Mish's Global Economic Trend Analysis

Bubblicious Questions: What Causes Economic Bubbles? When Do Bubbles Burst? Can the Fed Prevent Bubbles?
Tsunami of Retail Store Closings and Downsizings Coming; Expect Layoffs and Shorter Hours
Liquidity Insurance
Eurozone PMI Strengthens, Except France; Germany-France Yield Spread Widens; Where to From Here?
Venezuela Strengthens Currency Controls in Impossible Mission to Stop Capital Flight; Airlines Collapse; End of the Line

Bubblicious Questions: What Causes Economic Bubbles? When Do Bubbles Burst? Can the Fed Prevent Bubbles?

Posted: 23 Jan 2014 10:42 PM PST

Today I am going to ask three simple questions that have easy to understand answers.

What Causes Economic Bubbles?
When Do Bubbles Burst?
Can the Fed Prevent Bubbles?

The Boy Who Cried Bubble

Before answering the questions (and hopefully many of you know the answers already), let's tune in to what the Dallas Fed has to say regarding bubbles in its report Globalization and Monetary Policy Institute Working Paper No. 167, entitled "The Boy Who Cried Bubble" by authors Yasushi Asako and Kozo Ued.

The article is 44 pages long. In the opening paragraph on page two, the authors state "History is rife with examples of bubbles and bursts. A prime example is the recent financial crisis that started in the summer of 2007; However, we have limited knowledge of how bubbles arise and how they can be prevented."

One could safely stop reading right at that point knowing full well that what follows cannot possibly be anything but self-serving platitudes and incomprehensible mathematical gibberish.

And that is precisely the case. The mathematical gibberish starts on page five and continues for the entire remainder of the document.

Here is a quick sample from page seven.

All the remaining pages are equally incomprehensible to all but the geekiest of geeks. Here is another example from page 39.

Hiding Behind Nonsensical Math

I am quite sure there are some academic geeks who understand the formulas presented by Yasushi Asako and Kozo Ued.

Regardless, it's all mathematical nonsense in light of their ridiculous conclusion stated upfront "We have limited knowledge of how bubbles arise and how they can be prevented."

It's So Tasty Too!

What Causes Economic Bubbles?

Every economic bubble in history started with reckless expansion of money supply and credit, reckless manipulation of interest rates, or government promotions of "low-risk" something for nothing schemes.

That statement holds true for everything from the Tulip Bubble, to the John Law Mississippi Bubble, to the 1929 Stock Market Crash, to the Housing Bubble.

For example, Tulipmania was a futures manipulation and options scheme (credit with leverage) accompanied by futures rules changes enacted by the Dutch Legislature in 1636.

For more examples, including a discussion of the John Law Mississippi Bubble scheme, please see Why does fiat money seemingly work?

The author,"Trotsky", is a purposely-sarcastic alias of Pater Tenebrarum at the Acting Man blog.

Dissecting the Fed-Sponsored Housing Bubble

Every time in history, even as late as 2007, those who caused the bubbles could not see them.

Housing in particular should have been easy to spot. Anyone who could breathe could get a mortgage. Housing prices spiraled three standard deviations from rent.

Yet, Bernanke did not see the housing bubble.

How?

The Fed did not consider asset inflation, including home prices. Instead of focusing on the Home Price Index (HPI) or numerous other housing indices (all showing bubble conditions), the Fed focused on Owners' Equivalent Rent (OER).

Here is the pertinent discussion from Dissecting the Fed-Sponsored Housing Bubble

Comparative Growth in HPI vs. OER

From 1994 until 1999 there was little difference in the rate of change of rent vs. housing prices. That changed in 2000 with the dot.com crash and accelerated when Greenspan started cutting rates.

The bubble is clearly visible but neither the Greenspan nor the Bernanke Fed spotted it. The Fed was more concerned with rents as a measure of inflation rather than speculative housing prices.

Fed Funds Rate vs. CPI and HPI-CPI

The above chart shows the effect when housing prices replace OER in the CPI. In mid-2004, the CPI was 3.27%, the HPI-CPI was 5.93% and the Fed Funds Rate was a mere 1%. By my preferred measure of price inflation, real interest rates were -4.93%. Speculation in the housing bubble was rampant.

In mid-2008 when everyone was concerned about "inflation" because oil prices had soared over $140, I suggested record low interest rates across the entire yield curve. At that time the CPI was close to 6% but the HPI-CPI was close to 0% (and plunging fast).

As measured by HPI-CPI real interest rates were positive from mid-2006 all the way to 2010, even when the Fed Funds rate crashed to .25%. That shows the power of the housing crash.

Real rates went positive again in mid-2010 until early 2011.

CPI and HPI-CPI Variance From Fed Funds Rate

The above chart shows the "Real" (inflation adjusted) Fed Funds Rate as measured by the Fed funds rate minus the CPI, and a second time by the Fed Funds Rate minus the HPI-CPI.

With the recent rise in housing prices, the HPI-CPI is 2.78% while the CPI as stated by the BLS is 1.76% (both numbers from November).

In my estimation, the BLS and Fed now understate price inflation by a full percentage point. Inflation as measured by expansion of credit is another matter.

Variance Between the CPI and HPI-CPI

The above chart shows the difference between the CPI and HPI-CPI. Note that the largest negative discrepancy marked the exact top of the housing market in summer of 2005.

Too Low Too Long

In short, the Fed held interest rates too low, too long, fueling asset inflation and credit expansion on ever-easing terms, the primary way in which bubbles are blown.

Government policy, notably President Bush's "Ownership Society" coupled with countless "affordable housing programs" and Greenspan's promotion of variable interest rate loans and derivatives was icing on the bubbleicious cake.

When Do Bubbles Burst?

In contrast to what Yasushi Asako and Kozo Ued suggest, I propose we know a heck of a lot about how bubbles burst. Here is the simple answer:

Bubbles burst when the pool of greater fools runs out.

Yes, it is precisely that simple.

Bear in mind, timing can be difficult, but sometimes there are precise clues. The housing bubble burst within a month of people standing in long lines and entering lotteries for the right to buy Florida condos.

Sentiment

Lesson: Sentiment can always get more extreme (Until it can't). I used sentiment to call the precise top of the housing bubble in summer of 2005. Here is a brief flashback history. I updated that chart numerous times, in real time, since then.

I also called the 2007 stock market top in 2007 within a few percent based on sentiment. See Quotes of the Day / Top Call

That said, it's easy enough to think sentiment can't get more extreme when it can. The third time was not a charm when I called a market top on February 3, 2003 in Extreme Sentiment: Barron's Cover "Get Ready for Record Dow - We Told You So"; Top Call

Law of Predictions

Make enough predictions and sooner or later you are going to look mighty foolish. Since someone is bound to point them out, you may as well admit them yourself.

That said, my underlying thesis is correct: Once gain the Fed has totally and completely ignored asset price inflation, and once again, the Fed cannot see a massive bubble staring them right in the face.

This bubble will bust, on time, like all other bubbles, as soon as the pool of greater fools runs out.

Can Bubbles Be Prevented?

That is kind of a trick question. The correct answer is "In general, bubbles can be prevented".

The "trick" is I modified the question from the title of this article "Can the Fed Prevent Bubbles?"

The answer to the question as originally posed is an emphatic "No!"

The Fed cannot prevent what it cannot see, even after the fact, when bubbles are in plain sight to any clear-thinking person.

More importantly, the biggest cause of economic bubbles is the Fed (central banks in general).

It is axiomatic that the cure for the disease cannot possibly be the same as the cause of the disease (the Fed).

Academic Wonderland vs. the Real World

A small bit of common sense is far better than ridiculous formulas that cannot possibly work in the real world.

The way to prevent bubbles is easy enough in theory: Get rid of the Fed; get rid of government-sponsored corporatism; stop government central-planning activities, and instead try free-market economic solutions.

Since no Fed-sponsored research could possibly come to the correct conclusion, the Fed and its research departments both sit in academic wonderland, hiding behind obscure mathematical absurdities that do not and cannot work in the real world.

For rebuttal of other equally ridiculous self-serving Fed propaganda, please see Money as Communication: A Purposely "Non-Educational" Fallacious Video by the Atlanta Fed.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Tsunami of Retail Store Closings and Downsizings Coming; Expect Layoffs and Shorter Hours

Posted: 23 Jan 2014 07:42 PM PST

Due to competition from online retailers like Amazon and dismal holiday sales at Target, J.C. Penny, Sears, Best Buy, and other major retailers, a flood of retail store closings are on the way.

