Lessons Not Learned - No Failure Too Great to Admit It

Hoping to reverse a clear slowing of the Japanese economy, Japan Cabinet OKs $61 Billion Economic Stimulus

Japan's Cabinet on Friday approved a 5.05 trillion yen ($61 billion) stimulus package aimed at boosting the country's flagging economic recovery.

The package, to be submitted this month to parliament for approval, follows 915 billion yen ($11 billion) in measures that Prime Minister Naoto Kan's government has already approved.

The latest package includes measures to boost employment, help small and medium sized businesses, and support regional economies. It also calls for ongoing support of programs to boost sales of environmentally friendly products to consumers.

Tokyo has recently made several major moves to bolster its economy. Earlier this week Japan's central bank cut its key interest rate to virtually zero, and last month it intervened in currency markets to weaken the yen.

A couple of charts is all it takes to show just how ineffective Japan's currency intervention was.

Yen Daily Chart Shows "One Day Wonder"



Yen Weekly Chart

The weekly chart helps put the size of that daily intervention "One Day Wonder" in proper perspective.



Except in the short-term I have yet to see any of these intervention measures stick.

Japan Throws in the Towel?

Japan's finance minister has all but thrown in the towel on large-scale interventions, at least if you believe what he is saying. Please consider Noda Signals Japan to Avoid Return to Large-Scale Intervention

Japan’s finance minister signaled that while his government is ready to sell yen in market if needed, the country doesn’t intend to return to the long-term, large scale intervention campaigns of the past.

“The intervention we conducted on Sept. 15 was to rein in excessive movements,” Yoshihiko Noda told reporters today in Tokyo before departing for a Washington meeting of Group of Seven finance authorities. “It has a different character from one seeking a certain level with large scale, long-term intervention.”

Japan conducted the intervention to "rein in excessive movements". The results are shown above. I fail to see Japan accomplished anything.

Given that interventions don't work, It's a good thing Japan "doesn’t intend to return to the long-term, large scale intervention campaigns of the past."

The question at hand is "Do you believe that?" I don't.

China Unloads Japanese Debt, Japan Complains

Add government bond purchases to the list of things Japan and China are openly feuding about. Bloomberg highlights the story in China Sold Most Japan Debt on Record in August

China sold a record amount of Japanese debt in August, snapping a seventh-straight month of purchases.

China sold a net 2.02 trillion yen ($24.5 billion) of Japanese debt in August, the Ministry of Finance said today in Tokyo. That was the biggest monthly sale in data going back to 2005. It sold 2.03 trillion yen in short-term debt and bought 10.3 billion yen in long-term securities, ministry data showed.

Japanese Finance Minister Yoshihiko Noda suggested at a meeting last month that it’s inappropriate for China to buy Japan’s bonds without a reciprocal ability for Japanese to invest in China’s market.

“I feel strange that China can buy Japanese government bonds while Japan can’t buy theirs,” Noda said in answering lawmakers’ questions at a hearing on the economy on Sept. 9.

Japan's Economy Slows, Trade Surplus Shrinks

Wrapping up this spotlight on Japan, please consider Japan Current-Account Surplus Narrows as Exports Slow

Japan’s current-account surplus narrowed in August as export growth slowed, adding to signs the country’s economic recovery is moderating.

The gap contracted 5.8 percent from a year earlier to 1.114 trillion yen ($13 billion), the Ministry of Finance said in Tokyo today.

“There’s no doubt the economy is slowing,” said Shinke, senior economist at Dai-Ichi Life Research Institute in Tokyo. On top of demand that’s slowing in China and other trading partners, “we’ll begin to see the strong yen’s impact on exports very soon,” he said.

Governor Masaaki Shirakawa’s board this week unexpectedly cut the central banks’ benchmark interest rate, pledged to keep borrowing costs at “virtually zero” until price stability returns and established a 5 trillion-yen asset-purchasing fund. Japan’s ruling party proposed an economic stimulus in excess of 4.8 trillion yen that would help local governments and small businesses create jobs.

No Failure Too Great to Admit It

Japan is in debt to the tune of 200% of GDP, which is all it has to show for all its Keynesian and Monetarist stimuli over the past decade. So what does Japan do but toss another $61 billion into the fire, fresh on the heels of an $11 billion stimulus plan.

$72 billion total may not sound like much these days, but it is a sizable chunk of money for Japan's economy. Supposedly these stimuli will "boost employment, help small and medium sized businesses, and support regional economies".

It will do no such thing. If these stimulus efforts worked, there would be results to show for it.

Yet the only conclusion of the Keynesian and Monetarist clowns is that Japan did not do enough!

This should be a lesson for the US, but it won't.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Gallup Survey Shows Unemployment Jumps From 9.4% to 10.1%

As economists up their forecasts for tomorrow's jobs report, I am lowering mine.

First, the recent ADP report suggests private nonfarm employment dropped by 39,000 with expectations of a gain. Second, Gallup Finds U.S. Unemployment at 10.1% in September

Unemployment, as measured by Gallup without seasonal adjustment, increased to 10.1% in September -- up sharply from 9.3% in August and 8.9% in July. Much of this increase came during the second half of the month -- the unemployment rate was 9.4% in mid-September -- and therefore is unlikely to be picked up in the government's unemployment report on Friday.



The increase in the unemployment rate component of Gallup's underemployment measure is partially offset by fewer part-time workers, 8.7%, now wanting full-time work, down from 9.3% in August and 9.5% at the end of July.



Friday's Unemployment Rate Report Likely to Understate

The government's final unemployment report before the midterm elections is based on job market conditions around mid-September. Gallup's modeling of the unemployment rate is consistent with Tuesday's ADP report of a decline of 39,000 private-sector jobs, and indicates that the government's national unemployment rate in September will be in the 9.6% to 9.8% range. This is based on Gallup's mid-September measurements and the continuing decline Gallup is seeing in the U.S. workforce during 2010.

However, Gallup's monitoring of job market conditions suggests that there was a sharp increase in the unemployment rate during the last couple of weeks of September. It could be that the anticipated slowdown of the overall economy has potential employers even more cautious about hiring. Some of the increase could also be seasonal or temporary.

Further, Gallup's underemployment measure suggests that the percentage of workers employed part time but looking for full-time work is declining as the unemployment rate increases. To some degree, this may reflect a reduced company demand for new part-time employees. For example, employers may be converting some existing part-time workers to full time when they are needed as replacements, but may not in turn be hiring replacement part-time workers. Another explanation may relate to the shrinkage of the workforce, as some employees who have taken part-time work in hopes of getting full-time jobs get discouraged and drop out of the workforce completely -- going back to school to enhance their education, for example, instead of doing part-time work. It is even possible that some workers may find unemployment insurance a better alternative than part-time work with little prospect of going full time.

Regardless, the sharp increase in the unemployment rate during late September does not bode well for the economy during the fourth quarter, or for holiday sales. In this regard, it is essential that the Federal Reserve and other policymakers not be misled by Friday's jobs numbers. The jobs picture could be deteriorating more rapidly than the government's job release suggests.

Crapshoot

Gaming the monthly job report estimates is something akin to a crapshoot. Nonetheless, I sense a degree of optimism that is both high and unwarranted.

Did the Fed manage to up expectations with its Quantitative Easing shenanigans? It seems that way to me.

However, if the Gallup survey is to be believed, the sharp increase in the unemployment rate will not occur until the October data (next month's report). Tomorrow we find out.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Weekly Claims Drop to 445,000, 4-Week Moving Average at 455,750; Where to From Here?

Weekly Claims fell this week to 445,000 but that number is still consistent with an economy losing jobs.

Please consider the Unemployment Weekly Claims Report for October 7, 2010.

In the week ending Oct. 2, the advance figure for seasonally adjusted initial claims was 445,000, a decrease of 11,000 from the previous week's revised figure of 456,000. The 4-week moving average was 455,750, a decrease of 3,000 from the previous week's revised average of 458,750.

