by John Galt

July 7, 2009

Instead of doing my Obamarket update for last week since it was just a hint of instability to come, I thought it would be better to address the “big” picture and let me sum it up in one photo:

Yup, the first half was ugly. The second half, well, is going to be dog ugly.

Every conceivable blunder or mistake that I feared the Federal government, the Federal Reserve, the states and the banksters could possibly commit, they found a way to do it. Let’s just cover a few…

1. The government failed to create a serious program to remove the bad banks and insure the good ones would survive long term without diluting the value of their assets.

2. The Federal Reserve decided to pause the presses and leave their balance sheets at a stable and what I feel is low number of $2 trillion with over $9 trillion just evaporated into the ether with no accounting for those monies. This is totally inadequate for dealing with the nightmare implosions in the CMBS, RMBS, ABS and derivative markets. Not to mention they are going to have to buy Treasuries like there is no tomorrow or interest rates will destroy any of Ben’s green shoots.

3. Many large states and municipalities failed to address the budget issue seriously and kicked the can down the road. The problem is that both primary insurers for municipal issues were downgraded which means that the stability of that entire market is now in question, especially with tax revenues continuing to decline at a frightening pace.

With just those gems, we could say ‘game over’ and go on from there. But I like to say it with pictures so here is the second half kickoff, nightmare by nightmare, for all to see.

I. RESIDENTIAL AND COMMERCIAL REAL ESTATE

Realistically there will be no recovery in this market and showing the Credit Suisse reset chart for adjustable rate mortgages serves no purpose. Demographics should tell anyone with common sense that an aging population is not going to drop $410 thousand on a McMansion to bail out Mr. and Mrs. Beamer and their 4 kids, 2 cats, 3 SUVs and a goldfish named Wanda. Not to mention the $410 K Mr. Beamer is asking is facing empty homes everywhere to drive the prices down.

This number will continue to rise as our foreclosure process moves faster this summer. To make matters worse a ton of inventory is being held off of the markets, and that is not a positive development either.

While this is depressing enough, the implosion of the Commercial Real Estate Markets should continue unabated. Instead of focusing on the recent hotel and mall bankruptcies, let us look into the Senior Loan Officers Survey to get their view of loaning money for Commercial ventures.

That’s another “all time low” a phrase typically not heard during run of the mill Jim Cramer like recessions. To add to the problem, the survey shows that the loan officers are still in a tightening phase for loan requirements.

* - Surveys through Q1 2009; no data for Q2 as of publication.

Although it is off the peak at 87%, we are still at historical highs for this measure and thus the banksters will have no incentive barring 100% government backing to loosen standards and start taking risks again.

Thus we have tight money with low demand, a formula which means the declines will continue into 2010. Look for the nightmare to continue through 2009 with more builders, commercial and residential, demanding government bailouts or going bankrupt.

Add in the single family home permit data and you realize that this very important leading indicator demonstrates that the United States does not even have a projection of realizing starts six months from now that equal mid 1960’s levels. Thus why there will be no recovery in housing this year and in fact, with projected foreclosure numbers to worsen, look for this to drag on up until 2012.

II. INDUSTRIAL CAPACITY AND EXPANSION

Remember all the garbage we heard in 2008 about how our export markets would bail us out? If you look at the chart above, the most realistic thought should hit your mind: We’re operating at the lowest utilization levels in history and our exports are dropping at such a fast pace that we could see historically low levels there also as our government continues to dilute the dollar and destroy what little faith other nations have in our full faith and credit clause.

When you add in the massive drop in inventories (in dollars) you begin to realize that what is left of American manufacturing and wholesaling does not trust the future projections of our illustrious leader since so far they are sending Good Ole’ Joe out there to discuss their “misreading” of the economic situation.

Care to tell me how green shoots grow underground while you’re at it Joe?

Thus why I just do not see any incentive to take a risk and make massive capital investments in the second half as the issues outlined in Prime Advantage’s survey of 103 industrial manufacturing companies (Story at EC&M April 27, 2009: Top Economic Concerns for 2009 Include Revenue and Capital Spending Projections ) especially when you review the concerns at the beginning of the year and realize that those same concerns are valid for the remainder of this year.

