US Hit By Global Slow Down

WASHINGTON – Will US stocks recover? Or are they headed even lower? The optimists tell us that Wall Street panicked in the last few days. Forget about China. The fundamentals of the US economy are solid. There is no reason to liquidate stocks. Therefore:“Be smart. Buy the dip!”

Over valued stocks 

This is almost unbelievable. We all know that US stocks are over valued because of an unprecedented stretch of zero interest rates decreed years ago, at the time of the financial crisis, by the US Federal Reserve. As traditional savings accounts became non viable, most people went into stocks, therefore inflating valuations. We know that. Besides, we also know that many major companies, instead of investing in additional capacity, have been busy buying their own stocks. Obviously this provided extra support. However, it is clear that IBM and others cannot inflate their share price for ever by propping up their stocks in this way.

Modest GDP growth 

More broadly, there is an obvious disconnect between modest US GDP growth (about 2% a year) and stellar stocks valuations. And this modest growth is not going to improve. The Congressional Budget Office (CBO) just revised down its own optimistic projections for 2015. According to the CBO, the US economy will not grow at 2.9%. Most likely the rate is going to be only 2%. Well, that is 30% less than estimated only a few months ago. So, no improvements.

All this should be enough to tell us that a major stock market correction was indeed in order. In fact, whatever the daily gyrations, probably we are not quite done with that.

China: worse than you think 

That said, if we look at the global economy, there is reason to be even more pessimistic. First of all, the China story. Well, it looks that it is much worse than it appears. For starters, for the first time major business media are openly saying what many have been suspecting all along. The Chinese authorities falsify their growth statistics. China says that it is growing at 7% a year. Well, make that 5%, or even less, according to many analysts. This is no mere detail. This tells us that China’s problems are most likely bigger and deeper.

And since most of China’s growth comes from fixed investments, especially in construction, a major slow down of this gigantic engine has and will have an enormous negative ripple effect across the global economy.

Excess capacity 

Consider this. In the 1990s China steel production was about 100 million tons a year. Today it is 1.1 billion tons! However, because of the slow down, this capacity represents double its current demand. That’s more than  500 million tons over capacity!

And what is the effect of this rise and fall of production on world iron ore prices? Iron ore used to be $ 30 a ton in 2008. Thanks to China’s demand, it went up to $ 200 a ton. Now it is down to $ 100.

This means that major producers made huge investments to increase their capacity, counting on continuing Chinese demand. Well, now they are in big trouble. BHP Billiton, a world mining giant, just announced its worst results in 12 years. Profits are down 86% .

End of the BRICS

So, thanks to China, commodity prices are down, way down, hurting many producers across the globe. To make matters worse, commodities happen to be abundant in poorly managed emerging countries. So, falling economic fortunes have to be added to garden variety mismanagement, incompetence, corruption, and political crises.

Mix this nasty brew and you see that all the famed BRICS are out of luck, (India is probably the only partial exception). China aside, Brazil is in very poor shape, while there are mass protest against President Dilma Rousseff. Under performing South Africa just announced a GDP contraction. Russia has been hit by the double blow of low oil prices, and economic sanctions due to the Ukraine crisis.

Dismal prospects almost everywhere 

You want more? Abenomics failed in Japan. The economy is anemic at best, and there is no plan to diminish the burden of a monumental public debt. Saudi Arabia will run huge deficits because of lost revenue due to low oil prices. Turkey is in political turmoil, while its economy is sputtering.

Almost the entire Arab World is in chaos, with civil war in Libya, ISIL in Iraq, and self-destruction in Syria. Europe is barely treading water. Its southern periphery is and will continue to be in bad shape. France is doing poorly. Coming into the Western Hemisphere, Canada is also suffering because of low oil prices.

US to be affected by the global economy 

Given this rather uninspiring world scenario, the idea that the US will continue to do well because of our “good fundamentals” is just crazy. First of all, our fundamentals are rather weak. Secondly, we live and operate in a global economy.

Because of its insane investments binge, China used to drive growth. Now it is dragging a good portion of the world economy down. And there are no other locomotives of comparable size.

The idea that America can keep chugging along all by itself, even if at a modest rate, while the rest of the world is losing speed or worse is a complete fantasy.




America Needs Good Pro-Growth Structural Reforms

WASHINGTON – After the August 24 sell off, there was no real bounce back. The US stock market regained some ground, but only some. Still too many uncertainties for investors, I guess, from the Fed and its decisions on interest rates to the real global ramifications of the Chinese sudden and somewhat mysterious convulsions.

