Friday, May 29, 2009

Saving GM's Privates

Several years ago a Tom Hanks film had a title something like this. In the movie he was one of the last sons of a large family whose other boys had been killed in battle and the army was trying to find him bring him back from the front where he was at risk and save his life so the family would have one son survive the war. It always struck me that the point was to save Ryan's privates.

In the case of GM it is not clear what is the real objective; is it to save something vital that will be GM? Or, is the point to save the privates? The point is not to  save the excecutives, certainly not to save the shareholders, but is the real objective to save the privates who work there, the rank and file, the UAW members, the largely democrat work force?

Yes, save those privates.

So the GM case drags on. And there will be malcontents, there will be survivors and there will be net job losses. Still some jobs will be saved. Time will  tell how well the various government backstops will keep buyer willingness aloft. But it will help to stave off even more job losses in the Big Three and among their suppliers.

It will help.   

Saturday, May 23, 2009

Selling the dollar on credit concerns


So the UK has been put on notice by S&P that it could be in for a credit downgrade.

Yes, some want to mechanically look at those key financial ratios like debt-to-GDP and extrapolate that fear to the US. But there are differences: the US is not the UK and it is definitely not Europe. It's not that the US can post or carry loads more debt than other countries or that its deficits can be sustained at high levels, but that it has showed resiliency that Europe has not. The US has the ability to grow strongly from a position of indebtedness and make great strides to reduce the problem- unlike most countries in Europe whose growth is less dynamic and whose unemployment rates are normally as high as the US rate gets to be at its high point in the business cycle.  

The cost has risen risen for credit default swaps on US debt but we have to wonder if even that is a direct play on US credit prospects or a roundabout way to bet on overall volatility. 

In a world in which the US was not the best credit quality who would be - and what kind of world would that be? 

Oh, yes the euro area has debt to GDP restrictions on various members' fiscal ratios and budget restrictions to boot. It also is a much less flexible place that would not be able to accommodate the kind of transactions and capital flows we see in the dollar zone. Trash the US credit rating and you'll live in a garbage dump for sure, wherever you live.  Imagine how international capital flows would dry up if the US was no longer thought of as issuing safe debt? On second thought, don't imagine that...  

Moreover, the US is battling a crisis that has very likely seen its worst.  So reacting to the UK news as though it's a wake up call on the US seems a bit out of touch.   

Perhaps one of the oddest things is that after a warning that the UK could get its credit downgraded an extrapolation that the US might be next has sent the pound sterling soaring Vs the dollar. Huh? Buy the rumor IGNORE the fact?  C'mon that's just odd. 

We are seeing the 'best' case of buy the rumor and sell the fact embodied in dollar-selling.  Most likely it is not that at all but classic magician's misdirection. I would not say traders should fight or buck this dollar trend because that is always foolish. I would say these trends are likely to play out soon since the pound and yen are likely reacting to their own oversold positions more than to this 'news'. When the 'credit quality trade' is over, market 'insiders' will find another excuse. By that time the dollar will have stabilized, helped by an improving US economy, that once again will be leading the world into recovery. By Keynesian logic a stronger recovery should weaken the dollar by expanding the US current account deficit. And we have already seen some hint of that. I'd sooner believe that the current dollar selling is related to that than to concerns of a US credit downgrades.   

Things were 'so bad' and credit fears were 'so advanced' that US share prices were rocked but they still rose on the week.  Also as speculation runs wild and pea-brains extrapolate two-point trends, let's remember that in this crisis one of the factors that stabilized markets was the Fed expanding its swap lines to foreign central banks so they could in turn provide MORE dollar financing to their banks. The dollar has been is great demand. Confidence has not been shaken.   

Currency markets can and will flutter. Rumors always have driven markets. Money is usually made by reacting to the sniff of rumor instead of waiting for the hard fact of substantiated evidence. However true that is,  that does not mean that all rumors or early moves by markets are correct. Rumors often are planted or floated to make money for the quick who see the fleeting opportunity for what it is and to catch unawares those who actually swallow the stuff whole. 

