Tuesday, July 24, 2012 – The Dog Days of Summer

The Dog Days of Summer
– by Sinclair Noe

DOW – 104 = 12,617
SPX – 12 = 1338
NAS – 27 = 2862
10 YR YLD -.03 = 1.40%
OIL +.58 = 90.29
GOLD + 4.40 = 1582.10
SILV – .10 = 27.06
PLAT – 13.00 = 1391.00

These are the Dog Days of Summer; those lazy, languid, sultry days where not much happens; theoretically.

The economy could use another boost, and it won’t come from fiscal policy. Can the Federal Reserve provide it? Chairman Ben Bernanke keeps insisting that the central bank is not out of ammunition, and in a literal sense he is right. After all, the Fed has not yet exhausted its bag of tricks. It is still twisting the yield curve.  Maybe Bernanke has a few tools he hasn’t pulled out yet. For example, some sort of “funding for lending” plan that favors banks that are actively making loans; lowering the rate the central bank pays financial institutions for parking their reserves at the Fed, currently at 0.25 percent.

Or, the Fed can purchase more assets; they are clearly still considering a third bout of quantitative easing, or QE3, and recent weakness in the economy could prompt policymakers to launch such a program as early as September. The problem is that the economy is building up resistance to monetary stimulus that only stimulates the banks and the stimulus never works its way to Main Street. 

Another alternative is the possibility of cutting the rate of interest on excess bank reserves (IOER), now at a quarter percentage point, all the way to zero, or even making it negative; in other words kick the capital off the sidelines and into circulation; stop rewarding the banks for not lending. 

We don’t know exactly what a lending incentive program might entail, but the Fed might accept longer-maturity collateral for loans only if the banks prove they will lend to small businesses, which have generally struggled more than big firms to borrow.  In another approach, the Fed could accept certain mortgages as collateral to stimulate demand for mortgage-backed securities and encourage lending to home-buyers having trouble getting loans.

Of course, these monetary tools would not necessarily create demand.  If there is nobody to lend to, then money will not circulate. And the banks might just take the money and gamble in derivatives or some other such risky bet. The Fed might be better off simply distributing the money to the end users – direct distribution to individual savers and consumers.  Of course, if the Fed actually dropped money from helicopters, people would begin to realize that their hard earned money was actually printed at will by the folks that run the electronic printing press. 

So, why were the markets trading lower today? Earlier in the session, the Dow was down more than 200 points. Today marked the third straight day of triple digit losses, the worst streak since last September. Two possible answers: the markets realized that Europe really is in trouble and could drag down the US, coupled with slow trading (these really are the Dog Days) and the only people still pushing buttons are the High Frequency Traders, and they can be turned like a herd of sheep by just yelling depression, which is something they should have known anyway. The second possibility is that folks were anticipating a weak earnings from Apple and when you strip Apple out of the market, the market is weak. During the latest quarter, Apple shipped 26 million iPhones, well below the 28 million to 29 million predicted, even taking into account a pause in buying ahead of the iPhone 5. They sold more iPad tablets than anticipated. Apple’s fiscal third-quarter revenue rose to $35 billion, much lower than the average analyst estimate of $37.2 billion. It reported net income of $8.8 billion or $9.32 a share, compared to $7.3 billion or $7.79 a share a year earlier. That lagged the $10.37 Wall Street had forecast. And then they lowered expectations for the third quarter.

Catalonia has joined Valencia in requesting a bailout, and Spain is considering asking for a bailout. Things in Spain are now in freefall. Greece needs more money and we don’t know what they are willing to do to get the money. Yesterday, Moody’s warned that Germany is now officially on the hook should it continue bailing out the insolvent periphery. And so Germany has a decision to make – are they all in or all out, or maybe they’ll just drag out the pain, doling out small doses of relief while demanding more and more austerity. 

The whole point of exiting the Euro-zone is because a country no longer has the money to finance its continuing operations. When Greece, or Spain, or Italy run out of money they will demand more and if they don’t get it, the most likely response will be to drop out of the euro and print their own currency and devalue the currency and pay for day to day operations and inflate away their debts. Think of it as a fresh start. In a couple of years, things are rolling along again. 

By the way, this morning, the European Central Bank said its investigation of Libor rate rigging will not be closed without results. It now appears Barclays has been manipulating Libor rates since at least 2005 and they were regularly pulling in $40 million dollars a day in bets on interest rate derivatives. If the LIBOR, one of the most fundamental metrics of our banking system can be rigged, can you imagine what other elements of our financial system are a fraud?  Sure, the answer is the gold markets. Now, who will step up and start that investigation?

Americans’ trust in the US financial system fell in June to its lowest point since March 2009, driven down by a notable drop in confidence in big banks, according to the quarterly Chicago Booth/Kellogg School Financial Trust Index. The authors of the survey say the drop resulted from concern over the trading losses at JPMorgan, not that it directly affects individual Americans, but because it had the catchy name “London Whale” and it sounded bad. The authors of the survey say Americans are too stupid to understand the Libor scandal. They say it’s quite interesting to see what catches people’s imagination. It may be that Libor is too technical. 

Or maybe Americans are concerned about potential bank holidays (think Argentina in 2001), multiple sovereign defaults as well as broad economic contractions and widespread unemployment and diminishing retirement accounts and pensions – this process has already begun in some US municipals, like San Bernandino and Stockton in California, and Scranton and Harrisburg in Pennsylvania). Maybe new currencies being introduced or new denominations of currencies; followed by immediate devaluation and big bouts of inflation, massive wealth destruction to the tune of tens of trillions of dollars think MF Global but bigger; the money is gone, vaporized, only systemically; followed by a global contraction that will result in new political structures. And maybe consumer price inflation is set to remain positive following a large spike in global food prices. Few things damage economic confidence more than food price inflation – working on the assumption that there aren’t devastating shortages. 

I’m not saying that is how it will work out but if your confidence is shaken it just means your paying attention.

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