretionary fiscal loosening in EU countries should be avoided. There is ample evidence that activist fiscal policies were not effective in stabilising European economies but rather led to sustained increases in the ratios of government expenditure and debt to GDP. Allowing the free operation of automatic stabilisers in countries with strong fiscal positions and safeguarding the long-term sustainability of public finances are the best contributions that fiscal policy can make to macroeconomic stability. Countries with fiscal imbalances are urged to make further progress with consolidation, in line with the requirements of the Stability and Growth Pact. There is a clear risk that some countries will fail to comply with the provisions of the preventive arm of the Pact, thereby undermining its credibility.

And that's left cross to the US politicians rushing to enact a "stimulus package". Wouldn't it be great if Bernanke had the guts to tell Congress that their stimulus package was BS and would only increase the budget deficit?

Structural reforms help economies to adjust to adverse shocks, foster productivity growth and increase employment and competition, thereby also helping to reduce inflationary pressures. In particular, enhancing competition in the services sectors and network industries, as well as applying adequate measures in the EU agricultural market, would be conducive to price stability in the euro area.

I love this last part. What he's saying is that capitalism works and the Europeans ought to try it.

And finally there's this at the end of the statement:

We are now at your disposal for questions.

Wouldn't it be great to see Bernanke on the hot seat answering questions about monetary policy?