The Mess That Greenspan Made

Inside the UCLA student protests

2009-11-21T13:59:00.000-08:00

Although the cost of higher education in California still probably compares favorably to other states (this data from 2004 shows there was a good deal of room to raise tuition costs back then), students are understandably not too happy about big increases as part of the state's never-ending effort to balance its budget.

Of course, the millennials would probably be a lot less peeved if more of the pain in California was shared by more of the Baby Boomers, particularly from this list of over 6,000 retired government workers that pull down $100,000 or more every year.

Surely Bruce Malkenhorst of Vernon could share some of his $499,674.84 pension to help out a couple dozen college kids.

Gross national happiness?

2009-11-20T18:05:00.000-08:00

After just spotting the headline of this WSJ story and then reading the first paragraph or two, it seemed a sure target for ridicule, particularly since that's what is done around here most of the time. But, after reading the whole report, that view had to be reconsidered.

Chávez Discounts Accuracy of GDP
President Hugo Chávez wasn't pleased with data released this week that showed the Venezuelan economy tumbling into a recession. So the populist leader came up with a solution: Forget traditional measures of economic growth, and find a new, "Socialist-friendly" gauge.

"We simply can't permit that they continue calculating GDP with the old capitalist method," President Chávez said in a televised speech before members of his Socialist party on Wednesday night. "It's harmful."
...
The Venezuelan president isn't alone in suggesting traditional economic-output measures are too rigid. French President Nicolas Sarkozy recently said his country, in addition to measuring GDP, would start gauging prosperity by including factors such as vacation time, health care and family relationships.

An economic commission headed by Nobel Prize winner Joseph Stiglitz supports such moves, saying every country should design its own basket of indicators that would include factors such as unemployment, security, and income inequality.

Both France and Venezuela argue their citizens are better off than economic data suggest. French workers have generous social-security benefits and vacations. Mr. Chávez said free health care in Venezuela isn't counted in economic output because money doesn't change hands.

The most famous example of this line of reasoning is the tiny Himalayan kingdom of Bhutan, which has tried to measure gross national happiness instead of GDP.

Food for thought, though, they've got to come up with something better than "gross national happiness" if they really want to be taken seriously.

Grayson on the Audit the Fed amendment

2009-11-20T13:33:00.000-08:00

Rep. Alan Grayson (D-Florida) speaking yesterday during the House Finance Committee hearing that resulted in a much weaker amendment by Rep. Melvin Watt (D-NC) being replaced by one backed by Ron Paul (R-Texas) and Grayson.

Uh-oh! From Alex Jones: Fed Sicks Attack Dogs on Ron Paul after Audit Bill Passes.

Big FHA loans are easy

2009-11-20T10:58:00.000-08:00

It's a good thing that the folks at the FHA (Federal Housing Administration) know what they're doing. Otherwise, their tiny capital reserves as compared to the nearly $700 billion in home loans they guarantee might be cause for concern, especially after reading a story like this one that, if you were to change some of the names and dates, sounds a lot like the stories you heard a few years ago when the housing bubble was fully inflated.

With F.H.A. Help, Easy Loans in Expensive Areas
By DAVID STREITFELD

SAN FRANCISCO — In January, Mike Rowland was so broke that he had to raid his retirement savings to move here from Boston.

A week ago, he and a couple of buddies bought a two-unit apartment building for nearly a million dollars. They had only a little cash to bring to the table but, with the federal government insuring the transaction, a large down payment was not necessary.

“It was kind of crazy we could get this big a loan,” said Mr. Rowland, 27. “If a government official came out here, I would slap him a high-five.”

In its efforts to prop up a shattered housing market, the government is greatly extending its traditional support of real estate, including guaranteeing the mortgages of middle-class and even upper-class buyers against default.

Surely, the FHA knows what they're doing, don't they? Just because one in six FHA borrowers is now behind on their payments shouldn't be cause for concern after the agency quadrupled the number of loans it guarantees and now has capital reserves below the minimum level mandated by Congress.

Congress grows a pair

2009-11-20T08:34:00.000-08:00

Edmund L. Andrews reports on how Ron Paul's "Audit the Fed" amendment got tucked into the new House bill on financial market regulation, maybe as a result of a growing number of elected officials having read Paul's new book End the Fed.

At the House Financial Services Committee, which was working on a sweeping bill to overhaul financial regulation, Mr. Frank had argued that Mr. Paul’s amendment went too far and would damage the Fed’s credibility.

