In this issue:
The Recent GDP Numbers – A Real Statistical Recovery
Consumer Spending Rose? Where Was the Income?
A Bubble in Complacency
Egypt
Rosie, Las Vegas, Phuket, and Bangkok

This week I had the privilege of being on the same panel with former Comptroller General David Walker and former Majority Leader (and presidential candidate) Richard Gephardt. A Democrat to the left of me and a self-declared nonpartisan to the right, stuck in the middle and not knowing where the unrehearsed conversation would take us. As it turned out, to a very interesting conclusion, which is the topic of this week’s letter. By way of introduction to those not familiar with them, David M. Walker (born 1951) served as United States Comptroller General from 1998 to 2008, and is now the Founder and CEO of the Comeback America Initiative. Gephardt served in Congress for 28 years, was House Majority Leader from 1989 to 1995 and Minority Leader from 1995 to 2003, running for president in 1988 and 2004.

Some housekeeping first. We have posted my recent conversation with George Friedman on the Conversations with John Mauldin web site. And on Saturday we will post the Conversation and transcript I just did with David Rosenberg and Lacy Hunt, which I think is one of the more interesting (and informative!) ones I have done. You can learn more about how to get your copy and the rest of the year’s Conversations (I have some really powerful ones lined up) by going to www.johnmauldin.com/conversations. Use the code “conv” to get a discount to $149 from the regular price of $199. (If you recently subscribed at $199 we will extend your subscription proportionately. Fair is fair.)

And go to www.johnmauldin.com to contribute comments on this letter. I do read them!

The Recent GDP Numbers – A Real Statistical Recovery

Now, before we get into our panel discussion (and the meeting afterward), let me comment on the GDP number that came in yesterday. This is what Moody’s Analytics told us:

“Real GDP grew 3.2% at an annualized pace in the fourth quarter of 2010. This was below the consensus estimate for 3.6% growth and was an improvement from the 2.6% pace in the third quarter. Private inventories were an enormous drag on growth, subtracting 3.7 percentage points; this bodes very well for the near-term outlook and means that current demand is very strong. Consumer spending, investment and trade were all positives for growth in the fourth quarter; government was a slight negative. The economy will see very strong growth in 2011 as the tax and spending deal passed in December stimulates demand and the labor market picks up, creating a self-sustaining expansion.”

This 3.2% followed a 1.7% in the second quarter and a 2.6% in the third quarter. The trend is your friend.

Well, maybe not so much. That inventory number seemed odd to me, and looking into it with Lacy Hunt, it turns out there is more than the headline number. For some of you, this is going to be a little like “inside baseball;” but the way they calculate the GDP number can have some odd effects every now and then. And this quarter the effect was way more than normal. This is going to be somewhat counterintuitive, but hang in there with me as I try to make it simple.

You remember our old friendly equation:

GDP = C + I + G + (Net Exports) or

Gross Domestic Product is the combination of domestic Consumption (both consumer and business) plus Investments plus Government Expenditure plus Net Exports (exports minus imports). This latter category has been negative for quite some time, as imports, especially oil, have been larger than exports.

Now to get Real GDP (actual GDP after inflation) you have to take away the effects of inflation/deflation. This is done by the use of a deflator built in for each category. But the deflator for exports/imports is a little tricky at times.

Moody’s correctly noted that “private inventories were an enormous drag on growth” and concluded that this was a good thing, in that they assumed that meant inventories went down and thus inventory rebuilding in future quarters will add to GDP growth. And that is where you have to look at the numbers, and there we find our anomaly. There really wasn’t that big a drop in inventories. It was in large part in the statistics, not in the warehouse.

Oil in the 4^th quarter rose from roughly $81 to $89, or about 10%. On an annualized basis, this is 40%. Inventory investment is equal to the change in book value of the inventories, minus what is known as the IVA, or inventory valuation adjustment, which is used to correct for prices going up or down. Because the value of oil rose and thus cost more to acquire, the accounting requires that you reduce the value of the current inventories. Thus “real” imports fell at a 13% annual rate. Why? Because the deflator rose by 19%, largely because of the rise in the price of oil.

I know, I know, I just wrote that because the price of oil went up, the “real” value of imports went down, as well as inventories. Some of you are getting economic whiplash right about now.

If oil were to go back down this quarter by the same amount, that “growth” could be wiped out. There is no conspiracy here. It is just a statistical necessity, like hedonic measurements, and it is all very clear in the fine print; but when there are wide swings in oil prices over a quarter, and because our imports of oil are so large, you can get these odd accounting factoids. Which the gunslingers on TV (and elsewhere) miss in their urge to be the first to get out a bullish statement!

How much did it change things? Lacy thinks by anywhere from 0.5% to 1%. That means GDP is still a positive number, but there is not a “3” handle at the beginning of it. In the grand scheme of things, no big deal, as it will balance out over the coming quarters and years. But I just wanted to point out (once again) that you have to take some of the numbers we get from our government with a few grains of salt. That’s the key takeaway here. And they CERTAINLY should not be traded upon. (Anybody who trades on the employment numbers deserves what they get, which is usually a loss. But back to our story.)

Consumer Spending Rose? Where Was the Income?

The really surprising number you saw the talking heads on TV mention was the growth of consumer spending, at 4.4%. Is the US consumer back? After all, real final sales rose by 7.1%, a number not seen since 1984 and Ronald Reagan. But real income rose a paltry 1.7%. Where did the money that was spent come from? Savings dropped a rather large 0.5% for the quarter. That was part of it. And I can’t find the link, but there was an unusual drawdown of money market and investment accounts last quarter, somewhere around 1.5%, if I remember correctly. (David Walker remembered that article as well.) That would just about cover it. But that is not a good thing and is certainly not sustainable.

Let’s see what good friend David Rosenberg (more on Rosie below) has to say about those numbers:

“Even with the Q4 bounce, real final sales have managed to eke out a barely more than 2% annual gain since the recession ended, whereas what is normal at this stage of the cycle is a trend much closer to 4%. Welcome to the new normal.

