Friday, April 10, 2015

Silly Or Delusional?

The Dollar Dropped On News Job Creation Slows
I caution those who are silly or delusional enough to think a bad jobs report should bolster other currencies and weaken the dollar. While it may lessen the call for raising the interest rates sooner rather than later little else changes. The dollar remains the best house in a bad neighborhood,or the cleanest dirty shirt in the closet, this means it is still the least worse option or currency to place your wealth. The bad news that blows a weak dollar theory out of the water is that consumption by Americans is what fuels the export economies of countries like Japan and China. Without the continued flow of goods from their shores such economies are "toast" and will further slow, this has a negative effect on their currency. As the world's reserve currency the dollar has gained as faith in other currencies has diminished because of central banks pursuing policies of printing evermore money.

These policies to support and prop up both derivatives and economies have morphed into the main driver of economic data but has generated little real growth. Between the low interest rates that propel investors into high risk assets in search of a positive return and all the money being pumped into the system the markets have become distorted and disconnected from the economy. The myth that poor quality growth can be sustained or generate escape velocity and free us from our economic woes is again proving false. No matter how hard we try to forget, it is becoming more apparent that America's last big economic surge just before the 2014 elections was driven by a 10% jump in federal spending, mostly on Pentagon hardware. This "pre-election" spending was the biggest increase in spending by the federal government since 2009 when the Obama administration put in place its huge economic stimulus package. This means that 2014 third quarter growth was directly tied to government action rather than true demand, this is not a formula for sustainable growth.

The chickens may be coming home to roost on a policy the Fed has pursued for seven long years. Over this time the Federal Reserve has failed to take serious efforts in pushing the government to take the necessary reforms needed to move the economy forward. Not dealing with what we were told were massive problems has only reinforced the idea that far too much has been made as to the ramifications of an out of control budget. Remember the horror stories surrounding sequestration and the financial cliff? I recall one Sunday morning talk-show host referring to them as "draconian" and predicting "dire consequences." Up to this point a strong case can be made that sidestepping financial responsibility has been rather painless, sadly to many people this only reinforces the idea that we can continue down this path.

Over the years investors have been lulled into complacency by the extraordinary actions taken by central banks and governments. These actions have temporarily masked major flaws and structural problems, but by not demanding the right kind of growth and merely throwing money at problems we have only delayed and added to a financial day of reckoning that faces us in the future. In what most of us view as a fast moving world many people have come to think if a financial crisis doesn't occur today or in the next few weeks it is simply not going to happen at all. But when looking at the numbers the thought that we will be able to grow out of our problems is a bit simplistic and an unrealistic strategy. "Future growth" is often promoted as the best path forward because it is viewed as a painless easy solution to problems and avoids confronting hard choices to address deeper rooted flaws that undermine our economic system.

Those in power have embraced and taken it to a new level financial engineering with MMT or Modern Monetary Theory. Unfortunately, a critical flaw exist in the concept and while it is viewed as our salvation by many economist and much of the world MMT has a Achilles heel. That flaw is revealed by the question, what do you do when it becomes apparent the economic efficiency of credit is beginning to collapse? This means that as more money is poured into the system and lower rates are no longer effective in driving the economy forward options evaporate. As the extra GDP growth generated by each batch of loans drops and momentum ends this become the equivalent of pushing on a string and is a sign of exhaustion. Now that companies have ushered in the savings from interest they paid on debt into their earning columns we should consider that a huge onetime tailwind is now mainly behind us.

As artificially low interest rates promoted by America's Federal Reserve and other central banks in time proves to be a massive one-off in driving corporate earnings only then will people realize the size of the problems before us. Now that rates are in the cellar and may even reverse the positive effect of MMT is about to ebb and become a major headwind. Keep in mind a major reason inflation remains low is that companies are sitting on a hoard of cash, this contributes to the drop in the velocity of money and is apparent by the large number of stock buybacks that have pushed the markets higher.  Also, adding to instability are falling oil prices and unrest in the currency markets. With massive government debt in many countries and the economy still weak these factors if untethered have the potential to create a devastating situation.

We are constantly bombarded by the message that we have rounded the corner and things are getting better, this invites optimism to return and generates a feeling that blue skies with promising times will soon arrive, but avoiding real action comes at a great cost that we will have to pay in the future. A great deal of our problems come from the poor quality of what we call growth, again we have seen policy makers aided by the media promising simplistic answers to solve both economic and society’s problems with little or no effort required from the masses. We often forget how interesting the times we are living through will be when viewed from a historic perspective. Hope tends to blurs reality, but understand the worst of the financial crisis most likely is still before us. I hate to beat the same drum, but proof that the economy is not well is obvious in that the numbers simply do not work.

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