Markets fluctuate in part because they anticipate all sorts of things that do not happen or that do not happen on the market's schedule. Then there are things that are surprises. Some events are seen in advance and get discounted. But the markets mash all these sorts of reactions together in hopeless tangle. 

The Obama administration says there is nothing to these rumors and on the other hand whines that it inherited these financial problems. That is a mixture of 'hey were OK' and  '...but if we aren't, don't blame me'.  It's another example of how this administration is having a hard time sending the right message.  That's just too bad and it explains why rumors and conjectures like this have legs even if they have no heart or brain. 

Thursday, May 14, 2009

Roubini is light-years off on China as a reserve currency country

A repy to the Roubini letter to the editor in the NYTimes

'The Almighty Renminbi' A rejoinder 

 Mr Roubini: As you warn of the potential ascent of the renminbi why not also warn of the end of the world? It’s about as pressing an issue.

Nouriel Roubini’s article on why the renminbi could become the next super currency, or reserve currency, misses any number of crucial points.


In terms of nuts and bolts: China is a capital account deficit country. It runs a trade and current account surplus meaning it has a capital account deficit, exporting capital to the world. What that means is that China is a net placer of funds in international markets and does not attract funds on net basis. It is hard to become a reserve currency these days in that situation. The reserve unit is something for others to acquire. China would be asking the international investor to do the equivalent of swimming upstream while it would increase the flow downstream to remain a net investor itself. Not likely.


Addressing the lessons of history: The world is no longer on a gold standard. The old metrics of history on the characteristics of reserve units should been read with caution and re-written for these times.  Countries today, need to acquire currency reserves in a floating exchange rate environment. Conversely, on a gold standard they needed to acquire gold (you do that by running a current account surplus, by the way). So forget history and the notion that reserve unit countries are surplus countries. That worm has turned: been there, done that.


Dollar fragility: There are certainly issues that the US needs to address, mostly in terms of making US assets safe for acquisition by overseas investors and protecting the value of the dollar by keeping inflation low (a Fed task). Protecting the policy of free trade would also help to assure the place of the dollar.  


Beyond nuts and bolts: Even more fundamentally, China cannot issue the world’s reserve unit because it is not trusted. A true reserve unit needs a strong legal framework and property right protections. The lack of those elements are a far greater impediment to China being a reserve unit country, given China’s current standing. There is the need for freedom of capital movements, too. How about an even more basic issue: free speech; an internet that is not censored?


China’s day in the sun: When China solves these ‘other’ problems and develops its own financial sector we may be able to consider the nuts and bolts economic issues. The problem is not just mechanics. I don’t think Professor Roubini has any idea how far away China really is; it far more than the decade he casually refers to at his article’s end. It is generations away. A reserve currency is more than mechanics; it needs a certain socio-economic framework, culture and mindset. Not only is China not there, it is not clear that China is headed there.     


Tuesday, May 12, 2009

Krugman is at it again

Paul Krugman has decided to be the curmudgeon. 

His latest attack of sourness is aimed at the soaring stock market and prospects for economic growth. Krugman has assailed the notion of a 'V'-shaped recovery. He contends that the equity market is priced for that.

This raises several questions. First, the stock market was bludgeoned in recession and in the financial crisis; it made a dive of near historic proportions. All it is doing now is gaining some of that ground back. There is nothing in the market now that makes stocks look like they are overpriced. If you look at the market in its range in this cycle the S&P is up 37% from its cycle lows  yet down 40% from its cycle peak. 

The economy typically goes into recession (a period in which growth slows and GDP generally declines), then has a recovery (a period of stronger than normal GDP growth), then settles into its expansion period in which growth normalizes. Stocks typically drop before and during recession. They begin to rise before recession ends and rise strongly late in recovery anticipating the economic the revival.  Stocks then settle into the expansion period, a period in which they continue to demonstrate cycles.  

It is hard to look at P/E ratios in the business cycle to diagnose the level of the stock market.  In recessions earnings get trashed; in recoveries earnings spurt. Currently, contrary to what Krugman says, about Wall Street's view most analysts are not forecasting a huge boom in earnings over the next 12- to 15-months when the economy should swing into recovery.  

