March 10, 2013 7:27 pm

 
A good engineer who knows his own limits
 
Ben Bernanke’s Fed has been the only serious US economic actor
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Comment Page©Matt Kenyon



At the start of this century the journalist Bob Woodward anointed Alan Greenspan as “the symbol of American economic pre-eminence”. Ben Bernanke must pray that he never attracts that kind of praise. As a student of business cycles, the current chairman of the US Federal Reserve knows all about reputational bubbles – and few have burst more convincingly than Mr Greenspan’s.


With just seven Fed open market meetings before he completes his second term, Mr Bernanke is in no danger of emulating the maestro’s former heights. Last week, the Dow broke its historical record.


There were no Greenspan-style celebrations. Conservatives dismissed the surge as a “sugar high” caused by quantitative easing. The left saw it as yet more Fed-fuelled froth that was bypassing Main Street.



Both contain some truth. The $85bn a month in QE3 is fuelling a “reach for yield” that is driving a mini equity boom. And America’s wealthiest 10 per cent are its main beneficiaries. But they ignore the big picture. Without the Fed’s easy money, the stock market would be languishing and unemployment would be rising. Instead of “helicopter Bendropping reserves from the sky it would belawnmower Benshredding the green shoots of the recovery.


History is likely to treat Mr Bernanke more kindly. Peter Drucker, the management consultant, once said: “The greatest danger in times of turbulence is to act with yesterday’s logic.” Mr Bernanke’s chief virtue has been to ignore the normal rule book. As a scholar of the Great Depression, he understood its chief cause was the extinction of credit: the US escaped the slump because it went off the gold standard. The New Deal had little to do with it.


Most of the unorthodox steps Mr Bernanke has taken since 2008, such as the galaxy of lending windows he set up after the Lehman bankruptcy, or the various quantitative easings, may seem obvious in retrospect. But it is not clear any of his former rivals for the job would have responded the same way. “Bernanke’s grasp of the Great Depression and also of Japan’s liquidity trap in the 1990s has been a very important element of how the Fed has handled its challenges since 2008,” says Liaquat Ahamed, whose book, Lords of Finance, chronicles the central banking errors of the 1930s.
“There is no doubt he is the right chairman for this kind of crisis.”


Mr Bernanke’s grounding has given him the authority to dismiss those who view the meltdown through a moral lens and want to purge society for its excesses. Had he embraced this popular intuition, the US would now be following the UK into triple-dip recession. As Mr Bernanke noted in Texas shortly after Rick Perry, its governor, had all but threatened him with a lynch mob: “I am not a believer in the Old Testament theory of the business cycle.”


In recent years it has become common to worry about weakening democracies and fraying institutions. Moisés Naím’s new book, The End of Power, crystallises that view well. Since 2008, the Fed has proved a notable exception to the trend. “When the Fed has met a new problem it has usually engineered a new solution,” one of Mr Bernanke’s Group of Seven counterparts told me. “It has used its power effectively.”


For the bulk of the past five years, the Fed has been the only serious economic actor in Washington – and remains so today. With the big exception of President Barack Obama’s 2009 stimulus, it alone has tried to find ways to keep the US economy afloat. Since 2011, fiscal policy has been a drag on the recovery. US growth is expected to hit about 2 per cent in 2013. Were it not for the fiscal cliff and the sequestration, it might be heading for 3 per cent.


Likewise the Fed has stood alone in its attempts to confront America’s jobs and housing crises – albeit with its limited monetary tool kit. Political gridlock has stymied any serious action elsewhere. For the first time in its history the Fed is taking the full employment half of its mission seriously. In December Mr Bernanke broke precedent by pledging to keep zero-bound interest rates until unemployment fell to 6.5 per cent or inflation exceeded 2.5 per cent.


At the open market meeting next week, Mr Bernanke is likely to come under renewed pressure to take his foot off the pedal. Last Friday’s strong jobs report will bolster those arguing that the risks are now tipping towards inflation. But they have been sounding the same alarm for four years. In the last year, US inflation has fallen to 1.6 per cent. And unemployment is still at 7.7 per cent. Mr Bernanke will get to keep QE3.


