Five Things You Need to Know: Finally, Some Bullish Talk From Bernanke
Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
1. Finally, Some Bullish Talk From Bernanke
So far, it appears the conventional wisdom in the financial media is that Federal Reserve Chairman Ben Bernanke delivered yet another grim message in his testimony this morning before the House Financial Services Committee. We disagree.
A look back at Bernanke's February 14 testimony, the St. Valentine's Day Massacre speech, shows that as recently as two weeks ago he outlined the long-term bearish case for the economy; namely, that the U.S. recovery following the Internet bubble was largely led by a very profitable banking industry able to provide large amounts of credit to willing borrowers from top to bottom in the economy, but now conditions have changed, resulting in a sharp slowdown that is more worrisome than continued price pressures in non-core inflation measures, food and energy.
Today, Bernanke outlined that scenario, but was decidedly more bullish at the end. Gone was the long string of IF's at the end of the St. Valentine's Day Massacre Speech.
"On a more encouraging note," he said, "we see few signs of any serious imbalances in business inventories aside from the overhang of unsold homes. And, as a whole, the nonfinancial business sector remains in good financial condition, with strong profits, liquid
balance sheets, and corporate leverage near historical lows."
"In addition," Bernanke continued, "the vigor of the global economy has offset some of the weakening of domestic demand." The exports of goods and services increased at an annual rate of about 11% in the second half of last year, he noted, boosted by economic growth abroad and the lower value of the dollar. This has also improved the trade deficit, which probably narrowed on an annual basis for the first time in six years.
Finally, as we note the dollar down near 30-year lows, it is worth keeping this one sentence in mind going forward: "Although recent indicators point to some slowing of foreign economic growth, U.S. exports should continue to expand at a healthy pace in coming quarters, providing some impetus to domestic economic activity and employment." This means the Federal Reserve is intent on continuing to devalue the dollar. It is no secret that Bernanke believes some inflation is more welcome than deflation.
2. The More Things Change...
It's interesting how much we can learn by studying history. We're not talking about boring books and such, though. We're talking about the popular history as documented in the pages of popular magazines.
Time magazine, for example, is a terrific source for these types of articles. We went back and looked at some financial articles in the Time archives from the 1930s. They say that history doesn't repeat itself, that it rhymes... well, the rhymes below are eerie.
Headline: Federal Reserve Comes Under Scrutiny
Time magazine, Feb. 16, 1931
"Planting itself at the halfway point of the Era of Change, a subcommittee of the Senate Banking & Currency Committee has been seriously taking stock of the Federal Reserve system and its implications," Time Magazine reported.
To test the strength and flexibility of the Federal Reserve system there were three major inflations during the decade:
1) the boom in western farm land values followed by the long collapse of Agriculture;
2) the rise and fall in Florida land;
3) the boom of "Coolidge prosperity" followed by the stock crash and Depression.
Some of the questions to which Chairman and Virginia Senator Carter Glass sought answers:
1) Why did 6,000 banks out of 30,000 fail in the U. S. in ten years?
2) What did the Federal Reserve do to check 1929 stock speculation?
3) What new laws might stop excessive stock speculation?
4) What new powers does the Federal Reserve system need?
The following shares an eerie familiarity with today:
"Most impressive, most lucid, most constructive witness before the Committee was Owen D. Young, a director of the New York Federal Reserve Bank. Said he of the stock crash: "The low [rediscount] rates were continued too long. An active, firm and decisive policy of advancing rates should have been carried out in 1928. The Federal Reserve Bank of New York did not make its recommendations for rate increases early enough or advance the rates rapidly enough. I was quite as much to blame for that as anyone."
Headline: Out, Out, Damn Deflation
Time magazine, Jan. 25, 1932
"To inflate or not to inflate was no longer a question last week. The only question: Will inflation succeed?," Time Magazine reported.
"If it succeeds the downward spiral of deflation will be definitely checked. If it fails, historians may well look back upon 1932 with a shudder." (Editor's note: It's true! They do! We're shuddering even now!)
The first step in this grand deflation-fighting scheme was the creation of the Reconstruction Finance Corp. (RFC). "Congress will appropriate $500,000,000 from the Treasury as starting capital, whereupon the RFC will then move to raise $1.500,000,000 from the public by the sale of its bonds, debentures, short-term notes, all underwritten by the U.S. government."
To pave the way for this "great flotation" the Federal Reserve began pumping money out into the market to create the necessary buying power, or as it is know today, liquidity.
