"The Federal Reserve will not monetize the debt."
That last sentence has a ring to it. It reminds us of Richard Nixon's "I am not a crook." Surely, it is destined to make its way into the history books, alongside Bill Clinton's "I did not have sex with that woman" and the builder of the Titanic's "even God himself couldn't sink this ship."
Monetizing the debt is precisely what the Fed will do. But it will not do so precisely. Instead, it will act clumsily...reluctantly...incompetently...accidentally...and finally, catastrophically.
That's our prediction, here at The Daily Reckoning. Prove us wrong!
In today's reckoning we describe why you don't have to be an astrologer or an economist (the two are similar...except the astrologers have more professional credibility) to see what is coming.
First, a look at the market. Yesterday, investors seemed to think it over and change their minds. Their first reaction - on Wednesday - to Geithner's reassurances to the Chinese and Bernanke's reassurances to Americans was positive.
"Maybe these guys are on the level, after all," they said to themselves. "Maybe the dollar won't fall apart."
But after 24 hours of deep reflection and heavy drinking they came to their senses: "What was I thinking? Of course they're going to undermine the dollar...what else can they do?"
So yesterday they were back at it - buying assets that are priced in dollars but that move in the opposite direction. The euro went right back to where it was at the beginning of the week, at $1.41. Gold, which had lost $18 on Wednesday, recovered $16 on Thursday. Oil had slipped $2 after Bernanke's comments; yesterday, it gained $2.
Stocks rose too - with the Dow up 79 points.
A friend sent a recent report from analysts with Barclays Bank. Barclays is advising private clients that the "bear market is probably over."
Anything is possible, of course. But for the many reasons we've described in these reckonings we doubt that we've seen the last of this bear. Or the last of this recession. What we've seen so far is merely a classic post-crash bounce. Nothing more.
Which is WHY the Fed will eventually monetize the debt. "Monetizing" debt, by the way, is larceny on the grandest scale. Rather than honestly repaying what it has borrowed, a government merely prints up extra currency and uses it to pay its loans. The debt is "monetized"...transformed into an increase in the money supply, thereby lowering the purchasing power of everybody's savings.
Of course, the Fed will not want to do such a dastardly deed; but it will do it anyway. Even good people do bad things when they get in a jamb. The feds are already in pretty deep...and they're going a lot deeper.
Now over to Ian at The 5 for some news on today's jobs report:
"The U.S. economy shed 'only' 345,000 jobs in May, the Labor Department said this morning. We forecast Wednesday that today's employment gauge would beat expectations, but wow...this number smashed the Street's guess of 520,000. Last month's loss is the smallest since it all hit the fan last September.
"May's number establishes a trend for 2009, too. The jobs scene is far from rosy, but at least it doesn't seem to be getting worse...not yet anyway.
"So 'Buy, buy, buy!' as they say in Cramerica, right? U.S. index futures jumped on the news and the Dow and S&P 500 opened up 1%. And if you aren't the type to be bothered by the fine print, we suggest you slam the buy button too.
"But the details of today's jobs report aren't quite as rosy as the headline number. The unemployment rate rose to 9.4%, notably higher than the expected 9.2%. In other words, the unemployed are not being rehired. While the rate of firings cooled off, the bread line is just getting longer and longer. 9.4% is the highest rate since 1983.
"And it's funny how the dark science of charting works. The chart above would lead you to believe the jobs scene has bottomed...but does this one inspire the same confidence?"
Wanna make sure you get The 5 - in its entirety - sent to your inbox, every Monday through Friday? You can...by becoming a subscriber to one of Agora Financial's paid publications, such as Capital & Crisis. And in the latest report of C&C, you'll discover a little-known way to receive up to three extra paychecks a month...without lifting a finger. It's the perfect way to ensure a constant influx of money, whenever you may need it. Click here for all the info.
And back to why the Fed will monetize the debt:
The European Central Bank came out yesterday and said that its forecasts for the recession were on the low side. Instead of putting total output back 3.5% this year - as it had estimated in March - it now thinks the setback will be between 4% and 5% of GDP.
Unlike Japan's slump of the '90s and '00s, this depression is worldwide. Americans aren't buying like they used to. So, foreigners aren't selling. Everyone gets poorer as expected income and profits disappear...and turn into losses.
Meanwhile, in America, today's jobs report shows that unemployment is still on the rise. People without jobs can't buy stuff - neither the kind of stuff you get at the grocery store...nor the kind of stuff you get from real estate agents. Since they don't buy stuff, manufacturers don't make stuff. And since they don't make stuff, they don't need the stuff that stuff is made of, nor the employees who turn the raw stuff into the finished stuff.
Result: the stuffing gets knocked out of the economy.
Also, while Tim and Ben reassure investors, long bond yields go up. The Chinese have shifted from buying long bonds to buying short bills. This causes the return on bills to go down, but it pushes up yields on the 30-year bond...to which long-term fixed-rate mortgages are calibrated.
Last week, according to Freddie Mac, the average 30-year mortgage had a fixed rate of 4.9%. This week it's 5.27%. At the margin - which is where most people live - this extra cost of financing pinches would-be homeowners. Either they buy a smaller house...or they pay less for it.
It also pinches anyone who needs to refinance - which includes not only sub-prime borrowers, but many others too. MSN Money reports:
"The next group of Americans to lose their homes seemed to have good credit and affordable loans. But those families have been walloped by the recession.
"In the housing market, a lot of prime mortgages are becoming subprime as a new wave of foreclosures begins to hit. Mainstream homeowners - those previously 'safe' borrowers with sound credit who have conservative, fixed-rate mortgages - are getting into trouble at an alarming rate.
"In the first quarter, the percentage of these borrowers who were behind on their mortgages or in foreclosure had doubled from a year earlier, to nearly 6%. For the first time in the housing crisis, these homeowners accounted for the largest share of new foreclosures.
"Job losses are a major reason once-safe borrowers are falling into trouble. With unemployment likely to rise, the problem will only get worse. So the core challenge at the heart of our economic crunch - a poor housing market that infects banks and the whole credit system - is not going away soon. That's bad news for the stock market and the economy in general.
"'A couple of months ago, a lot of people had hoped that the housing collapse was about over,' says money manager and forecaster Gary Shilling, a well-known bear who called the housing problems early in the cycle. 'But it was more hope than reality.'
"Economists call rising delinquencies and foreclosures among prime borrowers the third wave of trouble. The first two waves were housing speculators going bust and subprime borrowers - those with poor credit histories and some version of no-down or low-down adjustable-rate mortgages - getting into trouble.
"Mark Zandi, the chief economist for Moody's Economy.com, calls the third wave a 'significant threat' to the economy. '"It is gathering momentum,' he says. 'The problem is now well beyond subprime and deep into prime.'"
Following this article was a series of comments. One, filed on Wednesday, was particularly interesting:
"This is my world crashing down on me. I own apartments and I rent to poor people. I more than most know what people are experiencing. While my properties are struggling, the income they generate has not dropped significantly to threaten the payment of any loan. Unfortunately, my loans are due this year and I am simply unable to borrow money to replace the loans I am currently servicing successfully. What can I do? All my capital reserves are gone, but effectively, I am losing my job because the banking system and market will not allow me to borrow money. If you bought my property today at the current market rate, your cash on cash return would be over 15%. This type of return in the Atlanta Real Estate market has not been seen in decades. When employment growth rises in Atlanta in 12 to 24 months, the cash on cash return will be over 20%. I probably will not survive. I will lose everything, my house, my business and my savings. I will have to start all over..."
Now, dear reader, we ask you a question: Is a politician from either party willing to stand in front of this man and tell him that interest rates are going up? Or how about telling him that Congress is raising his taxes? Even if the goal were only to balance the budget ten years from now, it would take a permanent, across-the-board tax increase of 60% to do so. (See below...) Would any politician in his right mind vote for such an increase? Ben Bernanke talks about cuts in spending and tax increases. But Bernanke is not up for election. Besides, practically every economist in the country in telling Congress it needs to spend MORE money, not less. Cut spending and increase taxes in a recession? Are you kidding?
We are in a serious, multi-year depression. No increase in taxes and no decrease in spending will be seriously considered until we are out of it. But if it follows the patterns of the past, then genuine, durable healthy growth will probably not return for many years...maybe 5...maybe 10...maybe 20. Long before then the US will have too much debt to carry...let alone pay back. It will have no choice but to "monetize" this debt by means of inflation.
We'll tell you more of the HOW...on Monday.
And back to why the Fed will monetize the debt:
The European Central Bank came out yesterday and said that its forecasts for the recession were on the low side. Instead of putting total output back 3.5% this year - as it had estimated in March - it now thinks the setback will be between 4% and 5% of GDP.
Unlike Japan's slump of the '90s and '00s, this depression is worldwide. Americans aren't buying like they used to. So, foreigners aren't selling. Everyone gets poorer as expected income and profits disappear...and turn into losses.
Meanwhile, in America, today's jobs report shows that unemployment is still on the rise. People without jobs can't buy stuff - neither the kind of stuff you get at the grocery store...nor the kind of stuff you get from real estate agents. Since they don't buy stuff, manufacturers don't make stuff. And since they don't make stuff, they don't need the stuff that stuff is made of, nor the employees who turn the raw stuff into the finished stuff.
Result: the stuffing gets knocked out of the economy.
Also, while Tim and Ben reassure investors, long bond yields go up. The Chinese have shifted from buying long bonds to buying short bills. This causes the return on bills to go down, but it pushes up yields on the 30-year bond...to which long-term fixed-rate mortgages are calibrated.
Last week, according to Freddie Mac, the average 30-year mortgage had a fixed rate of 4.9%. This week it's 5.27%. At the margin - which is where most people live - this extra cost of financing pinches would-be homeowners. Either they buy a smaller house...or they pay less for it.
It also pinches anyone who needs to refinance - which includes not only sub-prime borrowers, but many others too. MSN Money reports:
"The next group of Americans to lose their homes seemed to have good credit and affordable loans. But those families have been walloped by the recession.
"In the housing market, a lot of prime mortgages are becoming subprime as a new wave of foreclosures begins to hit. Mainstream homeowners - those previously 'safe' borrowers with sound credit who have conservative, fixed-rate mortgages - are getting into trouble at an alarming rate.
"In the first quarter, the percentage of these borrowers who were behind on their mortgages or in foreclosure had doubled from a year earlier, to nearly 6%. For the first time in the housing crisis, these homeowners accounted for the largest share of new foreclosures.
"Job losses are a major reason once-safe borrowers are falling into trouble. With unemployment likely to rise, the problem will only get worse. So the core challenge at the heart of our economic crunch - a poor housing market that infects banks and the whole credit system - is not going away soon. That's bad news for the stock market and the economy in general.
"'A couple of months ago, a lot of people had hoped that the housing collapse was about over,' says money manager and forecaster Gary Shilling, a well-known bear who called the housing problems early in the cycle. 'But it was more hope than reality.'
"Economists call rising delinquencies and foreclosures among prime borrowers the third wave of trouble. The first two waves were housing speculators going bust and subprime borrowers - those with poor credit histories and some version of no-down or low-down adjustable-rate mortgages - getting into trouble.
"Mark Zandi, the chief economist for Moody's Economy.com, calls the third wave a 'significant threat' to the economy. '"It is gathering momentum,' he says. 'The problem is now well beyond subprime and deep into prime.'"
Following this article was a series of comments. One, filed on Wednesday, was particularly interesting:
"This is my world crashing down on me. I own apartments and I rent to poor people. I more than most know what people are experiencing. While my properties are struggling, the income they generate has not dropped significantly to threaten the payment of any loan. Unfortunately, my loans are due this year and I am simply unable to borrow money to replace the loans I am currently servicing successfully. What can I do? All my capital reserves are gone, but effectively, I am losing my job because the banking system and market will not allow me to borrow money. If you bought my property today at the current market rate, your cash on cash return would be over 15%. This type of return in the Atlanta Real Estate market has not been seen in decades. When employment growth rises in Atlanta in 12 to 24 months, the cash on cash return will be over 20%. I probably will not survive. I will lose everything, my house, my business and my savings. I will have to start all over..."
Now, dear reader, we ask you a question: Is a politician from either party willing to stand in front of this man and tell him that interest rates are going up? Or how about telling him that Congress is raising his taxes? Even if the goal were only to balance the budget ten years from now, it would take a permanent, across-the-board tax increase of 60% to do so. (See below...) Would any politician in his right mind vote for such an increase? Ben Bernanke talks about cuts in spending and tax increases. But Bernanke is not up for election. Besides, practically every economist in the country in telling Congress it needs to spend MORE money, not less. Cut spending and increase taxes in a recession? Are you kidding?
We are in a serious, multi-year depression. No increase in taxes and no decrease in spending will be seriously considered until we are out of it. But if it follows the patterns of the past, then genuine, durable healthy growth will probably not return for many years...maybe 5...maybe 10...maybe 20. Long before then the US will have too much debt to carry...let alone pay back. It will have no choice but to "monetize" this debt by means of inflation.
We'll tell you more of the HOW...on Monday.
This week brought an entertaining episode. Wall Street's man in Washington, incidentally Secretary of the US Treasury, was sent to Beijing. His mission: to convince the canny Chinese of something that everyone knows is untrue - that US bonds are safe. But if the Americans keep faith with China, it won't be for lack of trying.
Of US government paper China has plenty. Bond holdings alone tote to $768 billion. Other dollar-denominated assets in Chinese hands add another $700 billion or so. Despite this Newcastle in its vault, the US would like China to buy more coal.
But lately, those dollar holdings have done poorly. Thanks, supposedly, to the economic rebound, the dollar has fallen against just about everything. Against gold, it is down 15% in 2009. Against oil, it is off 50%. As for copper, the dollar has lost 65% of its purchasing power. Thirty-year US Treasuries have fallen too - down about 27% since January. A rough guess is that China has lost more than $200 billion so far this year, thanks to the fall of the dollar and US Treasury bonds.
Martin Wolf, in the Financial Times, says these trends are signs of progress. "Rising government bond rates prove policy is working," begins his line of thought. Spreads between corporate bonds and Treasuries are narrowing. Real yields on corporate bonds are falling while yields on Treasuries go up. "Normalization," he calls it; investors now expect inflation instead of extinction.
The rise in inflation expectations is clearly visible in the US bond market, where inflation-indexed bonds are once again selling for substantially higher prices than their non-indexed cousins. Towards the end of '08, the bond market anticipated zero inflation. Now, the latest figures imply a 1.6% positive inflation rate over the next 10 years.
If inflation doesn't show up as forecast it won't be for lack of effort on the part of Mr. Geithner and his friends. The US deficit for the current year is $1.84 trillion. Every two months, the feds need to borrow nearly the equivalent of the previous entire year's record- breaking deficit. And if private lenders balk, the Fed stands ready to raise its own hand at the next auction of US government debt.
The Chinese are worried. They've put a lot of eggs in the basket now being carried by Geithner, Bernanke et al. What if Team America isn't as surefooted as it claims?
"It will be helpful if Mr. Geithner can show us some arithmetic," said Mr. Yu Yongding, described as a former advisor to the central bank of China.
Mr. Geithner showed up with numbers, of course. From a deficit of 12% of GDP, the US plans to take its deficit down to 3%, he said. But when he delivered this solemn fib at the University of Beijing the students laughed at him.
American Secretaries of the Treasury are not used to being laughed at. Almost 40 years ago, a US Treasury Secretary - John Connally - expressed the imperial view: "it may be our currency, but it's your problem." Even after the crack up in the fall of '08, the US continued in the fantasy that it could lay off as much paper on the foreigners as it wanted.
The aforementioned Mr. Yu Yongding addressed this point directly:
"I wish to tell the U.S. government: 'Don't be complacent and think there isn't any alternative for China to buy your bills and bonds... The euro is an alternative. And there are lots of raw materials we can still buy.'"
China is hedging its bets, buying assets that don't have dollar signs on them. Along with shrewd speculators, they're worrying about a government-fueled melt-up in prices. These anxieties - not a return to 'normalcy' - are sending the price of gold back towards $1,000 and the dollar towards $1.50 per euro.
Inflation, like cholesterol, comes in two forms - good and bad. The good inflation raises asset prices. The bad inflation raises consumer prices. No one complains when prices of houses and stock are rising. But when toothpaste and bread begin to follow, an alarum goes up. Soon, central banks are taking action to stop it - raising interest rates and credit standards. But this time it is different. Both types of inflation are welcome. Harvard economist Ken Rogoff says he advocates 6 percent inflation "for at least a couple of years." It would make it easier for debtors to repay loans, he says. Economist John Taylor, of the eponymous 'Taylor rule' gives another reason inflation would be well met. He points out that running a balanced US federal budget - even 10 years in the future - would require a permanent 60% tax increase. "A 60% tax hike won't happen," he writes. "The government will attempt to inflate the problem away instead." Even Warren Buffett told CNBC that the likely solution to America's problem was inflation.