Unemployment Claims



The weekly claims numbers are volatile so it's best to focus on the trend in the 4-week moving average.

4-Week Moving Average of Initial Claims



The 4-week moving average is still near the peak results of the last two recessions. It's important to note those are raw numbers, not population adjusted. Nonetheless, the numbers do indicate broad, persistent weakness.

4-Week Moving Average of Initial Claims Since 2007



No Lasting Improvement for 10 Months

There has been no lasting improvement for nearly 10 months.

To be consistent with an economy adding jobs coming out of a recession, the number of claims needs to fall to the 400,000 level.

At some point employers will be as lean as they can get (and still stay in business). Yet, that does not mean businesses are about to go on a big hiring boom. Indeed, unless consumer spending picks up, they won't.

Questions on the Weekly Claims vs. the Unemployment Rate

A question keeps popping up in emails: "How can we lose 400,000+ jobs a week and yet have the unemployment rate stay flat and the monthly jobs report show gains?"

The answer is the economy is very dynamic. People change jobs all the time. Note that from 1975 forward, the number of claims was generally above 300,000 a week, yet some months the economy added well over 250,000 jobs.

Also note that the monthly published unemployment rate is from a household survey, not a survey of payroll data from businesses. That is why the monthly "establishment survey" (a sampling of actual payroll data) is not always in alignment with changes in the unemployment rate. At economic turns the discrepancy can be wide.

With census effects nearly played out, It may be quite some time before we weekly claims drop to 400,000 or net hiring that exceeds +250,000.

Want to know why some businesses aren't hiring? Please consider Creating Jobs Carries a Punishing Price

Where To From Here?

The 4-week moving average has ticked down for a few weeks but the number is nothing to crow about. Moreover, claims have been generally in 450,000 range for 10 straight months of sideways movement so we can easily see more of the same. I am still expecting lots of state cutbacks so that could have an impact. Finally, the holiday shopping season is now just around the corner. It will be interesting to see what that portends.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Inflation Expectation Noise

Scott Grannis on Seeking Alpha has written a pair of interesting articles regarding inflation expectations and Quantitative Easing. Grannis thinks that Quantitative Easing is working. I don't, but that debate depends on the definition of "work".

In regards to inflation expectations as measured from TIPS, Grannis says Bond Market Bracing for Return of Inflation

Lots of important action in the bond market these days. 10-yr Treasury yields have plunged to a mere 2.36%. Recall that they hit a generational low of 2.05% at the end of 2008, when the entire world was terrified of impending economic death and destruction. Are yields today telling us that doom is just around the corner? Absolutely not. This time around things are very, very different.

The interesting part of the bond market action is in the TIPS market, where yields have plunged by much more than Treasury yields, and in the long end of the Treasury curve, where the spread between 10 and 30-yr Treasuries has widened to its steepest level ever. Since the end of August, when QE2 expectations started to heat up, 10-yr Treasury yields have declined by 10 bps, whereas 10-yr TIPS real yields have dropped by 50 bps. That's a 40 bps increase in annual inflation expectations over the next 10 years. Using the more sensitive measure of inflation expectations—the 5-yr, 5-yr forward breakeven rate—inflation expectations have jumped almost 50 bps since the end of August. The spread between 10- and 30-yr Treasuries has shot up to a record-breaking high of 127 bps, up from 105 bps at the end of August.



Note in the chart above how the drop in Treasury yields in late 2008 reflected deflationary fears (with inflation expected to average zero over the subsequent 10 years), whereas the current drop reflects inflationary fears.

So the market is saying that it has little doubt that the Fed will ramp up its quantitative easing efforts, and almost no doubt that this will prove inflationary in the years to come. The plunging dollar and the soaring price of gold fully support this interpretation.

This is the best evidence you can find that deflation risk has evaporated. The question now is not how low inflation will be, it's how high it will be in the years to come.

If the prospects for the economy are improving and inflation expectations are rising, why in the world would the Fed proceed with QE2, when it would only complicate things in the long run? This is really important stuff, and I get the feeling that Bernanke & Co. have not yet thought through all the ramifications of what they are planning, nor have they paid sufficient attention to market-based signals.

Deflation Risk Very Much Alive

For starters, deflation risk has not evaporated. Rather deflation expectations as measured by TIPS have fallen, which is a decidedly different thing. Moreover, and more importantly, those deflation expectations pertain to prices, specifically the CPI (which is an extremely poor measure of inflation).

As I have pointed out on numerous occasions, prices are not what is at risk. The risk is of a credit collapse, a far different (and far more important thing).

What's Really Important?

In case you missed it, please consider Myths About "What's Economically Important"

Day in and day out I hear it from readers who insist that we are not in deflation and will not be in deflation because prices are rising and continue to rise.

Still others tell me it is illogical for a deflationist to like gold.

When I counter with a discussion about credit conditions I tend to get a blank stare or a comment like "I do not care about credit conditions. I own my home. What I care about are rising prices of food and energy."

When I counter with falling asset prices and zero percent interest rates on savings accounts I am likely to get as statement like "Who cares, I rent?", or perhaps "The poor have no assets or savings, all they care about is food prices."

Really?

Such comments come from those who are not thinking clearly about what's important. Here's why:

• In a fiat credit-based financial system, when credit is plunging businesses are not hiring. There are currently 14.9 million unemployed who want a job but do not have a job because businesses are not hiring. There are 2.4 million "marginally attached" persons who do not have a job yet want a job, but are not considered unemployed because they stopped looking. There are 8.9 million part-time workers who want a full time job but cannot get one because businesses are not hiring. There are countless millions of college graduates who are underemployed, working at WalMart, delivering pizzas, or attempting to sell trinkets on eBay, because businesses are not hiring. There a still millions more in college hoping for a job upon graduation who will not get one because businesses are not hiring. This is all related to the ongoing credit contraction.
  


• When credit is plunging so do yields on treasuries and in turn yields on savings accounts. Those on fixed incomes attempting to live off interest income are screwed. Indeed, many are rapidly draining their principal because they collect no interest.
  


• Those who have a job, pay for those who don't. Food stamp usage is soaring and now costs over $60 billion dollars a year.


• When credit is plunging, consumers are not shopping, business earnings are under pressure, and wages stagnate or in many cases outright decline. Even those with jobs and no debt have been affected by deteriorating credit conditions. Public employees had escaped this debacle so far, but that is about to change in a big way, with huge implications.
  


• When business earnings are under pressure or when business owners face uncertainty over consumer spending trends, businesses cut back on benefits, especially health care. Those with health cares benefits are asked to chip in more of the costs. This too is a function of deflation.


• When profits are weak and business uncertainty high, stock prices do not act well (at least in the long run). Those with 401Ks or personal investments are affected.
  


• With credit falling and wages stagnant or falling, anyone in debt is likely to have a harder time paying back that debt. Foreclosures rise so do bankruptcies and divorces. Entire families have gone homeless.
  

So, What's Really More Important?

Expanding credit (inflation) created an enormous housing bubble, a commercial real estate boom, a rising stock market, and an enormous number of jobs.

Contracting credit (deflation), burst the housing bubble, burst the commercial real estate bubble, burst the stock market bubble, resulting in millions of foreclosures and bankruptcies, millions of broken homes, millions on food stamps, 26.2 million unemployed or partially employed, and countless additional millions who are underemployed.

People notice food and energy prices because they tend to be somewhat sticky. Everyone has to eat, heat their homes, and take some form of transportation at times, but is that what's important?

No!

In the grand scheme of things, nominal increases in food and energy prices are but a few grains of salt in the world's largest salt-shaker compared to the massive effects of rising or falling credit conditions.

Yet, every day, someone writes to me complaining about the price of milk (or something else) going up 30 cents or whatever telling me that is "inflation" or that is what is most important. ....

What About Housing?

If one wants to claim risk of falling prices as measured by the CPI is behind us, I beg to differ, while admitting I can easily be wrong. However, the CPI is fatally flawed in that it ignores housing prices and I am quite sure housing prices are headed for another plunge.