Perhaps his least appreciated contribution has been to steer well clear of Mr Greenspan’s cult of omniscience. By insisting on the Fed’s limitations, Mr Bernanke has sometimes enraged the staunchest Keynesians, including Paul Krugman, the New York Times columnist, who once depicted him as a “profile in cowardice”. Mr Krugman has recently tempered his criticisms.


But Mr Bernanke misses no opportunity to remind people there is only so much the Fed can do: it can help boost demand but it cannot force banks to lend; it can assist job creation but it cannot reverse the fall in median earnings. Most of America’s challenges are not monetary. Since the Fed is not an orchestra, its chairman can never be a maestro. Posterity should reward Mr Bernanke for having the serenity to know that.


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Copyright The Financial Times Limited 2013


Q4 2012 Flow of Funds

by Doug Noland

March 08, 2013



For years, I would anxiously await the opportunity to sift through each new voluminous quarterly Z.1flow of fundsreport. On a quarterly basis, the Federal Reserve’s Credit data illuminated the evolving U.S. Bubble – with each report reliably offering additional clues and Credit insight. The past few years analyses have been somewhat boring to write and, surely, painful to read. More recently, however, the data have again turned more interesting. As you read through this analysis, please keep in mind the Fed’s decision to increase quantitative easing to $85bn monthly beginning this past January.


For Q4 2012, Total Non-Financial Credit expanded at a 6.4% rate, the strongest expansion since Q3 2008 (7.0%). Total Household Borrowings expanded 2.4% annualized, the briskest pace going back to Q1 2008 (3.6%). Household Mortgage Credit contracted 0.8% annualized, the smallest pace of decline since Q1 2009 (positive 0.2%). Corporate borrowings grew at a blistering 10.7% pace, the quickest since Q4 2007 (11.5%). Federal debt expanded at an 11.2% rate during the quarter. In nominal dollar terms - seasonally-adjusted and annualized (SAAR) - Q4 Total Non-Financial Credit expanded $2.536 TN. Looking at the main categories, Total Household debt increased SAAR $312bn, Total Business SAAR $1.076 TN, and Federal Government SAAR $1.259 TN. Credit expansion has become increasingly broad-based.


For full-year 2012, Total Non-Financial Debt (NFD) expanded $1.848 TN, up from 2011’s $1.351 TN to the strongest pace since 2008. For comparison, NFD increased $1.457 TN in 2010, $1.078 TN in ‘09, $1.907 TN in ’08, $2.552 TN in ‘07, $2.387 TN in ‘06, and $2.343 TN in ’05 (nineties avg. $715bn). For the year, Household debt growth turned positive for the first time since 2007, with the strongest (non-mortgage) Consumer Credit growth ($154bn) since 2000 just offsetting the continued contraction in Mortgage borrowings. Total Business Credit expanded $687bn, up from 2011’s $546bn for the strongest expansion since 2007’s booming $1.316 TN (business Credit expanded $163bn in 2010, after contracting $245bn in ’09). The growth in Federal government market debt increased to $1.140 TN, up from 2011’s $1.068 TN – for the fifth straight year of Trillion-plus deficits.


I’ll briefly interrupt Q4 2012flow of fundsanalysis in order to update data for the deleveraging vs. leveragingdebate.” The fourth quarter’s $655bn expansion pushed Total Non-Financial Debt (NFD) above $40 TN ($40.099 TN) for the first time. In the past four years, NFD has increased $5.620 TN, or 16.3%. As a percentage of GDP, NFD ended 2012 at a record 253%, up from 232% to end 2007 and 240% to conclude 2008. It is worth noting that Household liabilities contracted $663bn over the past four years, while Federal debt expanded $5.580 TN.


Total (non-financial and financial) system Credit ended 2012 at a record $56.281 TN (355% of GDP). Total system debt growth has been somewhat restrained by the four-year $3.261 TN drop in Financial Sector debt obligations to $13.852 TN (low since 2006). As I have tried to explain in previous CBBs, the contraction in U.S. Financial Sector Credit market borrowings has been chiefly due to the shift of assets onto the Fed’s balance sheet coupled with the significantly reduced intermediation requirements for government debt when compared to mortgage Credit (no need for the financial sector to securitize/intermediate Treasury bills, notes and bonds!). Especially after 2012’s strong Credit expansion, the deleveraging thesis has become even more flimsy.


Much of “deleveraginganalyses focuses on the decline in household debt. In aggregate, total Household Liabilities contracted $663bn, or 4.7% during the past four years to $13.453 TN (worth noting liabilities ended 2000 at $7.353TN). Meanwhile, fueled by a remarkable accumulation and price inflation in financial asset holdings, Total Household Assets surged $11.764 TN, or 17.4%, in four years to a record $79.525 TN (up 57% since 2000). Over four years, Household Net Worth (assets minus liabilities) jumped $12.428 TN, or 23.2%. Notably, Household Net Worth surged $5.464 TN, or 9.0%, during 2012, surely helping to explain the ongoing vigor in household consumption. As a percentage of GDP, Household Net Worth jumped to 421%, down from the 2006’s real estate Bubble spike to 490% but still significantly above the 385% average for the period 1985-2003.


Along with quite strong inflation in Net Worth, the aggregate Household Sector continues to enjoy respectable income gains. Fourth quarter Compensation was up 3.9% y-o-y (strongest gain in 6 quarters) to a record $8.662 TN. Total National Income was up 3.3% y-o-y for the quarter to a record $13.995 TN. Compensation increased 3.3% in 2012, somewhat less than 2011’s 4.1% increase. Total National income increased 3.6% in 2012, down from 2011’s 4.3%. National Income has risen 14.0% over the past three years, with Compensation gaining 9.8%.
 

Most of the ongoing inflation in asset prices and incomes is either directly or indirectly related to Washington’s extraordinary policymaking. Since mid-2008 (18 quarters), publicly held Treasury market debt has increased 120% to $11.569 TN. Federal debt (includes some other obligations) doubled to $13.469 TN, increasing over this period from 46% of GDP to 85%. State & Local debt increased 33% in 18 quarters to a record $3.732 TN.
 

Federal Expenditures were flat during 2012 at $3.758 TN, or 24% of GDP. Recall that federal spending jumped almost 28% in the three years ended 2010. In the process, federal spending as a percentage of GDP jumped from about 20% of GDP in 2007 (1995-2007 avg. 20.3%) to 25.5% in 2010. Federal Receipts were up 5.9% in 2012 to $2.669 TN, fueled by accelerating non-federal Credit growth. Since 2007 (five years), annual receipts have increased $14bn, or 0.5%, while federal expenditures have surged $858bn, or a whopping 29.6%.


The Fed’s balance sheet expanded $117bn during Q4, the strongest expansion since Q2 2011. Federal Reserve Assets were little changed for the year, while being up $502bn, or 20.5% over two years. Fed holdings are up $2.1 TN, or 210%, since Q2 2008. In ten years, Federal Reserves have inflated an historic 292%.


Huge federal expenditures and deficits coupled with the Fed-induced collapse in borrowing cost have lavished inflated earnings and cash-flows upon corporate America. Despite these inflated earnings, ultra-loose financial conditions have nonetheless incited a mini boom in corporate borrowings. Corporate bonds increased SAAR $719bn during Q4 to a record $12.511 TN. For the year, Corporate bonds jumped $527bn, or 4.4%.


Bank Credit has quietly been showing a pulse. Bank Assets jumped $226bn during Q4, or 6.1% annualized, to $14.992 TN. Bank Assets were up 2.4% y-o-y and 10.7% over two years. During Q4, commercial loans increased $75bn, with a 2012 gain of $195bn, or 9.5%, to $2.252 TN. Mortgage loans increased $55bn during the quarter, although they were down $47bn for the year. The banking system continues to accumulate government securities, with this asset class jumping $140bn, or 6.7%, during 2012 to $2.245 TN. It is worth noting that Total Bank Deposits rose $714bn, or 7.0%, in 2012 to a record $10.948 TN.