Yu countered: "You should not try to inflate away your debt burden..." But that is exactly what the US is trying to do. So far, it's not good faith that protects China's dollar assets. It's a depression...and incapacity. The Geithner team tries to create inflation, but hasn't yet got the hang of it. Give them time.
Of US government paper China has plenty. Bond holdings alone tote to $768 billion. Other dollar-denominated assets in Chinese hands add another $700 billion or so. Despite this Newcastle in its vault, the US would like China to buy more coal.
But lately, those dollar holdings have done poorly. Thanks, supposedly, to the economic rebound, the dollar has fallen against just about everything. Against gold, it is down 15% in 2009. Against oil, it is off 50%. As for copper, the dollar has lost 65% of its purchasing power. Thirty-year US Treasuries have fallen too - down about 27% since January. A rough guess is that China has lost more than $200 billion so far this year, thanks to the fall of the dollar and US Treasury bonds.
Martin Wolf, in the Financial Times, says these trends are signs of progress. "Rising government bond rates prove policy is working," begins his line of thought. Spreads between corporate bonds and Treasuries are narrowing. Real yields on corporate bonds are falling while yields on Treasuries go up. "Normalization," he calls it; investors now expect inflation instead of extinction.
The rise in inflation expectations is clearly visible in the US bond market, where inflation-indexed bonds are once again selling for substantially higher prices than their non-indexed cousins. Towards the end of '08, the bond market anticipated zero inflation. Now, the latest figures imply a 1.6% positive inflation rate over the next 10 years.
If inflation doesn't show up as forecast it won't be for lack of effort on the part of Mr. Geithner and his friends. The US deficit for the current year is $1.84 trillion. Every two months, the feds need to borrow nearly the equivalent of the previous entire year's record- breaking deficit. And if private lenders balk, the Fed stands ready to raise its own hand at the next auction of US government debt.
The Chinese are worried. They've put a lot of eggs in the basket now being carried by Geithner, Bernanke et al. What if Team America isn't as surefooted as it claims?
"It will be helpful if Mr. Geithner can show us some arithmetic," said Mr. Yu Yongding, described as a former advisor to the central bank of China.
Mr. Geithner showed up with numbers, of course. From a deficit of 12% of GDP, the US plans to take its deficit down to 3%, he said. But when he delivered this solemn fib at the University of Beijing the students laughed at him.
American Secretaries of the Treasury are not used to being laughed at. Almost 40 years ago, a US Treasury Secretary - John Connally - expressed the imperial view: "it may be our currency, but it's your problem." Even after the crack up in the fall of '08, the US continued in the fantasy that it could lay off as much paper on the foreigners as it wanted.
The aforementioned Mr. Yu Yongding addressed this point directly:
"I wish to tell the U.S. government: 'Don't be complacent and think there isn't any alternative for China to buy your bills and bonds... The euro is an alternative. And there are lots of raw materials we can still buy.'"
China is hedging its bets, buying assets that don't have dollar signs on them. Along with shrewd speculators, they're worrying about a government-fueled melt-up in prices. These anxieties - not a return to 'normalcy' - are sending the price of gold back towards $1,000 and the dollar towards $1.50 per euro.
Inflation, like cholesterol, comes in two forms - good and bad. The good inflation raises asset prices. The bad inflation raises consumer prices. No one complains when prices of houses and stock are rising. But when toothpaste and bread begin to follow, an alarum goes up. Soon, central banks are taking action to stop it - raising interest rates and credit standards. But this time it is different. Both types of inflation are welcome. Harvard economist Ken Rogoff says he advocates 6 percent inflation "for at least a couple of years." It would make it easier for debtors to repay loans, he says. Economist John Taylor, of the eponymous 'Taylor rule' gives another reason inflation would be well met. He points out that running a balanced US federal budget - even 10 years in the future - would require a permanent 60% tax increase. "A 60% tax hike won't happen," he writes. "The government will attempt to inflate the problem away instead." Even Warren Buffett told CNBC that the likely solution to America's problem was inflation.
Yu countered: "You should not try to inflate away your debt burden..." But that is exactly what the US is trying to do. So far, it's not good faith that protects China's dollar assets. It's a depression...and incapacity. The Geithner team tries to create inflation, but hasn't yet got the hang of it. Give them time.
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