What Is Not Seen

On wednesday, oil reached over $134 per barrel, on numbers showing a decline in inventories with 5.32 million barrels. This is the biggest decline in four months. On the news, major stocks market declined.

The recent rise in crude oil is also reflected in the average retail regular gasoline price, which set a new all time high with 379.1 cent per gallon, on Maj 19.

Read the full EIA report here, or the highlights here.

Today, The Conference Board published their so called Leading indicators, that are suppose to lead investors in the right direction where the economy is currently heading. According to the report, leading indicators increased by 0.1 % in April. This was great news if we want to believe the media. While the stock markets early got a good start, little focus, as usuall, was given to the coincident indicators. These indicators were actually flat in April, and were down 0.4 % in the latest 6 months.

They compose of, Employees on nonagricultural payrolls 0.5426 %, Personal income less transfer payments 0.1890 % Industrial production 0.1493 % and Manufacturing and trade sales 0.1191%, that is, the same indicators used by the NBER (National Bureau of Economic Research) in calling recessions. This is one of the reasons, I believe these indicators give a more accurate view of the economy than the real “leading” indicators.

Looking at the components of the coincident indicators, we get a clear picture of where the economy is heading. Non-farm payroll have lost 260 000 jobs so far during the first four months of the year. We know that manufacturing is deteriorating, according to the latest ISM reports the manufacturing sector is slowing. The only indicator, that until recently have held up is Industrial production. But the latest report, show that production fell 0.7 % in April, together with negative revisions for both March and February. Industrial production now appear to have reached its top in January this year.

A good Herald Tribune article: Money is tight, or is it? points out that the rate of credit expansion is still increasing, despite the fact that banks allegedly are tightening credit. Foremost, this can be seen in commercial and consumer loans, which have been continuously increasing the last 6 months. The reason for this gain is partially explained by companies utilizing alternative and new lines of credit.

What happened was that many companies that financed themselves through securities markets, particularly commercial paper, had paid for backup lines of credit. The banks thought few of those lines would ever be used, but suddenly many were.

Looking at the numbers, we see that the rate of change in Commercial and Industrial Loans, are 20 % higher now, than last year. Consumer credit rose 5.4 % the first quarter this year, shown in a report released Maj 7. Even if some banks probably are reluctant in approving new credit lines, they have little or no control of the already existing lines that have been fueling overall expansion since last year.

Another factor, not mentioned in the article, that cannot be stressed enough, is that a lower federal funds target rate creates additional incentive for businesses and consumers to encourage new loans, resulting in further credit expansion.

I recently came across a balance sheet of ‘Amsterdamsche Wisselbank’ or ‘ The bank of Amsterdam’(1609 – 1820). The Bank of Amsterdam was the last bank in history that operated without fractional reserves.

Compared to modern banks, where bank reserves only amounts to a fraction of outstanding debt, The Bank of Amsterdam kept close to a 100 % reserve ratio between the years 1609 and 1720, as you can se below.

In 1610, total liabilities reached 925,562 florins. By looking at coins and other precious metals held in vault, we can se that 100 % of the banks liabilities constituted bank reserves.

By adherence to traditional legal principles and accountability to all its liabilities, the bank thrived as total assets grew 31 fold in the next 150 years, and totaled 30,835,194 florins in 1764.

As U.S. are currently digging it self deeper into a recession, with employment in decline, manufacturing on a slippery slope, inflation on the move, and large banks are on the verge of bankruptcyt, perhaps it is time to take a look in the rear-view mirror for future guidence.

Source: van Dillen (1925), A compiled collection.

It is not only spending on regular consumer goods that are in decline. According to Business Week:

[s]pending on vices is also dropping. According to the government’s figures, alcohol consumption and casino gambling have been declining since November. Indeed, Nevada gambling revenues are down by 4% over the past year.

How about that!

There is another sad story related to the 0.1 % year on year increase in the latest retail sales report. Considering the conditions for the US consumer, we can see that he is still heading in the wrong direction, with no signs of rescue.

Data from the St Fed show that the personal savings rate is at the moment hovering just above zero. With falling home equity values and a savings rate on 0.3 %, the average consumer has hardly any real resources to draw on. According to other numbers, showing the yearly percentage change in real disposable personal income, consumers have on average experienced a 2.1 % decline in income growth over the last year. This augurs ill for both the private- and the overall economy, and cast a shadow over the retail report.