“There is no doubt that there will be rejoicing in Mudville because real GDP did manage to finally hit a new all-time high in Q4. The recession losses in output have been reversed (though what that means for the 7 million jobs that have to be recouped is another matter). But, before you uncork the champagne, just consider what it has taken just to get the economy back to where it was three years ago:

· The funds rate moved down from 4.5% to zero.

· The Fed’s balance sheet expanded by more than 1.5 trillion dollars.

· The printing of M2 money supply of around 1 trillion dollars (the illusion of prosperity).

· Expansion of federal government debt of 4.8 trillion dollars.

“All this heavy lifting just to take the economy back to where it was in the fourth quarter of 2007. As they rejoice in Mudville, the memory is conjured up of Billy Joel bellowing out those famous words ‘Is that all you get for your money?’”

“With that being said, the bulls have the upper hand as they have since late August. At this point, the best advice we can give is to remind everyone that we entered 2010 with a 5% real GDP print in our hands. Back then, the most dangerous thing anyone could have done was extrapolate that performance through the winter, spring and summer months, when air pockets in the economic data surfaced, as Fed and federal government stimulus faded, and the equity market rode a wild roller coaster ride until Ben reclaimed his helicopter license.”

A Bubble in Complacency

Thursday put me in an introspective mood. It was the annual Tiger 21 conference, and the room held about 150 or so very-high-net-worth participants. The lunch session was Greta van Sustern interviewing Newt Gingrich. And yes, from what I heard he is going to run. I am glad about that, because he will raise the intellectual heft of the debate. I am nothing if not a political realist, having been involved in a lot of campaigns. I know the issues surrounding Newt. But far more important is that we have an honest national conversation that is a few notches above what we got in 2008. We so need more than sound bites and posturing. We need actual plans. There are several people I hope will run on the GOP side, as I think they bring something to the discussion. I will interject a few comments from Newt below.

As noted above, I did not have any real idea where we were going with the panel. Clearly, Leader Gephardt was a pro-union, card-carrying Democrat, but he was very obviously concerned about the direction of the country and is very up on the issues. You don’t run for president twice without having some personal “mojo.” (And for the record, let me say that I really liked him. We three got together in the bar with some good wine after our presentation, waiting for the cars to take us to the airport, we and really got along. How in hell did Kerry beat him?) David Walker has been running around the country for three years telling people that we are on an unsustainable path. I have a book coming out in a month talking about the next and coming crisis (some of which has been the subject matter of this letter).

There was surprising agreement among us (surprising to me, at least). The gist of it is this (and if you have been paying attention this is no surprise):

We (the US) are on an unsustainable path. As Walker noted, cutting the budget (spending) by a few hundred billion dollars does not get us to sustainability. Going back to the 2007 budget level would be helpful but not sufficient.

Did you see the CBO (the more or less independent Congressional Budget Office) estimates of the deficit that came out this week? The CBO said the fiscal 2011 deficit will hit $1.48 trillion, up from last August’s $1.07 trillion estimate. Other estimates, not forced to use unrealistic assumptions, are much higher.

And the real world? It is a whole lot uglier. From my friend Bill King at The King Report:

“The following tables from the US Treasury for January 21, 2011 (Friday) and January 22, 2010 (Saturday) show the public debt of the US Treasury has increased from $17.422 trillion to $20.713 trillion, a surge of almost $3.3 trillion in one year. So, the official budget deficit doesn’t tell the real US debt story. Please note that the current US ‘Public Debt Issues’ is 44.75% higher than the $14.3 trillion debt limit because it includes bailouts, Fannie Mae, Freddie Mac, student loans and other off-balance sheet funding.

The simple answer is that no possible resolution of the fiscal deficit that gets us to sustainability (which logic defines as below-nominal GDP, although surpluses would be nice) can be done without real cuts to Medicare entitlements or increased taxes or some combination.

Yes, there is a lot of waste in the medical system. Gingrich pointed out that American Express has about 0.3% fraud and Medicare had 13%. That is a hundred billion or so. American Express runs a real-time system and Medicare is still on paper. He listed other things that can be done. But back to our plot line of controlling the fiscal deficit.

We located the problem. There is about 30% of the electorate that is mad at Obama and the Democrats for not getting a single-payer, full health-care program. They want nothing less than that.

Then there is the 30% or so that are mad about increased taxes, runaway spending, and budget deficits. They will likely punish any Republican who even utters the word “increase” in the same sentence with taxes, unless they are talking about those bad tax-and-spend Democrats.

Right now, neither side seems willing to compromise. Obama has punted on coming up with any real solutions. Offering to freeze spending at today’s level is a joke. It is like one of my kids (and this has happened, kind of) getting my credit card, spending a ridiculous amount of money, and then saying, “Ok, Dad, if you’ll give me the card again I promise I won’t spend more than that!”

But the GOP is saying they want to cut spending around the edges of the budget without dealing with the real elephants in the room, Social Security and Medicare. They have some plans that get us closer, but none that David or I could see that gets us there.

What happens if someone talks about real adjustments to the entitlement programs, or tax increases? Look at what happened to the Deficit Commission and their reports. They were dead on arrival. I thought they had some interesting ideas.

It is hard to get to a real compromise with that level of conversation. But what the three of us on the panel did agree on is that if a compromise is not reached, the end result looks like Greece.

My points were that much of Europe is getting ready to give us a real crisis, sooner rather than later. Great Britain is headed for what looks like a recession and further problems. Japan, as I am wont to say, is a bug in search of a windshield. We are going to get some great real-time lessons on what happens when you don’t deal with a problem in time. The longer you wait, the worse the results will be when you are forced to deal with the issues.

The lack of compromise is going to run head on into a bond market that will force one, or raise rates until there is truly a crisis of biblical proportions. If you think high rates were bad in the ’70s (and they were, trust me!), think what they would be like in a deflationary environment.

For that is what would happen. We would fall into a severe recession, and recessions are by definition deflationary. And depending on how late we are in getting our act together, it could be worse than a recession. We could drag the whole world down.

