GLOBAL ECONOMICS AND POLITICS

Leo Haviland provides clients with original, provocative, cutting-edge fundamental supply/demand and technical research on major financial marketplaces and trends. He also offers independent consulting and risk management advice.

Haviland’s expertise is macro. He focuses on the intertwining of equity, debt, currency, and commodity arenas, including the political players, regulatory approaches, social factors, and rhetoric that affect them. In a changing and dynamic global economy, Haviland’s mission remains constant – to give timely, value-added marketplace insights and foresights.

Leo Haviland has three decades of experience in the Wall Street trading environment. He has worked for Goldman Sachs, Sempra Energy Trading, and other institutions. In his research and sales career in stock, interest rate, foreign exchange, and commodity battlefields, he has dealt with numerous and diverse financial institutions and individuals. Haviland is a graduate of the University of Chicago (Phi Beta Kappa) and the Cornell Law School.

 

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FED FIXES AND DOLLAR DEPRECIATION © Leo Haviland September 17, 2012

The broad real trade-weighted United States dollar will depreciate. Over the next several months, its retreat probably will reach July 2011’s record low around 80.6 (for the nearly four decades going back to 1973, monthly averages; March 1973=100) and break beneath it, with around 77.0 a reasonable target. Over the longer term, a descent to around 72.5 to 75.0 would not be surprising.

We know that all else equal, debtors (and borrowers) want as low an interest rate as they can get.

The Fed’s interest rate policy is (and has been for several years) geared toward aiding debtors (borrowers) at the relative expense of creditors (savers). Since debtors deserve special Fed help, surely the unemployed do.

We know that all else equal, debtors in a home currency (imagine the beloved US dollar) tend to enjoy some modest home currency depreciation. This makes their debt obligations less burdensome to pay off. This perspective assumes that these debtors can keep borrowing fairly easily, and at interest rates that not too high (overly punitive).

However, all else equal, foreign creditors are not enamored of such currency degradation. Foreigners hold an enormous amount of US Treasury securities, nearly $5.3 trillion (as of June 2012,

What happened to the US dollar after the Fed’s prior two massive rounds of quantitative easing? The TWD depreciated.

Significantly, the Fed’s determination to keep interest rates pinned to the floor (and thus offering pitiful returns on government debt relative to inflation) for an extended time period, say out to mid-2015, boosts the odds that its QE3 money flood will help to push the dollar down. In addition, recall that he TWD has been in a declining pattern over the past decade (or longer). So has America’s relative international economic and political prominence. Remember that QE3 is occurring alongside substantial US indebtedness (with a potential federal deficit disaster lurking on the horizon), a noteworthy current account deficit, and only modest domestic savings (compare Japan).

The Fed presumably is aware that the TWD declined after the QE1 and QE2 episodes. So apparently the Fed will tolerate dollar weakness to achieve its employment objectives.

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Fed Fixes and Dollar Depreciation (9-17-12)

AMERICAN CORPORATE PROFITS AND THE S+P 500 (c) Leo Haviland August 1, 2012

In recent decades, the overall United States debt outstanding relative to nominal GDP has substantially increased. America’s national willingness to accumulate debt (borrow and spend) generally has played an important role in the generation of its economic growth. It of course is not the sole factor. This national debt increase thereby has tended to boost (be a bullish factor for) equity prices, at least up to now. A significant cut in America’s debt burden (deleveraging) probably will promote a decline in the nominal after-tax profit to GDP ratio from current elevated levels. This reduction also may encourage a slowing of after-tax profit rises, or even encourage an actual decline in profitability levels. These processes in turn probably would be bearish for US equities. Debt levels and trends are not the only factor influencing US GDP, corporate profits, and stock levels and patterns. Will American corporate profits forever keep rising? History is not destiny, but they often have declined.

Besides, growing debt does not inevitably guarantee economic health, corporate profitability, or soaring stocks, whether in America or anywhere else. Sustained Federal Reserve monetary easing buys time and sells hope, but it does not solve the US national debt problem. History reveals that at some point more and more national debt can generate grave problems. America probably is at or very near the danger level from its current and near-term debt situation, not just over the so- called long run horizon.

Let’s place American after-tax profits in the context of economic output. The average United States yearly ATP level relative to nominal GDP from 1946 to 2011 is about 6.2 percent. However, during the marvelous Goldilocks economy, and even up to the present despite the ongoing worldwide economic crisis, this indicator has been remarkably strong. Recall lows of

3.1pc in 1986 and just under 5.0pc in 2001. Before the 2004 to the present period, the last high over eight percent was 1950’s 8.6pc. From 1951 through 2004, it exceeded seven pc only three times (1978, 1979 and 2004). Over 2004-2011’s span, the average jumped to 9.0 percent.