Those are the normal internal U.S. based concerns that one would expect in times like these. Now look at some of the external concerns then think about the proposals and actions of this government in the graph above and this graph below:

With consumers retrenching and paying down or defaulting on debt, the concerns of customer demand are still valid as is the lack of clarity with regards to United States dollar policy. Thus why I feel we will see no massive capital investments or manufacturing upgrades nor any reason for corporations to expand hiring until the summer of 2010 at the earliest. Unfortunately for corporate America, one of the factors putting a ceiling or impeding capital expansion is the labor costs. With the current administration throwing all of its weight behind the unions and preparing to attempt an imposition of mandatory health insurance coverage, the Employment Cost Index from the BEA indicates that the weight of adding personnel will be too onerous for most companies operating exclusively within the United States should the Obama administration get all of its wishes.

These same factors are evident in the state and local government ECI which is putting pressure on them to increase taxes at the expense of the citizens and business to satisfy tax collection shortfalls created by the real estate crash and recession.

Unfortunately for the worker facing the decisions made by the political elites, corporations are being put into a box where to operate profitably or even just survive, operations will have to be moved overseas unless massive protectionist actions are undertaken. Like government takeovers of the automotive industry; oops! Despite popular belief and populist rhetoric, protectionist actions being hinted at and undertaken already could further aggravate an already dire unemployment picture.

III. UNEMPLOYMENT AND WAGES

On July 24th the United States government will enact an increase in the minimum wage which was approved by the Bush administration in 2007 and touted by the leftists in this nation as a “just” action which will increase productivity and insure a living wage for all Americans. The reality?

As you can see from the graph above, the increase in unemployment, the public number used by the BLS and Bubblemedia is somewhat grim and when you break it down into reality, it is downright equal to and surpassing many of the 1930’s and 1893 Depression era numbers. The BLS table that many more economists and prognosticators are finally starting to follow, the Table A-12 U-6 data, reflected a 16.8% rate for unemployed and underutilized workers as of the June 2009 report. Sadly, that number is probably dramatically higher as the Center for Labor Studies at Northeastern University has already stated that by May of this year they estimated the total number of underutilized workers at 18.2% or 29.37 million workers(From NY Times Op-Ed by Bob Herbert: No Recovery in Sight, June 26, 2009); this does not however include contractors who lost positions with companies seeking work thus the under count of self-employed contract workers continues and by my estimates is a full 4-5% higher than the U-6 data published by the BLS. This would mean that the total number of unemployed and underutilized workers in America could be as high as 37 to 38 million individuals by now which does not portend any type of potential recovery this year since 70% of GDP consists of consumption now.

When you look at the Civilian Participation rate and the unemployment rate compared to the Civilian Participation Rate, it does nothing to inspire “hope” or a change for the next two quarters.

As the elderly workers attempt to retire or get laid off due to contractions in the economy the ability for them to have any type of sustained purchasing power declines rapidly, thus adding a layer of unemployed to the work force that not only are difficult to find positions for in the service economy our leaders desire, but also receiving benefits earlier than scheduled putting further strains on our fiscal issues.

When you take the first graph in this section and then review this chart, you realize that the under utilization numbers are even more damning.

Let’s break down some of the sectors that normally would be considered critical to a recovery and look at the weakness that is continuing and probably will expand during the second half of 2009.

According to the graph above for US Goods producing industries (all) the employment levels are akin to the numbers from November of 1960 and indicating a further decline. Think it gets better after this? Think again.

That’s correct. In the arena of Durable Goods Manufacturing we are at and heading below levels unseen since the Korean War era, March of 1950. The sad part is you hear the talking heads on Bubblemedia profess how important the Durable Goods report is each month but none of them have bothered to inform the public how fewer and fewer Americans are employed in this area of our economy.

And we’re recovering, right Dennis?

But that’s just a wee bit worse than the first graph but not even close to as bad as this one:

Bingo! You have now seen how bad our economic structure and the “recession” data has become. The numbers in the graph above and the information presented earlier from the Center for Labor Studies at Northeastern University are indicative of a DEPRESSION, not a recession, but that will be one for historians, probably Chinese ones, to declare. The fact that Non-Durable Goods Manufacturing is at a historic low for all time, unseen in over 70 years of measurement, should raise alarms, but it does not as we are now in a “service” economy theoretically. When one starts to take those graphs above into context of the total population of the United States now and then, it starts to make one wonder where the job creation will come from outside of the government.

For those poor souls who are still employed your hours worked are now at an all time low on average. Thanks to rationing hours to keep the doors open and avoid unemployment taxes, employers have been shaving hours, trimming staff and putting many employees on part time hours but declaring them still full time workers to avoid unemployment insurance tax increases in some states.

So despite the inflationary (Keynes rules, not mine) indications of rising wages, that is countered by a decline in average hours worked.

Since we have not seen an increase in manufacturing employment and a persistent decline in average hours worked since the 1980-1983 recession era, there is nothing to indicate that the employment picture either in quantity or quality will improve for the civilian workforce.

By the way, if someone does lose their full time job as a Bovine with Dairy Enhanced Product Assembly Engineer (makes cheeseburgers at a fast food joint) the duration of unemployment is also at modern era historic levels, thus putting the civilian work force under further strain and eventually impacting wages as demand for employment gives employers who remain the leverage to reverse the years of accelerating wages, even though they have failed to keep up with inflation, expenses and taxes over the past 29 years.

IV. CREDIT, BANKSTERS, AND MORE

There is this perceived belief that the credit markets are improving. The simple answer to that is:

That is the latest chart of outstanding Commercial Paper from the Federal Reserve which seems to indicate a further contraction, not expansion and thus continued credit tightening. If you look at the condition of the banksters that could easily give you a clue as to why.

With the continued deterioration of loans outstanding, the deteriorating delinquency rates at the GSEs and within the commercial banking structure, and the now imploding CRE market, my assumption of a 4% Net Loan Loss may be conservative at best.

The last graph in this series is a pure indication of when the crisis started in February of 2007 and where we are at today, with little improvement and concern that this is going to expand in the years ahead. The Allowance for Loan and Lease Losses is crucial to determining a safe buffer for banks and projected loan loss reserves. Although the OCC was somewhat lax during the boom with oversight in this area, the recent crash has forced a renewed effort by regulators to flush out the weak banks to prevent the FDIC from being overwhelmed with bank runs and failures, which would have occurred last year without massive intervention by the government.

This ratio needs dramatic improvement and fast if we expect to see the credit markets recover by 2012, which I do not think they will do. Thus my concern with the Senior Loan Officer Surveys above, the poor condition of some of our major banks, and the lack of any sustained economic growth to guarantee employment levels stabilizing soon, the credit markets will remain vulnerable to shocks for the next two to three years and put further strain on the Federal government and the levels of fiscal expansion we have already seen.

What makes matters worse is the continue acquisition of RMBS holdings by the GSEs and the dollar amount they are acquiring in an attempt to stabilize the mortgage securitization markets may in fact destabilize it in the long run as the banks refuse to take risk back on to their books and only act as mortgage servicing companies for the Federal government. In fact if you look at the loans already taken on to the books by the government then the graph which follows on GSE debt ownership you realize that fiscally speaking it is almost half of our Real GDP.

To say that our government is the major if not sole proprietor for ‘conforming loans’ in the residential real estate market is disturbing and terrifying with the long term implications not just for losses and debt added to the Federal budget, but the ideas of controls imposed on citizens when their loans are issued by or acquired by the government should send a chill down the spine of every freedom loving American.

Unfortunately the total Household Debt as a percentage of GDP is not reassuring and sadly does not indicate enough of a contraction of household balance sheets (or defaults) to bring this number into some sort of realistic ratio.

This is not the path nor intention of our founding fathers nor Adam Smith. Thankfully we still have that old standby chart, total credit as a percentage of GDP to really illustrate just how screwed as a nation we are:

Thankfully our Congress can issue more paper to insure that we keep these levels in excess of any historical norm and insure the future if not total destruction of the Dollar as the world’s reserve currency. Because if they do not, we had best “create” some 9% plus GDP growth numbers to insure this nation has a future and its children are not reading Chinese text books and working as employees at a Nike shoe factory sweat shop in Bakersfield, CA to manufacture shoes for the Asian markets.

V. IT’S ONLY INFLATION IF YOU ARE ALIVE

Thankfully the deflationistas continue to assure all of us that we are experiencing massive deflation so paying attention to real CPI-U is irrelevant and the rate of change is more important. It’s a good thing Nixon assured the world we would not dilute the dollar and inflate our currency beyond all reasonable belief. Of course the deflationist camp also reminds us constantly that monetary velocity is the key figure to watch and that the number is so weak that it is impossible to have inflation or even disinflation.

So far so good. That looks negative to me (/sarcasm way off). M1 though is not a reliable indicator, so let’s see if M2 is negative.

Ah, now that’s a weak number. We’re not at a negative ratio but the destruction of assets is taking its toll as taxpayer monies are created (that’s printed for those of you in Rio Linda or Fort Pierce, FL) out of thin air and stacked on bankster’s balance sheets to give the appearance of solvency. Let’s cross that number with CPI-U just for fun on a historical basis to see if declining M2 Velocity guarantees declines in overall inflation or just disinflationary pauses in the upward price impact.

So when the curve or drop in M2 velocity started in to steepen in the second half of 2008, the rate of inflation actually declined in the same time period. But despite a continued drop in velocity into 2009, the rate started to stabilize and climb again. Thus some of the printed dollars must be filtering into the economy and credit expansion, although selective and slow, is continuing; just not at the bubble pace of the earlier half of this decade.

Let’s drop the inflation-deflation debate as it will never be won by either side until we either acknowledge that we’re back in the same type of deflationary depression we experienced in the 1930’s (impossible without the gold standard, but I’m tired of arguing that point) OR until Bubblevision starts offering CNBC labeled wheelbarrows to haul your money around with each “Mad Money Trillionaires Extravaganza” they will host.

Enough picking on Bubblevision and let’s look at the things people have to use or consume and the level of inflationary growth of each item since 1990. I think you will realize that unless you are dead, you are paying more for everything as measured by and reported on by the Bureau of Labor Statistics:

Whew, thankfully we have to eat and the prices have declined. Slightly. To uh, still absurd levels. Must be a hint of massive deflation on the horizon.

Hmmm, the expense of housing is up but prices are crashing. Can’t be, the government said so. Ooops, they did say so and it is stable, but still considerably higher than it was almost twenty years ago. Go figure.

Hmmm, so if you rent and the price goes up, it is a mirage. So why complain?

If you only flush once per week America, perhaps this rate of inflation will decline.

Ahh, some relief. It must be because the dollar has increased in value so dramatically. Or they added more buses. Or perhaps there is just a wee bit less demand for electricity and natural gas at this time.

Don’t get sick and these prices will come down. Or better yet, Bernanke gets sick and quits his damned printing fetish.

The bottom line to all of these numbers? The dilution of our currency since the departure from the gold standard in 1971 has guaranteed we will experience some level of inflationary expansion. The idea was to fleece the sheep at a 2 to 3% annual level and the tax will not hurt and the banksters can book trillions in profits. The problem is they found out that by accelerating the process after the dot com bust, they accelerated the bubble to proportions beyond their control as they desired fiscal restraint did not accompany their desperate post 9-11 efforts to prevent a recession. The lack of a necessary and healthy recession from occurring as deep as it needed to be and re-emergence of a healthy economy has provided the basis for the situation we are in now. And the consequences of continuing reflation efforts will eventually destroy a nation’s currency unless a truly deflationary depression is allowed to occur and complete the deleveraging process.

VI. CONCLUSION

Unless the process of continuing to socialize losses and privatize profits ends soon, the consequences will be the destruction of the American financial system. At the beginning of this year I was hopeful and of the mindset that a recovery would take hold naturally and the economy would reflect this with minor but positive GDP numbers by the second half of this year. I am no longer hopeful nor counting on it. The interference in the business cycle, the disregard for two centuries of contract law, and the reckless expansion of the government’s share of GDP at all levels, state and Federal, has caused business to pull its horns in and cower in fear because regulatory and taxation policies prevent planning for a course of action that could alter the economic situation several months into the future. Thus I fear the recession, which by many economic statistics is in fact a depression, will continue at least into the second quarter of 2010. By that time, hopefully our taxation policies will become clearer and the banks reinforced to prevent a total implosion as the Option ARM resets occur at that time.

The major problem I see emerging in the second half of this year is simple:

I fear that is our autumn event which once again brings a shudder and hopefully final decline to our equity and credit markets. Since there appears to be no other plan from the Federal Reserve or Federal Government to do anything beyond throwing money at the problem, the deleveraging process within this industry will be extended for over a year if not much longer. Despite the popular refrain that “unemployment is a lagging indicator” we have heard and will hear, the life insurance industry depends on a younger demographic of employed workers to insure a steady cash flow. In a major recession or depression, insurance of any sort is usually jettisoned as a discretionary item behind food, shelter, medical and transportation expenses. Thus why this shoe, when it drops, could leave a permanent footprint in the legacy of this economic disaster and the Federal Government expanding its ownership of the industry far beyond the takeover of AIG.

Prepare yourselves accordingly.