"the Fed Is Preparing For Failure" By Mike Swanson

[Guest ike]

This is by Mike Swanson from http://timingwallstreet.com

I consider Mike a friend, and someone who I respect tremendously, both for his market and trading acumen.

 

12/22/02 - TraderMike: The Fed Prepares for Failure

 

Gullabulls are ignoring high valuations in the face of a faltering economic recovery and war. They are also ignoring the fact that stocks have gone sideways in December while the the dollar has broken down to make a new 52 week low and gold has broken out of a 6 month base to make a new 5 year high.

 

These latter two events are important warning signs that are being totally ignored by the Wall Street Journal, Crapvision, and the Wall Street anal cyst community. When gold goes up it is a repudiation of the Federal Reserve.

 

The bulls admit that the stock market has been pulling back over the past few weeks, but they view this as a healthy correction in a new bull market. They are telling you not to worry about a war in Iraq. Stocks will sit where they are and go sideways until the war starts. Then they will take off like a rocket and you'll get the money you lost holding through the bear market while the insiders sold. As for high valuations - don't worry about them they tell you. The economy will boom in the second half of 2003 like it did in 1999 and justify current valuations.

 

The bullish case is typified by Larry Kudlow, Crapvision's always bullish pseudo celebrity and head "economist."

 

Kudlow wrote the following this week:

 

"As long as the Federal Reserve keeps pumping the economy with sufficient new cash to boost investing, spending and saving, it looks like we're set for something of an economic boom next year."

 

"A much sounder prosperity model is coming from President George W. Bush. Bush intends to reduce tax rates on business investment, including a big cut in the personal tax on dividends. The president must think he's the Ronald Reagan of the 21st century. You know what? He just might be."

 

"Taxes matter, and money matters. Today, both appear to be moving in the right direction. Next year, we could witness real GDP growth of 4 percent to 5 percent -- up from this year's 3 percent -- with inflation at 2 percent or less. And if productivity continues at its current 5 percent pace, then the economy could easily grow at 6 percent or 7 percent next year. "Think of what this will mean to top-line revenue sales, cash flows and profits."

 

"Is there a stock boom in the making? That could very well be the case. "

 

Kudlow has been saying this same exact thing for the past 2 and a half years - Greenspan's easy money and tax cuts would create an economic boom that in turn would cause stocks to rise. A bear market, terrorism, or a recession couldn't make him adjust his views to reality. Nor does Kudlow ever factor in stock valuations or the technical action of the market in his predetermined conclusions. Anything that doesn't match up with what he wants you to believe is simply ignored.

 

Kudlow reminds me of the Communist Party hacks who constantly rewrote current events and history to fit their ideology. He is akin to the poor Winston Smith who rearranged facts to create "NewsSpeak" in George Orwell's 1984, except unlike Smith, Kudlow is well rewarded for his manipulation of facts.

 

All data points to an economy that is entering another recession, not to one that is about to have a big boom. Christmas retail sales have been disappointing so far and the employment market remains week. In fact October and November were the second and third heaviest months of layoffs over the past 12 months. Last week 433,000 people filed for first-time unemployment benefits. That's a staggering number for the Christmas season. More than 8 million Americans are jobless as the unemployment rate stands over 6%. What is worse there still has been no pickup in corporate investment spending and there won't be a real recovery until there is one.

 

This recession and bear market in stocks has been caused by a collapse in capital spending that began in the Fall of 2000 as a result of a record current account deficit and an overhang of corporate and personal debt which were products of the stock market bubble, which in turn was a creation of Alan Greenspan's easy money policies pursued in order to "bail out" hedge funds and international bankers whose investments in Asia, Latin America, and Russia were going sour.

 

 

People like Kudlow - who don't understand that we are living in a post-bubble environment - cannot understand why the economy hasn't responded to low interest rates and tax cuts. The economy won't have go through another secular growth phase until it works of its huge debt levels and the current account deficit.

 

Greenspan has tried to bail out the economy by using low interest rates and home refinancing to generate credit fueled consumer spending while the corporate debt gets worked off. His hope was that consumers could keep the economy afloat long enough for the corporate debts to disappear.