Leader Gephardt spoke to the fact that it will take politicians essentially violating what they feel are their core views, for the good (and survival) of the nation. He thinks that there are enough leaders who get it now that a compromise is possible, although he noted that Obama is going to have to back off on some of his main issues. Newt said flat out that he did not think a compromise was possible, as he did not think Obama would reverse. Let’s call Walker a skeptical optimist. Me, I think it is 2013 before we get the real changes. I just see a bubble in complacency. The market is going up, so all must be right with the world.

If we don’t get those real changes, we will need to start thinking the unthinkable.

Can we last until 2013? Most likely, as we are going to see some cosmetic changes and that should encourage the bond market. But as our leaders watch the problems of the rest of the developed world increase then, depending on what they do, they could cut us a much shorter leash. We are approaching the Endgame. I worry that we could go much beyond that point without serious volatility and market upheaval.

And that is why the GOP primary is so important. There is not going to be much of a debate, if any, in the Democratic primary. Obama will coast to the nomination. All the real debate will be on the Republican side. And that is why we need “idea leaders” to step forward. Philosophy is all well and good, but we are getting ready to encounter a potentially very difficult bond market. There is hope that we can avoid the real hitting of the wall that I think is going to be Japan’s fate, but it will take some real solutions to problems, not just words. I want to see budgets. What do you cut? Do you raise taxes? Can we take this opportunity (let no crisis go to waste!) to actually reform the tax code? Maybe move to more of a consumption-based tax? Tax less of the things we need and want (like jobs, exports, and savings!) and more of the things we have less need of? Just a thought. Can we get a thought leader on the debate platform to offer a real restructuring? And make a solid case for it? Actually get the American people to focus on the crisis that is coming if we don’t act? (Not to mention those pesky wars, energy policy, the environment, etc. etc.)

Is there a compromise out there? Should there be one? That is the conversation we will have to have.

This national conversation will be the most important in my lifetime (I don’t say that lightly). Not just because of whom we elect, but because the bond market vigilantes will be paying attention to what we are saying. If they see the same old rhetoric, we will be in for a very bumpy ride.

Egypt

For those looking for good analysis on Egypt and the Arab world, I commend this video from George Friedman of Stratfor to you, at http://www.stratfor.com/analysis/20110128-agenda-george-friedman-egypt.

Rosie, Las Vegas, Phuket, and Bangkok

Next week is as busy as it gets, crammed with meetings and airports. Non-stop meetings all day Monday, which means I have to get up early to get my reading done, then an evening with the guys. Good friend David Rosenberg is flying in from Toronto, and Darrel Cain and I will take him to the Mavericks game, along with my new Chief Implementation Officer, Peter Mauthe; friend and soon-to-be business partner Barry Habib; and son-in-law Ryan. I see steaks at Nick and Sam’s.

The night before I will be with Brad Kroenig, eating fish at Ocean Prime. Google that name and then wonder what the hell we have in common. I met him in Palm Beach. Very smart young man. (Think biotech.)

Off to Vegas on Wednesday for a conference with Steve Blumenthal of CMG, and then Thursday night I board a plane for Hong Kong and then slip over to Bangkok and Phuket. I will play tourist for a few days getting on the time zone, then deliver a longish presentation, and spend the rest of the week in Bangkok, where I am going to take some time to see a city where I have never been. While I will work about four hours a day (the plan now), I really do hope to take some time to enjoy the sights and sounds and food. One of my long-time best friends, Tony Sagami, has graciously offered to show me around, although he says we will not go to restaurants frequented by farang (foreigners). Local favorites only.

It is my intention to write while I am away. Since I seem to be traveling more, I need to get able to keep up. We have switched my main computer to my laptop, so that now I carry my work with me rather than remoting in, which will make it easier to write on the road. I have upgraded to all the latest and great Microsoft, so I have some learning curves ahead of me, and may do a few educational videos on the plane ride. Old dog and new tricks and all that.

I am really excited about Thailand. It is a place I have wanted to visit forever. Tony says I will try and find excuses to go back every chance I get. But then there is Tuscany. I have to go back there this summer.

Life is good. Tiffani and I were talking about how we are literally busier than we have ever been. But I am grateful, as many are not.

Your amazed at how my world has changed analyst,

John Mauldin
John@FrontlineThoughts.com

Copyright 2011 John Mauldin. All Rights Reserved

Related Posts

1. First, Let’s Lower the Bar – John Mauldin’s Weekly E-Letter

First, Let’s Lower the Bar

China’s currency is rising ever so slowly against the dollar. But is that hurting China? We will look at a very interesting chart and some research. And then we’ll gain some more insight into why the employment numbers seemed to surprise. I guess if you lower the bar, it’s easier to jump over. I also deal with the pushback from last week’s Outside the Box! And Ireland is on my radar. There is a lot to cover, so let’s jump in.

I start this week’s letter on a flight from Cleveland (where I was at the Cleveland Clinic meeting with my good friend and doctor Mike Roizen (of Oprah and the various “YOU” books with Mehmet Oz) on some non-health-related business, and we talked last night about the state of health care. Mike keeps pointing out that much of our health-care cost comes from chronic diseases that are either directly or partially lifestyle choices. And he is right. The data shows it. Smoking, overeating, lack of exercise – all contribute to our health-care bills. And health care was on my mind.

Now, a little mea culpa. I get letters from readers who start their missive out with something like, “I know you probably won’t read this, but…” Well, I can’t say I read every letter, but someone does and I get and read as many as I can. And my rule is that I get all the negative ones, and any letters that show particular thoughtfulness and give me suggested reading or just good suggestions. I do pay attention to you. It takes some time, I admit, but I think it is important.

And the feedback I got on last week’s Outside the Box on health care was definitely running much more on the negative side. And as it turns out, for good reason. There were just simply some factual errors in the piece that made it more partisan than it sounded when I first read it. And many readers justifiably took me to task for that.

What attracted me to the piece to begin with was the central fact that the incentives within the health-care bill give businesses significant monetary reasons to do things that are not in what I think of as the best interests of the economy or labor. Businesses will be able to save a great deal of money by canceling their employer-paid insurance plans and simply paying the fine and offering their employees some kind of cash payment to buy managed-care programs. Go to Friday’s USA Today. Read the story on Medicare-managed health care, about the shortage of specialty doctors and the denial of benefits that I think of as routine in my more or less plain-vanilla health insurance plan. I don’t think people are going to be happy.

Second, there is the incentive to hire part-time employees over full-time, and thereby not have to provide insurance. This is already an issue I see every week with my own kids, as getting full-time jobs even in relatively OK Texas is an issue. As a nation, we are already witnessing a disconcerting and still-rising level of part-time employment. Do we really want to encourage more of that?

If there is one thing we know in economics (and there are admittedly distressingly few of them), it is that people respond to incentives, whether intended or unintended. I don’t think the writers of the health-care bill intended to increase part-time employees, keep payrolls under 50 employees, or encourage businesses to dump their health insurance or move to outsourcing, etc. But if you are a business person facing budget and sales shortfalls, rising prices, and fierce competition (is there any other kind?), saving $2-3,000 per employee is going to be tempting. When two part-time employees cost $3-6000 a year less than one full-time? What do you choose when the boss is breathing down your neck about expenses? The recent employment data tells me that already businesses are opting for more part-time workers. It doesn’t work for every business, but it will for a lot of them. I hope that is not going to be the case, but I want policies that encourage and reward good corporate behavior.

For many people who read the letter, the factual errors obscured the main points. Frankly, I understand. I often have that reaction in reading other material myself. But Outside the Box is not “other material.” I put this out there, and with the core standards we have in place, I should not have been as tone deaf. I WILL be better. And in a few weeks, we will have a new website with reader forums and feedback (targeting December – this is a major project and they always take more time than I would like).

Two things I did take away from the feedback. First, most of my readers are amazingly civil in an era where simple civility on the internet is not the norm. And second, this is an extremely emotional issue. Most of us have stories about people who have been hurt by not having access to health care. And it is a lot more complex, with more moving parts, than any issue we face as a nation.

I spent some time with Newt Gingrich this Wednesday. He seems to me surprisingly upbeat about the potential for solutions to the health-care issue. He points out that there are some amazing medical advances just around the corner. A cure for Alzheimer’s would save, according to Newt, about $20 trillion over the coming decades. Cancer? Heart disease? My friend Pat Cox suggests we are on the edge of a tsunami of medical breakthroughs.

But we have been seemingly on the edge for a long time. As I wrote a few weeks ago:

Let’s look down the road. I think we will at best be in a Muddle Through Economy for the next two years. Unemployment is going to be above 8%, best-case, in 2012. If the Bush tax cuts are not extended, in my opinion it is almost a lock that we go into recession next year, unemployment goes to 12%, and underemployment gets even worse. That is not a good climate for Obama and the Democrats in 2012. It is especially bad when you look at the number of Democratic Senate seats up for re-election that are in conservative states. The Republicans could take a serious majority in the Senate.

And then what? Right now Republicans are running on promises that they will not cut Medicare and Social Security, but are going to reduce spending and get us closer to a balanced budget. But everyone knows that the only way to get the budget into some reasonable semblance of balance will be to either cut Medicare benefits or increase taxes.”

There are only the two options. Yes, you can reform medical care, and I think much of Obamacare should certainly be repealed, but that does not get us anywhere close to dealing with the real issue, and that’s a fact. There are tens of trillions in unfunded liabilities in our future, which must be dealt with.

Let me be very clear on this. I am not really worried about the supposed $75 trillion in unfunded Medicare liabilities in our future. That is an impossible number. If something can’t happen it won’t happen. Long before we get to that apocalypse, we find a bond market that simply refuses to fund US debt at anywhere near an affordable cost. Crisis and chaos will ensue.

People only accept change when they are faced with necessity, and only recognize necessity when a crisis is upon them.

- Jean Monnet

The simple reality is that if We the People of the US want Medicare, in even a reformed and more efficient manner, we must find a way to pay for it. It will not be cheap. Raising income taxes on the “rich” is not enough. You have to go back and raise income taxes on the middle class, too. Oh, wait, that will be a drag on the economy and consumer spending. And in any event it will not be enough.

The only real way to pay for those benefits will be a value-added tax, or VAT. And while it could be introduced gradually, let there be no mistake that it will be a drag on economic growth. Government spending does not have a multiplier effect on the economy. It is at best neutral. What creates growth is private investment, increases in productivity, and increases in population. That’s it. Tax increases have a negative multiplier.

A significant VAT along with our current income taxes will give us an economy that looks more like the slow-growth, high-unemployment world of Europe. Can we figure out how to deal with that? Sure. But it is not growth-neutral.

Republicans in 2013 will be like the dog that caught the car. What do you do with it? The last time they (embarrassingly, we) really screwed it up. The defining political question of this decade will not be Iraq or Afghanistan, or the environment or any of a host of other problems. The single most important question will be what do you do with Medicare? Cut it or fund it? Reform it for sure, but reform is not enough to pay for the cost increases that will come from an increasingly aging Boomer generation.

There is no free lunch. At some point, Republicans cannot run on “no cuts in Medicare” and “no new taxes” and be honest. At least not this decade. Maybe when we have cured cancer and Alzheimer’s and heart disease and the common cold at some future point, medical costs will go down, but in the meantime we have to deal with reality.

You may be able to fool the voters, but you will not be able to fool the bond market. Not dealing with reality will create a very vicious response. Ask Greece.

And that is the national conversation we must have with ourselves. There is a cost to government. There is a cost to extended Medicare benefits. (I am blithely assuming we deal with all the “easy” stuff like Social Security, and make real cuts in other areas.)

Enough on medical issues. Let’s jump into the rest of the letter.

The Chinese Renminbi is Going Down, Not Up

While I was sitting in the trading room of my co-author of The Endgame, Jonathan Tepper, last week, we got to talking about the need for the Chinese currency to rise against the dollar, and of late it has been, slowly, accompanied by the moaning and groaning of the Chinese leadership. But has it really gone up? Take a look at the following charts I had the guys at Variant Perception make for us:

Notice that of China’s main trading partners, the US is the only one against whose currency the yuan has risen over the last three months. If you are in the eurozone, you have seen an almost 4% rise.

Now look at the next chart. We are comparing the Chinese yuan against the dollar and then against the trade-weighted Chinese yuan. Notice that for the last 18 months the trade-weighted yuan has dropped well over 10%! In terms of real trade with China’s real trading partners, the yuan has fallen in value! That is extraodinary.

Expect more calls from around the world for China to allow its currency to rise. And as China has to deal with inflation, it may be in their interest. We will see. But it does make you go “hmmm.”

First, Let’s Lower the Bar

I was sitting in London when the employment numbers came out last Friday, and I didn’t have time to really get into the data. I did send you Lacy Hunt’s quick analysis as to why it was weaker than it appeared, but something else did not seem right. I follow a few people who are pretty good at predicting the employment numbers (like Philippa Dunne of The Liscio Report). Most were expecting numbers in the 60,000 range. Most unusual for there to be such a big miss from these guys. I read the press release and saw nothing to raise my eyebrows. And then Alan Abelson in Barron’s gave us the following, after reciting the headline number:

“Happily, the always astute Stephanie Pomboy of MacroMavens provided a quickie explanation:

” ‘The seasonal bar which the payroll data must jump was (inexplicably and dramatically) lowered from prior Octobers.

” ‘Thus, in October 2009, the BLS set the bar at 870,000 jobs, similar to the 840,000 it anticipated in October 2008. This year, by contrast, it lowered the bar to 768,000. Mumbo, jumbo, payrolls presented “an upside surprise” of 100,000.’

“According to John Williams at Shadow Government Statistics, the BLS’ fiddling with the figures via what he calls ‘seasonal-factor games’ actually created 200,000 phantom jobs last month. John cites such finagling as the reason his prediction of an October decline and a rise in the jobless rate was wrong. It also explains why seasonally adjusted payrolls were revised upward by 110,000 in September, including 56,000 in August.”

In the opinion of your humble analyst, if they are going to make such changes, they should be announced up-front or noted prominently in the press release. People (foolishly) trade on these numbers and money is made and lost. This is serious stuff.

They Need to Borrow How Much? Really?

The team over at Recovery Partners sent this note along:

“This week we heard from the IMF that the total borrowing requirements of key governments in 2011 will amount to around $10.2 trillion. The estimate represents a rise of 7% from 2010 and over 27% of the annual GDP of the developed economies.This rollover profile exposes the vulnerabilities in thematurity composition of Sovereign liability portfolios and thelikelihood that most Sovereigns will find it impossible to appropriately de-risk their financial exposures by extending term or otherwiseexecuting an immunization strategy. The bottom line is that unless deficit control and the establishment of debt management performance benchmarks is adopted as a matter of urgency in many economies, it becomes very easy to envision the near term onset of another round of severe financial turbulence.”

That is obviously a lot of money. It is also government borrowing that is crowding out private investment. And as we look over the “pond,” the euro is again under pressure. Just when you thought QE2 was going to tank the dollar.

Irish Eyes Are Not Smiling

Mother Ireland (Dad said we were once Muldoons before we were kicked out) is having problems. It was only a few years ago that we talked about the Irish Miracle. They had gotten a grip on their fiscal deficits and were even running surpluses. And then came the housing bubble, and their bank problems dwarfed those (relatively) of the US.

Ireland is simply not having a good go of it. They can’t seem top catch a break of late -their Irish luck is abandoning them. Let’s look at some charts from my favorite slicer and dicer of data, Greg Weldon, which just hit my inbox. After noting the rise in suicides and calls to suicide hotlines due to economic pressures on farmers (who are caught in a drought) and foreclosures, he writes:

“… the Irish Central Bank determined that Ireland’s financial institutions needed MORE capital, essentially DOUBLING the cost of the original bailout, and obliterating ANY chance for cutting the Budget Deficit in 2010. In fact, according to “The Economist”, if we were to include the cost of the financial system bailout, and, consider the decline in GDP … Ireland’s Deficit-to-GDP Ratio, already FOUR TIMES the EU’s (allegedly) ‘hard-ceiling’ of 3%, as just under 12% … would EXPLODE, to 32% !!!!

“Subsequently, on October 6th Fitch cut their sovereign debt ‘rating’ for Ireland, to AA-, from A+, in order to … ‘reflect the exceptional and greater-than-expected cost of the nation’s bailout of its banking system.’

“Then note the ‘projected’ Deficit when we include the government’s increasingly large bailout of the country’s financial institutions. Irish eyes are no longer smiling … rather, Irish eyes are crying.

“During a debate on Tuesday in the Parliament, Prime Minister Cowen said …

” ‘… If this country and this parliament fails to make the necessary adjustments, then we put at risk the funding of the State after July of next year and what will happen then is that we will be faced with a situation where we will only be able to spend EUR 31 billion. The State could not go on spending EUR 50 billion a year, when it was only taking in EUR 31 billion. Being only able to spend EUR 31 billion would involve a serious adjustment in the level of (government) services that could be provided. No responsible government, therefore, could contemplate that approach.’

“Say what … no responsible government could contemplate spending what they take in?? Indeed, herein lies the core of the crisis … to cut spending by the amount needed to ‘fix’ the fiscal mess that European countries now find themselves facing … would be so dramatic as to cause INTENSE economic PAIN, enough so to drive even more Irish farmers, policemen, realtors, and plumbers … to suicide.”

I have been writing for years that much of Europe was in far worse shape than the US, and we are not in a good way. Irish 5-year bonds now cost 8.44%, up from below 4% in August, just three months ago. Ireland is going to have to finance debt of almost 40% of GDP this year and 20% next year. As they roll over that debt, interest-rate costs are going to skyrocket, making those budget cuts even harder.