For the first time since Q2 2008, Total (home and commercial) Mortgage Debt (TMD) actually posted a quarterly increase ($17bn). Overall, TMD declined $259bn (1.9%) in 2012, down from contractions of $328bn in ‘11, $621bn in ’10 and $292bn in ‘09. Total Mortgage Credit declined $1.567 TN, or 10.7%, from its Q2 ’08 high, having now dropped back to 2006 levels. For perspective, TMD is today double the level where it ended the 90’s. If the current backdrop holds, I would expect positive mortgage Credit growth in 2013.
  

While we’re on the subject of Mortgage Credit, GSE Assets declined $35bn during Q4 and $211bn for all of 2012, to $6.269 TN. But we have to temper our enthusiasm for the so-calledwinding down” of Fannie and Freddie. Agency-backed MBS increased $32bn in Q4 and $135bn (10.4%) in 2012, to $1.440 TN. Overall, outstanding Agency Securities (debt and MBS) declined only $33bn (0.4%) during 2012 to $7.544 TN.
 

In the miscellaneous financial sector categories, Credit Union Assets expanded 6.0% in 2012 to $904bn. Securities Broker/Dealer Assets increased 6.1% to $2.068 TN, the first annual growth since 2007. REIT Liabilities were up a notable 22.9% to $778bn, with a two-year gain of 55%. For the year, total Securities Credit jumped a notable $200bn, or 15.2%, to the highest level since 2007. Securities Credit has increased 40% in three years.
 

Rest of World (ROW) holdings of U.S. assets increased $583bn in 2012 to a record $19.384 TN. ROW Treasury holdings jumped $474bn last year to $5.546 TN, with Official Treasury holdings up $339bn to $3.992 TN. Over three years, total ROW holdings jumped $3.578 TN, or 22.6%. During this period, Treasury holdings jumped 50%, or $1.848 TN, with Official holdings up $1.121 TN, or 39%.


Granted, the fourth quarter was an odd one. There were clearly impacts from fiscal cliff uncertainties and looming tax increases. Still, the quarter was noteworthy for the big jump in Credit growth and the even wider divergence between strong Credit/financial markets and weak economic performance. A jump in (non-financial) Credit expansion to a 6.2% pace equated with a barely positive (0.1%) real GDP reading. It would be easier to dismiss this as an anomaly if it wasn’t such a prominent global dynamic (i.e. China, India, Brazil, etc.). As for the maladjusted U.S. economy, we’ve reached the phase were it requires exceptionally strong Credit expansion (and overheated markets!) to attain what most economists would view as “normalgrowth.
 

A few years back I opined that it would take roughly $2 TN of annual system Credit growth to more fully reflate the deeply maladjusted economy. After four years of outrageous fiscal and monetary stimulus, our Credit system is poised to possibly reach this milestone in 2013. The good news is that jobs are growing at a decent clip (as one would expect with ultra-loose financial conditions and strong corporate borrowings). The bad news is that this reflation has required a doubling of federal debt coupled with incredible Bubble-inducing monetary measures.
  

The government finance Bubble has significantly inflated household incomes and corporate earnings, a Bubble dynamic that has worked to incite speculation and inflation throughout equities and corporate debt markets. The reflation in securities and, increasingly, real estate markets has again inflated Household Net Worth. Perceived gains in wealth and ongoing (government policy-induced) income growth have spurred boom-time spending levels, in the process sustaining the consumption and services-based U.S. economy. Ignore the underlying Credit dynamics and things almost look OK.
 

Importantly, the government finance Bubble has succeeded in sustaining the U.S. Bubble Economystructure that evolved over the prolonged Credit Bubble period. This has ensured unending Current Account Deficits and endless dollar liquidity; historic global financial and economic imbalances; and attendant myriad Bubbles around the world. Desperate global central bankers, meanwhile, are content to disregard precarious Bubble excess throughout global risk markets - fixated instead on acute economic and financial fragilities. Flawed economic doctrine, analytical frameworks and policies over years fostered deep economic maladjustment and market Bubbles. Resulting fragilities these days ensure even more aggressivelyactivistpolicy measures viewed as necessary to bolster an acutely vulnerable globalsystem.”
 

Two of the savviestmacroanalysts of this era Stan Druckenmiller and Marc Faber – this week separately warned that this central banker-induced boom will end badly. Mr. Faber went so far as to predict unpleasant happenings for 2013. I don’t know if this historic Bubble will burst this year. But I am convinced the longer the current backdrop continues the greater the eventual economic and financial turmoil. The Q4 2012flow of fundsprovides added confirmation that policymakers have painted themselves into a corner. It’s hard to believe the Fed will stick with $85bn monthly QE in the face of mounting Credit and market excess. On the other hand, the liquidity backdrop has created such unsettled global markets that central bankers will look for any excuse to avoid watering down the punch.

Gold: A 'Fundamental' Perspective Of Bottoming 'Fundamentals'

Mar 10 2013, 08:25

by: Avi Gilburt




So, you think that central banks' buying of gold signals an imminent uptrend? Well they have been doing so for years, yet the price of gold continues to languish. You think that the Fed's quantitative easing signals an imminent rally? Well, we are now in the midst of QE-Infinity, and gold has still been in a downtrend. Maybe you think "logic" dictates that gold should be rallying? But, there is a very good reason you have never seen a logician used as a market analyst.


So, maybe you believe that reading articles and analysts that believe exactly as you do will make you feel better about the 20% decline in gold through which you held and suffered? I am sure it is comforting to know that others also feel as you do and that you will ultimately be vindicated. But, are you looking for emotional validation or honest answers about the direction of the metals?


Most seem to be looking for emotional validation, and the best place to turn for that is your spouse. When you invest, you should be looking for intellectually honest answers and accurate predictive analysis, and not validation. Reading and following those that think as you do will only keep you mired in the muck of the majority, which is not where you want to be when investing in financial markets.


As I am sure you have heard from me so many times already, I believe that gold moves based upon sentiment and not fundamentals. Yes, I know how many of you ridicule me for this perspective. I know that many of you think that I have completely missed the boat. And, I know how many of you simply dismiss my analysis because I make statements that you believe are completely inaccurate.


So, why don't we take a step back, and actually explore what I am saying in a bit more depth, and let's see if it actually holds water.


The fundamentals since gold reached its top a year and a half ago have not changed. In fact, central banks around the world are supposedly accumulating more gold, and offering much more quantitative easing than even before. Our own Fed is now on a program of Quantitative Easing Ad Infinitum. So, can the fundamentals of gold be any more bullish? I think not.


Yet, when we look at the fundamental story, one would think that gold would now be trading around $3,000. But, in reality, we are languishing around the lows for the last year and a half. So, how can this be possible? Maybe gold simply did not get the multiple memos or read the ridiculous number of articles written about the fact that it should have been on its way to $3,000 already?


Or, maybe there is something that actually controls the metals' movements much more than fundamentals? Nah!!! That can't be possible!! You have been told by all the "smart" people to ignore what you are seeing with the price of gold. You have been told that it is manipulated. You have been told that the price will "eventually" adhere to fundamentals.


But, don't you get tired of waiting for the "eventuality?" Could there be another way to analyze the metals that didn't have you holding the bag while gold depreciated 20% from the highs? I propose there is.


As I have said time and again, the metals are moved by sentiment, both in the short term and in the long term. In other words, both the long term trend and the short term trends are governed by sentiment. And, yes, it is generally track-able.


Ralph Nelson Elliott theorized that public sentiment and mass psychology move in 5 waves within a primary trend, and 3 waves within a counter-trend. Once a 5 wave move in public sentiment has completed, then it is time for the subconscious sentiment of the public to shift in the opposite direction, which is simply the natural cycle within the human psyche, and not the operative effect of some form of "news," or "fundamentals."


This mass form of progression and regression seems to be hard wired deep within the psyche of all living creatures, and that is what we have come to know today as the "herding principle," which gives this theory its ultimate power.


In 1941, Elliott stated, regarding the financial markets, that "the [Fibonacci] ratios and series have been controlling and limited the extent and duration of price trends, irrespective of wars, politics, production indices, the supply of money, general purchasing power, and other generally accepted methods of determining stock values."


