Five Things You Need to Know: Fiscal Stimulus Smoke and Mirrors
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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I'm not certain that the fiscal stimulus serves us well. Maxed out credit plus a short term stimulus drives what behavior?
Higher consumption?
Repayment of credit balances, and then higher consumption?
Investment/saving of the higher cash flow?
And out of all of those, what serves to best help the current problems?
1) Pay off 100% of the debt of every American.
2) Enact a government program for 0% financing for 15 year home mortgages.
Short of that, what good is $300 going to do to a person that has $15k in credit card debt, is underwater on his mortgage, and who just was one of 20,000 people laid off from Citi?
I am being somewhat sarcastic, but what else can be done of any significance.
Thanks for the article.
On January 17th at 02:53 PM
James Fraasch wrote:
> My stimulus package would be this:
>
>1) Pay off 100% of the debt of every American.
> 2) Enact a government program for 0% financing for 15 year home > mortgages.
Well, I'm being a little sarcastic, too, but if we get enough inflation, we could get quite close to your two proposals.
It’s time to go around work telling people that the chairman just cut their pay, and then fall into the depths of their empty and confused gaze.
Due to the inflationary effects of the eventual repatriation of trillions of foreign-held dollars, my own best guess would be that even as some things fall in price (due to dropping domestic demand), other things will rise in price (due to increasing demand from abroad), and since that foreign demand may increase for long-term purchases once the dollar bottoms out, some things that are falling now may be rising later. So, it may be that we'll have deflation in some areas, and inflation in others, in a shifting pattern, and the net effect upon any given person will depend upon the mix of things that she wants to buy, and when she wants or needs to buy them.
A second driver of domestic inflation will be dollar devaluation, which increases the cost of imports. This will join the aforesaid uptick in foreign demand (decreasing the availability, to US, of goods produced domestically).
The effect of dollar depreciation on import costs, and therefore on domestic inflation, should be obvious. But that's only half of the story. Thanks to the U.S. trade deficit, nearly seven trillion dollars have accumulated in the central banks of creditor nations such as China. Until not very long ago, the Chinese and others very nicely kept most of that money invested in U.S. Treasuries and other things that did not require the delivery of actual goods from the U.S. to those nations. But now, with the weakened dollar, certain items are rushing out of the country at an accelerating rate. Especially in demand is the now-inexpensive U.S. grain and other foodstuffs; a recent report indicates that in at least one Western U.S. port, grain exports have quadrupled. This is creating a very tangible inflationary effect domestically, as anyone visiting her local food market can tell you first-hand. These foreign buyers do not need the article's hypothetical American Express Wheat Card; they are perfectly capable of paying cash, and the sooner the better, as their dollars aren't getting any more potent as they wait. Commodities are reflating quite nicely now, thank you very much, but only due to foreign demand. This is already creating a bit of a problem here with that esoteric thing called "eating," about which the virtual denizens of Minyanville may not know or care a great deal, but which affects those of us out here in the "meat world" quite trenchantly.
And if you live near any tourist destinations, you'd better be carrying Euros, because prices have been driven way up by foreign tourists spending exchanged dollars as if they were quarters.
The spending of these trillions on U.S. goods is guaranteed to have an inflationary effect on anything that can be consumed immediately, even as many U.S. workers experience reduced or no income due to the domestic recession/depression.
So long as the dollar continues to fall (as it has been for years, with minor interruptions), inflation of more long-term investments, such as houses, commercial real estate, factories, companies (and their stocks), and so on, should be limited, because foreign investors (with their trillions of dollars) will be reluctant to buy and hold with the dollar continuing to tank, devaluing their investments day after day, so long as they can spend those same dollars on things they can consume right away. So, during the immediate period ahead, my guess would be that we will have inflation in consumables like grain, but deflation (due to falling domestic demand) in real estate, factories, company valuations (i.e., the stock market), etc. The net effect on you might be neutral if you don't own a home and happen to have the cash or credit to buy when real estate (or the stock market) bottoms out, but for most U.S. residents, food, clothing, oil, and so on will represent a far greater percentage of total purchases, and so the net effect for most of US will be inflationary, not deflationary. Or, more precisely, STAGflationary.
Furthermore, once the dollar (and real estate) bottoms out, get ready for the other shoe to drop, because the rest of those foreign trillions will rush in to buy houses, commercial real estate, and factories at dirt-cheap prices, and we'll all be paying rent to landlords with addresses in Hong Kong or Berlin. This will bring up the depressed prices in these long-term investment areas somewhat from their lows, although probably nowhere near their present values. But of course that will eliminate some of the offsetting deflationary effect of the long-term items vs. the inflated consumables, resulting in even more net inflation.
Now, there may be some consumables that are produced exclusively domestically, with domestic labor, and domestic materials, that nobody overseas wants to buy, and in that case, yes, domestic demand will be determining and those goods will deflate in value (unless, of course, a lot of the manufacturers have to shut down due to liquidity problems plus said lack of demand, in which case even those goods may be scarce and expensive). But this probably will not affect you, unless you are planning to buy a U.S. flag, and last time I checked those, too, were being made in China.
A house for every taxpayer, two cars in every garage, and a chicken in every pot may give a jolt to the economy, but I don't think it will solve its problems.
It took several years for the bubble to expand. Now that its burst it will take us years to pick up the pieces. If history provides us a lesson, take a look at Japan's credit/housing bubble and what the impact was on their economy and how long its lasted.
Give married couples a check for $30,000 and give singles a check for $15,000.
The stipulation would be this money is to be used to pay down credit card debt, with the leftover amount, if any, to be put in a savings account, or an IRA.
WHY THE HELL CAN THIS GOVERNMENT SEND MONEY, BILLIONS OF DOLLARS, TO FORIEGN LANDS, BUT CANNOT SEND BAILOUT MONEY TO ITS OWN CITIZENS!!!!?????