And the same goes for Greece, Portugal, and Spain. With German Chancellor Angela Merkel having to face elections, she says her goal is to “enforce fiscal discipline in the euro area and avoid putting German taxpayer money on the line in any future bailout.” She noted at the G-20 meeting yesterday:

“There may be a conflict here between the interests of the financial world and the interests of politicians… We can’t constantly explain to our voters that taxpayers have to be on the hook for certain risks rather than those who make a lot of money taking those risks.”

This is not going to be easy. I expect it to end in tears for some of the more troubled countries. It is all so very sad.

La Jolla, New York and a Forbes Cruise

If it seems like I have been living on planes of late, I guess it’s because I have. And in another last-minute trip, Tiffani and I will go to La Jolla to meet with Jon Sundt and the management of Genworth, which has bought Altegris. I am rather enthusiastic about the new arrangement, as it opens up all sorts of possibilities.

Then I am home for a while. Thanksgiving will feature lots of kids and friends, and I am looking forward to it. I really enjoy cooking and the whole feel of the holiday. Then Tiffani and Ryan and I go to LA, where we get on a ship for the Forbes Cruise. I am looking forward to a little R&R going down the Mexican coast, and spending time with old friends and making new ones. I have to sing for my supper a few times, but I can do that. It is actually fun for me.

Then a quick trip to New York in mid-December (details to be determined), and then home for the holidays and Christmas. I love this time of year.

Have a great weekend and enjoy the season.

Your ready to relax analyst,

John Mauldin
John@FrontLineThoughts.com

Copyright 2010 John Mauldin. All Rights Reserved

Note: The generic Accredited Investor E-letters are not an offering for any investment. It represents only the opinions of John Mauldin and Millennium Wave Investments. It is intended solely for accredited investors who have registered with Millennium Wave Investments and Altegris Investments at www.accreditedinvestor.ws or directly related websites and have been so registered for no less than 30 days. The Accredited Investor E-Letter is provided on a confidential basis, and subscribers to the Accredited Investor E-Letter are not to send this letter to anyone other than their professional investment counselors. Investors should discuss any investment with their personal investment counsel. John Mauldin is the President of Millennium Wave Advisors, LLC (MWA), which is an investment advisory firm registered with multiple states. John Mauldin is a registered representative of Millennium Wave Securities, LLC, (MWS), an FINRA registered broker-dealer. MWS is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB). Millennium Wave Investments is a dba of MWA LLC and MWS LLC. Millennium Wave Investments cooperates in the consulting on and marketing of private investment offerings with other independent firms such as Altegris Investments; Absolute Return Partners, LLP; Fynn Capital; Nicola Wealth Management; and Plexus Asset Management. Funds recommended by Mauldin may pay a portion of their fees to these independent firms, who will share 1/3 of those fees with MWS and thus with Mauldin. Any views expressed herein are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest with any CTA, fund, or program mentioned here or elsewhere. Before seeking any advisor’s services or making an investment in a fund, investors must read and examine thoroughly the respective disclosure document or offering memorandum. Since these firms and Mauldin receive fees from the funds they recommend/market, they only recommend/market products with which they have been able to negotiate fee arrangements.

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(Note: This interview was originally recorded on September 20, 2010)

In the video below, Robert Prechter talks to Yahoo! Finance Tech Ticker host Aaron Task and Henry Blodget about a technical pattern he sees forming in the Dow.

Get Up to Speed on Robert Prechter’s Latest Perspective — Download this Special FREE Report Now.

About the Publisher, Elliott Wave International
Founded in 1979 by Robert R. Prechter Jr., Elliott Wave International (EWI) is the world’s largest market forecasting firm. Its staff of full-time analysts provides 24-hour-a-day market analysis to institutional and private investors around the world.

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In this new short video, I show you what I’m looking at and how we showcased this market last week when we did our last webinar. This webinar is set to be rebroadcast on Friday, September 24th at 5pm EST/9pm GMT.

This market is still looking good and looking strong. Pay very close to it this Friday because if it closes well, it should bode well for the following week.

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June 28, 2010

By Elliott Wave International

Ralph Nelson Elliott discovered the Wave Principle in the 1930s. Over the decades, his discovery was kept alive by a handful of individuals. A few of those, such as Bolton, Prechter and Frost, educated investors on how to use pattern analysis in financial markets.

To help out Elliott Wave International’s readers in learning the basics of the method, we put together a free 10-lesson online tutorial. Here’s an excerpt. To get it in full, look for details below.

EWI’s Basic Elliott Wave Tutorial
Lesson 1, excerpt

At that time [of his discovery], with the Dow in the 100s, R. N. Elliott predicted a great bull market for the next several decades that would exceed all expectations at a time when most investors felt it impossible that the Dow could even better its 1929 peak. As we shall see, phenomenal stock market forecasts, some of pinpoint accuracy years in advance, have accompanied the history of the application of the Elliott Wave approach.

Under the Wave Principle, every market decision is both produced by meaningful information and produces meaningful information. Each transaction, while at once an effect, enters the fabric of the market and, by communicating transactional data to investors, joins the chain of causes of others’ behavior. This feedback loop is governed by man’s social nature, and since he has such a nature, the process generates forms. As the forms are repetitive, they have predictive value.

The market…is not propelled by the linear causality to which one becomes accustomed in the everyday experiences of life. Nor is the market the cyclically rhythmic machine that some declare it to be. Nevertheless, its movement reflects a structured formal progression. In markets, progress ultimately takes the form of five waves of a specific structure.

Three of these waves, which are labeled 1, 3 and 5, actually effect the directional movement. They are separated by two countertrend interruptions, which are labeled 2 and 4, as shown in Figure 1-1. The two interruptions are apparently a requisite for overall directional movement to occur.

At any time, the market may be identified as being somewhere in the basic five wave pattern at the largest degree of trend.