 

His theory is turning into a failure as consumer spending is faltering without any sign of a pickup in corporate investment spending. The economy is reaching an important tipping point.

 

Back in August I told you that we were seeing signs that the consumer was getting exhausted. One was a slowdown in what had been a red hot housing sector and the near end of the boom in refinancing.

 

The Fed saw this too and began to fret publicly about its implications last month. In recent speeches Fed officials have warned that an economic slowdown could lead to a deflationary depression while simultaneously blaming any possible future slowdown on "external events." In political terms they are preparing you for the worse while shifting the blame and responsibility elsewhere.

 

On December 19th, Greenspan made the following remarks in a speech to the Economic Club of New York, in which he expressed doubts on whether or not his interest rate policy would work or not:

 

"It is too soon to judge the final outcome of the strategy that we adopted. The contractionary impulse from the decline in equity prices appeared to be diminishing around the middle of this year. But then the fallout for stock prices from corporate governance malfeasance, argued by some as having been spawned by the bubble, became more intense. This, in turn, damped capital investment and trimmed inventory plans. More recently, of course, geopolitical risk has risen markedly, further weighing on demand. Though unrelated to the bubble burst of 2000, it has muddied the evaluation of the post-bubble economy. "

 

Note that Greenspan blames the second half decline in stock prices on the corporate scandals. Nowhere does he mention their real culprit - high stock valuations that came as a result of the stock market bubble he helped to create.

 

"As I pointed out earlier, the U.S. economy exhibited considerable resilience to a series of post-boom shocks. The list is rather impressive: First, a halving of stock prices and household equity wealth; second, a dramatic decline in capital expenditures; third, the tragic events of September 11; fourth, the disturbing evidence of corporate malfeasance; and fifth, the recent escalation of geopolitical risks. I would scarcely state that our economy was not shaken by these series of shocks, one on top of the other. But after we experienced a mild recession, real GDP grew in excess of 3 percent over the year ending in the third quarter. "

 

"The recovery, however, ran into resistance in the summer, apparently as a consequence of a renewed weakening in equity prices, further revelations of corporate malfeasance, and then the heightened geopolitical risks. Concern on our part led the Federal Open Market Committee to reduce its targeted federal funds rate 50 basis points at our early November meeting as some insurance against the possibility that the weakening would gain some footing. Although our most probable forecast already was that growth would pick up, we judged the cost of the insurance provided by additional easing as exceptionally modest because we viewed the risk of an imminent rise in inflation as remote. "

 

The economy rebounded from recession in the first quarter of this year. That rebound topped out in the summer and has been losing steam ever since. Greenspan blames this on falling stock prices and "geopolitical risks" - a reference to the impending war in Iraq. However, the slowdown really came as a result of exhausted consumers. Consumers simply can't continually fuel their spending through debt. Only a rebound in corporate spending would create sustainable economic growth. Without that rebound it was inevitable that the consumer would eventually slowdown. But paying attention to these facts means acknowledging the credit and debt based boom/bust cycle that Greenspan inadvertently created. That is why Greenspan seeks to divert your attention away by blaming the slowdown on falling stock prices and Iraq war fever. To look at what is important would lead you to recognize his mismanagement of interest rate over the past decade.

 

"The limited evidence since the November easing has supported our view that the U.S. economy has been working its way through a soft patch. And the patch has certainly been soft. The labor market has remained subdued, as businesses apparently have been reluctant to add to payrolls. The manufacturing sector remains especially damped, and nonresidential construction has trended lower. By all reports, state and local governments continue to struggle with deterioration in their fiscal conditions. Oil prices have recently risen and, not least, the economies of most of our major trading partners have shown little vigor. "

 

"Corporate risk-taking underwent pronounced retrenchment following the traumatic disclosures of corporate malfeasance this summer. Capital appropriations slowed noticeably across a broad spectrum of American industries. Aggressive accounting practices seemingly disappeared virtually overnight. I would not be surprised if further disclosures of questionable practices were to surface in the months ahead, but I would be quite surprised if such practices were introduced after mid-2002. "

 

In these two paragraphs Greenspan acknowledges the growing risks to the economy and admits that it is not recovering the way he predicted it would in his public statements in January and February of 2002.