General prices (especially 2% CPI inflation expectations) are meaningless compared to housing prices, credit conditions, and defaults.

If there was one price Bernanke could force up if he could, it would be housing prices. Does anyone disagree?

Demographics Important Too!

These inflation expectation measurements ignore not only housing, but also demographics and other investment cycles. As I see it, Long-Wave, Fixed Investment, Inventory, and Demographic Cycles all Downwardly Converging and the implications are anything but inflationary.

Inflation Expectation Flaws

In light of the above, modest inflation expectations are essentially meaningless.

For the sake of completeness of this discussion, however, there is considerable debate as to whether or not it's as simple as subtracting 10-Year TIPS from 10-Year Treasuries to arrive at "inflation expectations".

Cleveland Fed Estimates of Inflation Expectations

Inquiring minds are reading Cleveland Fed Estimates of Inflation Expectations

News Release: September 17, 2010

The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.54 percent. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade.

The Cleveland Fed’s estimate of inflation expectations is based on a model that combines information from a number of sources to address the shortcomings of other, commonly used measures, such as the "break-even" rate derived from Treasury inflation protected securities (TIPS) or survey-based estimates.

The Cleveland Fed model can produce estimates for many time horizons, and it isolates not only inflation expectations, but several other interesting variables, such as the real interest rate and the inflation risk premium.

Inflation Expectations Trendline


click on chart for sharper image

Over a long horizon, one can see inflation expectations have been on a downtrend for 20 years!

Inflation: Noise, Risk, and Expectations

For an explanation of the Cleveland Fed Methodology, please see Inflation: Noise, Risk, and Expectations

The Cleveland Fed model of inflation expectations provides a simple measure of expected inflation that has two advantages over the break-even rate derived from TIPS. The first is that the measure is adjusted for the inflation risk premium. Because people don’t like the risk associated with inflation, they pay less for a nominal, unprotected bond, which means it has a higher interest rate. Thus the difference between nominal bonds and TIPS overstates the expected inflation rate. And because the model does not use the difference between TIPS and Treasuries, it does not capture liquidity differences along with inflation expectations.

Figure 1 [Mish Note: Same Chart as Above Trendline Chart] shows the model’s estimate of 10-year expected inflation. Expectations show a gradual decline from the early 1980s to about 2003, after which they fluctuate in the neighborhood just north of 2 percent. The financial crisis coincided with very low expectations.

It’s tempting to think that inflation risk is simply the risk of high inflation, but it is rather associated with inflation deviating from expectations, whether higher or lower. Put another way, people anticipate that $10,000 will buy less in 10 years, but they are unsure exactly how much less it will buy.

The inflation risk premium fluctuates around half a percent.

Removing Short-term Effects

Even “purified” expectations of inflation are not always the most useful indicators for monetary policy. In the short run, there are price pressures, unemployment effects, and shifts in money demand that move the price level around in ways that are out of the control of the central bank. What’s needed is a longer-term measure of inflation expectations that purges out the short-term effects.

The forward inflation rate (figure 3) does that.



Figure 3 shows what a difference the approach makes: the Cleveland model shows a lower rate than the other two series over the past several quarters. It stays near 2 percent, while the other measures show a potentially worrying increase. This implies that longer-term inflation expectations are still well anchored and the time for tightening has not yet come.

Self-Serving Claptrap from the Fed

I am certainly not one to give praise to self-serving claptrap from the Fed. Unfortunately, if you read the complete text of those articles you will likely be as nauseated as I was about the glorious praise the Fed heaped upon itself about inflation.

However, what the article says about risk premiums makes quite a bit of sense.

Yet, even if one assumes the model used by Scott Grannis is correct, those expectations are at the lower end of the range for the last 7-years, discounting panic action in late 2008.

Confusing Expectations and Reality

Grannis asks "If the prospects for the economy are improving and inflation expectations are rising, why in the world would the Fed proceed with QE2, when it would only complicate things in the long run?"

The above question seems to confuse expectations with reality. Does anyone remember the expectation (and all the models built on that expectation) that housing prices would never decline nationally? Yet it happened, didn't it?

While I am one to give credence to the bond market (especially over equities), it is important not to make too much ado over short-term fluctuations, especially when the long-term trendline is crystal clear.

Nonetheless, I agree with Grannis that the Fed's actions needlessly complicate things for the simple reason the Fed is making its exit strategy worse, while not doing a damn thing to stimulate lending.

Prospects Worsening

Returning to the phrase "If the prospects for the economy are improving ..." I suggest the prospects are clearly not improving. Indeed, the odds that the economy is already back in recession have risen from 1% in April to 20% in July (the latest month available).

Please see Real Time Probabilities of Recession Above 20% Second Consecutive Month for details.

Moreover, in spite of heroic buying of mortgage backed securities by the Fed and mortgage rates at all time lows, housing has fallen into the gutter with new home sales and housing starts also at all time lows.

Now, indications are that inventory rebuilding is nearly complete and unemployment is about to tick up. By what measure is any of this improving?

Is Quantitative Easing Working?

Grannis says Quantitative Easing Is Working: A Look at Action in the Markets.

The steepness of the long end of the Treasury yield curve reached another all-time high today of 126 bps. 10-year Treasury yields have fallen to their lows for the year, but investors in longer maturities are balking — the steepening of the curve is coming mainly from rising yields on 30-year Treasury bonds, which are up 20 bps since the end of August. That's a sign that the Fed's quantitative easing program is working.

A Debate Over the Word "Working"

The steepening spread is not a sign QE is working. It is a sign that investors, hedge funds, and banks are plowing into the central part of the yield curve because that is the part of the yield curve they think the Fed will buy.

Bear in mind that I do not think such actions can work against the trend except in the short-term. The implications of that statement are that treasury yields would be falling on their own accord.

However, the Fed certainly can goose the market in the direction of the trend, and that it has done. I wish I could quantify exactly how much, but I can't, nor can anyone else.

That said, before we can debate whether or not a policy is working, we must define what "work" means. If "work" means steepening the yield curve or getting commodity prices to rise, then one can indeed make a case that QE worked.

Grannis also says "The Fed can pin the 10-year Treasury yield at artificially low levels, but easy money can't make an economy grow, except to the extent that the prospect of inflation causes people to invest money they would rather just keep in cash. Shoveling money into the economy mostly results in higher prices, and there is growing evidence that this is occurring."

I essentially agree with that paragraph, especially the part "easy money can't make an economy grow."

However, this is NOT about inducing rising prices per se (except perhaps housing prices). I do not believe the Fed wants rising commodity prices unless they are accompanied by more bank lending, rising employment, and increased economic activity.

If the goals were to jump-start lending, spur the economy, and reduce the unemployment rate, (I am quite certain those were the goals), then QE did not "work", rather it failed miserably.

Finally, unless and until the Fed jump-starts lending, inflation expectations can go to the moon but there will not be significant inflation.

Please see Are we "Trending Towards Deflation" or in It? for further discussion regarding deflation trends.

Inflation Expectations Be Damned

Because the Fed has not stirred bank lending, the best way of looking at the current environment is that we are in a temporary inflation scare, similar to the inflation scare that we saw when oil touched $140, with talk of inflation expectations not much more than noise, at least for now.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Trichet's Exit Strategy Trapped by PIIGS; Currency Tensions Continue to Build; China Tells EU to Stuff It

In the midst of the crisis with sovereign debt of Greece, Spain, and Portugal, Trichet and the ECB acted by offering as much cash as the countries needed. This stabilized things for a while and Trichet was supposed to drop this support.

However, yield spreads between Germany and the PIIGS is once again soaring, and if unlimited lending is withdrawn now, it is a near-certainty that spreads will widen further.

Thus Trichet is ‘Trapped’ by Banks’ Addiction to ECB Cash.