It is probably more accurate to say that the stock market has roared back from its lows because investors have acknowledged that the extreme economic conditions that drove stocks below their proper values no longer are valid. With the Fed and Treasury backstopping banks and with a huge stimulus program kicking in, the extremely low-valued stock market made no sense.

Moreover, since analysts are not projecting strong earnings growth at the company level it is hard to maintain that Wall Street is geared for a 'V"-shaped recovery, as Krugman contends. Krugman is judging from this spurt in the stock indices but forgetting that stocks had to climb out of a deep hole just to get back to neutral. Basically there is very little support for the idea that 'Wall Street' sees a "V'-shaped recovery. Individual company earnings estimates don't look for it, economists forecasts don't look for it and the stock market - as far as it has come - really is not priced for it - yet. Paul simply has this one wrong. 

As to the issue that this will not be a "V"-shaped recovery, that is another matter.   

History shows that we do not and have not had 'V"-shaped recessions without getting "V"shaped recoveries, at least in the Post War period.  Since the Fed/Treasury are backstopping banks, it seems unlikely that the financial sector will backslide and hinder the normal expansion. Krugman has said that talking of 'green shoots' could make policymakers complacent.  On the contrary, some positive talk from policymakers could be very helpful to lift the pall of uncertainty and fear that Krugman seems to relish. 

In this cycle the administration should be pushing optimism much more than it is. The Fed, on the other hand, needs to nurture pessimism and be on guard for backsliding. It does not want to encourage thoughts of a too-strong economic revival as that would put it on the spot early in the recovery. That might suggest that the Fed's balance sheet expansion should be reversed. The Fed does not want to do that until the economy can surely stand on its own two feet. If Krugman refers to this as the risk of complacency, I would agree. The Fed is under a lot of pressure to reverse its easing and its policy of balance sheet expansion.  There is a risk that it might be pushed to unwind its quantitative easing too soon.  

Recessions always breed pessimism just as booms breed optimism. In each environment it is hard to convince people that the regime-du-jour is coming to an end.  Krugman has fallen into the trap of being a recession pessimist. 

The economy does face real challenges; some of of historic proportions. But it has fallen so far below trend, there is so much pent up demand, that once the fear is gone, consumption can once again rise strongly for a period to make up for lost time. What I see is the possibility of some very strong growth over four-to six-quarters followed by a more mature stage of the expansion in which some of these fundamental constraints finally become more binding and restrict growth. At that point sub par growth could become the norm, but not until a rapid economic recovery has first played out.  

Krugman is right to be worried about the drop in home values and in consumer wealth and the shocks faced by the economy which will require rebuilding and reorientation. Business cycles are special periods.  Recession and recovery actions are not driven by the same dynamics that drive trend growth. Recovery periods are periods in which the economy typically 'recovers.' It makes up ground.   Rapid recovery economic growth rates are historically the norm after deep recessions. I do not understand Krugman's opposition to that concept. This recession has been very deep and certainly should spawn a recovery consistent with the downturn.  This recession was not 'dish'-shaped or 'U'-shaped.   It should not generate the type of recovery that past two recessions fostered.   The recession basically determines the shape of the recovery. But the following expansion period is when the fundamentals kick in and they are in need for work in this cycle.   

Despite my forecast of a strong recovery I think the economy remains at risk and if anything, the rapid recovery will increase the possibility of a policy error that could harm prospects for growth in the expansion period that normally follows recovery. A slow recovery will keep all policy efforts focused on nurturing growth; a rapid recovery would foster the sort of complacency that Krugman claims to fear.  

Wednesday, May 6, 2009

The donut and the hole

As you travel though life, my friend
where ever you may go
keep your eye upon the donut
and not upon the hole

Good advice.

To all you 'hole watchers' out there Swine flu is the wrong issue. Stress tests are irrelevant unless you own 'that' bank's stock. ADP is where the action is at.

Threats that don't threaten
Swine flu may have the potential to become a threatening pandemic but for now, IT'S THE FLU. Yes it can kill people, especially those with other maladies, but its the flu. Could it mutate? Yes. Has it? No. But then it would be something else if it mutated. Heath officials should be worried, not the rest of us. Let them do their job and worry about the 'what ifs' and stop blowing things out of proportion. Let others worry about asteroids hitting earth and Martians landing. These are other 'threats' that do not threaten. 

