Shenandoah

By John Galt

August 4, 2008

Instead of just reflecting on the usual rants, raves and more, I thought this would be a good day to post up some of those charts with a little commentary that only us boring historian types find interesting. I hope you enjoy the perspectives I am trying to present because to by quite honest, I had a little hope for our future.

Until I started reading all of the news and reports on Sunday.

1. Let’s Review Inflation and Monetary Reports 

So you think the government CPI data is bad? Well, let’s look at some charts.

Well ,using their own data, it would appear that inflation has been sufficiently out of control since Paul Volcker brought it under control. Historically speaking to unwind this much inflationary pressure will take another, much bolder, Volcker like action yet we can not do that without wiping out the banking system. More on the banks later. Why is this the case? Let’s look at the remaining monetary indicators since the Fed disposed of M3, using M1, M2 and MZM.

Don’t see a downward spike there yet. Let’s try M2…

Nope, not quite there yet. MZM?

Hmmm, money stocks still seem to be accelerating. And if you use a ruler, you can see the similarity to the CPI chart at the top of this series. Of course we could not possibly have that much currency in circulation either. Then again, let’s just take a peek at this last chart in the monetary series that indicates that there is only one direction, thus far, regarding our monetary policy history of the last 25 plus years:

Just keep that snapshot in your mind and let’s see if there are any currency comparisons that illustrate just how bad the dollar has been devalued. For the sake of argument, let us pick on an innocent land locked little nation where billions of our dollars have been hidden from the IRS according to recent news reports. How does the Swiss Franc look historically against the dollar?

Ouch. We are below the recessionary levels of the past and in truth below the horrid inflationary periods of our past. I guess this means the Swiss do not want to drink the Kool-Aid and destroy their currency now. Since Bubblevisions 1, 2 and 3 all feel we must follow the popular US Dollar Index, let us look at some of the Trade Weighted version to get a clearer, more accurate picture.

Pretty darned ugly. And that is against the major currencies.  Once again please note we are well below all previous recessionary levels. The fantasy that the commodity bull market is over is about to surprise the cheerleaders once again because the fact that we have displayed a willingness to print like there is no tomorrow and issue debt like we will ever have enough to pay for it guarantees that the monetary inflation will accelerate. Just because there is “demand destruction” it does not necessarily mean that the prices of the goods needed for an individual’s survival have to drop also. The dollar  may drop into a black hole as other nations do everything in their power to divert their financial resources into tangibles, as Helicopter Ben offers no indication he will pull back from the brink and with the economy slowing along with no indication at all that we will “defend the dollar” the box he has put himself into is obvious. The credit crisis is about to undergo the next major lurch into burning death and a lot of people who played the side that it was “over” are about to go down like a Kamikaze pilot in the gun sight of a P-51.

2. It’s the Economy SLOWING Stupid

You hear the cheerleaders and commentators night after night saying such clever phrases like “it’s contained” or “a bottom is in sight” or “housing is about to turnaround”, etc., etc..

Horsehockey. This is only the start of the recession. The most over used words on television and radio now are “bottom” and “capitulation.” The fact is that we have neither sniffed nor recognized either of them. There has been no mass liquidation of soured assets. The charade pulled by Merill Lynch was a public relations stunt of unheard of proportions and now they are acting quickly as many investors and politicians are demanding an investigation. I hope we get one. As I would like some sort of public accounting to confirm that TSLF loans were not used by Merrill to loan to Lone Star to finance the CDO purchase.

That story is for the lawyers to investigate and it is doubtful we will get an honest accounting of this in our lifetime. So why do I insist that things are just now slowing? Let’s take a look at private business inventories:

That chart indicates the change in private inventories. Thank you FRED for that one. I was not aware of just how drastically this chart would indicate the suspected change when I first looked for the data. If you note, that rate of change is well below recessionary indicators of the past, keeping in mind the size of our economy since the start date of the chart. To analyze this further, let us look at the percentage rate of change:

That should be a major hint that the sunshine and lollipops crowd that perhaps private industry has recognized the enemy that inflation presents to the system since PPI has been one heck of a lot worse than CPI in recent years no matter how much you exclude food, energy, lollipops, sunshine, fresh air and widget dust. Now that we have notice that private industry has seen the slowdown coming and is trying to adjust their inventories for it, let us look at some other charts, courtesy once again of the Fed.