Near-record borrowing costs for nations across the euro region’s periphery are making it harder for the ECB to wean commercial banks off the lifeline it introduced two years. The extra yield that investors demand to hold Irish and Portuguese debt over Germany’s rose last week to 454 basis points and 441 basis points respectively. Spain’s spread hit a two-month high.

The risk for the ECB is that it gets pulled deeper into helping the banking systems of the most indebted nations in the 16-member euro bloc. Governing Council member Ewald Nowotny said Sept. 6 that addiction to ECB liquidity is “a problem” that “needs to be tackled.” Complicating the ECB’s task is that interbank lending rates have risen, tightening credit conditions and making access to market funding more expensive for banks.

“The ECB is trapped and the exit door is blocked,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London. “The state of credit markets is going to force them to stay in crisis mode for longer than some of them would like.”

Irish 10-year bond yields soared to a record on Sept. 29 on concern the bailouts of Anglo Irish Bank Corp. and Allied Irish Banks Plc. would overwhelm government finances. The Portuguese- German 10-year yield spread, which hit a record on Sept. 28, was at 398 basis points yesterday, up from 88 basis points on March 10.

While it has phased out its 12- and 6-month loans, the central bank still lends unlimited amounts in its weekly, monthly and three-month tenders. In May, it was forced to reintroduce the unlimited three-month loans and start buying government bonds as Europe’s deepening debt crisis started to threaten the survival of the euro.

With the ECB unlikely to match other nations’ “expansive monetary policy measures,” the euro may continue to strengthen, crimping the region’s exports and economic expansion, economists at WestLB AG economists said in a research note. The single currency has gained 16 percent against the dollar in the past four months and touched $1.3941 yesterday, the highest since February.

Currency Tensions Build

With the rise in the Euro vs. the US dollar, the Euro is also rising vs the Yuan given the Yuan's peg to the dollar.

Trichet and the EU are pissed that the Euro, and not the Yuan is at the center of global currency trends. Japan is also upset to the point of currency intervention.

China Tells EU to Stuff It

In the midst of global currency debasement wars, China Hardens Opposition Over Yuan Gains, Tells EU to Back Off

China stiffened its opposition to a rapid appreciation of the yuan, setting the stage for a confrontation over exchange rates at this week’s international monetary meetings in Washington.

Premier Wen Jiabao said China will stick to its policy of gradually increasing the currency’s flexibility and lashed out at European Union leaders for teaming with the U.S. to pressure the Chinese government.

“Europe shouldn’t join the choir” clamoring for a higher yuan, Wen told a business conference yesterday before an EU- China summit in Brussels. “If the yuan isn’t stable, it will bring disaster to China and the world. If we increase the yuan by 20-40 percent as some people are calling for, many of our factories will shut down and society will be in turmoil.”

International exchange-rate diplomacy shifts into high gear at the Oct. 8 Group of Seven meeting in Washington after China rebuffed EU and U.S. pleas, the Bank of Japan sought to drive down the yen by unexpectedly easing monetary policy, and Brazilian Finance Minister Guido Mantega warned of a global “currency war.”

“There’s a game of brinksmanship being played,” David Cohen, an economist at Action Economics in Singapore, said in a Bloomberg Television interview. “I suspect at the end of the day the Chinese will agree to return to gradual appreciation of their currency.”

Mistake To Assume Anything

While it's crystal clear a game is underway, it's debatable whether that game is better called "brinksmanship" or "currency wars". Furthermore, it's a mistake to assume China will agree to anything.

Every country wants a weaker currency to stimulate exports, but that is physically impossible, except of course against gold. The irony is rising gold prices will not stimulate anything that central banks want, but global competitive currency debasement sure has stimulated the price of gold and silver.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Real Time Probabilities of Recession Above 20% Second Consecutive Month

Seeking to eliminate the enormous lag of NBER in declaring the beginning and end of recessions, economist Marcelle Chauvet computes real-time recession probabilities in a manner consistent with the long after the fact findings of the NBER.

The probability is down from last month, nonetheless Real Time Probabilities of Recession are above 20% for the second consecutive month.

Real-time means a one quarter delay, but that is still faster than the NBER is likely to make proclamations.



click on chart for sharper image

Month/Year	Probability of Recession%
January 2009	100.0%
February 2009	99.7%
March 2009	98.9%
April 2009	94.3%
May 2009	92.6%
June 2009	69.4%
July 2009	41.0%
August 2009	39.3%
September 2009	27.1%
October 2009	18.9%
November 2009	7.9%
December 2009	6.5%
January 2010	4.1%
February 2010	2.4%
March 2010	2.1%
April 2010	1.1%
May 2010	2.8%
June 2010	27.0%
July 2010	20.6%

Note the drop from 69.4% to 41.0% in June/July 2009 accurately timing the end of the recession well in advance of the NBER. Also note the huge leap from 2.8% in April to over 20% in June and July.

For a description of the methodology, please see the Center for Research on Economic and Financial Cycles post CREFC Real Time Probabilities of Recession.

Also see Real Time Analysis of the U.S. Business Cycle

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Hussman calls for 10-Year S&P 500 Total Return in the Low 5% Area; Thoughts on Risk Management

John Hussman is bearish on the economy and stocks. He backs up his beliefs with good commentary and a series of charts in Economic Measures Continue to Slow .

Please see the article for some excellent economic charts. Here are a few snips regarding equity returns.

With the S&P 500 at a Shiller P/E over 21, and our own measures indicating an estimated 10-year total return for the S&P 500 in the low 5% area, it is clear that investors have priced in a much more robust recovery than we are likely to observe. Our long-term total return estimates are consistent the historical norms based on Shiller P/Es - since 1940, Shiller P/E values above 21 have been associated with annual total returns for the S&P 500 averaging 5.3% over the following 7 years and 4.9% annually over the following decade.

Dividend payout ratios and operating earnings growth

A note on valuation. A number of observers have suggested that the low level of dividend payouts as a fraction of operating earnings is indicative of strong prospects for reinvestment, which is then extrapolated into assumptions for high rates of future earnings growth. Unfortunately, this argument is problematic on two counts.

First, forward operating earnings are not realized cash flows. As I've noted frequently over the years, forward operating earnings represent analyst estimates of the next year's earnings excluding a whole range of chargeoffs and "extraordinary expenses" as if they do not exist. While operating earnings provide a smoother measure of business performance, they don't provide a good measure of the cash flows that are actually deliverable to shareholders.

Losses that are booked as "extraordinary" are still losses, and represent the results of bad investments and a consumption of amounts that were previously reported as earnings. Similarly, the portion of earnings used for share buybacks is often expended simply to offset dilution from grants of stock to employees and corporate insiders, and again do not reflect cash that is deliverable to shareholders. In recent years, based on the widening gap between reported operating earnings on one hand, and the sum of dividends and increments to book value on the other, a great deal of what is reported as earnings ends up evaporating as extraordinary losses and share compensation.

The second problem with the low level of dividend payouts, relative to forward operating earnings, is that there is no historical evidence whatsoever that low payouts are accompanied by higher growth in future operating earnings. To the contrary, when dividends are low relative to forward operating earnings, it is a signal that operating earnings are temporarily elevated - typically because of transitory profit margins. As a result, subsequent growth in forward earnings is actually slower than normal over the following decade.

On the latitude for a constructive investment stance

Based on the data that we've observed in recent months, my view remains that a fresh downturn in the economy remains a not only a possibility but a likelihood. Little of the economic improvement we've observed since 2009 appears intrinsic, but instead appears driven by enormous government interventions that are now trailing off. Still, while I believe that there is a second shoe that has not dropped, I recognize that the full force of government policy is to obscure, stimulate, intervene and borrow in every effort to kick that can down the road. I believe that the unaddressed and unresolved problems relating to debt service, employment conditions and housing are too large for this to be successful, but as we move through the remainder of this year - as I've said throughout 2010 - we are gradually assigning greater probability to the "post-1940" dataset. Accordingly, there are developments that could potentially move us to a more constructive position. We don't observe those at present, but an improvement in economic evidence and a clearing of overbought conditions, leaving market internals intact, would be one configuration that might warrant less defensiveness.