 

This is an important revision in Greenspan's view about the economy. Throughout the bear market he has remained steadfastly bullish about an economic recovery. In the past few weeks he has begun to express doubts to whether or not it will materialize. Even worse - he has warned that if the economy fails to rebound it could lead to a deflationary disaster.

 

Greenspan's views stand in stark contrast with the Wall Street anal cysts and Crapvision talking heads who are predicting a big economic recovery in the 2nd half of 2003 and have grave implications for the stock market. Stocks are already priced high and if the economy doesn't boom they will inevitably fall.

 

This is the real reason why the dollar has been dropping while gold has been rallying in the past month. They may move in the short term over Iraq, but the real long term trends in both of these assets(a falling dollar and a rising gold price) have been going on for over a year and will continue throughout 2003. If the economy fails to respond the way Greenspan wishes then he will be forced to pump more liquidity into the economy - an inflationary move that will make gold more attractive. With interest rates almost at zero Greenspan has gotten to the point where he is running out of options. At some point he will only be left with one: to allow the dollar to drop. Not coincidentally this is the same exact option that every other country in history has been forced to turn to when its current account deficit has risen over 5% of GDP - a level the United States has been at since October. The bearish implications this has for stocks cannot be overstated.

 

"Since early October, conditions in financial markets have turned less adverse. Stock prices have, on net, moved up, and corporate yield spreads, especially for below-investment-grade debt instruments, have narrowed significantly. Those spreads, nevertheless, remain quite elevated relative to their readings of early 2000. Credit derivative default swaps have improved recently in line with yield spreads. The overall cost of business capital has clearly declined, inducing in recent weeks increased issuance of bonds of all grades and halting the runoff of commercial paper and business bank loans. "

 

Greenspan searches for hope and incredibly the only positive fact he can find is the bounce in stock prices that began in October and has already came to an end. There have been three major rallies during this bear market. One in the summer of 2000 and one in the Fall of 2001 and 2002. Each bounce has been weaker than the last one, with this one coming on worse breadth than the previous two. Saying that this bounce means that the bear market is over is wishful thinking.

 

"In the end, capital investment will be most dependent on the outlook for profits and the resolution of the uncertainties surrounding the business outlook and the geopolitical situation. These considerations at present impose a rather formidable barrier to new investment. Profit margins have been running a little higher this year than last, aided importantly by strong growth in labor productivity. But a lack of pricing power remains evident for most corporations. A more vigorous and broad-based pickup in capital spending will almost surely require further gains in corporate profits and cash flows."

 

Greenspan's speech has two important components to it. First he publicly abandons his bullish predictions on the economy and warns that his low interest rate policies may end in failure. Now we get to the second component: blaming any further slowdown on the "geopolitical situation" - the coming war in Iraq. This is a convenient political move that is designed to cover him from any blame for the economy. The reality is that low interest rates and tax cuts simply can't gain much traction in a post-bubble economy until all of the excess debts are worked off. But Greenspan doesn't want you to realize that because then you'll ask why we are in that situation in the first place. So instead he blames Saddam Hussein.

 

He did the same exact thing a year ago after the terrorist bombing. He argued back then that the country wouldn't have entered a recession if it weren't for the terrorist attack. This statement was a bold faced lie, but one that he found necessary to make for political reasons. He is doing the same thing all over again. He will never take any responsibility for the economy or the stock market when either falter, but never hesitated to pat himself on the back and take the credit for being an indispensable man when everything seemed to be good.

 

We are now reached the point where Greenspan and his Federal Reserve cohorts are preparing themselves for the worst. First Greenspan is trying to politically position himself so that he won't be blamed. Secondly, he is using the concept of deflation as a reason to engage in unprecedented emergency measures.

 

Late in November Fed governor Ben Bernanke made an unprecedented speech in which he warned that the Federal Reserve would engage in a series of emergency measures to bail out the economy if current Federal Reserve policies were to lead the country into a deflationary depression.

 

These measures included not only pumping more liquidity into the economy, but devaluing the dollar, buying stocks outright, even paying for the loans of international bankers by printing money. It is a description of a Federal Reserve run amok and out of control. In Bernanke's view the Fed would buy up masses of government debt, even private corporate debt and private real estate, as a way of pumping liquidity into the economy. Fed governor Bernanke also points out that big devaluations of the US dollar have helped defeat deflation in the past. "The US government has a technology, called a printing press ... that allows it to produce as many US dollars as it wishes at essentially no cost ... Sufficient injections of money will always reverse a deflation," he said.

 

Morgan Stanley's Stephen Roach told the Financial Review that these speeches and actions "are all very carefully orchestrated; they are shaping policies as if deflation is going to happen - and that's a good thing, because it is such a dangerous time".

 

Now you know why gold is going up and will continue to trend up throughout 2003, even after the Iraq war is over.

 

Greenspan is trying to position himself politically so that he can survive in office. Have you positioned your portfolio accordingly or are you going to hold and suffer through another brutal market drop?

 

Mike Swanson

http://timingwallstreet.com

[BAREister]

SNOTwithstanding any rhetoric to the contrary, the Fed has to be profoundly worried about the palpable failure of both the stock market and the economy to respond to it's repeated interventions and rate cuts of the pASSt few years.

 

HRFF has said since he showed up on the InterNUT circa the spring of 1995 that the BIG story, globally, was DEFLATION and that it would, eventually, OVERWHELM stimulus efFURts, inflation. THAT is the drama being played out now, with increasing desperation. This rally off the October lows is only a minor vignette/chapter in this Titanic (and HRFF DOES mean "Titanic" metaFURically speaking thatiz) struggle twixt REflation and DEflation.

 

We're "real, real gone" in the debt arena. Our policymakers have no "fixes" of any lASSting effect.

So it is NO surprise to hear that the "Fed is preparing for failure".

We've been postponing the inevitable since Jimmy Carter's days.

It could only go on FUR SO 'long'.

Now, the jig is (almost?) up, time to pay the piper and dance to the music.

[richmtn]

Thanks Ike.

Where to begin with that mouthful? I'll just ramble.

Kudlow. Kudlow proves that some people can't handle drugs.

The economy sure looks to be headed for the crapper. Easy Al has been performing unnatural acts to keep a dead body animated. He is Dr. Frankenstein. His behavior is criminal, immoral, vain and futile. He allowed and encouraged the bubble to grow out of control. Now he is trying to put the genie back in the bottle. It would have been far easier to keep the economy healthy before the situation became this severe. Now he feeds it the same excess liquidity that caused the problem in the first place.

Economic cycles appear to be organic and natural. Now he is trying to fool mother nature. He seeks to cheat the natural rythym of things. Can he do it? Anything is possible. He could get lucky. It's never happened before and logic says his chances of success are very low. Much of this is a VAIN attempt to be a god.

Immoral.

The continuing bombardment of recovery is just around the corner and the stock market is going up.

Relentless encouragement of people to buy buy buy,

Refi and increase personal debt rather than save and pay down debt.

Government's fiduciary irresponsibility.

Failure to enforce corporate and individual responsibility.

Redistribution of wealth to a tiny percantage of the population.

Wag the dog.

Manipulating economic statistics.

Manipulating supposedly free markets.

Corporate welfare.

Add your own here...

 

"Fed governor Bernanke also points out that big devaluations of the US dollar have helped defeat deflation in the past. "The US government has a technology, called a printing press ... that allows it to produce as many US dollars as it wishes at essentially no cost ... Sufficient injections of money will always reverse a deflation," he said."

Can anyone who has the least understanding of economics take this as a sound proposal. Where will this experiment with our lives and well being end. Probably in disaster.

 

Markets.

I'm not sure that the economy and stock market have ever been bound very tightly. Any confluence seems like two separate cycles passing in the night. With the current level of manipulation by Al and the Wall Street Insiders the market has also been distorted. Its seems a very dangerous game right now. Bulls and bears are being slaughtered. See any Mark to Market for a frightening and entertaining description of the participants.

 

EARTH TO THE BOYZ.

You can't fool all of the people all of the time. When the stool hits the fan they are gonna be pissed.

[megabear]

Personally, I think every step has been carefully planned. The Fed is not "worried", (at least not the guys in the know). It is all working out precisely as they want it to. This is the only way the world can be re-structured to get to the next phase. It will take a depression and a war, but in the end, the world will be completely reshuffled and the guys that "really" run the show will still be there sitting with more power and assets than ever before. Shrub and the other puppets will, no doubt, be replaced; maybe even tyrant-ized, but the real power will solidify.

[Hypertiger]

It's turning into a broken record but here it is for the millionth time...

 

This is how ?modern? Fractional Reserve banking has worked for 100?s of years.

 

Phase/Stage 1

 

Everyone?s favorite drug INFLATION of Debt?

 

Once the maximum potential for debt inflation is reached phase/stage 2 begins. (this is where we/you are? standing at the edge of ?the good old days?)

 

Phase/stage 2

 

DEFLATION of debt, How or why?

 

Compound interest is the price to sustain inflation. As long as you can pay the price, inflation will continue and your hopes and dreams will usually come true. Once you can not afford the payment your hopes and dreams will not come true. Simple

 

The only way to pay compound interest is to borrow money/create debt. Once borrowing slows or stops compound interest can not be paid and debt deflation is the result.

 

Aren?t we just in a mild recession or ?soft spot??

 

No, In the past there was ?slack? in the economic system what is slack? ?SAVINGS?. with the introduction of computers the economists have figured how much everyone has, and marketing specialists have figured out how to get it. The charts below are some evidence that the slack is gone?

 

 

 

 

We are just in the beginning stages of deflation.

 

Phase/stage 3

 

?Bank?ruptcy

Complete collapse of all interconnected banks in the system, since the US dollar is the world reserve currency the world banking system will collapse. plain and simple.

 

Recap of the ?LIFECYCLE? phases/stages of fractional reserve banking.

 

Phase/stage 1 = debt INFLATION

 

Phase/stage 2 = debt DEFLATION

 

Phase/stage 3 = ?Bank?ruptcy

 

Simple as 1,2,3

 

We are so close to the end of the line it ain't funny... Unless they build the zoo mentioned in Mark to market...

[Pretzel Logic]

I heard some anal cysts talking on Crapvision the other day about the possibility that the Fed may lower rates yet again... and the ridiculous thing, to me, was that they were (yet again) talking about this like it would be bullish for the stock market! Are people really that stupid? Like another rate cut is suddenly going to be the Magic Bullet and accomplish something that the previous 475 rate cuts couldn't? It's mind-boggling.

 

The whole thing reminds me of Monty Python:

 

Alan Greenspan on the Economy and the Wisdom of Repeated Rate Cuts

[Guest]

Greenspan's efforts to control the bubble economy reminds me of the problems scientists had with trying to contain fusion reactions with toroidal magnetic fields - the TokaMac project. They described the problem as similar to trying to contain a balloon by strapping on rubber bands, which would just cause the balloon to bulge out even stronger between the bands. In other words, by trying to contain one bubble, Greenspan just creates others.

[Guest yobob1]

Gosh I don't know what I've been so concerned about. Monday I'm going down and getting a new Suburban; 0 down, 0%, and 90 days to first. Tuesday I'll go buy a new house; 0 down, variable interest only payments for 5 years. Then I can go get it filled with furniture and appliances; 0 down, 0%, 3 years to pay. May as well pick up a 0 down boat and a couple of ATV's too.

 

Then when the fed destroys the dollar I will owe virtually nothing........right?

 

Say I wonder if my income, inflation adjusted, will still be there? Oh you say it won't?

 

Therein is the big lie. The gaping hole in the theory of reinflation. There is no automatic bridge to incomes which are falling dramatically, if anybody cares to notice what is happening to income tax receipts. Labor has no pricing power outside of a very few select fields temporarily.

 

There is no bridge to increase capital spending either...that is dictated by profit motive only. Profits are being vaporized by falling unit sales prices, increased input costs, no pricing power, and soon to follow substantially lower unit volume. Wake up folks, most of these reduced revenues are being caused by decling sales prices, not sales volumes. When volumes begin to fall in earnest the blood and red ink will flow.

