23 Sep 2011 All the Kings’ Horses and All the King’s Men . . .
Where there was considerable unity among world leaders at the outset of the Great Recession, the latest economic retreat is preceded by worsening splits and schisms. The scant fiscal and monetary responses so far lack not only coordination, but real long-term effectiveness. At home, our government is divided into three incalcitrant ‘parties’ each defying leadership and each seemingly oblivious to the costs of delay. Across the pond the European Union teeters on the brink of not only recession, but potential disintegration.
The European Purchasing Managers’ Index fell 1.5 points in September taking the index below 50 (indicating contraction) for the first time since July 2009. Another report showed euro-zone industrial orders down 2.1% in July and consumer sentiment falling to a two-year low. Gross domestic product rose only 0.7% in the second quarter, at an annualized rate, after expanding more than 3% in the first quarter. Economists expect it to avoid recession this quarter, largely due to growth in the German economy.
The slowing European economy makes it all the more difficult for member governments to service their sovereign debt. How ironic would it be should a Greek sovereign default cause the breakup of the European Union? A Bloomberg article yesterday points out that history’s first sovereign debt default came in the 4th century BC. It was committed by 10 Greek municipalities against one creditor: the temple of Delos, Apollo’s mythical birthplace.
Twenty-four centuries later, Greece’s potential default of $483 billion is five times the size of Argentina’s $95 billion 2001 default. Greece, along with Ireland and Portugal who are also asking for assistance, make up about 6% of Euro GDP. But the slowing economy is also putting strains on Italy and Spain the third and fourth largest Euro- economies. On Thursday, Italy said it reduced its forecast for GDP growth below 1% through 2013.
This week alone, $3.4 trillion has been erased in global equity values as investors have largely ignored pledges by both domestic and European bankers to address risks to growth. This week US stocks are headed for the worst weekly drop for the S&P 500 since 2008. Valuations are now at March 2009 levels. The index has fallen 18% since April 29th.
Following their meeting this week, the Federal Reserve announced “Operation Twist.” In its statement the Fed said: “To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.”
This week’s economic data was dominated largely by housing and some of it was promising. The FHFA home price index in July rose for the fourth month in a row, rising 0.8% following a 0.7% increase the prior month. On an annualized basis, though, the FHFA HPI is down 3.3%, compared to down 4.5% in June.
Also on the positive side, existing home sales rebounded 7.7% in August to an annual rate of 5.03 million. All regions showed gains with strength centered in the single-family component where sales surged 8.5%. In annualized terms, sales are up an impressive 18.6%, down a bit from July’s annualized rate of 21.0%. The sales surge drew supply on the market down by 3.0% to 3.577 million units.
However, the existing homes report didn’t confirm the price trends suggested in the FHFA report indicating that at least some of the sales strength is tied to price reductions. The median price fell 1.7% to $168,300 with the average price down 1.6% to $216,800. Annual price contraction is slowly deepening, at minus 5.1% for the median and minus 4.0% for the average. The National Association of Realtors, which compiles the report, calls August’s strength impressive especially given disruptions tied to Hurricane Irene.
Housing starts declined 5.0% in August, following a 2.3% decrease in July. The dip in August was led by a 13.5% fall in the multifamily component, following a 7.2% gain in July. The single-family component declined 1.4% after a 5.8% decrease the month before. Hurricane Irene likely impacted starts as indicated by the increase in building permits. Permits in August were up 7.8% on a year-ago basis.
In its statement Wednesday the Fed said: “To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.”
A notable report, not from the government bears mentioning. In a resounding rebuff of recession talk, railroad shipments are the highest in almost three years. Total rail volumes excluding grain and coal averaged 381,831 carloads in August, the most since October 2008, according to data from the Association of American Railroads in Washington. These shipments represent the bulk of materials for industrial production, so rising volumes show the economy is still growing, according to Art Hatfield, a transportation analyst at Morgan Keegan & Co. He went on to say, “we’re not seeing declines in rail volumes that are synonymous with a recession.”
As investors grapple with the possibility that policy makers are running out of tools to put the economy back together, the capital markets have been volatile. Commodities including silver, copper and nickel fell to a nine-month low this week. Gold is down 12% from its August highs. The S&P GSCI Index of 24 commodities is down 7.8% this week, the most since May 6th. Since July 22nd, the S&P 500 is down 15.8%. The MSCI Total US Market is down 16.9%.
And where are equity sellers taking their money? They are buying bonds – overwhelmingly, US Treasuries to be precise. Since July 22nd, the 7-10-year US Treasury Index is up 15%. Over the same period, the S&P National Municipal index is up 7.4% and the Barclays Credit Fund (US Corporate) is up 5.23%. Treasuries have out-performed corporates by an almost 3:1 ratio during this period of intense global uncertainty. The downgrade from AAA to AA+ apparently hasn’t diminished the safe haven character of the Treasury one bit.
Can Humpty Dumpty be put back together?
In Europe, economists are putting odds at 10-20% that the Euro will break up. That’s still an 80-90% chance they will make it, but not without significant sacrifice. It can be argued that their problems are worse than our 2008 credit crisis because their economies are so interwoven and their banks hold so much of each other’s sovereign debt that they are more vulnerable to a dominos effect.
What is clear is that both the ability and, in some cases, the will of governments to provide simulative measures are in short supply relative to 2008-9. The falling economic tide is exposing the weaknesses of socialist big government largely in order of its pervasiveness by country; Greece, then Ireland and Portugal, then possibly Italy and Spain. As European leaders led by France and Germany grapple with remedies, they risk dragging their own economies down as they ‘socialize’ the debt and assets of their weaker members.
Here at home, the problems of disintegration are more ideological. Republicans espouse lower taxes, fewer regulations, and shrinking government to enable enterprise and trade to prosper. Democrats hold to a model not unlike European socialism where government plays the predominant role in society. Entitlements are foundational.
The confluence of the credit crisis which prompted the near-nationalization of banks and auto manufacturers, the collapse of the economy, skyrocketing debt, and the government grab of one seventh of the economy through ‘healthcare reform’ gave rise to a third party. Tea Party quickly became an unprecedented force in America politics. Whether that force, over the long-run will be disintegrating or invigorating remains to be seen. What is certain is; they have pledged to stop the growth of government, they have the power to do it, and none of the establishment likes it.
For now, it appears the economy is largely on its own. It will come back slowly, led once again by the industrial sector, which depends largely on exports to developing economies. Politics promise to be as ugly as any time in American history. We are in for an ideological debate of two directions for this country, where the contrasts have not been starker, perhaps since Lincoln. Is more government or less the answer? Will free-enterprise once again be championed as our way out, or will government continue to drain its lifeblood of capital and individual risk-taking? Some 47% of Americans don’t pay taxes and there’s little doubt where their allegiances are. The question is; how much longer will the 53% be willing to pick up the pieces?