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Pangloss Sees the Rising Sun


Late last night CNN interrupted its regular drone with a breaking story: Japan Emerges from Recession. They played it up a like an airplane crash or celebrity arrest. They even had to rouse a financial correspondent from sleep to get up-to-the-minute commentary over the phone. Faintly optimistic-sounding news about a government statistic from a foreign economy has become sensational.

Although credit was given to the Japanese government’s stimulus spending, the reporter failed to grasp the (in)significance of figures showing Japan’s domestic demand had continued shrinking. The reported growth was entirely from exports. If anybody’s stimulus is responsible, it must be the Chinese. They’re the only big player still growing demand.

Despite persistent efforts of politicians and pseudo-news organizations like CNN to proclaim the economy has “turned a corner” and is “getting back on track” (someday I’ll have to rant about vapid economic metaphors), the US stock market reacted to this phenomenal news by dropping 186 points (2%).

Yves Smith at Naked Capitalism has a nice summary of factors pointing to continued decline [edited]:

But most savvy people I know have been skeptical of this rally, beyond the initial strong bounce off the bottom. It has not had the characteristics of a bull market. Volumes have been underwhelming, no new leadership group has emerged, and as greybeards like to point out, comparatively short, large amplitude rallies are a bear market speciality.

In addition, this one has had some troubling features. Most notable has been the almost insistent media cheerleading, particularly from atypical venues for that sort of thing, like Bloomberg. …

More bank woes. We may be two thirds of the way through the losses, but it could also be as little as half. And despite the stress test baloney, the banking system is undercapitalized by a large margin. …

Consumers tapped out
. The lousy retail sales report was a reminder of a rather central fact most have chosen to forget.

Foreclosures set to rise. We are not having a housing bounce. Some markets may be close to a bottom, but foreclosures grind on. …

Fed in a box. Some e-mail chat pointed out a key fact: the term structure of US funding has gotten very short term. We have become in some ways like a massive bank, borrowing short and lending long. …

More AIG losses, I am told more AIG losses are in the offing. …

Lack of political leadership. The health care fiasco is going to be a defining event for Obama, in a negative way.

I have been looking for an increase in trading volume as a sign that investors were back in. The rally has been thin, even though one’s 401(k) statement appears healthier. There’s no excitement, no fundamental reason for an extended rise in stock prices. I see the current level as fragile, with any major disaster or negative statistcal surprise ready to take us back to the year’s low.

Foreclosures will continue even if house prices are stable. That’s because the prices are stable at 20-30% less than the amount owed on people’s notes. There’s another wave of ARM resets coming, and unemployed people will not be able to make higher payments.

Consumers may have some money to spend, but they’re paying down debt. Partially by choice, but also because banks are cutting credit lines and raising interest rates. Look around your local mall at all the deep discounts and clearances. People are not paying full retail when they do buy.

The “Fed in a box” is a potential cataclysm. Borrowers generally prefer long contracts—imagine if your mortgage payment was financed like a credit card debt that could be called due at any time. Short-term borrowing by the government means the government has to roll over it’s debt more often. They have to redeem 90-day notes with money gained from selling new 90-day notes. This makes the debt much more sensitive to interest rate rises. A point or two on several trillion dollars and the US can’t tax enough to make debt payments.

TARP, bailouts, the spendulous bill, Cash for Clunkers, and pretty much everything the government has done serve only to push distortions into the future. It’s hard to decide where to invest when the rules are subject to arbitrary change, and when the statistical measures are being manipulated in increasing orders of magnitude.

Extending the crappy road metaphor—While we were turning the corner somebody changed the street signs and scribbled all over the map. If we avoid a deadly crash, we’ll still have to back our way out of a dead end.