Stress tests: much ado about nothing 
The stress test is all about how bad off banks are. If they need more capital they will raise it. Until then, they are bolstered by the government and guess what? That worst case scenario that the tests test for is not on our door step and it is probably at least one more business cycle away if not much more than that. So why should anyone worry about it? It is hypothetical and the tests are a jury-rigged joke. It's the economy's slide that is decelerating not accelerating. We are perched on the precipice of better times, not worse times. What better time to assess banks against much worse times than when things are improving! Sounds like government in action to me. Not only are the stress tests impossible to do but they are in all likelihood, meaningless.

The business cycle: the MAIN EVENT
ADP on the other hand has made a sharp turn for the better. The original ADP assessment of losses from March has been cut by about 40K.  That is an early sign that things are not worsening as much as we thought- but a small one. The mo/mo change in the ADP from a loss of 708K to loss of 491K is an important signal. It is the second largest positive shift in the mo/mo ADP change  since 2001. In Dec 2001 just as the last recession was ending a slightly larger shift occurred as the ADP went from a change of -428 in November to -186 in December. December marked the start of the recovery from that recession.  Actual private job losses shifted from a reading of -343K in November to -207K in December, -154K in January, -160K in February and to  -65K in March. AND that was a poor jobs recovery.  

While we don't know what the real nonfarm number will do yet, we will on Friday. But all sorts of indicators are lining up on the side of 'better,' and much 'better.' 

At the end of past long deep recessions: 
At the end of the 1982 recession private sector job losses were at -310K in October two months later the recession ended and private job losses were cut to -18K. By March, a set of steady increases was in train, with March at +172 K and the following months even stronger; July gains were +427K. 

Private job losses were at -629K in December 1974. That recession ended By March of 1975. May of 1975  showed the first monthly increase in jobs and by July increases were at a steady stream of positives +172K, +372K and so on. 

What Paradigm? 
Too many economists (and the Fed) take their paradigm of job gains in the recoveries from the 1990 and 2001 recessions as the right one.  In fact those two recessions were mild. This recession is not mild. Neither were 1973-75 or 1981-82 downturns. These recoveries were strong job producing machines. The ADP was not around for those cycles but the strong shift of the ADP in this cycle is an interesting tid bit. Will it be more than that?   

Is a real strong recovery about to start?
Many indicators point to a recovering economy. This is the first of these signals that is also a strong signal. The strong tilt in the ADP potentially is a statement about the strength of the recovery ahead.  More emphasis should be put on this since a stronger recovery is an event that will have wide- ranging repercussions. The marked shift in job losses signaled by the ADP result is not just about April but about what we are going to be seeing over a series of months. So open your mind beyond the consensus and consider the possibilities.



Monday, May 4, 2009

Three forecasts and a funeral

Forecasts: the accepted, the shunned and the feared

The 'Consensus' or accepted forecast: The 'consensus' forecast is a gradual return of GDP growth to positive territory. The consensus forecast does not kick the economy into gear quickly and the growth rates for GDP remain low for some time. The rate of unemployment will continue to rise in this scenario well into the recovery as it did in the 1990 and 2001 recovery periods. The consensus forecast is an odd bird: it grafts the reality of a deep, long, recession onto the fantasy of a weak drawn out recovery a combination we have never seen. The consensus pretends that recessions like 1973-75 and 1981-82 could have produced recoveries like those for the 1990 and 2001 recessions. Frankly I doubt it. 