I elected to only use the 5 year chart so we do not argue apples and oranges about the 91 or 79-82 recessionary periods. The most recent recession pretty much ended in 2003 and as you can see we are accelerating upwards not in short term unemployment but in the numbers of people out of work over 6 months. If you look at the BLS Unemployment Data release last week under Table A-12, Section U6 “Total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers” it is now up to
a very recessionary 10.3% rate. Time for another Polaroid moment…

As you can see from this graph, we have surpassed the unemployment levels in the last recession and this time I fear that unknown distortion to the data is the fact that we have upwards of anywhere between two to five million more 1099’s or “independent contractors” in various fields from programming to plumbing that are being under counted as they are not eligible to file for unemployment nor accounted for in any BLS statistical models. Then add in the additional five to ten million uninvited guests, invited by Jorge, and you can see that one aspect of the employment picture that is not measurable and very muddled is the population of illegals doing lower end jobs that unemployed Americans normally would resort to during slower economic times. That will build a new amount of social pressure unseen in prior economic downturns but that is for another posting at another time.

If you would like another picture of the duration of unemployment, no problem. It just validates the chart above even more so.

As the chart above illustrates based on historical norms, we are well into recessionary territory but have no fear “it’s contained and we are not in a recession until we see two quarters of consecutive declines in GDP.” If I hear that one more time, I’ll be cleaning puke off of my monitor. For those that continue to use this definition, I offer one more time, the true definition per the NBER (National Bureau of Economic Research):

 ”A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

The 2001 recession NEVER experienced two consecutive periods of decline of GDP into negative territory yet the main stream media persists in using this convenient conclusion to proclaim their ignorance of fact.
So of those who are working, just how many hours are they working?

Better pray those wages accelerate soon or we are looking at a nightmare; an under utilized wage earning class who are making less than they did fifteen or twenty years ago due to the inflation tax but working harder and fewer hours to earn less. Not good, not good at all. But what about all the “overtime” they get? Let us check out the manufacturing sector, where overtime and higher output go hand in hand:

Well, with the decline in manufacturing and this chart that speaks volumes. We are below the hours of overtime in the last recession approximately and there is no indication that we are about to see this chart turn upwards. For those of us on a salary however, there is not enough room on this graph or this page to illustrate the “overtime” we are putting in now to bail water out of the Titanic with our sand buckets. The reflection on just how bad things are about to get is obvious when one looks at the housing statistics that are not often discussed and the situation the banks find themselves in now.

3. Paging the NAR, Your House is Not in Order, Nor On Order, Nor Sold, Nor Financed, Etc….

First the really bad news….

That is not a pretty picture for single family home sales.Nor does it appear that with the firecracker called WCI going off in the distance that supply is going to be in shortage any time soon. Let us get one more perspective on this:

Now the good news:

It appears we may have found a temporary bottom but it is too early to tell. Just because a permit is issued, it does not mean the building can or will be built. We can compare that chart in about six to nine months to the housing starts chart to get a better picture. Either way, the data indicates a recession has or is occurring. The problem is that the stress on the banking system may prevent the credit necessary from being freed up to loan to individuals unless a government sponsored enterprise agrees to buy every shanty on the side of the road. Oops, they already did!

4. Banking Troubles Blowing Bubbles, or Dear Ben, Can We Keep our TSLF for Ten Years Please?

Now the obvious consequence of a slowing economy in an inflationary environment with a deflationary housing market which will soon have a deflationary commercial real estate market joining it.

People are over extended.

Duh.