In fact, studies have been done in which subjects simulated trading currencies, however, there were no exogenous factors that were involved in potentially affecting the trading pattern. The specific goal of the studies was to observe financial market psychology "in the absence of external factors." One of the noted findings was that the trading behavior of the participants were "very similar to that observed in the real economy," wherein the price distributions were based upon Fibonacci ratios.


So, let me say that again. When subjects traded without any news or fundamentals, the price distributions mirrored what we see in the general financial markets. One can only conclude, based upon these studies, that fundamentals mean nothing when we want to understand and predict the price direction of a market. Rather, movements within markets are based upon human decision making and sentiment, which is governed by Fibonacci proportions.


But, many of you have questions whether this is really a "chicken or egg" argument? So, let's take a hypothetical case and see how sentiment drives fundamentals and not the other way around, as most people incorrectly believe that news can cause or change sentiment.


Let's say that an economy has been in free fall for quite some time. Everyone questions when the bottom will be seen and the news and fundamentals sound so bleak, that no one believes it is any time soon. Yet, the stock market has begun to go up for the last 3 weeks, even though the "fundamentals" are showing that the economy is still in free-fall.


Experienced and astute market observers know that, historically, the stock market has always bottomed before the economy does. But, have any one of you ever considered what causes this phenomena? Well, for those that understand what Elliott understood, this makes perfectly good sense.


During a negative sentiment trend, the stock market price declines, and the news seems to get worse and worse. However, once the negative sentiment has run its course, and it is time for sentiment to change direction based upon attaining its Fibonacci proportions, the general public then becomes subconsciously more positive. When people become positive about their future, they are willing to take risks. And, what is the most immediate manner in which the public can actuate this newly turned positive sentiment? Well, the easiest and most immediate way for the general public to actuate positive feelings about the future of the country is to buy stocks. For this reason, we see the stock market lead in a movement in the opposite direction. And, this is why Elliott believed that the stock market was the best barometer of public sentiment that we could find.


But, let's look at the same change in positive sentiment, and what it takes to have an effect upon "fundamentals." When the general public's sentiment turns positive about the future, this is the point in time where they are willing to take more risks based upon their positive feelings about the future.


So, business owners and new entrepreneurs seek loans to either build or expand a business, which takes time to secure. They then place the newly acquired funds to work in their business by hiring more people or buying additional equipment, and this takes further time. With this new capacity, they are then able to provide more goods and services to the public, and, ultimately, profits and earnings begin to grow, again, after taking much more time.


And, when the news of such improved earnings finally hits the market, most market participants seemed shocked that the stock moves up strongly in an uptrend, and simply attribute the stock's rise to the announcement of positive earnings. This is exactly what prompted Elliott to note, in his 1946 publication of Nature's Law, "At best, news is the tardy recognition of forces that have already been at work for some time and is startling only to those unaware of the trend."


So, there is a significant lag between the positive turn in public sentiment and the resulting change in "fundamentals" of a stock or the economy, especially when considered relative to the immediate actuating of such sentiment through the buying of stocks. It is for this same reason that fundamentalists are left holding the bag at the top of a market when the news and fundamentals look the best to them right before the market begins to dive. Anyone remember a little company named AAPL?


So, now you must be questioning how one can tell when sentiment is about to turn. Well, again, it brings us back to Leonardo Fibonacci and R.N. Elliott. After a 5 wave move in sentiment has completed, and the Fibonacci proportions have been mathematically satisfied, that is usually the signal that the market is ready to turn. This is the exact reason why I was able to predict the top in AAPL when everyone else was looking for $800-$1000.


So, where are we now in the pattern for gold? Well, nothing has really changed since last week:
As for GLD, it has still not been able to take out the long time support region we have been noting at the 151 level. So, for now, the immediate region of resistance I see for GLD is the 157-158.25 region. Assuming we can see a strong move through that region in GLD, then we can look towards the 161 region next, which represents the .764 extension down, as well as the .500 retracement of the prior larger rally.


And, if GLD can move through that region, then the final region that will be contested is the 170-174 region before we can see a massive break out taking us to new highs.


And, to remind you of the support levels below the important 151 region Fibonacci extension, it is the 148/149 confluence region, and then 146.