It is not hard to guess where the money – that resulted in the 0.1 % increase in spending –came from. Consumer credit or consumer loans, increased with a total of 9.2% or $65 billion during the last year. That is, American consumers incurred on average 9.2% more debt. It is this debt that is presently financing the additional consumption.

What both households and business are in desperate need of, is not consumer spending, but real saving. Only then can the US economy eventually get up on sober feet’s.

The second estimate of forth quarter GDP was unchanged for the euro area on +0.4%. A closer look at the numbers show a slightly stronger net export than in the first estimate, with an upward revision for exports of 0.6 % from 0.5% and a downward revision for imports of -0.3 from -0.4.

Even if fourth quarter export growth has slowed compared to the third quarter growth of 2.2%, euro zone exports have held up good, despite the strong euro. This is confirmed by german export numbers published today, that show exports have risen in February by €0.4 billion since January this year.

What is to expect? Surely, it takes time for a move in exchange rates to affect trade volumes, especially if business hedge against the surge in currency. As forward contracts eventually will reset, profit margins will contract in the short term. This will likely result in higher prices as business tries to maintain their margins, which in turn will have a negative effect on overall exports in the euro area. Goods that are sensitive to price changes will naturally experience a significant slow in exports as foreign demand will lessen. For countries, like Germany and Finland, exports may be sticky. With a large amount of non-euro exports consisting of capital goods, both countries could benefit from strong Asian demand.

With euro zone inflation at an all time high of 3.5%(p), many companies have already experienced higher costs, as inflation has affected transportations and overall energy prices, resulting in an increase of input prices. According to the CPI euro annual report for February, transports had increased 5,4 % and energy 10,4% since last year. For the exporting sector of many countries this will surely have a double negative effect, also resulting in slower GDP growth.

In a recent WSJ interview, Alan Greenspan goes on the defence once again, by refusing to take the blame for the present housing mess. Alan Greenspan the former FED chairman, has time and time again pointed out the impossibility of spotting stock market bubbles. According to him “bubbles are an avoidable feature of a dynamic economy” and that “[n]o sensible policy could have prevented the housing bubble.” Greenspan’s lack of understanding, or willingness to acknowledge, the cause of stock market bubbles, brings to mind a recent interview with Fama (from Paul Kedrosky). Eugene Fama is the creator of the efficient market theory, who recently spoke about stock market bubbles.

Region: Some economists—you know them well—say that the stock market crash of 1929 and the more recent climb and decline of the market in the early 2000s suggest that “irrational exuberance” affects the stock market. How do you reconcile this alleged evidence of herding behavior and animal spirits with the notion of market efficiency?

Fama: Well, economists are arrogant people. And because they can’t explain something, it becomes irrational. The way I look at it, there were two crashes in the last century. One turned out to be too small. The ’29 crash was too small; the market went down subsequently. The ’87 crash turned out to be too big; the market went up afterwards. So you have two cases: One was an underreaction; the other was an overreaction. That’s exactly what you’d expect if the market’s efficient[...]

If Greenspan is a believer in Fama’s market efficiency, or if Fama is a believer of Greenspan’s interventionist policy, I do not know, but clearly they have somethings in common. When it comes to the workings of stock market bubbles they both seem to have, no clue.

From Market Watch we can read that IMF will be selling a significant portion of its gold supply. The Fund is the third largest holder of gold in the world with a total of 113.5 million ounces valued at approximately $103 billions in stock. The selloff consists of $13 billion dollar or 12,5 % of their total supply. Some of the money will be used to cover deficits of $400 millions. According to the article there are

[...] at least two key hurdles. One is that the U.S. Congress must approve the IMF’s proposal to sell gold. And most member countries also will have to enact legislation to expand the IMF’s investment authority.

With gold over $900 and the euro at $1.57 I would be really surprised if the congress did not approve the proposal. As the dollar keeps loosing momentum to almost every foreign asset class, the selloff could be viewed as an aesthetic short term dollar fix. Regarding the long term, additional gold supply will hardly affect prices as investor demand is continually fueled by overall economic weakness.