Read the rest of this 10-lesson Tutorial and see multiple charts now, free! All you need is to create a free Club EWI profile.

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This eye-opening free report, which represents more than 10 years of research by Robert Prechter, goes beyond the Fed’s history and government mandate; it digs into the Fed’s real motivations for being the United States’ “lender of last resort.” In this 34-page report, you’ll discover how the Fed’s actions, combined with public outrage, may ultimately lead to its demise, plus much more about its secret activities and how it affects your money.

Download your free copy of EWI’s Understanding the Fed eBook, here.

About the Publisher, Elliott Wave International
Founded in 1979 by Robert R. Prechter Jr., Elliott Wave International (EWI) is the world’s largest market forecasting firm. Its staff of full-time analysts provides 24-hour-a-day market analysis to institutional and private investors around the world.

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The Dow Jones industrial average was stopped in its tracks on Friday as it tried for a ninth consecutive session of gains, a feat last achieved in 1996.

A sharp drop in the price of oil weighed on shares of energy companies, and by day’s end, stocks were firmly in negative territory.

The market was hurt as the price of oil retreated nearly 2 percent, briefly dipping below $80 a barrel. That bolstered the appeal of the dollar, which strengthened against the euro and the British pound amid concerns about unwieldy deficits in Europe.

Despite the losses, the Dow ended the week 1.1 percent higher. On Friday, it fell 37.19 points, or 0.35 percent, to 10,741.98. The Standard & Poor’s 500-stock index fell 5.93 points, or 0.51 percent, to 1,159.90. It was 0.85 percent higher for the week.

The Nasdaq fell 16.87 points, or 0.71 percent, to 2,374.41, posting a 0.28 percent gain for the week. It was held back by the smartphone maker Palm, which fell more than 29 percent after offering a disappointing revenue forecast.

A decision by the central bank of India to raise interest rates for the first time in nearly two years brought jitters to the world’s equity markets. Analysts worry that the announcement could encourage other high-growth countries to follow suit as concerns about inflation grow. But investors bristled at the prospect of higher rates, which make lending more expensive and can hurt profit.

Currency markets were in flux on Friday amid lingering uncertainty about Greece, which is grappling with a wide budget deficit as deadlines for debt payments loom. No clear resolution has emerged for the nation, with Germany recently backing off its support of a European-led rescue package. Europe’s wealthier countries are now looking to the International Monetary Fund for help.

Germany’s words exposed new fissures in the effort to ward off a crisis for the Continent and its monetary union.

“It does not look like Europe has a united face to deal with the Greece situation,” said Marc Chandler, the global head of currency strategy at Brown Brothers Harriman.

The pound also weakened, falling more than 1 percent against the dollar, as an official at the Bank of England raised the possibility that the British economy could fall into another downturn. Andrew Sentance, a member of the monetary policy committee, told CNBC, “There is some risk of a double-dip recession but it is not the central forecast.”

Investors also remain concerned that looming elections could result in a fractured Parliament that would be unable to tackle Britain’s deficit problems.

The dollar benefited from those concerns, strengthening against most world currencies. Mr. Chandler said a consensus was emerging that the Federal Reserve would soon move to raise the rate it charged banks on short-term loans, known as the discount rate.

Interest rates were steady. The Treasury’s 10-year note fell 4/32, to 99 14/32, and the yield rose to 3.69 percent, from 3.68 percent late Thursday.

The stock market’s movements were clouded on Friday because of “quadruple witching,” the expiration of futures and options for stocks and stock indexes.

Despite Friday’s losses, investors said they thought some optimism had returned to the market. Economic data has been largely positive lately, and traders are expecting first-quarter earnings to show strong revenue growth. Many also say they think a government report on the labor market to be released next month will show that the economy created jobs in March.

“Investors are starting to get their confidence back, starting to get their feet back underneath them,” said M. Jake Dollarhide, chief executive of Longbow Asset Management.

But recent gains for the market have been small, and trading has been light on some of the most enthusiastic days, raising doubts about the durability of an upward turn.

“It’s a very tenuous, nervous time for Americans,” Mr. Dollarhide added.

New York Times

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By Susan Walker

If everyone says that shocks from outside the financial system — so-called exogenous shocks — can affect it for better or worse, they must be right.

It just sounds so darned logical, right? Economists believe this trope to be true, mainly because they believe that investors are rational thinkers who re-evaluate their positions after every new bit of relevant information turns up.

Beginning to sound slightly impossible? Well, yes.

It turns out that logic is exactly what’s missing from this it-feels-so-right idea of rational reaction to exogenous shocks. Read an excerpt from Robert Prechter’s February 2010 Elliott Wave Theorist to see how Prechter deals with this widely held belief.

Find out what really moves markets — download the free 118-page Independent Investor eBook. The Independent Investor eBook shows you exactly what moves markets and what doesn’t. You might be surprised to discover it’s not the Fed or “surprise” news events. Learn more, and download your free ebook here.

* * * * *

Excerpted from Prechter’s February 2010 Elliott Wave Theorist, published Feb. 19, 2010

The Efficient Market Hypothesis (EMH) argues that as new information enters the marketplace, investors revalue stocks accordingly. … In such a world, the market would fluctuate narrowly around equilibrium as minor bits of news about individual companies mostly canceled each other out. Then important events, which would affect the valuation of the market as a whole, would serve as “shocks” causing investors to adjust prices to a new level, reflecting that new information. One would see these reactions in real time, and investigators of market history would face no difficulties in identifying precisely what new information caused the change in prices. …

This is a simple idea and simple to test. But almost no one ever bothers to test it. According to the mindset of conventional economists, no one needs to test it; it just feels right; it must be right. It’s the only model anyone can think of. But socionomists [those who use the Wave Principle to make social predictions] have tested this idea multiple ways. And the result is not pretty for the theories that rely upon it.