Fed officials have argued that global investors would immediately become more skeptical about the central bank’s willingness to fight inflation by raising interest rates, which in turn would force the Fed to raise interest rates higher to accomplish it owns goals to keep prices stable. The result, they have warned, could be both higher inflation and slower growth.

But Mr. Paul and his supporters argued that the measure would do nothing to undermine the central bank’s independence. Its only purpose was to force the Fed to be more transparent and accountable to the public.

In a surprising display of political rebellion, about half the Democrats present and all the Republicans voted for Mr. Paul’s bill instead of a compromise measure drafted by Representative Mel Watt, Democrat of North Carolina.

Of course, prior to penning "End the Fed", Paul wrote The Revolution - A Manifesto, so maybe he's attracted something of a cult following in the House.

Or, perhaps Congressman have been reading The Creature from Jekyll Island by G. Edward Griffin, in particular, the second chapter that probably describes what has happened in the U.S. banking system better than anything else - The Name of the Game is Bailout.

Another call for Geithner to go

2009-11-20T06:47:00.000-08:00

Rep. Tom Brady (R-Texas) talks to Fox Business News after calling for Secretary Tim Geithner's resignation during a hearing of the Joint Economic Committee yesterday.

This comes just two days after Rep. Peter DeFazio (D-Oregon) suggested it might be a good idea to increase the jobless total by two - Geithner and White House Adviser Larry Summers.

Oh Dear! When asked, Brady suggests replacing Geithner with Phil Gramm who was instrumental in passing a number of bills that were key elements in deregulating the banking and investment industry. Topping that list was the Commodity Futures Modernization Act of 2000 that allowed derivatives such as Credit Default Swaps to be traded amongst Wall Street firms without the prying eyes of regulators ... maybe they ought to replace Brady.

Friday morning links

2009-11-20T06:11:00.000-08:00

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Panel votes to audit the Fed

2009-11-19T18:14:00.000-08:00

MarketWatch reports that, much to the dismay of Fed chief Ben Bernanke, the House Financial Services Committee approved a measure sponsored by Rep. Ron Paul (R-Texas) that would require the government to audit the Federal Reserve.

Ron Paul's provision was opposed by Rep. Barney Frank (D-Mass.), the committee's chairman who preferred a less intrusive measure proposed by Rep. Melvin Watt (D-N.C.) in a surprising turn of events given how things looked the other day. For more, see Google News.

The jobless rate-interest rate conundrum

2009-11-19T11:38:00.000-08:00

Just about everywhere you look these days in the financial media, when the topic of discussion turns to the plunging U.S. dollar, you'll hear someone saying something like, "Unless the Fed raises interest rates, the dollar's got nowhere to go but down".

And then someone invariably says, "But the central bank can't raise interest rates. Not with the unemployment rate at over ten percent!"

What's a central banker to do?

A look at history with the help of the chart below sheds some light on the current jobless rate-interest rate conundrum and, as you might expect, things don't look good for Fed chief Ben Bernanke if he's at all concerned about the value of the nation's currency.
Obviously, this graphic is too chock full of information to be addressed as a whole so it will be broken down in detail below, however, it is interesting to note that the 55-year time span above with just these two curves - U3 unemployment and the Fed funds rates - has two very distinct features.

First, current short term interest rates of around 0.15 percent are without precedent and, based on all but the most optimistic forecasts for the labor market, the jobless rate will soon share that attribute. In fact, if you were to simply subtract today's Fed funds rate from the unemployment rate you'd get 10.1 percentage points, an all-time high. Prior to 2009, over a period of almost six decades, this measure had exceeded six percentage points during only four months, back in 1958 when unemployment was around 7 percent and the Fed funds rate was just under 1 percent.

Second, "jobless recoveries" are a relatively new development. It's clear to see that, as you move from left to right in the chart, the unemployment rate falls at a slower and slower pace during economic recoveries. When weighed against economic cycles that have grown longer and longer, part of what was once affectionately known as The Great Moderation, this may not have seemed like such a bad trade off, however, the Great Moderation is not likely to fare well in history books now that the jobless rate has risen so sharply over the last year with little hope of "full employment" returning in the U.S. anytime soon.

A look back at the historical relationship between jobless rates and interest rates will help to understand the difficulty ahead for the Federal Reserve in formulating monetary policy.

The 2001 Recession

The first thing you are likely to notice about the recovery from the 2001 recession is the trademark "baby-steps" campaign of former Federal Reserve chairman Alan Greenspan in which short-term interest rates were raised in 0.25 percentage point increments at 17 consecutive Fed meetings, the last three quarter-point hikes being accomplished by current Fed chief Ben Bernanke in early-2006.