Put our house in order 

Alright, enough of that. Forget about markets. The smart thing for America would be to begin –right now– to put our own house in order. In order to do so, we need to focus on at least three major areas:

1) Fiscal and Tax Reform

2) Deregulation

3) Public Education Reform

Fiscal reform 

On fiscal and tax reform, Washington had a great opportunity to start the process back in December 2010, after the release of the final Report by the National Commission on Fiscal Responsibility and Reform headed by Erskine Bowles and Alan Simpson, (it was also known as the “Debt Commission”). The bipartisan Report, (endorsed by the majority of the Commission members), was aptly titled “The Moment of Truth”. It provides a good start on a process eventually leading to entitlement and fiscal reform. It is a genuine bipartisan effort led by two credible, experienced national leaders, a Democrat and a Republican. Granted, it is not comprehensive. It does not seriously address health care policies. But, there again, it was a good faith attempt to get things moving. It was a very good start.

Well, President Obama looked at the Report, thanked the co-chairmen and essentially discarded it. Notwithstanding subsequent political upheavals, Tea Party activism, Republican congressional victories and more, we have made zero progress to reach the needed political agreement on reform. And yet real fiscal reform that would have to include a major overhaul of the large and soon unsustainable entitlement programs (Social Security, Medicare and Medicaid) is essential.

Necessary 

Let’s be clear. This reform is no guarantee of long term economic growth. But it is hard to believe that we are going to go very far while America will carry the weight of an enormous debt burden. Look at anemic Japan. Is this where we want to go?

Same for tax reform. America has an absurdly long and complicated federal tax code. We have the highest corporate tax rate in the developed world. This is not good for business.

(It would be nice to see some serious discussion about these issues in the unfolding campaign. This would be more substantive than stupid polemics about “anchor babies”).

Deregulation 

Ditto for deregulation. When concerns about regulatory compliance become the overriding daily preoccupation of business owners, we have a real problem.

Regulations should be about establishing and enforcing reasonable environmental, work safety and public health standards. But now we have gone way beyond that. The attempt by the US Environmental Protection Agency, EPA, to essentially outlaw coal-fired power plants (and more) by regulatory fiat, on questionable legal grounds, is just the latest illustration of this.

Education reform 

And finally public education. This is after all and will be the “Knowledge Economy”. In this new world, If you do not have a good education, you are done. If you do not know much, if you do not master sophisticated skills, you simply do not have the entry ticket. Period. No way to have access to good jobs. You will be relegated to the lower echelons of society. No prayer to  become “upwardly mobile”, as we used to say.

Slice it the way you want, but if we do not get serious about drastically improving American public educations standards, at least half the country, the half that cannot afford private education and live in poor neighborhoods, will be left behind.

We need an action plan 

This is what needs to be done –today. Forget about Wall Street gyrations. Let’s get busy and rebuild the solid fundamentals of a world-class, truly competitive US economy.




US Stocks Rise Because Of Bad Economic News?

WASHINGTON – Here is a clear economic news non sequitur, now considered “normal”, as financial markets lost any connection with the real economy. This is from a recent Reuters (May 18, 2015) news story: “U.S. stocks edged higher, with both the Dow Jones industrial average and the S&P 500 hitting records, as weak economic data suggested the Federal Reserve will hold back on raising rates any time soon”.

Bad economy, stocks go higher

Yes, this exactly it. US stocks edge higher on weak economic data. But, wait a minute. Shouldn’t it be the opposite? Shouldn’t it be that stocks are valued less when we have indications that the economy is not doing so well?

Well, not any more. And here is the perfectly logical and rational reason. Right now investing in stocks is practically the only way to put money to work. And this is because the zero interest rates policy, (ZIRP), inaugurated many years ago by the Fed in order to counter the Great Recession, has made any other form of investment unprofitable, and therefore unattractive.

Stocks are over valued

That said, everybody knows that because of this market distortion created by the Fed (in order to encourage more investments) stocks are over valued. If and when the Fed will end this incredibly long ZIRP stretch, interest rates will go higher and investors will have once again viable alternatives to buying stocks.

At that point stock valuations will be deflated, because stocks will no longer benefit from the “subsidy” provided by zero interest rates. And this is why all observers anxiously watch the Fed, trying to divine when and what speed the Federal Open Market Committee (FOMC) will take steps to go back to “normal” interest rates.

