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Trading Lessons

America Flirts With Deflation

Economics / Deflation Oct 17, 2014 - 08:36 AM GMT

By: Raul_I_Meijer

Economics

“When it becomes serious, you have to lie,” said brand-new EC head Jean-Claude Juncker back in May 2011. I’m thinking the last few days have been serious enough to warrant some real whoppers from Brussels. And beyond.

Yesterday, one hour after the S&P reached its low point, not only was it deemed necessary to bring out the Plunge Protection Team, Fed grey head Janet Yellen was trotted out as well to soothe the dark mood with rosy tales about the US economy.


A multi-day series of downturns got a temporary crescendo, with many of the richest stock European exchanges at 10-11% losses from recent highs. Many lost 3-3.5% for the day alone, with Greece down 6.25% (Athens is off some -25% in all), and having its bonds dumped while Germany et al see ‘investors’ fleeing into theirs. A new attack on Athens certainly looks possible. And where Greece goes, so go Italy and Spain, albeit a few mph slower. Bond markets

Is this the end or the beginning? Well, as should have been clear for a very long time now, you cannot buy growth. And in ‘our’ efforts to buy growth instead of working for it, a lot of damage has been done. Which won’t all show up at once, but it will at some point. There will be many, and mighty, voices clamoring for more of the same, in more than one sense, as people seek to hold on to what looks familiar with additional debt injections in the by now 7 year-old tradition spirit of ‘stimulus’.

It’s become a new normal to claim the Germans must be insane not to follow the teachings of the Great Lord Keynes, with the huge success stories of the US and UK as ‘proof’ of just how wise he was. Then how come this kind of plunge is so predictable?

US stocks see their heaviest trading volume in 3 years. That takes liquidity. Dollars. But they are getting scarce. The ‘insanest’ amounts of free money, from China and America, are shrinking (Japan has become a story all of its own) and right away, panic ensues. Add the threat of higher rates and you get a sell-off. I see plenty ‘experts’ saying both Beijing and Washington will see the folly of their ways in time, but can they really do more of the same? And what would be the benefit vs the cost?

I remain solidly convinced that Yellen et al will suffocate QE, hike interest rates, and raise the dollar. Because that’s the triple that benefits big banks the most. And that’s also why she, yesterday, held that speech in which she ‘voiced confidence in the durability of the U.S. economic expansion’.

Yellen Voices Confidence in U.S. Economic Expansion

Federal Reserve Chair Janet Yellen voiced confidence in the durability of the U.S. economic expansion in the face of slowing global growth and turbulent financial markets at a closed-door meeting in Washington last weekend [..] Yellen told the Group of 30 that the economy looked to be on track to achieve growth of around 3%. She also saw inflation eventually rising back to the Fed’s 2% target as unemployment falls further… [..] Yellen’s reported remarks were roughly in line with the forecasts presented by Fed policy makers at their last meeting in September.

Not only did she, with the PPT, save the day on Wall Street, she also provided the reason why rates will rise, even if world markets have a high fever. In an aside, an Air France plane has been quarantined at Madrid airport just now with a Nigerian man with high fever and 182 other passengers. We can’t seem to get this right, can we?

Back to da mullah. Here’s a few interesting lines from Bloomberg yesterday afternoon:

U.S. Stocks Drop as Weakening Economic Data Fuel Selloff

The Chicago Board Options Exchange Volatility Index, the benchmark gauge of options prices known as the VIX, jumped 15% to 26.25, the highest level since 2012, amid demand for protection against losses in equities.

Almost 12 billion shares changed hands in the U.S., the most since October 2011. Stocks pared losses after the S&P 500 fell to its low of the day of 1,820.66 shortly before 1:30 p.m. in New York. About an hour later, Bloomberg News reported that Federal Reserve Chair Janet Yellen voiced confidence in the durability of the U.S. economic expansion in the face of slowing global growth and turbulent financial markets at a closed-door meeting in Washington last weekend.

Retail sales in the U.S. dropped more than forecast in September, decreasing 0.3% after a 0.6% gain in August that was the biggest in four months, Commerce Department figures showed. Another report today showed manufacturing in the Federal Reserve Bank of New York’s region slowed more than projected in October. The bank’s so-called Empire State index dropped to 6.2 this month from an almost five-year high of 27.5 in September.

That ‘demand for protection against losses in equities’ is a curious line. Can’t they let the PPT act in secret anymore? What else is its use? You can’t very well make it the Public Plunge Protection Team, nudge nudge…

But the big one is the drop in US retail sales. No harsh winter, no hurricanes, not even heavy rains. And the Empire State Index falling of a cliff. I know that today US industrial output came out looking like a harvest queen, and initial claims were down a bit, but I find the timing odd, and I can’t rhyme it with the heavy drop in that NY Fed index. Is it winter in Manhattan already? Or is it Juncker time?

It gets truly hilarious when you see things like this from Bloomberg. Pay special attention to Deutsche’s Joseph LaVorgna:

The $11 Trillion Advantage That Shields U.S. From Turmoil

Call it America’s $11 trillion advantage: Consumer spending is likely to steer the U.S. economy safely through the shoals of deteriorating global growth and turbulent financial markets. The combination of more jobs, falling gasoline prices and low borrowing costs will help lift household purchases. Such tailwinds probably matter more than Europe’s struggles or the slackening in emerging markets that caused the Dow Jones Industrial Average last week to erase its gains for the year.

