Thursday, April 29, 2010

The Wheels On The Bus Go Flying Down The Street

The Market Ticker ®

Thursday, April 29. 2010

Posted by Karl Denninger in Editorial at 09:05

The Wheels On The Bus Go Flying Down The Street

We're told, of course, that the economy is improving.

The "strongest indicator" that is incessantly pointed to (and which is a part of the "leading economic indicators") is, of course, stock prices.

But who's buying stocks and driving their prices higher?

The outperformance of risk assets over the past year suggests investors appear to believe that all credit problems have been solved – but nothing could be further from the truth, says Leigh Skene at Lombard Street Research.


Surprisingly, says Mr Skene, surveys show that the usual investors in major rallies – pension funds, hedge funds and retail investors – have not been net buyers of equities. And he says the most likely explanation for this anomaly in the biggest stock market rally since the 1930s is that major investment banks are the anxious buyers.

That's a problem folks.

In fact, it's a serious problem.

There are only two possible explanations for this in terms of "theme" - first, that they believe that the authorities will be able to spur people to "lever up" again (exactly how we get into this mess in the first place, and which will inevitably create a bigger bust) or that they are "too big to fail' and thus can continue to borrow at zero from The Fed and pass these shares back and forth between one another until they can goad those traditional investors to come back in and buy from them at ever higher prices - at which point, of course, the average American is again the bagholder.

Mr. Skene posits (and I agree) that one of these possibilities ultimately means prices "revert to the mean" (ex-leverage), which is very bad, the second, if they succeed, will destroy the average American and their pension and insurance funds.

The actual result of the policies that we've seen by nations has not been to "fix" anything.  Indeed, all we've done is shift the problem from private parties (who deserve to fail when they screw up) to governments - where failures are far more serious, even catastrophic.  PIMCO's El-Erian has suggested that:

The Greek debt crisis is now morphing into something much broader. ...... The heads of the European Central Bank and IMF have made the trip to Germany that is reminiscent of the Ben Bernanke-Hank Paulson trip to Congress in the midst of the US financial crisis.

Markets are now catching up to the reality of over-burdened public finances in the aftermath of the global financial crisis.

Yeah, like ours (America's) - shall we once again post this chart?

Again, the reality is this: We have shifted the burden of economic expansion - and maintenance of final demand - from private actors to government.  This is exactly the mistake made in Greece, Portugal, Spain, Ireland and elsewhere. 

The problem with trying to paper over a solvency crisis is that you can't accomplish it.  Illiquidity and insolvency are two different things; one can be fixed with temporary sources of funds and time, the other has to be absorbed somewhere

By shifting these liabilities to governments, the absorption is forced onto the taxpayer.  This means that the taxpayer - and recipient of government services must absorb much higher taxation, much lower service provision (including government salaries, pensions, handouts such as welfare, social programs and similar) or both.

If that adjustment is not immediately made then you get a graph that looks like the above.  Effectively, the nation shifts to attempting to pay for today's expenses with its credit card, instead of with its tax receipts.

This can go on for some period of time but it cannot go on forever.

But all of the western governments who got involved in "bailout world" failed to immediately transmit the costs of these bailouts to taxpayers through higher taxes and lower service provision, most likely because they (correctly) deduced that the people would not sit for it, and if they tried to do so there was a very material risk that the people would rise and lynch someone - and it would require luck for those lynchings to be confined to the banksters who had compelled governments to bail them out through their acts of extortion.

Trichet is caught in a nasty box:

Bonds and stocks plunged across Europe in the past week as Chancellor Angela Merkel delayed approving a rescue plan for Greece and Standard & Poor’s downgraded Greece, Portugal and Spain. European policy makers may need to stump up as much as 600 billion euros ($794 billion) in aid or buy government bonds if they are to stamp out the region’s spreading fiscal crisis, according to economists at JPMorgan Chase & Co. and Royal Bank of Scotland Group Plc.

“Loans are not transfers and loans come at a cost” Trichet said today. Strict conditionality “needs to be given to assure lenders, not only that they will be repaid but also that the borrower will be able to stand on its own feet over a multi- year horizon,” he said.

Remember, Greece was supposed to be a €30 billion problem!

Suddenly it has transmuted into €600 billion, or twenty times as large?

See what happens when you lie to people folks?  When you try to conceal what's really going on?

What's worse is that just as in the US the problem over in Europe is too much debt - and the so-called "solution" is even more loans - that is, more debt!

As I have said for more than three years now you cannot fix a drinking problem with a case of whiskey, nor can you fix a debt problem with more credit - that is, more debt.

To put this all in perspective - despite the claims of Treasury and others in our government - in the 29 days thus far this month Treasury has added $113 billion to the Federal Debt.

Annualized (assuming no additions for the next two days) this is $1.36 trillion "run rate", or approximately 10% of GDP - still.

Where's the "private economy" pick-up for final demand we keep being told about?  We've had two full years now where approximately 10% of final demand has been filled by government deficit spending, and there is zero evidence that this has fallen off.  For April to post a $113 billion debt addition is outrageous - remember, April is income tax month and is a month that frequently shows surplus for this reason!

In 2008 April ran a $60 billion surplus; in 2007, $9 billion, in 2006 $6 billion, in 2005 $12 billion.  In 2004 there was a $2 billion deficit; 2003 recorded a $395 million surplus; 2002 $21 billion and 2001 $112 billion. 

Point made?  I think so.

Oh, in 2009?  $111 billion of net deficit was recorded in April.

These numbers, unlike the so-called "budget" numbers, are not subject to being gamed.  The Treasury's actual "debt to the penny" is reported to the public every day.

But for today, it's "risk on", at least for the "too big to fails" who can (and have) sucked off the Federal Reserve's ZIRP and used it to drive "confidence" by pumping stock prices - even if it hasn't created a single job and government has utterly failed to put the economy in a position where it can support the level of GDP being produced on its own.

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