To some extent, I view current market conditions as something of a "Ponzi game" in that valuations appear neither sustainable nor likely to produce acceptably high long-term returns, and speculators increasingly rely on finding a greater fool. As the mathematician John Allen Paulos has observed, "people generally worry only about what happens one or two steps ahead and anticipate being able to get out before a collapse... In countless situations people prepare exclusively for near-term outcomes and don't look very far ahead. They myopically discount the future at an absurdly steep rate." Undoubtedly, we have periodically missed returns due to our aversion to risks that rely on the ability to find a "greater fool" in order to get out safely. But it is important to recognize that speculative risks are not a source of durable long-term returns. At a Shiller P/E of 21 and a historical peak-to-peak S&P 500 earnings growth rate of 6%, a simple reversion to the historical (non-bubble) Shiller norm of 14 would require seven years of earnings growth and yet zero growth in prices. Stocks are not cheap here.

Stocks Not Cheap

I wholeheartedly endorse Hussman's analysis that suggests stocks are not cheap. I have said the same thing repeatedly all year long, most recently in Analysts Cut S&P 500 Profits Forecast; Earnings Estimates Still Overly Optimistic; Stocks Not Cheap

Earnings Estimates A Mirage

It's important to understand why earnings have gone up: Trillions of dollars of stimulus worldwide that is not sustainable. Bank earnings estimates have been inflated by massive extend-and-pretend games encouraged by the Fed with a blind eye from the FASB.

Moreover, the FASB has delayed mark-to-market accounting rules and has still not forced banks to bring SIVs and off-balance-sheet assets back on the books. Those assets are held at inflated values.

Equities only look cheap if you use absurd forward earnings estimates, and ignore future writeoffs and other "one-time" items that seem to have a way of recurring with remarkable regularity.

No Sure Things

Although most are plowing hand-over-fist into the "QE-Trade", it is a mistake to assume that quantitative easing is a guaranteed play for equities. It's not. Please see Sure Thing?! for a discussion.

Moreover, QE is not a guaranteed play for the economy either, as noted in Bernanke says Lawmakers Should Consider Rules on Fiscal Limits; Expect Hissy Fit from Krugman; Bernanke Pisses in the Wind

Yet everyday I get emails calling me a "chicken little" or other unprintable names for not recommending everyone plow into equities. I heard the exact same thing in 2006-2007.

However, I have recommended gold continuously since it was $300. I have also recommended treasuries with many attempting to short the things and getting their heads blown off.

Superior Returns Come From Reducing Risk

I see no reason to like equities here, but that does not mean they won't go up. Indeed they did. However, investors need to understand why equities are rising, the likelihood it continues, and what the risks are, even if short-term traders don't.

When this rally ends, it is as likely as not to be a steep descent with dip buyers fully conditioned to "buy the dip" all the way down.

Day traders and swing traders seem to think that everyone ought to be hopping in and out of stocks every hour or every week. However, not everyone wants to, or can - for many reasons, trade that way. Money managers in particular are unlikely to trade that way.

It is important to honor your timeframe and trading style, not someone else's.

Most of those fully invested here were also fully invested in 2008, with disastrous consequences.

In the long haul, superior returns are made by reducing risk, patiently waiting for favorable opportunities to invest. In the meantime, (and although this opinion can change at any time without warning) I am comfortable owning gold and treasuries, and being hedged in equities.

It is far easier to make up for lost opportunities than it is to make up for losses, especially losses that happen while chasing the latest sure thing.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Global Competitive Debasement; Currency Wars Begin; Message of Gold

The Bank of Japan is leading the way to new measures of stimulus insanity with a plan to buy a wide variety of assets including real estate investment trusts (REITs) and asset backed commercial paper (ABCP).

Please consider Factbox: BOJ to set up fund to buy JGBs, corporate debt

The Bank of Japan on Tuesday decided to set up, as a temporary measure, a 5 trillion yen ($59.9 billion) pool of funds to buy assets ranging from government bonds to corporate bonds.

Following are key points about the new measure:

-- The programme will consist of a fund totaling 5 trillion yen to buy assets anew as well as the existing 30-trillion-yen fixed-rate fund-supply tool that will hold designated assets as collateral.

-- The programme is a temporary measure aimed at encouraging declines in long-term interest rates and risk premiums.

-- The fund is designed to cover Japanese government bonds, treasury bills, commercial paper (CP), asset-backed commercial paper (ABCP), corporate bonds, exchange-traded funds (ETFs) and Japanese real estate investment trusts (J-REITs).

-- The BOJ will not apply its self-imposed ceiling on its outright JGB buying to the JGBs to be purchased with the new fund.

-- The BOJ will aim to bring the balance of assets purchased using the new fund to 5 trillion yen in one year, with about 3.5 trillion yen assigned for JGBs and treasury bills and about one trillion yen for CP, ABCP and corporate bonds.

What About Paintings and Shellfish?

Why not paintings, equities, and shellfish? Given enough time, perhaps it comes to that.

Meanwhile, I am pleased to report that the global recovery has gained so much traction that numerous countries feel obliged to join the US/Japan sponsored stimulus party.

Global Competitive Debasement

Bloomberg reports BOJ May Have Acted First in Renewed Round of Action

The unexpected decision by the Japanese central bank yesterday to drop its interest rate to “virtually zero” and expand its balance sheet follows the U.S. Federal Reserve’s move toward more unconventional easing. Bank of England officials will consider further stimulus tomorrow, while the central banks of Australia, Canada and New Zealand are among those now holding fire on further interest-rate increases.

The renewed push for easier monetary policy comes as the International Monetary Fund warns growth in advanced economies is falling short of its forecasts ahead of its annual meetings in Washington this week. The dilemma for policy makers is that their actions may do little to revive growth and end up roiling currency markets.

Bank of Japan Governor Masaaki Shirakawa may not be alone for long in taking action and Daiwa Institute of Research argues he’s now engaged in a “vicious spiral” of monetary easing with the Fed as both compete to bolster their economies.

“The irony is that the Fed is creating all this liquidity with the hope that it will revive the U.S. economy. It is doing nothing for the U.S. economy and causing chaos for the rest of the world,” Joseph Stiglitz, a Nobel Prize-winning professor at New York’s Columbia University, said today in New York.

The ECB will be forced to postpone tighter policy as European exports fade and investors continue to fret about peripheral euro-area economies such as Portugal and Ireland, said Silvio Peruzzo, an economist at Royal Bank of Scotland Group Inc. in London.

“The ECB’s exit strategy is fully on, but the business cycle will turn against them,” said Peruzzo. “The communication will then be adjusted to consider downside risks greater than what they have anticipated.”

The ECB last week stepped up its government bond purchases as the cost of insuring against default on Portuguese government debt surged to a record and Irish bond spreads soared to euro- era highs.

Another risk is that the use of unconventional monetary policy is viewed as an effort to weaken currencies to boost exports, rising competitive devaluations and protectionist responses, said Eric Chaney, chief economist at AXA Group in Paris. Japan, Switzerland and Brazil are among the countries that have already intervened in markets to restrain their exchange rates.

“This is close to a currency war,” said Chaney, a former official at the French France Ministry. “It’s not through exchange-rate manipulation, but through monetary policies.”

Currency Wars

This is not "close to a currency war" this IS a currency war.

While I have had numerous differences of opinion with Joseph Stiglitz, he is absolutely correct when he says “The irony is that the Fed is creating all this liquidity with the hope that it will revive the U.S. economy. It is doing nothing for the U.S. economy and causing chaos for the rest of the world.”

Moreover what Stiglitz says about Bernanke and the Fed, applies equally to the Bank of England, the Bank of Japan, and the central banks of Canada and Australia as well.

Message of Gold

The competitive currency debasement can be seen in the price of gold and silver.