My forecast, the shunned forecast: My forecasts is considered by some to be a Pollyanna forecast but more rightly it could be construed as the risk forecast. What I foresee is a much faster rebound in GDP growth than the consensus. This rebound nets us roughly 4.5% growth in the first four quarters of economic recovery. That would make it a relatively strong recovery unlike the consensus and one that will contain the rise in the rate of unemployment within one of two months of recovery. If I am right there will be no drawn out recovery in the labor market. While it might not be a full recovery, it will be an immediate recovery. If this forecast comes to pass the rise in the rate of unemployment will come to an end quickly, early in the recovery period as GDP growth snaps back and hiring kicks back in after an overshoot of layoffs. This forecast seems to be one that takes us immediately to Nirvana but it may not. It is only good news if, after the strong phase of recovery (about the first year after recession ends) the economy can sustain its growth and keep from backsliding into recession. Yet this strong-start recovery puts that very event at risk

The feared disaster forecast:  While some will construe my forecast as the Pollyanna forecast it is in fact a riskier forecast than the consensus. Here is the risk: It’s that strong growth early in the recovery will prod the Fed into early action.  Many are concerned already in the presence of the consensus forecast with how the Fed will unwind its policy of extreme accommodation. The consensus forecast is for the economy to remain weak; in such a scenario the Fed will be able gradually to take back its stimulus as economic improvement gradually occurs.  But in my forecast everything happens fast. The economy jumps into recovery and job growth kicks back into gear early as the unemployment rate stops rising and begins to head lower. While the economy will not be entirely mended at this early point of recovery the strong growth will put the Fed on the spot.  The rapid growth will put maximum pressure on the Fed to begin to pull back in some of its stimulus including shrinking its balance sheet and hiking rates as well as to eliminate some of its special programs. It will make Congress skeptical that any added assistance is needed.  Yet the economy will not have solved all its structural problems at that point of recovery. The risk is that the Fed could pull back too soon and the structural problems could re-emerge form the background causing the economy to plunge into a second dip of recession.  It's the economy's funeral that is threatened.

We know where the risks lie even so... Policymakers have said that the risk in challenged times such as these is to keep stimulus in place long enough. We know that monetarists are already screaming for the Fed’s head and for a road map of the end game that will result in the stimulus being removed. We know the Fed will be under great pressure to act once the recession is over. We know that there is nothing like a few quarters of growth of 3% to 4% to say that recession is over. Yet we also know that a few quarters of strong growth like that will not heal all the wounds of the recession so that despite a few strong quarters the economy will not be fully healed. 

Where the real risk lies - We continue to think that is where the real risk lies in this recovery period despite our projection of a strong economic growth recovery. The risk will be in the potential to backslide.    The Fed is still talking about the risk of deflation and no one really believes it. As the Fed mounts campaigns to buy Treasury paper and knock long term rates lower treasury rates instead have been in a steady rise and rates have gone up above the 3% mark for 10-year notes, attesting to the impotence of the Fed on this matter.   

Why that recovery forecast?  - The strong growth scenario will be the hardest one for the Fed to deal with. An easy growth recovery would keep the Fed in a gradual back-off from its special programs and actions. But as we look back at history the strong growth scenario is the most likely since we have never seen the other. Deep long recessions never have produced weak drawn-out recoveries of the kind the market now says it foresees from this deep dark recession. I can understand the Fed offering such a forecast since it would be hard for the Fed to be forecasting such a rosy scenario and still offering all this assistance to the markets. If the Fed projected a jackrabbit recovery many would be on its back to right now start shrinking its balance sheet in anticipation of it. I think the Fed forecast is purposely naive. 

Beware the recovery -- We have seen a too-fast recovery run amok. A jackrabbit start to recovery from the 1980 recession brought a too-quick and too-high Fed tightening reaction that took the economy from a brief deep recession into a fast but truncated recovery and to a new deeper darker recession. So we have seen that happen before. Even if my forecast for recovery is correct this episode will be different from that one since the Fed does not have monetary policy on auto-pilot as it did in the 1980s. But the risk is the same, the risk of a central banking reaction mistake. In 1981 the Fed reacted to a too-strong recovery and a still too-high inflation rate; its overreaction gave us the double-dip recession. In 2009 the risk will be from an underlying economy that is weaker than the fast recovery will make it appear to be. The risk will be the risk of a Fed that is already worried about how much it has done stopping too soon. It will be the risk pushed onto the Fed by critics ideologically opposed to the assistance that the Fed already has provided.  So beware of the recovery. In it lurk perhaps even more risks than in recession itself. Because while recessions are renown for their danger few stand vigil against the failed recovery.  And who would expect such a fast recovery to be the first step on the road to economic perdition?