From the time that unemployment peaked during the summer of 2003 at 6.3 percent (a jobless rate that appears "quaint" as compared to the reality on the ground today), it was a full year before the first "baby-step" was taken in 2004.

Of course, years later, this is one of the most widely heard criticisms of Greenspan's final years at the Fed as even shoe shine boys know now, in the wake of the bursting housing bubble, that the former Fed chairman left interest rates "too low for too long".

While soaring home prices were clear to see in 2003, the peak in unemployment was only visible in hindsight, so, for future reference, note that when the rate increases did begin in mid-2004, unemployment had dipped almost a full percentage point, from 6.3 percent to 5.5 percent.

If memory serves, there was also an election in 2004 but, since the central bank is purportedly independent of the U.S. government (a point they make regularly now that some in Congress want to audit them or dismantle them), surely politics played no role in the "too low for too long" monetary policy or the massive credit bubble that followed it a few years later.

If this is the model that Ben Bernanke follows for the current recession, look for interest rates to start to rise no sooner than mid-2011 and don't be surprised if the Mexican peso looks pretty good relative to the U.S. dollar at that time.

The 1990-1991 Recession

The last "consumer-led" recession occurred in the early 1990s following the melt-down in the Savings and Loan industry and a housing boom that went bust, though this boom-bust was largely confined to California and parts of the Northeast.

In this case, the recession officially ended in March of 1991, however, unemployment continued to rise until June of 1992, coming down very slowly during the first major "jobless recovery" in America.

Short term interest rates continued to decline for a few months after the jobless rate peaked and then stayed at 3.0 percent for over a year before rate hikes began in February of 1994.

In this case, it was a full 20 months from the peak in unemployment until the Fed moved, the unemployment rate having moved downward more than a full percentage point from the peak of 7.8 percent in mid-1992 to 6.5 percent in early-1994.

This was the first economic recovery under the guidance of Alan Greenspan and, given how well the U.S. economy fared later on in the 1990s as his first monstrous asset bubble was inflating, it's easy to see why the same script was followed a decade later.

At this point in our look back, there are two data points for Ben Bernanke's latest conundrum - 12 months and 20 months from the peak in unemployment to the first rate hike - and those short the U.S. dollar at the present time would be advised to maintain those positions if the Fed chairman looks back no further.

If he does, the picture becomes much more confusing.

The 1980s Recessions

The Paul Volcker era at the Fed in the 1980s was characterized by penal interest rates early on to squash inflation that had run wild in the 1970s. His term was highlighted by the "Saturday Night Massacre", where he raised the overnight lending rate from 11 percent to 12 percent on a Saturday night shortly after taking charge, and a Fed funds rate that peaked at almost 20 percent in 1981.

During Volcker's early years there were two recessions, both brought on by the Fed chairman himself during a successful two-year campaign against a wage-price spiral that had been fostered by his predecessors.

Since the Fed funds rate moved up and down so dramatically during this period - a time when the official Fed funds target had to be inferred by the bond market as it was not announced to the public - it's hard to draw conclusions about the relationship between unemployment and short-term rates.

For example, the 1980 recession lasted from January to July, during which time unemployment went from 6.3 percent to 7.8 percent, however, over this same span, the Fed funds rate moved from 14 percent down to 9 percent, moving back up to over 19 percent by the end of the year.

In this case, the peak in unemployment and the low in the Fed funds rate occurred during the very same month, the jobless rate obviously not being the key factor in Volcker's decision.

The next recession was a bit more typical, the downturn being declared over in November of 1982, just two months before the peak in unemployment, and short-term interest rates hit bottom six months later.

It's hard to draw too many parallels from the early 1980s recessions to the present one - just the fact that interest rates are zero today versus ten or twenty percent during Volcker's term likely negates anything useful being available here for Ben Bernanke.

But, for those of you keeping score at home, there are now four data points - in reverse chronological order they are 12 months, 20 months, 6 months and 0 months.

The 1970s Recessions

For most of the 1970s, the Federal Reserve was run by Arthur Burns who presided over two recessions, one already underway when he took office in February of 1970. By all accounts, his term as Federal Reserve chief is not one that should be emulated, bending early on to powerful political pressure from the Nixon administration and blazing the monetary policy trail of "too low for too long" that, somehow, always seems to end up badly.