None of these central bank measures are doing a damn thing for the real economy (in the US or anywhere else), but it sure has ignited a fire in gold and silver.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Bernanke says Lawmakers Should Consider Rules on Fiscal Limits; Expect Hissy Fit from Krugman; Bernanke Pisses in the Wind

Proving that he far more of a Monetarist clown than a Keynesian clown, Bernanke Calls on Lawmakers to Consider Rules on Fiscal Limits

Federal Reserve Chairman Ben S. Bernanke called on U.S. lawmakers to consider rules limiting federal spending, annual deficits or accumulated debt to curtail the risk of a fiscal crisis.

“Well-designed rules can help promote improved fiscal performance,” Bernanke said today in a speech in Providence, Rhode Island. A rule “could provide an important signal to the public that the Congress is serious about achieving long-term fiscal sustainability, which itself would be good for confidence,” he said.

Bernanke provided one of his most detailed prescriptions yet for reducing the record federal budget deficit. He said in congressional testimony in June that unless the U.S. makes a “strong commitment to fiscal responsibility,” the country in the long run will have neither economic growth nor fiscal stability.

“It is crucially important that we put U.S. fiscal policy on a sustainable path,” Bernanke said at the Rhode Island Public Expenditure Council’s annual dinner, where he was invited to speak by Senator Jack Reed, a Democrat from Rhode Island and member of the banking committee.

“The only real question” is whether adjustments to taxes and spending will come from a “careful and deliberative process” or from a “rapid and painful response to a looming or actual fiscal crisis,” Bernanke said.

Bernanke cited Switzerland, Sweden, Finland, the Netherlands, Canada and Chile as countries that improved their budgetary performance by using fiscal rules. He didn’t elaborate on what kinds of spending, deficit or debt limits would be best.

“I do think that the additional purchases -- although we don’t have precise numbers for how big the effects are -- I do think they have the ability to ease financial conditions,” Bernanke told the students.

Fiscal Sustainability and Fiscal Rules

The above excerpts are from a speech Bernanke gave at the Annual Meeting of the Rhode Island Public Expenditure Council, Providence, Rhode Island.

The speech was on Fiscal Sustainability and Fiscal Rules

Expect Hissy Fit From Krugman

Paul Krugman, flag bearer for the Keynesian clowns, is without a doubt having a hissy fit at the thought of any step, no matter how small, regarding Bernanke's statement “It is crucially important that we put U.S. fiscal policy on a sustainable path.”

Krugman might object to that characterization, by claiming he is all in favor of fiscal prudence, but only after Keynesian stimulus leads to a full recovery.

The reality is Keynesian clowns in Congress and Monetarist clowns at the Fed have both wrecked the economy to a point that severe pain is not avoidable. Indeed, the unemployment rate and bank lending both say the economy is following a path of severe pain.

Monetarist Nonsense

Bernanke claims Quantitative Easing will "ease financial conditions.” Forgive me for asking the obvious, but what the hell needs easing?

Mortgage rates are at all time lows in spite of the fact that housing itself is in the gutter and risk of default is high, junk bonds are back to par, and the ability for corporations to get financing for total garbage is at or near historic highs.

If anything, Bernanke has ignited a bubble in junk bonds. The one thing Bernanke has not done is ignite bank lending.

Bernanke Pisses In Wind

The problem Bernanke faces is low rates will not stimulate bank lending. I discussed why at great length in QE Engine Revs, Car Goes Nowhere.

The economy is stuck in neutral so stepping on the QE gas pedal is highly unlikely to accomplish much except increase the noise level. Yet, the philosophy at the Fed seems to be, if gas doesn't work, give the engine more gas.

Providing unneeded liquidity may or may not help asset prices (please see Sure Thing?! for a discussion) but if quantitative easing helped the real economy, at some point yields would stop falling.

Clearly the Fed has no clue as to what to do, but it wants to "do something". The only thing the Fed can think of doing (or is willing to do) is have another round of quantitative easing, so the Fed eases whether it makes any sense or not.

The simple fact of the matter is increased borrowing power or lower interest will not cause business businesses to expand. I have discussed this point at length in

• $30 Billion Offer No One Wants - Small Businesses Hit by Deflation
• Ass Backwards: Senate to Shelve Bush Tax Cuts for Individuals; House to Pass Small Business Tax Cuts
• Response to Nouriel Roubini on "America Needs a Payroll Tax Cut"

Here are a few charts from NFIB Small Business Trends for September.

Prices Received



Actual Price Changes



Single Most Important Problem



The single most important problem is lack of customers. Access to credit is not even on the list. Small businesses don't want loans because they don't have any customers and prices they receive are falling like a rock.

This is deflation in action, and it is crucifying small businesses.

Floods Everywhere

The response from the Fed is to provide more liquidity. Hell, water is everywhere already. The action in corporate bonds alone proves it. Some think that liquidity will continue to flow into equities.

However, with junk bonds already at parity, it seems to me that gold and treasuries are a better bet.

Regardless, please note how Bernanke's policies have robbed those living on fixed income, now earning 0% on their savings.

Yet, here we go again, with another round of QE, another round that cannot possibly do anything positive for the real economy, but try we must because Bernanke does not want to appear like the powerless charlatan that he is.

Bernanke now attempts to distance himself from the Keynesian clowns, secure in the knowledge that Congress is highly unlikely to show any real prudence.

Calculated Risk Blasts Bernanke

It is very rare to see Calculated Risk take a hard swipe at anyone, let alone the Fed, but Bernanke managed to cross the line.

Please consider Calculated Risk's post Bernanke breaks promise, discusses fiscal issues

This speech isn't worth reading for substance (Ben Bernanke is clueless on budget issues), but it reveals something about Bernanke.

Bernanke never mentioned "PAYGO" when he was head of the Council of Economic Advisors in 2005. In fact Bernanke barely mentioned the deficit in 2005 - except in postive terms - even though the structural deficit was in place and the cyclical deficit was coming (because of the housing bubble).

Today he said:

Our fiscal challenges are especially daunting because they are mostly the product of powerful underlying trends, not short-term or temporary factors. Two of the most important driving forces are the aging of the U.S. population, the pace of which will intensify over the next couple of decades as the baby-boom generation retires, and rapidly rising health-care costs.

Weren't the baby boomers going to get older in 2005? Oh my ...

This is an issue that 1) is outside of Bernanke's area of responsibility, 2) he has promised not to discuss, and 3) he has zero credibility on. Enough said.

No Credibility on Anything

While Calculated Risk points out Bernanke has no credibility on fiscal issues, I point out that Bernanke has no credibility on anything.

Bernanke certainly did not see the housing bubble, he did not think the unemployment rate would get above 8.5%, he did not see a credit collapse, he never admitted the Fed's role in this mess, and he calls himself a student of the great depression but does not have a clue as to why it happened. I could go on, but I won't.

Instead I will point out that he is diving into fiscal issues when he said he wouldn't. That makes him a liar as well.

The irony in Bernanke's speech is that Congress really does need limits on spending.

The correct place to start would be a balanced budget amendment. That would stop needless warmongering and other stupidities like bank bailouts right up front before they even started.

Why Now?

In regards to Bernanke's new-found fiscal conservativeness, Calculated Risk asks "I wonder why? Well, he missed the housing bubble completely - but what about the structural deficit?"

The answer should be pretty easy to spot.

Bernanke, knows full well Congress is unlikely to act in any meaningful way. When they don't, and when a global currency crisis is well underway, Bernanke will point his finger and blame Congress.

Thus, Bernanke's statements are not about fiscal prudence, but rather all about absolving the Fed in general, and Bernanke in particular for the upcoming global financial collapse.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Japanese Politicians fed up with Deflation, Challenge BOJ Independence

Things are simmering once again in Japan. The Yen is approaching all-time highs and Japanese politicians have had enough of deflation. Another round of quantitative easing is now on the front burner.