"With $2,000,000,000 in hand, RFC will be ready to function as a colossal credit agency," Time said. "RFC credit will be largely used as a bank crutch. It will, its friends hope, relieve the strong banks of the job of carrying the weak ones, thus freeing their liquid assets for more constructive purposes."
And at that, looking back, we had to laugh.
Headline: Fighting Fire With Fire
Time magazine, June 13, 1932
"The Senate Banking & Currency Committee last week produced a currency-inflation substitute for the Goldsborough bill as passed by the House," according to Time Magazine.
"Under the Goldsborough bill the Federal Reserve would be required to inflate commodity prices by a deflation of the value of the dollar. Presumably this would be accomplished by an intensive form of U.S. security purchases such as the Federal Reserve has been using to pump credit into the country. As the quantity of currency in circulation increased its value would decline and the prices of commodities would climb until they reached the 1926 level."
One final note of hilarious irony. Senator Glass, one of the original sponsors, summarily rejected the so-called "controlled inflation" of this scheme. Why? On the grounds that it put autocratic powers in the hands of a small Washington group, the Federal Reserve Board.
3. A Dollar Here, a Dollar There; In a Deflationary Environment We're Talking Real Money
Dollar Tree (DLTR) is one of the few retailers up today after a downgrade of Costco (COST) spilled over in the group. Dollar Tree reported pretty good results and listening to the conference call it seems this company is a bit ahead of the curve. How so? By focusing on staples, according to CEO Bob Sasser.
"As most of you know, one of our key initiatives over the past several years has been to increase the selection of consumer basics to our merchandise mix and this strategy is serving us well," Sasser said. "We have added more of the merchandise that people need every day, and that is more frequently purchased."
4. Suddenly, It's Cooler Not to Spend
"The new status isn't how much you've got, but your ability to show what you don't spend," says futurist Watts Wacke in a USA Today article, "Cutting Back." "This is a seminal moment. It's not a fad that will die out when the economy picks up."
Trends guru Faith Popcorn puts it this way for the article: "It's cooler not to spend."
Indeed. One of our key themes in Five Things over the past two years is the long-term secular shift toward anti-consumption attitudes.
This is not to say that people will en masse suddenly decide to no longer buy unnecessary luxuries. There will always be a segment of society that basks in the ability to spend more than the average worker's yearly take home pay on a wristwatch - or, more likely, not "bask" in that ability so much as not even for a moment consider it. Rather, what this is about is a long-term shift in aggregate attitudes toward devaluing the act of spending itself, and revaluing the potential to spend.
As we noted in a piece, "Where's the Bling," Sep, 16, 2006, the Stephon Marbury $15 basketball shoe, the Starbury, speaks to the ongoing shift in consumer attitudes. Importantly, this is an attitude that "trickles up."
"A few years ago it would have been unthinkable for a professional athlete to endorse an "inexpensive" product like a $15 shoe since the bull market demanded the association of athletic ability, wealth and persona with high-price tag goods. Increasingly it seems it is becoming "cool" to disassociate from luxury and symbols of wealth."
5. Financially Embattled King of Pop Organizes Rescue Song
It turns out that not even pop star Michael Jackson is immune from the downturn in housing. According to Fox news, Jackson's Neverland ranch is facing foreclosure unless the singer forks over more than $25 million due by March 19.
Of course, that deadline is still weeks away, and Minyanville has learned the King of Pop may be busy organizing a potential bailout of his own with a handful of musical celebrities. Below, see Minyanville's preview of what Jackson reportedly has in mind to save Neverland:
USA for Neverland
We Are the Foreclosed
There comes a time
When we get a certain call
When the bank demands a payment , just one
There are letters arriving
Saying it's time to pay the man
The mortgage, on the greatest ranch of all
We can't go on
Pretending everyday
That the check someday is soon on its way
A two bedroom apartment
A deposit for security
It's the truth, you know that is all we need
[Chorus] 
We are the Foreclosed
We're the defaulters
We are the ones who make a brighter day
For subprime lending
There's a choice we're making
To simply walk away
It's true, our debt has gone away
We're clear and free
Well, send 'em the keys
So they'll know that no one's there
Strip the pipes, they're made of copper and free
As the Fed has shown us, by turning gold to lead
What's the point in paying back The Man
[Chorus] We are the Foreclosed
We're the defaulters
We are the ones who make a brighter day
For subprime lending
There's a choice we're making
To simply walk away
It's true, our debt has gone away
We're clear and free
When you're down and out
And nothing seems to sell
But if you just believe
We're much too big to fail
Well, well, well, well, let us realize
That the bailout soon will come
When we stand together as one
[Chorus] We are the Foreclosed
We're the defaulters
We are the ones who make a brighter day
For subprime lending
There's a choice we're making
To simply walk away
It's true, our debt has gone away
We're clear and free
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Nice work on the pieces from Time.
"Under the Goldsborough bill the Federal Reserve would be required to inflate commodity prices by a deflation of the value of the dollar. Presumably this would be accomplished by an intensive form of U.S. security purchases such as the Federal Reserve has been using to pump credit into the country. As the quantity of currency in circulation increased its value would decline and the prices of commodities would climb until they reached the 1926 level."
In fact, what is most astonishing to me is the rapidity with which we are either instituting, or demanding be instituted, the same types of programs today... with very little, if any, debate. Three of the largest consumer expenditure categories are Housing, Education and Medical Care, and they are being nationalized while we stand around and watch.
I've posted the link here a few times but its always a good time to read Ben Bernake's comments from 2002 regarding fighting the deflation. The plays are right out of the 1932 playbook.
http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm
Nationalization of banks (a la Northern Rock) is not that far around the corner. That will happen right after the Fed fixes long-term treasury yields. Its the final bullet the Feds have. After favoring slight inflation (Feds target inflation of 2%), after providing liquidity to banks in the name of financial stability (and changing what can be issued as collateral), after going zero bound (0% Fed Funds rate), the final hail mary in this playbook
A snippet from the article that Ben has already done (TAF):
"Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral. For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Pursued aggressively, such a program could significantly reduce liquidity and term premiums on the assets used as collateral."
Ben is not saying it but he is fighting deflation.
The "tell" was when he responded to Roscoe's real question of (and I'm paraphasing): if we are going considering all these "great depression" solutions for a "little economic slowdown" what sort of policy analysis is the Fed doing if this "slowdown" continues or becomes something worse?
Answer: "I thought you were going to ask me about something else. <pause> I ..." blah ... blah ... blah. I don't remember exactly what he said but it was along the lines of ... who knows, we are working on it.
So either the central bankers are seeing something "worse" as a real possiblity and the game is on or the money center bankers have the Fed in their pocket and somebody other than the money center banks are going to carry the water for their bad loans.
If these bad loans go south faster than the banks can jack up their credit spreads and fees to paying customers (unlikely) then this credit crunch is going to take on aspects of the slow motion scenes of a Sam Peckinpah movie. Lots of social acrimony as nobody likes to admit bad decisions, pay taxes or lose money.
What's Warren Buffett's rules of investing again?
Rule 1: Never lose money.
Rule 2: See Rule 1.
My question: Can the DKY go below zero or do they re-base?
People who don't have can't spend. Will those folks now relax their desires and console themselves by saying "I'm poor but cool" ?
It's commonly said that by the time the mass media catches on to the cool new thing, it's probably on its way out. By that logic we may be almost over the trend to not spend.
Love your columns.
"People who don't have can't spend. Will those folks now relax their desires and console themselves by saying "I'm poor but cool" ?"
I believe the answer to that is yes. Psychologically, people deal with deprivation in unique ways.
You make a good point about the media, but I would say that as long as we continue to have entire newspaper sections devoted to Style, for example, that we are still pretty far away from the point where the media has embraced the trend to completion.
Remember, almost all daily newspapers had Tecnology sections between 2000 and up until 2002 or so.
Also thanks to everyone who contributed to this thread. Its one of the best so far on the Exchange, and its helping this novice learn and prepare.
Cheers...
we owe our children"...
but thanks for the laugh!
Once again your perspective is fascinating and humor spot on. You have nailed your point about "Suddenly, It's Cooler Not to Spend"
I watched the regional economy in the pacific northwest grind to a stop in the late 70s and early 80s. I will only say that when an economy contracts dramatically, Socially speaking, things looks different. Having lived through that era, here are a few of my observations for what they are worth:
People still live.
People still work.
People still grow.
People have more time, weather of not they are aware of it or know what to do with it.
There is noticeably less money in circulation.
Prices are stagnant.
What money is available is coveted.
If you pay cash you expect a better price.
If someone offers cash, you take notice and are more willing to accept less. (Everybody wants more than they can afford. The person that can pay for it is rare.)
Social networks develop that prize thrift. (Imagine a friend telling you about a store closing where everyday items are reduced 40%. Then imagine a store closing every few weeks for six years)
Social networks that develop under these conditions, last long after the economic conditions that spawned them have disappeared.
Envy is displayed for the person who got the best deal as much or more so than the flashiest product.
Consumption still occurs but waste is shunned.
Local governments are forced to reduce basic services as tax bases decline.
Making due becomes common with everything from a forty year old city hall, to putting new engines in old equipment to personal items.
Prime commercial real estate is left vacant and used for outdoor flea markets on weekends.
Social status shifts from what car you drive, to more community oriented pursuits. Such as a picture of you in the local paper putting out a fire with the local volunteer fire department or helping at the local food bank.
Maintenance of houses is reduced dramatically as the cost to do so becomes a burden to the owners or the institutions that end up owning them.
If property tax rates are not capped they climb dramatically in percentage terms making ownership more burdensome and increasing inventories of unsold homes.
Construction grinds along for a while but eventually stops.
Eventually an economic expansion causes consumption, waste and excess to displace the values of thrift, efficiency, and sense of community purpose. The length of time the lessons last, I believe to be in direct proportion to the length of time they took to learn.
"People still live.
People still work.
People still grow."
Consider this in light of the fact that there is so much angst and consternation about whether we are even in a recession right now, much less a Stealth Depression. The reality you point out is that people find a way to adapt and thrive even during difficult economic times.
Love the Time retrospective and going back to the 30's. It's quite spooky how history rhymes and even has the same meter at this juncture.
I agree that the Fed is following the deflationary playbook of old, but it seems to me that this Fed believes that the only difference between then and now is in the timing of its policy - that we can somehow avoid the whole mess if we take drastic measures now. Personally, I think the only thing this gets you is a Japan 89-07 scenario. In other words, what would have been a severe clearing of the decks that takes 5-8 years becomes a slow bleed that takes 20. Add in the fact that consumer balance sheets here are worse than Japanese balance sheets were then, and maybe this time it's more severe or it takes even longer than Japan's scenario.
One question I have though is on the likelihood that the Fed would extend that zero interest rate term loan to banks. 90 and 180 day loans take you out to 3 and 6 months on the yield curve. If you throw in corporate loans and mortgages, you could go out to 30 years. As crazy as it sounds, this would mean that the long end of the curve could come down drastically (to zero). I'm just wondering aloud what the probability they do that is and the kind of opportunity it would present to get in at the long end of the curve.
Where the comparison breaks down, though, is that the US culture of consumption is not novel, it is cyclical. Obviously wallets get tighter if jobs and home values become uncertain. However, just as sure as the sun will rise tomorrow, we will return to consumption at the end of these uncertain times.
I was recently in NYC for the TradersExpo. It was held in Times Square, and during a break, I walked outside to grab a delicious NY hot dog. As I stood there on the corner of 43rd and Broadway, looking around, I imagined I was a visitor stepping foot in the US for the first time. What I saw was likely what they would see: piles and piles and piles of advertising. Flashy billboards demanding that you give up your money for the cool thing shown here. There were no ads describing the wonders of compounded interest in your savings account. When that happens, you'll know we've turned the corner.
Dan
Essentially he would guarantee a yield on bonds farther out on the maturity horizon by buying them back at a fixed price.
While the FED/Treasury would then hold these bonds on their balance sheet, the capital injection into the economy would tower over any kind of $160 billion toss into the wishing well.
http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm
From the article:
"A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well. "
Read that second sentence again. The FED playbook includes the possibility of unlimited purchases of bonds a specific period away form maturity. They would be willing to extend this program from government to quasi-government (FNM GNM) and even to corporate debt.
Instead of allowing the banks to fail, the FED is willing make the United States insolvent. This sort of thinking makes people understand why there is a movement to abolish the FED. A transfer of wealth from government (re: taxpayers) to the private large corporations is taking place right before our eyes.
You seem to type that would thoroughly enjoy some of the thought provoking stuff at a site that I found, especially based on the comment:
"But those rebuilding processes are necessary for the healthy development in all things; the human body, forests, ocean life, etc"
Reading that sentence reminded me of the incredible video:
http://www.ted.com/index.php/talks/view/id/40
Take a few minutes and check it out. It's worth it.
I was just looking at the longer end of the Treasury curve and trying to answer the simple question of whether or not bonds at the long end of the curve were overbought or not, not thinking of the ramifications of taking on the other forms of debt as well.
Thanks!