Moreover, that same competition also dictates a decided shift away from large stores in large malls, to smaller facilities.

All things considered, expect nothing less than a massive Tsunami of Retail Store Closings and Downsizings.

On Tuesday, Sears said that it will shutter its flagship store in downtown Chicago in April. It's the latest of about 300 store closures in the U.S. that Sears has made since 2010.
Earlier this month J.C. Penney and Macy's announced multiple store closings. J.C. Penney will close 33 stores.
Target said that it will eliminate 475 jobs worldwide, including some at its Minnesota headquarters, and not fill 700 empty positions.
American Eagle will move some of its aerie lingerie locations into its main stores.
Aéropostale will close 175 stores over the next few years.
Wal-Mart has about 100 stores in the U.S. producing same-store sales declines deeper than 3 percent.

Experts said these headlines are only the tip of the iceberg for the industry, which is set to undergo a multiyear period of shuttering stores and trimming square footage.

Shoppers will likely see an average decrease in overall retail square footage of between one-third and one-half within the next five to 10 years, as a shift to e-commerce brings with it fewer mall visits and a lesser need to keep inventory stocked in-store, said Michael Burden, a principal with Excess Space Retail Services.

January is typically a busy month for retailers to announce store closings. According to the International Council of Shopping Centers, 44 percent of annual store closings announced since 2010 have occurred in the first quarter. But this year's closings are likely indicative of a new trend, sparked by more and more shoppers turning to the Web, experts said.

Paired with a compressed holiday shopping calendar and a spate of freezing weather across much of the U.S., online shopping contributed to a nearly 15 percent decline in foot traffic this past holiday season, according to ShopperTrak.

"Stores are making a long-term bet on technology," said Belus Capital Advisors analyst Brian Sozzi. "It simply doesn't make strategic sense to enter a new 15-year lease as consumers are likely to continue curtailing physical visits to the mall."

Sozzi said that after a profitable but below-expectations holiday season, the retail industry will face its second "tsunami of store closures across the U.S.," only a few years after what he called the "fire sale holiday season of 2008."

Steering Clear of Traditional Malls

One big shift in store closings has come from retailers shying away from indoor malls, instead favoring outlet centers, outdoor malls or stand-alone stores. Although new retail construction completions are at an all-time low, according to CB Richard Ellis, the supply of new outlet centers has picked up in recent quarters.

"There's no question that mall stores are closing quicker than open air, as far as the department stores," Birnbrey said.

Rick Caruso, founder and CEO of Caruso Affiliated, said at the recent National Retail Federation convention that without a major reinvention, traditional malls will soon go extinct, adding that he is unaware of an indoor mall being built since 2006.

"Any time you stop building a product, that's usually the best indication that the customer doesn't want it anymore," he said.

Expect Layoffs and Decreased Hours

Fewer, smaller stores requires layoffs or shorter hours. Given that job growth over the past year or more has been largely influenced by Obamacare artifacts, and that wave has played out, expect economists (but not Mish readers) to be shocked by what happens next to future headline job numbers.

For further discussion of this important topic please see ...

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Liquidity Insurance

Posted: 23 Jan 2014 01:49 PM PST

In contrast to silly reporting yesterday regarding an alleged but nonexistent corporate cash pile that could be used for capital expenditures, here is a far more realistic report: US Corporate Capex to Grow at Slowest Rate in Four Years

Total capital expenditure by the non-financial companies in the S&P 500 index is forecast to rise by just 1.2 per cent in the 12 months to October, according to Factset, a market data company that compiles a consensus of analysts' forecasts.

In aggregate, analysts' forecasts indicated the slowest growth in capital spending by the largest US companies since it declined in 2010, in the aftermath of the recession of 2007-09.

Nick Nelson, an equity strategist at UBS, said: "Chief executives and chief financial officers have been battle-scarred by 2008-09, when they couldn't get financing when they wanted it. So they are running their businesses with much more available cash than in the past."

Cash Cow Capex Thesis vs. Liquidity Insurance Thesis

Nick Nelson has it correct.

I made a nearly-identical statement yesterday in a comment regarding my post False Thesis of the Day: Huge Cash Pile Puts Recovery in Hands of Corporations; Cash Cow Revisited.

"Cash is just not going to be used for the way Deloitte suggests. In 2008 and 2009, credit virtually dried up. Viable companies nearly went under because they had no cash. Much of the cash on hand is nothing but insurance against the same thing happening again. That's the intended use for much of the alleged cash. It is not really available to expand businesses."

A quick check shows I wrote the above as a comment to a subsequent post, also from yesterday.

Is Nelson reading my blog?

Since I stated the above in a comment, and on a different post, the most likely explanation is Nelson and I came to the same conclusion independently.

Cash on hand is not intended for expansion, for multiple reasons.

Businesses have no reason to expand.
The recovery is quite long historically, growth will slow.
The cash is really debt, so realistically it's already been spent.

Nonetheless, the cash does provide cheap liquidity insurance against a credit crunch.

Capex Proponents

Others don't see it that way.

For example, Mark Zandi of Moody's Analytics said: "All the preconditions for much stronger business investment are in place."

Doug Handler of IHS Global Insight said he expected growth in spending on plant and equipment to pick up from 3 per cent last year to 7 per cent this year.

Mark or Doug, care to make a token "bragging rights" bet of $250 to our favorite charity?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Eurozone PMI Strengthens, Except France; Germany-France Yield Spread Widens; Where to From Here?

Posted: 23 Jan 2014 11:35 AM PST

The Eurozone composite PMI hit its highest since June 2011, but it did so with France still in contraction as noted by the Markit Flash Eurozone PMI.

The euro area private sector economy grew for a seventh consecutive month in January, according to the flash Markit Eurozone PMI® , with the rate of growth accelerating to the fastest since June 2011. The headline PMI (which tracks output across both manufacturing and services) rose from 52.1 in December to 53.2

New orders across the euro area rose for a sixth successive month, albeit growing at a rate unchanged on December. Backlogs of work also continued to fall marginally, suggesting that the level of demand, although rising, remain s insufficiently strong to enable companies to build up a pipeline of orders to fall back on if demand weakens. Employment was consequently trimmed slightly again, having stabilised in December, as companies remained uncertain about expanding capacity. Employment has not risen since December 2011, though the trend in the rate of job losses has eased considerably over the past year.

Selling prices also continued to fall, highlighting the fragility of demand, and have now declined continually over the past two-and-a-half years. The latest reduction was only modest, however, and the weakest since May 2012. The easing in the rate of decline reflected in part the need to pass higher costs on to customers.

Growth in Germany hit the highest since June 2011. The strong pace of expansion was fuelled by a seventh consecutive monthly rise in new business. Manufacturing output surged at the strongest pace since April 2011, but services activity growth picked up only marginally on December. Employment in Germany rose only modestly as a result, the rate of job creation sliding compared with December. Staffing levels have nonetheless now risen in each of the past three months.

In France, output fell for a third successive month, through the rate of decline eased to the slowest seen over this period. Rates of decline eased in both manufacturing and services. New orders likewise fell at a reduced rate, but the pace of job losses accelerated slightly.

Commenting on the flash PMI data, Chris Williamson, Chief Economist at Markit said:

The upturn in the PMI puts the region on course for a 0.4-0.5% expansion of GDP in the first quarter, as a 0.6-0.7% expansion in Germany helps offset a flat-looking picture in France. Elsewhere across the region growth has improved to its fastest since early-2011, meaning the periphery is showing clear signs of starting 2014 on a firm footing. "However, while gathering pace, the upturn remains fragile. Companies cut employment again, and selling prices continue d to fall amid still-weak demand. Deflationary forces are clearly a concern in many countries . The growth disparities are also a persistent concern . We are seeing growth being led by Germany, especially its surging manufacturing sector, while France looks likely to act as a drag on the eurozone recovery for some time."

France-Germany Yield Spread Widens

Bloomberg reports France-Germany Yield Spread Widens as French Growth Trails Peers

The extra yield investors demand to hold France's 10-year debt over similar-maturity German bonds increased for a third day on signs the French recovery is trailing its regional peers.

The yield difference, or spread, between benchmark 10-year French and German bonds increased one basis point to 70 basis points after touching 71 basis points, the most since April 3 on a closing-market basis.

"We are back to levels which are pointing to the relative performance of France versus Germany," said Patrick Jacq, a fixed-income strategist at BNP Paribas SA in Paris. "Unless France improves its economic and fiscal performance, it will be very difficult to see the spread tightening further. Today there was supply in France and therefore there's been some concession in the market."

French Manufacturing

A gauge of French manufacturing output, based on a survey of purchasing managers, showed the industry failed to expand for the 30th month in January. A separate Markit Economics report showed an index of German manufacturing activity rose to the highest in more than 2 1/2 years. Markit's composite gauge of euro-area manufacturing and services output rose to 53.2, from 52.1 in December.

Where to From Here?

Germany continues to expand, France doesn't. Moreover, and on a "where to from here basis" Spain is better off than France, as in "closer to the bottom".

Unlike Markit economist Chris Williamson, I do not believe Germany can continue to pull the Eurozone economy forward much longer.

I will explain the above ideas in detail in a subsequent post.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Venezuela Strengthens Currency Controls in Impossible Mission to Stop Capital Flight; Airlines Collapse; End of the Line

Posted: 23 Jan 2014 10:22 AM PST

In an effort to get money out of Venezuela, airline ticket sales had been booked solid for months. However, following still more government restrictions on Venezuelan currency (known as Bolivars), some flights to and from Caracas were suspended today. One airline cancelled all flights.

Hyperinflation, and economic stupidity by the leftist government are both out of control. On the currency side, the official exchange rate is 6.3 Bolivars to the dollar. The exchange rate for foreign travelers was just set to 11.36 Bolivars per dollar. The black market exchange rate is 79 Bolivars per dollar.

No One Wants Bolivars

There is no demand for Bolivars. No one wants them. Venezuelans want US dollars, Euros, or gold. The Bolivar will soon be worthless. It nearly is already. This is hyperinflation in action.

Please consider Venezuela Bonds Plunge After Bolivar Weakened for Travel.

Venezuelan bonds plunged to the lowest in more than two years after the government announced the latest partial devaluation of the bolivar, this time for airlines and foreign direct investment.

Venezuelans traveling abroad, airlines and foreigners sending remittances home must use a secondary exchange rate determined at weekly auctions, Economy Vice President Rafael Ramirez said yesterday. The rate set at the latest auction was 11.36 bolivars per dollar, compared with the official rate of 6.3. Airlines operating in Venezuela fell and one carrier suspended flights.

The partial devaluation comes as the government attempts to halt a hemorrhaging of dollars that has pushed international reserves to a 10-year low. The announcement came on the same day that the country's largest private food producer, Empresas Polar SA, said it can't import more raw materials because authorities are delaying the release of dollars.

The country's international reserves fell to $20.5 billion this month from more than $28 billion a year ago.

Maduro's government sold $8.6 billion last year to finance travel, airlines and remittances, 19 percent more than in 2012, according to Ramirez.

Still, measured at the official rate, airlines have an equivalent of $3.3 billion in bolivars trapped in Venezuela that they can't expatriate because of exchange controls, according to the International Air Transport Association. Ecuador's state-owned Tame Linea Aerea suspended indefinitely all of its seven weekly flights from Caracas today because of payment delays, the company said in a statement today.

Food producer Polar said yesterday that authorities are delaying the release of $643 million dollars. In total, the government owes private companies $10 billion in foreign currency, according to Venezuelan business chamber Fedecameras.

"The companies will be lucky if the government pays them at all, at any exchange rate," said Aura Palermo, currency controls specialist at Caracas-based AP Consulting Group. "Businesses can't plan in any way now, as they don't know when they can participate in the auctions and at what rate."

End of the Line

The end of the line for the Bolivar is at hand. The leftist government nationalized oil reserves, and the result was an immediate collapse in production. The only way Venezuela can import anything is from dwindling US dollar reserves. When those run out, it's lights out for the Bolivar.

Ridiculous Idea

Hyperinflationists believe the same thing is going to happen in the US. The idea is ridiculous. For more on the story, please see Venezuela's Hyperinflation Anatomy; Army Storms Caracas Electronics Stores; Total Economic Collapse Underway; Could This Happen in US?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Mish's Global Economic Trend Analysis

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