MarketWatch reports Bank of Japan may buy asset-backed paper

Japan's central bank may announce plans to buy asset-backed securities when it issues its policy decision later Tuesday, the Nikkei business daily reported. The newspaper had reported earlier in the week that the Bank of Japan may expand its low-interest loans to financial institutions. But in the report Tuesday, the Nikkei said "a growing number of board members argue that the bank should go further" and begin buying securities backed by loans to small and medium-sized enterprises. The report, which didn't cite sources, said such a move would be aimed at making more funds available to the private sector.

BOJ Independence Under Attack

Bloomberg reports BOJ Independence Challenged as Deflation Continues

Increasing risks to Japan’s recovery prompted what may become the biggest threat yet to the Bank of Japan’s independence as politicians seek to redress its failure to end the deflation entrenched in the economy since 1998.

Your Party, an opposition group, plans to submit a bill in the Diet session running through December that would give the government a greater role in BOJ policymaking. Ichiro Ozawa, a former challenger to Prime Minister Naoto Kan whose calls for currency intervention and enlarged fiscal stimulus have been adopted by Kan, made a similar proposal last month.

The debate comes after BOJ Governor Masaaki Shirakawa refused to expand purchases of government bonds this year even as deflation persisted. The bank may today instead widen a 30 trillion yen ($358 billion) program providing loans to banks, according to 14 of 17 economists surveyed by Bloomberg News. The effort has so far failed to stanch a contraction in lending.

Shirakawa’s intransigence has incurred the ire of politicians pressing the bank to boost efforts to end deflation, which erodes corporate profits, makes debt harder to pay back, and enhances the yen’s lure by lifting its purchasing power. The GDP deflator, a gauge of prices across the economy, has fallen 14 percent since 1997, according to data compiled by Bloomberg.

“Japan is the only industrialized country which has had consumer price changes of minus or zero over the past decade,” Keiichiro Asao, head of policy research at Your Party, said in an Oct. 1 interview in Tokyo. “If the central bank is a guardian of stable prices, it shouldn’t allow price declines.”

The BOJ, which has kept its benchmark interest rate at 0.1 percent since December 2008, currently purchases 1.8 trillion a month of government bonds. At the current pace of buying, the bank’s self-imposed ceiling for bond holdings will be reached in 2014, according to Barclays Capital estimates.

The Federal Reserve, by contrast, has eschewed any such ceiling and indicated last month it’s prepared to add to its holdings of U.S. Treasuries. At the same time, the Fed’s balance sheet, at $2.3 trillion, is smaller than Japan’s relative to the size of the economy, at about 16 percent, according to data compiled by Bloomberg. The BOJ holds about $1.5 trillion, or about 26 percent of Japan’s GDP.

Bank Balance Sheets Compared

ZeroHedge Asks Is The BOJ Preparing An Imminent Announcement Of Its Own Latest (And Certainly Not Greatest) QE?

The BOJ's balance sheet, which has been relatively flat when compared to peer central banks, especially since FX interventions will likely be sterilized, is about to explode and the JPY will plunge once the carry traders reorient themselves to shorting the original carry currency of choice.

As a reminder, here is how Japan has demonstrated remarkable restraint (at least recently) as everyone else has been printing.



In other words, the BOJ will continue to use FX intervention as an acute weapon every time the USDJPY drops below 83, and gradually implement asset-backed purchases as the chronic intervention against endless deflation.

Because this time it will be different. And, because, as the G-7 people promised, and everyone believed them, there will be no competitive devalution. Ever.

Politicians Know This Time is Different!

It's hard not to laugh out loud at the sarcasm in the last paragraph above.

Not only did QE fail to do what the Bank of Japan wanted (raise prices), QE has also failed to stimulate bank lending as Bernanke wants. Moreover, Japan's currency intervention efforts have not accomplished anything, ever.

But yeah... this time is different, because .... politicians know better!

By the way, this exercise in stupidity by all the central banks in question, shows just how hard it is to destroy a currency, even when you try (except against gold of course).

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Analysts Cut S&P 500 Profits Forecast; Earnings Estimates Still Overly Optimistic; Stocks Not Cheap

Bloomberg reports S&P 500 Profits Cut for First Time in Year by Analysts.

For the first time in more than a year analysts are cutting their forecasts for Standard & Poor’s 500 Index earnings, jeopardizing gains from the biggest September rally since World War II.

Estimates for S&P 500 companies’ combined 2011 profit fell as low as $95.17 last month from an August high of $96.16 and posted the first quarterly reduction since the three months ended June 2009, according to more than 8,500 analyst forecasts tracked by Bloomberg. The revision came as the benchmark gauge for U.S. equities rose 8.8 percent last month, the largest September advance since 1939.

Estimates show S&P 500 earnings may rise 15 percent in 2011, down from a forecast of 20 percent growth in March, Bloomberg data show. The S&P 500 slipped 0.2 percent to 1,146.24 last week amid lingering concern that Europe’s government debt crisis may threaten the economic recovery.

Companies in the S&P 500 may report profits rose 23 percent on average during the third quarter, according to forecasts tracked by Bloomberg. That’s about half the 49 percent growth during the second quarter and the 52 percent increase from January through March.

Michael Levine of OppenheimerFunds Inc. says the outlook for lower earnings is already reflected in stock prices after the S&P 500 fell as much as 16 percent between April 23 and July 2. He predicts equity prices will keep rising as investors grow more confident that the U.S. economy isn’t headed for the second recession in three years.

“Equities are cheap,” said Levine, a money manager at New York-based OppenheimerFunds, which oversees about $165 billion. “The broader markets are assuming there’s a slow but gradual recovery. As long as that’s the message, the markets will be fine.”

“Stocks go up and they raise their earnings estimates, the markets go down they start reducing estimates -- a lot of it has to do with the psychology,” said Jeff Saut, chief investment strategist at Raymond James & Associates, which manages $235 billion in St. Petersburg, Florida. “Over the long run, investing is indeed all about the earnings, but over the short term it’s all about psychology.”

Earnings Estimates A Mirage

It's important to understand why earnings have gone up: Trillions of dollars of stimulus worldwide that is not sustainable. Bank earnings estimates have been inflated by massive extend-and-pretend games encouraged by the Fed with a blind eye from the FASB.

Moreover, the FASB has delayed mark-to-market accounting rules and has still not forced banks to bring SIVs and off-balance-sheet assets back on the books. Those assets are held at inflated values.

It is disgusting to hear those like Michael Levine of OppenheimerFunds Inc. says "equities are cheap". Equities only look cheap if you use absurd forward earnings estimates, and ignore future writeoffs and other "one-time" items that seem to have a way of recurring with remarkable regularity.

Stocks Not Cheap

Stocks are not cheap an besides, share prices are not always a direct function of earnings. I talked about that in Sure Thing?!

Earnings vs. Share Prices

Right now, sentiment is so bullish and earnings estimates so lofty there is room for hefty earnings expansion that falls short or estimates. Buying stocks that miss wildly optimistic earnings estimates is not likely to work out well.

Furthermore, even if earnings do come in on target, there is no historic guarantee that stock prices follow. For example, on March 31, 1973 the S& P was at 111.52 with trailing earnings of $6.80. Seven years later, on March 31, 1980 the S&P was at 102.09 with trailing earnings of $15.27.

Thus, over a span of seven years, earning rose 125% while stock prices fell 8.5%!

What happened? The PE ratio on the S&P fell from 16.40 to 6.68, that's what.

Moreover, those were real earnings then. Now, corporations hide garbage in SIVs with the blessing of the Fed and analysts cite pro-forma earnings that throw out "one-time" charges that occur with increasing regularity.

Thus, anyone who says stock prices will go up because earnings go up, does not understand history.

Fancy Numbers

“You need pretty fancy GDP numbers to get to $95 a share in earnings next year,” said Robert Doll, vice chairman of New York-based BlackRock Inc., which oversees $3.2 trillion. “Our view is that they’re still a little too high, and that nobody believes them.”

Robert Doll is half-right. He's right in that "You need more that fancy earnings to get to $95 a share". He's half-right because the consensus believes. Bear in mind we could still see a bit of earnings expansion, but with the inventory replenishment and stimulus coming to an end, and with consumers heading back into a shell, it will not be sustainable.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Factory Orders Drop More Than Expected, Treasuries Rally

Curve Watchers Anonymous notes the rally in treasuries continues in the wake of the third decline in four months in factory orders and expectations of renewed Quantitative Easing by the Fed.

Yield Curve July 2008 - Present



click on chart for sharper image

Two-year (not shown above) and five-year treasuries are at record lows.

Factory Orders Drop More Than Expected

The Wall Street Journal reports Factory Orders Decline

U.S. factory orders dropped more than expected in August, marking the third decline in the last four months.

U.S. manufactured goods orders decreased by 0.5% to $408.94 billion, the Commerce Department said Monday.

Commercial airplanes drove the decline; excluding transportation, all other factory orders rose.

The report had positive data. A barometer of business capital spending increased; non-defense capital goods orders excluding airplanes rose by 5.1%.

Economists surveyed by Dow Jones Newswires had expected overall factory orders would decrease by 0.4% in August. July orders rose 0.5%, revised from a previously reported 0.1% increase.

Factory orders are either durable or non-durable. Durables are designed to last at least three years -- things such as cars. The Commerce report Monday said durables dropped by 1.5%, revised from a previously reported 1.3% decrease. Nondurables rose by 0.3%.

Capital goods orders fell 0.1%. Non-defense capital goods orders rose 0.1%.

Meanwhile, defense-related capital goods dropped by 1.8%. Excluding defense, all other factory orders decreased 0.5%.

Among industries, orders rose for electrical equipment, machinery, and computers. Demand fell for primary metals.

Transportation equipment fell 10.2% as orders for cars and commercial airplanes dropped. Orders for manufactured goods excluding transportation rose 0.9%. This was the first increase in the last five months.

Manufacturers' inventories were up by 0.1% in August, after increasing 0.9% in July.

Shipments declined 0.6%. Unfilled orders, a sign of future demand, were flat.

That is a very weak report with inventories rising and nearly everything important falling or flat.

Durable Goods Drop Should Not Have Surprised Anyone

The drop in durable goods may have surprised some but it is consistent with my July 7th post Expect Second-Half Housing and Durable Goods Crash

This should have been pretty easy to figure out. If people stop buying houses, and they have, then people will not be buying many appliances for the houses they did not buy.

Moreover, autos are big ticket items and with sentiment souring on job prospects, one might have anticipated the auto recovery (as weak as it was), would also stall.

Rear View Mirror Look

Please note that today's report is a look in the rear view mirror. Today's factory orders report reflects August data.

October ISM Recap - Looking Ahead

Let's recap a few charts from Manufacturing ISM Expands, Rate Slows, Internals Weak

September ISM Manufacturing at a Glance



New Orders June Thu September



Falloff in the rate of growth of new orders is persistent and dramatic.

Inventories June Thu September



The backlog of orders is now contracting, and judging from the persistent trend in orders, it is highly likely orders will contract next month. Meanwhile inventories continue to rise.

This situation cannot last. Production is headed for a plunge if orders and backlog start contracting in a meaningful way, as appears likely.

Manufacturing ISM has likely peaked.

More Downward Surprises Coming

Today's Factory Orders report (for August) along with the October ISM report (September data as shown above) is further evidence the glowing September ISM report (August data) was an outlier.

Expect to see more downward surprises as the vast majority of economists do not understand the implications of the recent ISM data, or the meaninglessness of the Fed's renewed quantitative easing plans.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Long-Wave, Fixed Investment, Inventory, and Demographic Cycles all Downwardly Converging

Inquiring minds are reviewing a chart of Total Loans and Leases and also a chart of Quarterly Real Final Sales of Domestic Product for clues about the strength of the alleged recovery.

After a review of the charts, my friend "BC" shares some of his thoughts regarding the converging Long-Wave, Fixed Investment, Inventory, and Demographic Cycles. The possibilities are not pretty.

Real Final Sales of Domestic Product

Year	Annualized QoQ	Annualized YoY
Q2 '08	+1.10%	+1.80%
Q3 '08	-3.90%	+0.15%
Q4 '08	-4.60%	-1.93%
Q1 '09	-3.90%	-2.86%
Q2 '09	+0.22%	-3.07%
Q3 '09	+0.41%	-2.00%
Q4 '09	+2.07%	-0.33%
Q1 '10	+1.06%	+0.94%
Q1 '10	+0.90%	+1.11%
Avg.	-0.74%	-0.69%
Avg Since Q1 '09	+0.13%	-1.04%

Total Loans and Leases at Commercial Banks



My friend "BC" writes ....

US GDP Poised to Contract

The trend rate of bank lending and money supply ex incremental annualized government spending implies that the private sector probably decelerated to around 0% or slightly negative early in Q3 and is poised to contract again hereafter.

Consider what real final sales/demand would have been had the government not borrowed and spent 30% of private GDP over two years.

The average trend rate of real final sales since the secular '00 peak is 1.6% vs. the average long-term trend rate of 3.4%.

This means that the US economy has experienced a 14-15% decline (24-25% per capita) in real final sales/demand below what would have otherwise occurred had the long-term trend rate continued from the secular peak. Were the trend to persist through the rest of the decade, as the secular LW (Long-Wave) debt-deflationary precedent implies, the loss of US real final sales/demand from the long-term trend rate will be 30% (~40% per capita), which is likely to be the level at which the US labor market underutilization rate eventually reaches.

Downwardly Converging Cycles

Moreover, we are likely completing a weak Kitchin Cycle (inventory rebuilding) as a part of the simultaneously downwardly converging Kondratiev Cycle (Long-Wave), the Juglar Cycle (fixed investment), and the Kuznets Cycle (demographic swings).

If so, the post-'00 trend rate will likely decelerate well below the 1.6% rate to around the 1% rate or lower, implying the risk that real final sales/demand will be 35-40% (as much as 45-50% per capita) below the long-term pre-'00 trend rate by the late '10s or early '20s.

Note that bank loans grew 9%/yr. (5-6% in GDP deflator terms) from after WW II to the absolute peak in '08 and 7% from '74 and '82 (4-5% deflated), whereas real final sales grew 3.2% from after WW II to the peak in '08 and 2.9% from '74 and '82.

A deceleration of real final sales/demand of 35-40% or so below the long-term trend implies a similar scale of decline in bank loans of 35-40% (-4%/yr.) from the secular '08 peak to converge by '20 with the longer-term trend growth of final sales from the onset of the secular reflationary phase in the early '80s.

As mentioned earlier, the loss of growth of final sales/demand per capita from the secular peak will be closer to 50%, which is approximately the scale of decline per capita likely to have occurred from the '85 secondary peak for US oil production by '20.

The loss of bank loans and final sales/demand, with total government /GDP of 36-37% (and 56-57% of private GDP), implies a combined loss of GDP and resulting government receipts totaling no less than 8% of GDP or $1.1T/yr. avg. in federal deficits for the decade just to keep nominal GDP from contracting.

Loan Growth and PE Contraction

Growth of bank loans, final sales, and thus GDP and corporate earnings will have decelerated from the 6-7% secular bull and long-term trend to 4% by 2020. The implication for stock prices given the tendency for the P/E to contract and earnings to track GDP is for the SPX to fall to the 300s-400s at some point.

Unfortunately, by the late '10s to early '20s, the doubling or more of the US debt held by the public will have a net interest burden reaching and then surpassing 25% of government receipts (absent large tax increases and/or cuts in spending).

The larger the deficits in the meantime, the sooner the US government will reach the fiscal day of reckoning.

Please note that the above analysis is not a prediction that the S&P 500 will fall to 300. Many things can happen along the way.

However, it is important to keep an open mind on these things.

The S&P 500 certainly could fall that low. Moreover, were it to do so, it would be consistent with the convergence of the various cycles as described above, and it would also be consistent with Japan's Two Lost Decades.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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