That was certainly the case during Burns' eight year tenure as inflation soared to over 12 percent by the middle of the decade only to surge again as he was on his way out a few years later.

After the December 1970 peak in unemployment, short-term rates fell and rose and then fell again reaching a low for the cycle early in 1972 at just over three percent - a full 14 months later.

A period of calm followed but then in late-1973 an oil crisis erupted in the Middle East and inflation began to rise, followed shortly thereafter by the Fed funds rate, and then unemployment.

From the peak rate of 9.0 percent unemployment in May 1975, just two months after the recession was declared over, it was 20 months before interest rates began to rise from the eventual low of 4.6 percent in January of 1977.

Of course, the rest of the 1970s was a virtual inflation free-for-all as consumer prices rose seven percent in 1977, after which Burns was relieved as Fed chairman in favor of William Miller who then watched the inflation rate reach nine percent in 1978 and 13 percent in 1979 when Volcker was summoned.

You don't hear too much these days about parallels between the Burns-Miller era and the current one but there are more than a few similarities - soaring prices for commodities and multiple periods of "too low for too long" for interest rates.

Now having worked back through the last six recessions, adding periods of 14 months and 20 months to the data set above, we now have an average span of 12 months from the time that unemployment peaked until interest rates began to rise. This is not good news for either Ben Bernanke or the U.S. dollar.

The 1957 and 1960 Recessions

It's not clear what, if anything, can be gleaned from looking at the recessions in 1958 and 1960 and the term of William McChesney Martin - he kind of made things look easy as Fed chairman. As shown below, these two downturns were relatively short and sweet - old style recessions, if you will - with the central bank raising interest rates over a period of a few years, more or less inducing a recession, causing the unemployment rate to quickly peak and then return to more normal levels.

What politicians and economists today wouldn't give to see a recovery in employment like either of these two...

For the record, the 1957 recession officially ended in April 1958 and, three months later in July, unemployment peaked and short-term interest rates hit their low in what appears to be near-perfect monetary policy in a near-perfect economy.

The 1960 recession had similar characteristics in that the unemployment rate reached a peak three months after the recession ended in February, however, Martin didn't start raising interest rates until two months after that.

All in all, a pretty impressive record for a pretty impressive Fed chairman who is best known as having served longest in that position and for saying that the job of the central bank is "to take away the punch bowl just as the party gets going," referring to the need to raise interest rates when economic activity is rising.

Of course, this occurred during an era that will probably go down in history as America's greatest, having helped vanquish both the Germans and the Japanese and emerging after World War II as one of two global military powers, but as the single economic superpower.

It sometimes makes you wonder how stupid economists could have been a few years back to even think that former Fed chief Alan Greenspan would go down as the greatest central banker of all time...

For those of you keeping track, the two recessions discussed above bring the average time from the peak in unemployment to a sustained rise in the Fed funds rate to just over nine months, not a good sign for the current Fed chairman or the greenback if the jobless rate doesn't peak until sometime next year.

What Does this Mean for the U.S. Dollar?

Given the historical relationship between unemployment and short-term interest rates, current Fed chairman Ben Bernanke certainly has his work cut out for him if he is at all concerned about the international value of the dollar.

Based on his speech on Monday, apparently he is a little worried about the currency, but maybe not concerned enough to do anything about it other than talk, which, in itself is quite unusual since that's normally the job of the Treasury Secretary.

With a mid-term election quickly approaching next year and a "best case scenario" of unemployment peaking during the first part of 2010, it seems inconceivable that we'll see any increase in short-term rates for at least another year.

Then again, if the gold price tops $1,700 an ounce and oil again soars toward $120 a barrel, one could envision a scenario where the Fed raises interest rates to one or two percent, just to make a point.

But, when considering what that might do to the nascent economic recovery and when combined with the inability of U.S. central bankers to spot anything resembling an asset bubble in real time, policymakers will probably think better of it and just keep talking about a strong dollar instead of actually doing anything to make it stronger.

St. Louis Fed President James Bullard said as much the other day citing the last two recessions as the likely model for the central bank this time around. In fact, Bullard thought it more likely that rates would begin to rise in 2012 rather than in 2011.

What this means for the U.S. dollar is that, about the only thing that will prevent its value from eroding much further in the year ahead - a development that could ignite a currency crisis of monumental proportions - is some sort of a non-currency financial crisis where investors and traders from all around the globe seek safety in the world's most deep and liquid capital markets that are only found in the U.S.

That seems to be about the only hope for the dollar.

Critical moment for "Audit the Fed" effort

2009-11-19T09:43:00.000-08:00

It looks like today will be an important day for those, on one side, who seek to shine a little more light on the operations of the Federal Reserve and those, on the other side, hoping to keep prying eyes away. Bloomberg reports that the House Financial Services Committee is discussing the issue today:

The House Financial Services Committee will consider today how much to expand audits of the U.S. central bank in a test of Federal Reserve Chairman Ben S. Bernanke’s clout among lawmakers.

Panel members will vote on a Democratic proposal to retain a ban on audits of Fed interest-rate decisions. Approval would deal a blow to Representative Ron Paul, the Texas Republican who introduced a bill with 300 cosponsors that would allow audits of interest-rate decisions, a step Bernanke opposes.

Advancing the Democratic measure would be a victory for Bernanke as the Fed faces the biggest threats to its authority and independence in five decades. Lawmakers are seeking greater transparency for the Fed and limits on its powers, saying lax regulation by the central bank helped trigger the financial crisis.

There's much more than meets the eye here because there are competing efforts to audit the Fed, some watered-down versions apparently trying to get out in front of Rep. Ron Paul's (R-Texas) HR1207 bill that would subject nearly all central bank activities to audits.

The activity today surrounds a limited audit amendment offered by Rep. Mel Watt (D-NC) that would be tacked onto another House bill. Senator Chris Dodd (D-Conn.) also has Fed auditing included in his massive financial market regulatory reform bill introduced last week, however, it is the weakest of the three efforts.

Ron Paul wrote an op-ed piece titled "Americans Deserve a Transparent Fed" that appears in today's Wall Street Journal and both the Huffington Post and The Hill have recent reports:

You can also check on the one-hour Google News search for Audit the Fed for timely news.

Oil and gold contest - last day for entries!

2009-11-19T09:01:00.000-08:00

Today is the last day for entries in the seventh installment of the semi-annual "Guess the price of oil and gold" contest - be sure to get your guesses in by midnight PST today or they will not be accepted. Here's one last look at the historical chart:
A free one-year subscription to the investment website Iacono Research (a value of $159) will be awarded to the contestant with the lowest combined percentage error between their guesses and the prices for these two important commodities at the end of the year.

For full contest details and all entries that have been submitted so far, see these two previous items from last week and earlier this week. Entries may be made either by posting them in the comments section of this post (or either of the prior two posts above) or sending mail to either tim-at-iaconoresearch.com or tliacono-at-yahoo.com.

The winner will be announced on December 31st - good luck to all!

More middle class bankruptcies

2009-11-19T07:16:00.000-08:00

USA Today reports on a new study of how personal bankruptcies are working their way up the socio-economic ladder, increasingly affecting better educated families and homeowners.

A new study by Elizabeth Warren, Harvard Law School Leo Gottlieb professor of law, and Deborah Thorne, Ohio University associate professor of sociology, finds that personal bankruptcy has become a largely middle-class phenomenon led by filers who are college-educated and owners of homes. According to the study, "The Vulnerable Middle Class: Bankruptcy and Class Status," the shift occurred even before the Great Recession.

More than 100,000 middle-class families filed for personal bankruptcy every month in 2007, says the report, which was provided to USA TODAY but will be released in a book next year. Those who filed in 2007 were in worse financial shape than those who had filed in 2001.

"The bankruptcy filings are a warning about the risks now facing middle-class Americans," says Warren, chair of the Congressional Oversight Panel on the Troubled Asset Relief Program (TARP). No longer can they count on a college education, a good job and homeownership to protect them from financial collapse.

Since this study contains data through 2007 only, it's a safe bet that conditions have deteriorated significantly since that time, particularly in light of housing market distress making a similar move up the socio-economic ladder.

It's all about jobs, lifestyles, and debt loads, many families now finding that employment can vanish quickly, causing a more gradual decline in spending, whereas debt never seems to go away unless drastic measures are taken - like filing for bankruptcy.

Traditional savings is likely to make a big comeback in the years ahead as the "wealth building through asset appreciation" approach to personal finance is rapidly losing favor.

Poor savings habits, health problems and excess spending have traditionally been causes of bankruptcy. But the study finds that college education and homeownership, the traditional strategies for wealth building, may not be enough to guarantee financial security.

"As these time-honored wealth-building strategies become higher-risk undertakings, the middle class may face even greater economic instability in coming years, suggesting that in the modern economy, the path to prosperity may be far more perilous than anyone imagined," the authors conclude.