Understatement of the century. How understated?

Not good. Even if 5% default, not good. But in a deep recession 10, 12 or 20% default rates would not be unreasonable. That will not sit well with the banking system and starts to paint the fiscal stimulus camp into a major corner.

When did the problem start? Here is my theory:

It was about this time on the graph that I have highlighted that the first hints of a solvency crisis began to rear its ugly head. The consumers were applying for and receiving credit cards in record numbers. Automobile manufacturers, desperate to rotate inventory and continue producing at a rate far beyond demand offered 72, 78 and yes 84 month loans along with creative finance options on leases of every variety. The SUVs had to move so why not just “get them off the lot” was the theory. Then add in the housing circus that was peaking with “Flip this Outhouse” being the theory of the day and the first of the Subprimers calling up the banks and saying “Uh, nice house but I do not understand this word ‘reset’ that is in this letter you sent me. I can not afford a house with payments of $3400 per month on my Bennigan’s waiter’s salary. Care to cut it back and just rent it to me?” What is the hint that this problem is starting to get really bad? The chart above just illustrates that Debt Service Payments are declining as a percentage of disposable income at that time. Why is that important? Because in a lot of cases, the debtor just walked away and quit paying. It is that simple.

How are the banks faring now? Let’s look at nonperforming loans…..

As you can see from the graphs above, the charts indicate that the non-performing loans and assets are accelerating upwards while revenue streams due to tightened credit restrictions are starting to constrict. Maybe the Fed can create a ten year temporary loan facility to prevent those bonuses from going “buy-bye!” And if you think this is bad, think of the consequences of numerous small banks failing again. The small banks were supposed to screen applicants and prevent unqualified applicants from getting homes, cars, etc. at every level. But with “securitization” also know as pass-the-buck-to-the-Chicom-Indian-Saudi-Franco-Brazilian sucker theory, who cares who got what? They could approve people living under bridges for $300,000 homes and if they only had to keep ten percent of the liability on their books, they figured that the government would bail them out thanks to the new Greenspan Benefactor Policy. The problem with losing the local banks for day to day dealings and having to deal with the mega banks will become a fact of everyday life when you try to get a loan and have to explain everything to “Emma” in Mumbai at extension 2197.

The harsh reality is that the next shoe is dropping now, as I warned about and predicted well over a year plus ago. The commercial real estate failures always follow residential ones and since we are only halfway through the housing crisis, just wait and see how severe the commercial real estate crash is about to become. Per a Reuters story today, Delinquent US Property Loans Rise in June, the pace of defaults is starting to increase now up to 0.45%. While that does not sound like much, it is the relative impact you have to pay attention to. 0.45% to Citigroup is nothing; to a small undercapitalized bank that is borderline in FDIC violation of reserve requirements that dollar figure could trip it over the edge. In other words, one major project failing could trigger action at the local level due to too much bad paper on the books.

The reality of this is illustrated here:

The pace is starting to creep into historically recessionary territory. Add that in with residential weakness and this could get very, very ugly and much faster than the Fed or Congress can respond.

This chart:

Indicates that we are now above the 2001 recessionary levels. At that time though we did not have the residential real estate problems we are witnessing now.

There you have it boys and girls. I see no indication that without a massive inflationary effort will the problems illustrated above be reversed or prevented from worsening. Now that the FDIC is in action starting to clean up the obvious, one has to wonder at what point and pain level will the American people accept an Argentine style inflationary spiral to avoid the deflationary pain that is needed to clean the system out? I just do not see a student of history, especially the Great Depression, like Ben Bernanke making the same mistakes of his predecessors which allows the corrections to occur and spiral beyond the Federal Reserve’s control. Thus I see nothing to turn off the monetary spigots at this time. They will inflate and if the Fed refuses to, the politicians will introduce a fiscal monetary stimulus which will have the same impact by flooding the nation with money for projects we can not afford.

On the good news, one more graph. Someone is still hiring at least: