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Five Things You Need to Know: Fiscal Stimulus Smoke and Mirrors


Warning: Deflation Ahead


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Fiscal Stimulus Smoke and Mirrors

Federal Chairman Ben Bernanke is testifying on the U.S. economy here and vaguely endorsing a Fiscal Stimulus package that is itself at this point quite vague.

The quickest option for immediate stimulus - allowing Fannie Mae (FNM) and Freddie Mac (FRE) to raise loan limits above the current cap of $417,000 - was shot down by the Treasury Department yesterday afternoon because Treasury said it will only back raising the loan limits if it is bundled with reform. Reform is a very contentious issue, it's been years int eh making. It will probably not be resolved anytime soon.

Meanwhile, the Congressional Budget Office recently released its report on the effectiveness of various types of possible fiscal stimulus. See the report here.

The bottom line is fiscal stimulus options are limited to individual tax proposals, business tax proposals or spending proposals. It is improbable that any fiscal stimulus package could be implemented until the second quarter, and even then the lagged effect while it works through the economy will take even longer.

I am of the opinion that consumers hold not just some of the cards in a successful fiscal stimulus package, but all of the cards. Consumption accounts for 70% of GDP, a tiresome statistic, but nonetheless the key statistic given household balance sheet perceptions are directly related to housing, the single largest asset (or more truthfully, liability) on consumer balance sheets.

In the CBO report was this vital recognition as it relates to fiscal stimulus targeting consumers:

"In general, tax cuts or increases in transfer payments from the government to people (such as Food Stamps or unemployment insurance benefits) increase household demand by providing consumers with additional spending power."

True, but here's the recognition and caveat from CBO:

"But households do not predictably spend a fixed proportion of the extra income left in their hands when taxes are reduced or transfers are increased. Rather, a household's propensity to consume appears to vary with its income and depends on expectations of the household of what will happen to that income over the longer term."

In other words, you can lead a horse to credit, but you can't make it consume. That is why the combination of both monetary and fiscal stimulus will inevitably lose out in a deflationary credit contraction and unwinding of debt.

Keep the following in mind: Fighting deflation is a fifteen round match. Fifteen long rounds.

2. Philadelphia Fed Prognosis: Grim

The Philadelphia Fed's general economic index declined to minus 20.9, the lowest reading since October 2001, from minus 1.6 in December. Simply put, negative readings signal economic contraction. This reading plunged through contraction and straight into recession.

Inflation and stagflation hawks will note the following from the survey:

"A sizable share of firms reported higher prices for inputs this month. One-half of manufacturers reported higher input prices this month, and the prices paid index jumped from 36.5 in December to 49.8 in January, its highest reading since May 2006."

Just keep in mind that inflation statistics everywhere are lagging indicators, hence the tense: prices paid. Deflation lies ahead of us, not behind us. Deflation causes prices to fall. Declining prices don't cause deflation.

3. Consumer Deflation

Speaking of consumer deflation, yesterday JP Morgan (JPM) and Wells Fargo (WFC) joined Citigroup (C) in reporting fourth-quarter earnings hurt by higher credit costs and loan losses in consumer-related businesses.

  • Earlier this week Citigroup reported that credit costs in its consumer business had risen to $4.1 billion.
  • JP Morgan's loss provisions in its retail financial services division rose to $1.1 billion from $262 million last year.
  • Wells Fargo has set aside $1.4 billion to cover expected loan losses in the face of a 26% surge in loans 90 days past due.

In other words, as the Congressional Budget Office has warned, any fiscal stimulus targeting households depends on that household's propensity to consume. Household targeted fiscal stimulus could very well wind up in the hands of folks with the attitude that money well saved is far more desirable than money well spent. Period.

4. Deflation American Style

We continue to get feedback noting the sharp contrast between the way Japan's banks handled deflation and the way U.S. banks are handing the credit crunch here in the U.S. Indeed, banks today are quickly writing off bad debt in comparison to Japan's banks during that country's banking crisis.

Again, the real key here is that while the amount of writedowns by U.S. banks are enormous, they are not the driver of this crisis, but a symptom of it. Even worse, the writedowns by U.S. banks are only symptomatic of the sickness affecting loans that have already been made. From that vantage point, the sickness is merely a pre-condition to a far more serious disease where the demand for new credit by consumers shuts down.

By contrast, Japan, long known as a country of savers, saw virtually unchanged consumption levels between 1990 and the heart of their deflation. Consumption remained flat because consumers enjoyed a relatively nice cushion throughout.

Absent of that savings cushion here, the Federal Reserve must try and induce credit demand and consumption by reflating something. The question is, without real estate, what is left for the Fed to reflate? Perhaps commodities... more....but remember, this is a Main Street problem, not a Wall Street problem. Then again, what about an American Express Wheat Card? It's like a Triscuit, but for spending! Nothing surprises anymore.

5. Stocks Won't Go Down Forever... But All Things Must Pass, Even Bull Markets

Kevin -

Regarding yesterday's Five Things (Number Four) "Stocks Won't Go Down Forever," no they wont and a bounce is inevitable. However, to think any long-term all clear has been signaled may be dangerous. I seem to recall the time prior to October 2002 when these indicators flashed "buy" was after the first waterfall of the triple waterfall in 2000 - do you have the data at hand to verify??

Also, I think it is noteworthy that the 20 month average of the S&P 500 appears to be rolling over and the index is below it for the first time in some time. Last time it went below (Fall 2000), the down trend extended 2 years.

Minyan Scott

Scott -

Yes, there was a trade in 2000, briefly, when the indicators reversed up in May 2000, and even made higher lows until September of that year. Otherwise, you are right that the October 2002 low followed two consecutive years of steep declines. From that standpoint it was a conclusion, not a kickoff. I agree with you that this is more likely to be a kickoff rather than a conclusion. We'll only be able to judge that after the indicators reverse up to positive.


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