The absurd is now rational

But here is where all this becomes absurd. The conventional wisdom is that the Fed will continue to keep interest rates at zero, as long as the US economy remains  relatively weak and fragile. The moment we start gaining real velocity, (an indication that we are finally getting our act together), the Fed will start ratcheting up interest rates, this way ending the longest Wall Street party.

And this explains the non sequitur in the Reuters story quoted above: mediocre economy, higher stock prices. Please note all this. On account of Fed policies, these days “bad news” is good for investors. “Good news” causes stock prices to fall.

In my own words, the markets are extremely happy to see lackluster economic data, because this means that the Fed will have to delay any action on interest rates even further. Having taken note of this, as a fitting celebration, investor rush to buy more stocks.

Again, think about it. We keep buying stocks, not because there is true value in owning a piece of a successful company, but because the economy is weak, and so (thanks to Fed policies) there is an inherent advantage in owning over valued assets.

Fed-induced misalllocation of resources

So, there you have it. “Weak economy, Wall Street celebrates”. This is what the Fed has done. If the economy is good, then it is time to sell way over valued stocks. If the economy is bad or so-so, then we buy stocks, because we know that they will continue to be overvalued a little while longer.

All this is crazy. Our top monetary authority has created distortions that encourage a gigantic misallocation of financial resources. And nobody says anything.




Fed Induced Wall Street Bubble Keeps Going – For Now

WASHINGTON – Right before the most recent Federal Open Market Committee, (FOMC), meeting, Wall Street was on edge. Would the Federal Reserve now run by Janet Yellen (finally) signal the end of the longest period of ZIRP (Zero Interest Rate Policy) in modern US history? In other words, after 6 years of extraordinary “accommodative” measures (Fed speak for easy money), are we going back to normal?

Fed induced Wall Street bubble

This is not a technical question just for people working in finance. This is not about making a few timely adjustments to investment portfolios in the light of different monetary policies that may or may not be announced.

No, there is a lot more going on here. What is at stake is the unsustainability of the current Wall Street boom without the support of zero interest rates mandated by the Fed that caused an absurd hypervaluation of stocks.

Put it differently, if and when the Fed will decide that interest rates have to be increased, Wall Street will take a hit, simply because current valuations are due mostly to the fact that investors have no where else to go, since any other form of investment yields zero interest, thanks to Fed policy. What we do not know is how big a hit.

When good news is bad news

And so, here is the perversion. Any time we get supposedly “good news” about lower unemployment, the stock market takes a hit. This sounds really odd. You would think that investors would gain confidence by looking at numbers indicating a more robust economy that creates more jobs. But no, what they think is that the Fed, by looking at the same jobs growth numbers, would have the evidence it needs to conclude that unemployment is back under control, and therefore it may be time to end ZIRP and jack up short-term interest rates, this way causing a market collapse.

The party is not over yet

Well, going back to the recent FOMC meeting, after the ritual announcement of what was decided, the market rallied. And the simple reason is that Fed announced nothing. Fed Chair Janet Yellen said that there may be indeed a time to consider raising interest rates, but that time is not as near as we thought it might be. And this is largely because the economy is not growing as much as the Fed had anticipated in 2014.

Translation: “Contrary to what we feared, the party is still on, and the Fed just told us that it will go on for quite a while. Therefore, fear not. Keep throwing money into stocks. At some point this thing will end. But not now.”

The Fed created a monster

This may look like lunacy. But it is pretty much what is going on. The truth is that after 6 years of ZIRP, the Fed has created a monster. It has monetized trillions of dollars of US debt. It has quadrupled its portfolio, and ZIRP has induced investors to put their money into Wall Street, unless they really prefer zero interest alternatives (the functional equivalent of the old mattress).

Mad rush for the door

And yet, the very thought of putting an end to this unprecedented financial distortion creates market gyrations. Imagine what will happen when ZIRP will be truly over. It is wishful thinking to assume that there will be an orderly exit from the most overvalued stocks. Most likely there will be a mad rush for the door. It will be a huge mess.

But there is no way to avoid this. This ZIRP absurdity has to end. Unless we really want to believe that ZIRP is normal, that the Fed can keep printing money for ever, and all will be well, because our Keynesian mandarins running the show from the Eccles Building really know what they are doing.