[Jorma]

Another nice summary of our position which by the way is finding its way more and more into the mainstream.

 

It was interesting that Greenspan's speech was called 'reassuring' to 'investors' by more than one commentator I heard. I guess as long as Al isn't blubbering incoherntly people are reassured.

 

Do not discount the possibility of dollar strength comming from the barrel of our guns, to put it simply and bluntly. Saddam's removal will be short term bullish, and that is in fact not just spin. I think that is official economic policy. The more brutal the methods necessary to achieve it the less bullish it becomes.

 

Not that any of that addresses the fundamental economy or the credit bubble but if the dollar can hold then financial flows can continue in our favor and we could muddle thru for some time. Or so it seems to me.

[Goldilocks]

Agree with ya Jorma. But muddling along constitutes growth of debt. Which constitutes further negative influences on future economic stability. The estimates I have seen are that 2-3% debt addition is needed annually just for the economy to tread water.

We have dug our grave, and built our coffin. Now we are trying to erect a grand Mausoleum over where we will lay.

[Jorma]

One ill formed concept I have is that the main question in the future will be whose debts are forgiven. All signs point to the debts of the corporations and their majority holders, a true tiny minoirty, will come first. Individuals will not get off so lightly.

 

In addition, government debts to individuals as well will be defaulted on first as well. Foreign holders of Treasuries will be paid and those held by SS will be defaulted upon. This will be appluded by most here. Never mind that we will spend a trillion on new fighters we don't need, another trillion will go to missle defense that won't work, or a trillion more will go to Israel and a few more trillion will go to domestic spying and political control.. At least that isn't socialism.

[BAREister]

oh, it's convenient to think that it's all some mASSter plan , some nefarious GRAND DESIGN imposed by the few on the many.

It might be - practically anything is possible, except true intelligence emerging in the likes of Dan Quayle or Tammy Faye giving up makeup or Imelda, her shoes, say. But, like those scenarios, it's very, very doubtful/improbable.

HRFF hASS read enough history to know that grand designs rarely come to fruition, no matter how much power people possess. At least in the ways they intended.

Joseph Stalin excepted, of course, but even he almost blew it, too, when he hauled off and liquidated his officer corps by late 1939.

[MaxxPain]

"we judged the cost of the insurance provided by additional easing as exceptionally modest because we viewed the risk of an imminent rise in inflation as remote"

 

Inflation risk is the weak link in the whole plan. The risk of inflation is much higher than Greenspan admits. How do you inflate away a mountian of debt and keep interest rates low without anyone noticing? How do you keep the holders of 30 trillion in debt instruments happy while you deliver them a negative rate of return? If the dollar keeps falling and oil keeps rising the entire plan falls apart.

 

Jorma, Debts will be forgiven as always through bankruptcy. Greenspan's only power is to devalue the dollar by printing more and giving the holders of cash a negative rate of return.

[PDoody]

It is better to have bubbled and burst than never to have bubbled at all. I might have dreamt it but I believe I heard something to that effect early this Sunday morning. Greasie should be examined for Altzheimer's. Dimentia has obviously set in. Like Nixon, he is now obsessed with how his reputation will be recorded in history. His "Watergate" will soon be exposed and like Lott being betrayed by his own party, the politicians will gladly feed the egomaniacal feedfool to the wolves.

[Drano]

I suppose if I were totally confident of the inflation scenario, I'd re-fi my house and buy gold -- then pay back the mortage with a few ounces in a few years :grin:

 

Also, I recall a long time ago having a discussion with a colleague about a particular international incident which was being viewed as a provocation to the U.S. (involving a plane which was probably shot down by N. Korea). My theory was that it was not a well-thought-out nefarious plan, but a mistake by an inexperienced 18-year-old panicking and pulling a trigger. Don't ignore the possibility that the course of events can be totally changed by one person's stupid actions, which very well may be the opposite of what was expected.

 

For instance, it now appears that the inexperienced co-pilot may have been the one in control when Paul Wellstone's plane crashed in a full-power dive into the ground. That plane crash has changed the balance of power in the Senate, thus giving one party control of both congress and the executive branch. Mighty big result for one moment of incompetence, eh?