The tests that we will examine are not rigorous or statistical. Our time and resources are limited. But in refuting a theory, extreme rigor is unnecessary. If someone says, “All leaves are green,” all one need do is show him a red one to refute the claim. I hope when we are done with our brief survey, you will see that the ubiquitous claim we challenge is more akin to economists saying “All leaves are made of iron.” We will be unable to find a single example from nature that fits.

* * *

In his February 2010 Elliott Wave Theorist, Prechter then goes on to show charts that examine each of these claims that encompass both economic and political events:

Claim #1: “Interest rates drive stock prices.”
Claim #2: “Rising oil prices are bearish for stocks.”
Claim #3: “An expanding trade deficit is bad for a nation’s economy and therefore bearish for stock prices.”
Claim #4: “Earnings drive stock prices.”
Claim #5: “GDP drives stock prices.”
Claim #6: “Wars are bullish/bearish for stock prices.”
Claim #7: “Peace is bullish for stocks.”
Claim #8: “Terrorist attacks would cause the stock market to drop.”

To protect your personal finances, it’s important to think independently from the crowd, particularly when the crowd buys into what economists say.

Find out what really moves markets — download the free 118-page Independent Investor eBook. The Independent Investor eBook shows you exactly what moves markets and what doesn’t. You might be surprised to discover it’s not the Fed or “surprise” news events. Learn more, and download your free ebook here.

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By Editorial Staff
The following article is an excerpt from Elliott Wave International’s free Club EWI resource, “The Guide to Understanding Deflation. Robert Prechter’s Most Important Writings on Deflation.”

The Primary Precondition of Deflation
Deflation requires a precondition: a major societal buildup in the extension of credit. Bank credit and Elliott wave expert Hamilton Bolton, in a 1957 letter, summarized his observations this way: “In reading a history of major depressions in the U.S. from 1830 on, I was impressed with the following: (a) All were set off by a deflation of excess credit. This was the one factor in common.”

“The Fed Will Stop Deflation”
I am tired of hearing people insist that the Fed can expand credit all it wants. Sometimes an analogy clarifies a subject, so let’s try one.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing Jaguar automobiles and providing them to as many people as possible. To facilitate that goal, it begins operating Jaguar plants all over the country, subsidizing production with tax money. To everyone’s delight, it offers these luxury cars for sale at 50 percent off the old price. People flock to the showrooms and buy. Later, sales slow down, so the government cuts the price in half again. More people rush in and buy. Sales again slow, so it lowers the price to $900 each. People return to the stores to buy two or three, or half a dozen. Why not? Look how cheap they are! Buyers give Jaguars to their kids and park an extra one on the lawn. Finally, the country is awash in Jaguars. Alas, sales slow again, and the government panics. It must move more Jaguars, or, according to its theory — ironically now made fact — the economy will recede. People are working three days a week just to pay their taxes so the government can keep producing more Jaguars. If Jaguars stop moving, the economy will stop. So the government begins giving Jaguars away. A few more cars move out of the showrooms, but then it ends. Nobody wants any more Jaguars. They don’t care if they’re free. They can’t find a use for them. Production of Jaguars ceases. It takes years to work through the overhanging supply of Jaguars. Tax collections collapse, the factories close, and unemployment soars. The economy is wrecked. People can’t afford to buy gasoline, so many of the Jaguars rust away to worthlessness. The number of Jaguars — at best — returns to the level it was before the program began.

The same thing can happen with credit.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing credit and providing it to as many people as possible. To facilitate that goal, it begins operating credit-production plants all over the country, called Federal Reserve Banks. To everyone’s delight, these banks offer the credit for sale at below market rates. People flock to the banks and buy. Later, sales slow down, so the banks cut the price again. More people rush in and buy. Sales again slow, so they lower the price to one percent. People return to the banks to buy even more credit. Why not? Look how cheap it is! Borrowers use credit to buy houses, boats and an extra Jaguar to park out on the lawn. Finally, the country is awash in credit. Alas, sales slow again, and the banks panic. They must move more credit, or, according to its theory — ironically now made fact — the economy will recede. People are working three days a week just to pay the interest on their debt to the banks so the banks can keep offering more credit. If credit stops moving, the economy will stop. So the banks begin giving credit away, at zero percent interest. A few more loans move through the tellers’ windows, but then it ends. Nobody wants any more credit. They don’t care if it’s free. They can’t find a use for it. Production of credit ceases. It takes years to work through the overhanging supply of credit. Interest payments collapse, banks close, and unemployment soars. The economy is wrecked. People can’t afford to pay interest on their debts, so many bonds deteriorate to worthlessness. The value of credit — at best — returns to the level it was before the program began.

Jaguars, anyone?

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The following is an excerpt from the February issue of Global Market Perspective. For a limited time, you can visit Elliott Wave International to download the rest of the 100+ page issue free.

High levels of global debt are both financially debilitating and deflationary because they commit scarce cash to servicing interest payments. Up until now, most sovereign credit defaults occurred in emerging-market countries, such as Argentina and Russia. The deflationary tide, however, is starting to lap up against more developed Eurozone economies.

The chart shows the value of credit default swaps — an instrument similar to an insurance contract that pays holders (if they are lucky) in the event of default — for Greece, Portugal, Spain and France. In recent weeks these contracts have soared, with credit-default swaps on Greece’s and Portugal’s debt already surpassing the January-March 2009 extremes established in the latter part of Primary degree 1 down.

Obviously, the market is growing more skeptical that Greece can pay its debts, so the cost of protecting against default is rising fast. Greece’s budget deficit is 12.7% of gross domestic product, and Portugal faces a budget shortfall that’s more than twice the European Union’s limit. Traders are now buying default protection on sovereign debt at a rate of more than five times that of specific company bonds. “Greece’s neighbors would ‘step in’ to prevent a debt default to avoid ‘a problem for the whole of Europe,’” a Tokyo-based bondsalesman says. Maybe so, but who will step in to bail out Portugal, Spain, the next sovereign default or the one thereafter?

The world is running out of money to service its mounting debts, and this chart simply depicts the front edge of the next great wave of credit contraction, which will sweep into more established countries throughout Europe and eventually to the United States.

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