The proportion of bankruptcy filers who have been to college, whether they dropped out or graduated, increased from 46.5% in 1991 to 58.9% in 2007, the study finds.

"The data was taken from the boom years," Warren says, noting that it takes a long time to analyze and produce it. "I'm almost afraid to look at the data now."

There are few compelling human interest stories in here - all somewhat sad but, apparently, representative of the financial distress in the middle class these days (that is, if you can call someone who was making $275,000 a year "middle class").

DeFazio slams Goldman, Summers, Geithner

2009-11-19T06:40:00.000-08:00

Rep. Peter DeFazio (D-Oregon) has a few choice words for Goldman Sachs and suggests the nation might be better off with two more job losses - Larry Summers and Tim Geithner.

With all the criticism of the Federal Reserve lately, if Ben Bernanke happened to hear DeFazio talk, he would probably have been quite pleased not to hear his name mentioned.

Thursday morning links

2009-11-19T05:55:00.000-08:00

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Cats4Gold?

2009-11-18T21:27:00.000-08:00

A new company called Cats4Gold (hat tip AD) that offers felines in exchange for gold jewelry appears to be following the business model of well known (and controversial) Cash4Gold.
It looks promising, but I don't think it's a sign of a top - maybe in cats, but not for gold.

Toll: FHA lending is a "trainwreck"

2009-11-18T16:57:00.000-08:00

Bloomberg reports that the head of Toll Brothers doesn't think much of the quality of loans being guaranteed by the Federal Housing Administration.

The Federal Housing Administration, the agency that insures home purchases made with down payments as small as 3.5 percent, may create another lending crisis, Toll Brothers Inc. Chief Executive Officer Robert Toll said.

“Yesterday’s subprime is today’s FHA,” Toll said today at a New York conference for builders sponsored by UBS AG. “It’s a definite train wreck and the flag will go up in the next couple of months: Bail us out. Give us more money.” Toll Brothers is largest U.S. luxury homes builder.

The FHA’s insurance reserve ratio fell to 0.53 percent, the lowest level in history, and more steps are needed to shore up the agency that guarantees one of every five single family loans, Housing and Urban Development Secretary Shaun Donovan said Nov. 12.

While the insurance fund’s capital ratio is at an all-time low, Donovan said those who say FHA is the next subprime- mortgage crisis are “dead wrong.” The quality of the loans FHA insures is “actually very good,” Donovan said.

Perhaps a visual aid would be helpful here.

From this item a couple weeks ago last week:

In case you haven't seen the recent performance of the FHA's loan portfolio in chart form, well, here it is, compliments of T2 Partners fine (and lengthy) report on the U.S. housing market that you can download here, after a short registration.
Recall that the FHA went from about 2 percent of all loan originations a couple years ago to a whopping 25 percent this year. Obviously, they're going for quantity, not quality.

The pact between Obama and Hu

2009-11-18T15:00:00.000-08:00

From the Tom Toles collection at the Washington Post comes this summary of the agreement reached between President Barack Obama and Chinese President Hu Jintao.
Perhaps something in the background with U.S. dollars and firecrackers would have added to theme here of an uneasy relationship before they even met.

A tale of two American economies

2009-11-18T10:12:00.000-08:00

Economist/rock star Nouriel Roubini writes in the Globe and Mail about the two very different "recoveries" underway for the U.S. economy.

While the United States recently reported 3.5 per cent GDP growth in the third quarter, suggesting that the most severe recession since the Great Depression is over, the American economy is actually much weaker than official data suggest. In fact, official measures of GDP may grossly overstate growth in the economy, as they don't capture the fact that business sentiment among small firms is abysmal and their output is still falling sharply. Properly corrected for this, third-quarter GDP may have been 2 per cent rather than 3.5 per cent.

The story of the U.S. is, indeed, one of two economies. There is a smaller one that is slowly recovering and a larger one that is still in a deep and persistent downturn.

Consider the following facts. While America's official unemployment rate is already 10.2 per cent, the figure jumps to a whopping 17.5 per cent when discouraged workers and partially employed workers are included. And, while data from firms suggest that job losses in the past three months were about 600,000, household surveys, which include self-employed workers and small entrepreneurs, suggest a number above two million.

That seems to be a common theme these days if you look past the headlines - that small businesses are not only failing to play their usual role of leading the rest of the economy out of the downturn, but they are in fact laggards in this "recovery".

Of course, the "two economies" theme is reinforced by the fact that bonuses on Wall Street are expected to be near record highs in 2009, whereas, the holiday season will surely be a much more glum affair on Main Street.

Housing starts plunge

2009-11-18T09:22:00.000-08:00

That was quite a shocker this morning from the Census Bureau when, after many months of leveling off at, albeitly, historically low levels, they reported(.pdf) a plunge of 10.6 percent in housing starts last month along with a drop of 4.0 percent in permits for new construction.
Housing starts fell from a downwardly revised annual rate of 592,000 in September to just 529,000 in October, the third worst reading this year and, not coincidentally, the third worst reading since this data series began back in the 1960s.

The number of building permits also fell, down from a rate of 575,000 to 552,000, in one more indication that the effects of government stimulus - in this case, the expiring homebuyer tax credit that has since been extended - are not very long lasting.

Surprise! More budget problems in California

2009-11-18T08:37:00.000-08:00

Proving once again that the state of California is virtually ungovernable without some sort of an asset bubble in the inflation stage (rather than the current condition), Sacramento has released an early projection of its 2010 fiscal outlook and the news isn't good.

The LA Times reports that "borrowing, fiscal tricks and overly optimistic projections" have failed to stem the tide of red ink and another year of partisan wrangling awaits.

Less than four months after California leaders stitched together a patchwork budget, a projected deficit of nearly $21 billion already looms over Sacramento, according to a report to be released today by the chief budget analyst.

The new figure -- the nonpartisan analyst's first projection for the coming budget -- threatens to send Sacramento back into budgetary gridlock and force more across-the-board cuts in state programs.
...
"Economic recovery will not take away the very severe budget problems for this year, next year and the year after," said Steve Levy, director of the Center for Continuing Study of the California Economy.

You might have thought that there would more trouble for the California budget after having done such things as paying state workers on August 1st instead of late July in order to push those costs into the next fiscal year.

It seems as though the game of "extend and pretend" has become something of a national pastime these days, now being played at all levels of society and all across the country - from Washington to Wall Street to Sacramento.

The gubernator will probably be happy to say "Hasta la Vista baby" to the state capital a year from now, ironically, leaving under circumstances that are now even worse than the conditions in 2003 that were instrumental in his election after former Governor Gray Davis was recalled.

Gov. Arnold Schwarzenegger, who will present his next proposed budget to Californians in January as he begins his last year in office, started sounding the alarm last week.

"I think that there will be across-the-board cuts again," he said at a San Jose news conference.

The task in 2010 could be even harder than it was this year, when record deficits and cash shortfalls drove California to issue IOUs for only the second time since the Great Depression. Lawmakers have already cut billions from education, healthcare and social services while temporarily hiking income, sales and vehicle taxes.

"I can't think of any good solutions," said Assemblywoman Noreen Evans (D-Santa Rosa), who chairs the lower house budget committee.

The current budget year accounts for $6.3 billion of the deficit, the nonpartisan analyst projects. Prisons spending will outstrip what has been budgeted by more than $1 billion, and K-12 schools were underpaid by $1 billion under the complex formula that governs education funding, the report says.

Another $14.4 billion of the deficit is for the fiscal year that begins next summer, say those briefed on the report. The governor's next budget will have to account for both years.

Let's see, four months later and the budget is $21 billion worse.

That seems to be about the same rate of decay that was seen last year when they were trying to close a budget gap of $40 billion or more. Don't be surprised if, in another few months, projections are right back at the $40 billion mark.

Prices rise, "deflation" nearly averted

2009-11-18T07:31:00.000-08:00

The Labor Department reported that consumer prices rose more than expected last month, largely due to higher prices for automobiles and rising energy costs, and the year-over-year inflation rate moved back toward zero after spending nearly all of 2009 in negative territory as shown below.The government's measure of inflation rose 0.3 percent in October after an increase of 0.2 percent in September, the ninth monthly increase in prices so far this year after three months of plunging prices late last year, again, largely due to energy.

After sinking as low as -1.9 percent (on a seasonally adjusted basis) at mid-year, the annual inflation rate has now recovered to just -0.2 percent and is likely to move into positive territory next month, remaining there well into next year as energy price comparisons from year ago levels will produce some rather large percentage gains, that is, unless the price at the pump tumbles from its current level.

The 1.5 percent gain in energy costs last month, paced by an increase of 1.6 percent in gasoline prices, put the year-over-year change in the closely watched energy index at -14.0 percent in October, up sharply from many months of readings at -20 percent or more, and this is likely to produce a positive number when the November data is reported next month.
Aside from energy, there is little excitement in the inflation data these days as consumer prices still appear to be under control, the downside now well protected by the government's proxy for the cost of home ownership - the nefarious owners' equivalent rent - which stubbornly refuses to go down despite home prices that have been falling for years.

Owners' equivalent rent now shows an annual increase of 1.2 percent, a result that is clearly at odds with other homeownership costs.

Rental costs are also reported to be up 1.2 percent from last year but, given all the anecdotal accounts of landlords bending over backwards to attract tenants and reports of falling rental costs in most of the country, this seems to be at odds with the reality on the ground as well.

Of course, that seems to be standard operating procedure for the government inflation data.

Wednesday morning links

2009-11-18T06:25:00.000-08:00

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Guess the year-end price of oil and gold!

2009-11-17T16:40:00.000-08:00

There are only a few days left for readers to enter their year-end guesses for the seventh installment of the semi-annual "Guess the price of oil and gold contest" where the lucky winner will receive a free one-year subscription to the Iacono Research investment website.

Past contests have produced the following results:
Since the guessing began a week ago, that yellow diamond indicating the current price of oil and gold has moved a full $40 to the right.

Though the price moves during the first half of the year were dominated by rising crude oil, so far, the second half of the year is all about the gold price.

Who knows where it'll be in another six weeks.

The last contest was won by ycching at mid-year in a hard fought battle to the end.
In graphic form, you can see that, despite a number of bold calls for gold, there wasn't a whole lot of movement while the contest was underway.

Interestingly, that handful of off-the-chart guesses for gold don't look all that wacky this time around. Apparently, $1,200 an ounce wasn't wacky at all - just premature.
This time around the rules are the same as they've always been - the contest is based on the combined percentage differences between the guessed values and the closing prices on December 31st, 2009 using the near-month (February) Nymex futures contract for WTI crude oil and the COMEX closing bid price for gold bullion.

Entries may be made either by posting them in the comments section of this post or sending mail to either tim-at-iaconoresearch.com or tliacono-at-yahoo.com.

All entries must be received no later than Thursday, Nov. 19th

There will be one more notice on Thursday before entries close and current subscribers can win a free one-year extension to their existing subscription should their guesses be the closest.

The winner will be announced on December 31st - good luck to all!

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To learn more about investing in natural resources using commonly traded ETFs,
stocks, and mutual funds, see this description at Iacono Research.
For subscription details, click here.

Faber: Gold a better buy than at $300/oz.

2009-11-17T14:31:00.000-08:00

Dr. Marc Faber has been in the news a lot lately, asked repeatedly about the price of gold, and, while there was some confusion about his outlook last week as noted here (Mac Slavo at SHTFPlan going so far as to contact the good doctor to clarify his views and documenting the results here), the preponderance of recent reports point to a very bullish Faber.

There is a growing collection of related YouTube clips submitted in just the past few days and, again, the clear message is that he thinks gold is going higher, not lower. This story at LiveMint is typical of what's been published recently but, upon closer examination, it seems to me that the second comment below is more interesting than the now well known first.

What about gold?

I don’t think that you’ll see gold below $1,000 per ounce probably ever again. So I’m quite positive.

Maybe, gold at this level is a better buy than it was at $300 per ounce in 2001.

At first glance, the idea that gold priced at over $1,100 an ounce is "a better buy" than when the metal traded at about a quarter of that price seems preposterous. But, when you think about it just a little bit (i.e., what constitutes a "better buy" and how the fundamental factors have now swung so decidedly in gold's favor), maybe it isn't a crazy idea at all.

I wouldn't be surprised if, in another eight years - in 2017 - the yellow metal fetches $5,000 an ounce or more which, by my math, would make it a better buy. Gold may not rise as much against other currencies, but, after almost a decade of trillion dollar deficits, that almost seems like a slam dunk when the measuring stick is the U.S. dollar.

The Obama-Hu meeting

2009-11-17T11:14:00.000-08:00

Spotted over at Jesse Felder's Posterous, this cartoon by John Sherffius speaks volumes about the respective trajectories of the U.S. and Chinese economies.

Stateside, the USA Today blares China slams U.S. Federal Reserve's low interest rates as more talk is heard in Asia about the U.S. central bank fostering asset bubbles and, perhaps, auguring a full scale currency crisis at some point.
So far it's been a good day for the dollar, now up more than half a percent against other freely traded currencies and, no doubt, helping to keep the price of gold in check.

A stronger dollar no longer seems to cause the gold price to fall - it just stops it from rising...