“We’ve got a lot of things working in favor of the consumer right now,” said Nariman Behravesh, chief economist at IHS. “To have that kind of strength is the biggest asset for the U.S. It’s a pretty rock solid footing.” Household purchases make up almost 70% of the $16.8 trillion U.S. economy and have climbed an average 2% in the recovery that’s now in its sixth year. Spending growth will accelerate to 2.7% next year after 2.3% in 2014, according to the latest Bloomberg survey of economists.

The poll, taken from Oct. 3 to Oct. 8 in the midst of the meltdown in equities, showed little change in the median projections from the prior month. The economy is forecast to expand 3% in 2015 after 2.2% growth this year, according to the survey. “We’ve got the proverbial 800-pound gorilla – the consumer,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. “Households are more fixated on the good news here, and a big part of that is the labor market. The U.S. is going to be pretty immune to the rest of the world.”

“The U.S. is going to be pretty immune to the rest of the world.” No, Joe, it’s not. The US is less vulnerable than most to lower oil prices and higher and scarcer dollars, true enough. But the US also still has a population in which labor participation is at a historic high, in which those who have jobs are paid less and get far fewer benefits, and which has huge levels of personal debt.

Ergo, the only way the US consumer can consume is by delving deeper into debt. They have to borrow before they can spend. Just like much of the rest of the world. Only, in the US consumer spending accounts for 70% of GDP (and it’s down); in other countries, it’s substantially lower.

A nice example of where the US stands at this point in time is here: German states ask Merkel for more infrastructure spending, which she refuses, while the US can’t even afford it own infrastructure anymore, because all the trillions the US spent (by expanding its central bank balance sheet), – and Germany did not -, went to Wall Street. And then you get this:

German States Join Ranks Pressing Merkel to Spur Spending

Germany’s state governments stepped up calls for infrastructure spending, adding another source of pressure on Chancellor Angela Merkel to boost investment as economic growth falters. Much like Merkel’s national government, the states are caught between a deteriorating growth outlook and the balanced-budget drive that Germany started in response to the euro area’s debt crisis.[..] A day after the German government lowered its growth outlook, proposals to spend more on projects such as highways in Europe’s biggest economy are on the table at a retreat of state premiers that Merkel plans to attend.

Merkel will let some projects be executed, but she won’t let her country sink into debt to do it. For America, that’s not even a choice anymore. It needs Chinese funny money now or bridges will crumble. A country with such a rich history of citizens chipping in to build bridges, roads and other infrastructure, what a remarkable turn-around this is. Only 100 years ago, a town that couldn’t afford to build its own bridges would have been ridiculed. And look now:

Crumbling US Fix Seen With Global Trillions of Dollars

[..] Former Indiana Governor Mitch Daniels said: “America needs the upgrade and modernization of our infrastructure, and I don’t think you’ll get there if you keep excluding, or at least discouraging, private capital.” President Barack Obama’s administration, which had resisted private financing of public works, is starting a new center to serve as a one-stop shop for bringing capital into government projects.

U.S. Treasury Secretary Jacob J. Lew said while direct federal spending is indispensable in such cases, tight budgets demand creative ways for unlocking private money.His cabinet colleague, Transportation Secretary Anthony Foxx, put it more bluntly when he announced the Build America Investment Initiative in July. “There will always be a substantial role for public investment,” Foxx said. “But the reality is we have trillions of dollars internationally on the sidelines that are not being put to work.”

Now, America must pay hefty interest rates to strangers on its own bridges. Or they won’t get built. That should hurt. No, it really should.

You can focus on the hosannah news that comes out about the US economy every single day, and on Janet Yellen’s confidence booster yesterday, or you can look at how car sales are deteriorating, after they were upbeat for a while only on subprime loans.
The biggest number for me, amid the global storm in stocks and bonds, and the renewed – very real – threat of financial markets targeting southern Europe, is that drop in US retail sales.

So industrial output was up 1%. So what? That’s not the 70% of your economy. Retail sales are though. And they are down. Because Americans borrowed less, for whatever reason. And what they can’t borrow, they can’t spend. Because they’re dead broke.

So how are you going to make them less broke? Those 92 million Americans who are no longer counted in the work force, how are you going to get them to increase their spending patterns? Or the millions more who are still ‘counted’ in the work force, but have no jobs? Or the fast rising number who have jobs that pay close to or below a living wage?

I say let them stocks plummet, and let’s get a glimpse of where the real economy is at. We’ve seen the fantasy one for 7 years now, and it gets old and bitter.

I see deflation flirting with America. Retail sales equals consumer spending equals velocity of money. And unless the money supply is rising, hardly likely in the taper, less spending is deflation by definition. Forget about PMI and all that kind of data, it’s much simpler than that. Central banks can do all kinds of stuff, but they can’t make us spend our money on things we don’t want or need. Let alone make us borrow to do so.

And if we don’t, deflation is an inevitable fact. That doesn’t mean prices for some items won’t go up, but that’s not what counts. It’s about how fast we either spend the money we have – if we have any left – or how much we borrow. And if time is money, than borrowed money is borrowed time. So we really shouldn’t.

By Raul Ilargi Meijer
Website: http://theautomaticearth.com (provides unique analysis of economics, finance, politics and social dynamics in the context of Complexity Theory)

© 2014 Copyright Raul I Meijer - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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