The Glass is Half Full
By James J Puplava CFP, September 16, 2003
Well if the economy is improving, there is no sign of that improvement in the labor market. The Fed is also worried about this development. In the minutes accompanying today's Open Market Meeting, Fed officials stated, "Spending is firming, although the labor market has been weakening again." Pricing power for business remains nonexistent. This is keeping consumer prices under control. Policymakers separated today's outlook into two parts. The outlook for economic growth looks good, but the outlook for prices and the labor market looks weak. The weak pricing outlook is tilting monetary policy in favor towards the additional possibility of another rate cut. In economic terms the glass remains half full. There has been an improvement, but it isn't big enough to generate any job growth or allow companies to raise prices to cover rising labor and raw material costs.
In essence the Fed has very little to show for its monetary looseness other than a series of asset bubbles. On Main Street the only visible sign that things have gotten better is that you can still get a cheap mortgage, but the price of a home has become hyperinflated. This makes the main beneficiary of monetary inflation existing home owners. Existing homeowners are still able to take out a home equity loan and extract more equity out of their home at a lower cost.
Because the economic recovery remains so fragile, Wall Street experts believe that the Fed will keep its foot on the monetary pedal all the way through next year's presidential elections. The message from the Fed is that there will be plenty of money, liquidity and low rates available until after November of next year. Will that mean an improvement in the economy? Well, that depends on which part of the economy you look at.
Foreign Holdings of Treasuries at a Record
Parts of the economy that benefit from excess Fed created liquidity such as housing and the stock market are expected to do well. The Fed will do all it can to keep the mortgage, housing, consumption, stock and bond market bubbles alive through plenty of cheap money. Can they keep the bubble alive until next year's elections are over? Here again that depends on what foreigners do with our greenbacks. The fate of the dollar, the bond market, interest rates and ultimately the U.S. economy now rests in the hands of foreign investors. Foreign holdings of U.S. Treasuries now exceed 46%. The U.S. is mortgaging its future and the primary mortgage holder has become Asian central banks.
According to recent Fed reports, foreign investors poured $101 billion into U.S. Treasury bonds during the second quarter. Without that influx of money, interest rates would be much higher and the dollar much lower then where they ended up at the close of the quarter. China, Japan, South Korea and Hong Kong now own $696 billion in U.S. Treasuries as of the end of June. The Fed may determine short-term rate in the U.S., but the fate of the bond market rests lies entirely on the whims of these four foreign states. Without their direct support of the dollar and our bond market, interest rates would be a lot higher then where they now stand. It is a very precarious state to be in as a superpower. The U.S. continues to implement policies that favor debt, consumption, speculation at the expense of savings and long-term investments. Very little of what we consume these days outside of basic necessities is made here in the U.S. Even there we import most of the energy that we consume. In one sense without U.S. troops in the Middle East to guarantee the safe passage of oil out of the Persian Gulf, Americans would be paying much higher prices for the oil they consume.
This dependence on foreign goods to supply and meet the demands of robust consumption does not show any signs of abating soon. Last month I made two visits to the shopping malls. Both times I found the malls to be crowded and the parking lots full. In just about every outlet store I visited, the floors were busy with eager consumers. Standing in line in one store eight shoppers stood in front of me. Not one did I see pay for their goods with a checkbook, debit card or American Express card. Every purchase was paid for with Visa or MasterCard. I asked the clerk who rang up my purchases if this was unusual. She said that very seldom is anything sold in the store for cash. The store clerk told me that business has been robust lately. They were optimistic that Christmas would be even better. In fact the retailing association is now forecasting a 5.7% improvement in Christmas sales this holiday season. Consumer spending is expected to remain the main prop outside government spending for the economy for the foreseeable future. Americans are expected to go deeper into debt each month in order to keep the consumption bubble alive. What the country has become good at is manufacturing credit. Think of it: at one time the U.S. was the world's leading manufacturer of goods. Today the U.S. is the leading manufacturer of credit. The American economy has morphed from a manufacturing and producing economy to a credit and consumption society.
Our Foreign Debt Cycle
The way this works is an American worker goes deeper into debt each month to spend that money on foreign made goods from DVD players, flat panel television sets and furniture to foreign made cars. Foreigners then take our dollars and use them to purchase our assets. They own 46% of all of our outstanding Treasury debt, 13% of all agency paper, 17% of all corporate debt and an almost equal amount of all of our stocks. We work and go into debt each month to buy their goods. They in turn take our money and buy up our assets. As more companies shift manufacturing and service facilities to overseas, our dependence on foreign-made goods (and now services) will accelerate until such time they no longer have need of our dollars.
According to American economic thinking, this all makes perfect sense. The goal of economics is to turn everyone into a consumer. Americans will continue to borrow and spend and lead a lifestyle that exceeds our ability to pay for the goods we consume. Since the bulk of consumption will go towards foreign-made goods, very little will improve on the job front. It may come as a surprise to most analysts, but more rate cuts from the Fed will not improve the American labor market. The Fed is powerless when it comes to creating jobs and omnipotent when it comes to creating asset bubbles. Fed officials and Wall Street economists talk about productivity miracles a story, which I believe is fictional because of the way GDP is measured. The productivity numbers are as bogus as the GDP numbers, the unemployment rate and the CPI numbers. However, it makes for a plausible story when one tries to figure out why we are seeing no new job creation in what is considered to be an improving economy. The only beneficiary from all of this monetary largesse is debtors and speculators.
The markets responded in bubble-like fashion today after the Fed announced that it would keep interest rates at 45-year lows. Speculators coming into the futures pit pumped up the major indexes in the last hour and half of trading. The main reason for the market's gains was attributed to investors who now believe that economic and profit growth will accelerate. Nothing has changed from the last Fed meeting. No one expected rates to rise or for the Fed to lower them. What money managers were optimistic about is that the Fed will continue print billions--if not trillions--of money out of thin air into the economy and the financial system to keep all the various bubbles inflated. One money manager made a comment today that expresses the view held by most professional investors, "The Fed won't raise rates until inflation and hiring picks up." If money velocity falls faster, the Fed will print more money. If that doesn't work, they will look at extra-ordinary means of making cash worthless, from dropping money out of helicopters to a carry tax on money held on deposit. Nothing is out of the realm as the Fed will get more desperate in the months ahead when present policy measures run out of steam. The Fed is hell-bent on reflation, which means that the prices of goods and services you need are going to go higher. It also means you're going to be seeing higher gold and silver prices over the next year. We will know over the next year whether present monetary polices will lead towards a depressionary crash or hyperinflation. Maybe we will see both. We truly are living in historic times. Not since the days of John Law in 17th century France have we ever seen this degree of monetary madness.
What we can observe is that asset bubbles in real estate and the stock market continue to inflate. Companies continue to fire more workers even as economic growth picks up with unemployment claims back up to two-month highs. Jobs lost since this recovery began now stand at 2.8 million with the unemployment rate at 6.1%. The goods news is that inflation at the consumer level is at a historic low of 1.3%. The only trouble with this number is that it represents a basket of goods and services that bear little resemblance to what you and I actually spend money on to live each month. The other goods news is that another mini-bubble has developed in the stock market. If you don't look at a balance sheet, can’tread or understand financial statements, or grasp what you are actually paying to own a stock, this is a great market to be investing in. There is plenty of money coming into this market from both the pros and the little guy. It isn't the pros' money, so there is little attachment to it. The market's ability to absorb any bad news and turn it into a positive is definitely a plus.
Since March the right place to be is in stocks with only one caveat. You better keep your eye on the exit door and have your hand on the ripcord of your parachute. The pilots of the airplane (company insiders) have already jumped. The rest of the crew is jumping. You're sitting in coach and enjoying the view. Enjoy it while you can, for it never lasts. The market now appears to be in a topping process with distribution taking place. Maybe it is time you become a distributor too.
Volume in today's market came in at 1.36 billion shares on the NYSE and 1.78 billion on the Nasdaq. Breath was overwhelmingly positive by 23-9 on the Big Board and by 22-10 on the Nasdaq. The VIX and the VXN both fell with the VXN dropping .94 to close at 19.31 and the VXN closed down 1.27 to end the session at 31.66
See yesterday's WrapUp for more on "Distribution." Chart inspiration: Financial Times
© 2003 James Puplava