The ratio in 2004 was 7.8pc, rising to 9.7pc in 2005 and 10.1pc in 2006. Calendar 2006 thus established a new pinnacle (going all the way back to 1929 not just 1946). In the year the global financial crisis emerged, 2007, it remained high, at 9.2pc. Even in 2008’s savage US and worldwide downturn, accompanied by the plummeting S+P 500, ATP relative to GDP were almost 7.4pc. The S+P 500 reached a major low on 3/6/09 at 667. In 2009, that ATP/GDP relationship was 8.4pc. What about the fairly sunny recovery years thereafter? The ATP total for 2010 bordered ten pc of nominal GDP, with 2011 elevated at 9.8pc.

What was the ratio of ATP for first quarter 2012 relative to GDP? Nominal 1Q12 GDP was about $15.48 trillion (annualized). Corporate profits were about $1.67 trillion (annualized). This is about 10.8pc of 1Q12 nominal GDP, thus marching beyond 2006’s joyous Goldilocks Era height to establish a new record height for that measure.

Though 2Q12’s earning reporting season has not ended, news reports suggest the nominal ATP level is approximately in line with 1Q12’s, and maybe even a couple of percentage points higher. US 2Q12 nominal GDP inched up to about $15.60 trillion from 1Q12’s $15.48tr. Thus the nominal ATP/GDP ratio probably remains around record levels.

Alongside these lofty 2012 profit levels, the S+P 500 attained new highs relative to its 2009 abyss (4/2/12 at 1422, 5/1/12 at 1415). These spring 2012 levels neighbor the S+P 500’s final summit at 1440 on 5/19/08, though they remain quite a bit beneath the major high on 10/11/07 at 1576.

An army of intertwined variables interrelate to propel the S+P 500 up, down, or sideways. However, suppose ATP slide lower relative to first half 2012 heights and that the ATP to GDP relationship retreats to fairly near the long run 6.2 percent average. All else equal, this probably will be a bearish factor for the S+P 500.

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American Corporate Profits and the S+P 500 (8-1-12)

MARKETPLACE CLIFFS © Leo Haviland June 25, 2012

Ongoing and mounting concern regarding European problems, especially within the sovereign debt and banking sector, has distracted many marketplace observers from concentrating closely on similar major American issues. The global economic crisis is a long way from being surmounted. Fiscal, banking, debt, and leverage challenges in Europe and the United States (and elsewhere) remain substantial. For the near term, the international crisis probably will worsen. Many perceive the S+P 500 as a rough benchmark measure for overall economic strength. The S+P 500 will head downhill, perhaps precipitously at times. It probably will decisively break beneath its early June 2012 low at 1267.

The International Monetary Fund’s “Fiscal Monitor” (“FM”, April 2012) provides helpful numbers. Analysts can debate which tables illuminate the situation best. Events since April 2012 would adjust the data somewhat.

The FM “general government” tables include state and local government debt with that of the national governments. Look at Table 1, General Government Balance. The United States was -9.6pc (a deficit) of GDP in 2011. The FM predicts -8.1pc in 2012 and -6.3pc in 2013. The overall Euro area deficit is actually lower for these years than the American one; it was -4.1pc in 2011, with -3.2pc for 2012, and -2.7pc in 2013. The US deficit falls only to -4.4pc in 2017, notably above the Euro area’s -1.1pc that year. What about some specific Euro area nations about which many tremble? In 2012, Italy’s general government balance is -2.4 percent, well under that of America’s. Portugal’s 2012 hole was -4.5pc. Spain’s 2012 balance, -6.0pc, also is beneath America’s (though an update to the FM probably would raise Spain’s deficit, placing it closer to the US 2012 range).

Review Table 7, General Government Gross Debt. The US gross debt was 102.9pc of GDP in 2011 (soaring from 66.6pc in 2006). The IMF predicts it will be 106.6pc in 2012 and 110.2pc in 2013. It stays at a plateau with 2017’s 113.0. Thus there is no progress in reducing it. Moreover, the US gross debt percentage exceeds that of the Euro area. Euro area gross debt was 88.1pc of GDP in 2011. The FM predicts 90.0pc in 2012, 91.0pc in 2013, and 86.9pc in 2017. Thus the US fiscal situation is worse than that of the Euro area as whole from this viewpoint as well.

In addition, note the US’s 2012 out to 2017 gross debt levels in comparison with those of Euro area crisis/bailout nations other than Greece. Admittedly Greece’s gigantic 153.2pc is larger, and its problems interrelate with those of the Eurozone as a whole. In 2012, Italy’s debt is 123.4pc of GDP, Spain’s 79.0pc. That of Ireland is 113.1pc, Portugal’s 112.4 pc. The average for 2012 of Italy, Spain, Ireland, and Portugal is 107.0pc. However, this is almost exactly that of the US’s 2012 debt of 106.6pc.

So this perspective underlines that as the Euro area has a scary fiscal (sovereign debt) problem, so therefore does the US.

Yet travel further and look at US total credit marketplace debt US (nonfinancial, financial, and rest of the world sectors combined), not government debt alone. In 1951, it was about 132.4pc of nominal GDP. It ascended gradually to 168.1pc by 1981. It climbed to 250.8pc in 1995, marching to just under 300 percent in 2002. During the marvelous Goldilocks Era economy, total US credit marketplace debt flew even higher, touching 362.8pc of GDP in 2007. It advanced more as the economic crisis emerged, reaching a pinnacle of 381.6pc in 2009.

So where is this total credit marketplace debt now? At the end of 1Q12, it remained at a very lofty altitude, 353.6pc. Not only does the long run increase in total credit marketplace debt display devotion to (economic reliance on) debt. The only slight slide from the 2009 peak to the 1Q12 level indicates that at some point more debt reduction (deleveraging) for “America as a whole” lies ahead, and thus a significant probability of a weaker economy (and even recession).

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Marketplace Cliffs (6-25-12)

CASH AND CAPITAL CACHES © Leo Haviland, March 6, 2012

Everyone knows that money shifts into, within, and between geographic regions and broad financial sectors (stocks, interest rates, foreign exchange, commodities, real estate) sometimes are substantial or even “dramatic”. Price movements and other statistics indicate this. However, seldom is it underlined how gigantic capital marketplaces are.

Would it matter much if American stocks weakened on a sustained basis around ten percent? Such an US equity decline is a noteworthy absolute sum and large from the GDP and net worth perspective as well. US stock marketplace capitalization at end 2010 was $17.3 trillion. Suppose one uses 2011 US GDP at around $15.1tr (Bureau of Economic Analysis; the 2010 level in the IMF table is $14.5tr). A ten percent equity dive equals about 11.5pc of GDP (1.73/15.1 trillion).

Take another view using Federal Reserve data. According to the Federal Reserve’s “Flow of Funds” (Z.1, Tables B.100.e and B.100; 12/8/11, next release 3/8/12) 2Q11’s equity shares for households (and nonprofit organizations) were about $19.2tr. A ten percent equity dive equals around 12.7pc of GDP (1.92/15.1). End February 2012 US stock valuations probably are roughly around that 2Q11 total. A ten pc slump in stocks (using US equities as the benchmark for all stock holdings by US households) of $1.92tr equals around 12.7pc of 2011 nominal GDP (1.92/15.1), or around 3.2 percent of 2Q11’s household net worth of just under $60 trillion (3Q11 $57.4tr is most recent Z.1 information). US end 3Q11 household net worth still remains beneath end 2007’s over $65.1tr.

With consumers around 70 percent of the US economy, the Fed’s assorted accommodative monetary policies during the ongoing worldwide economic crisis that emerged in 2007 have sought to boost (and sustain rallies in) equity prices.

However, what does the fairly strong TWD in 1Q09 versus its April 2008 trough alongside the absence of any significant increase in the percentage of worldwide US dollar holdings over that time span indicate? It strongly suggests that something more may have been going on in (“behind”) these official reserve patterns than the consequences of US dollar appreciation. A reasonable conjecture is that it reflects a determination by developing/emerging nations in general not to expand their exposure to the US dollar. Given the longer run trend of their declining US dollar claims, they even arguably are trying to reduce their US dollar claims regardless of dollar fluctuations.

Note the recent coincidence in time of a bottoming of yields in the “flight to quality” destination. Compare the 10 year government notes of the United States, Germany, and Japan. Recent UST 10 year note lows were 1.67pc on 9/23/11 and 1.79pc on 1/31/12. The Japanese JGB 10 year low was 1/16/12 at .94pc (compare JGB bottoms at .83pc 10/7/10, .44pc 6/11/03, and .72pc 10/2/98). The German 10 year government note valley at 1.64pc on 9/23/11 was the same day as the UST note one. It made another trough at 1.74pc on 1/13/12 (about the time of Japan’s mid January 2012 low), as well as one at end January (1.78pc on 1/31/12; compare US 10 year).

Suppose there is some inflation, and that low nominal yields result in very low real (or even negative) yields. In the absence of another round of flight to quality concerns, how eager will official and private players be to own (or at least to be substantial net purchasers going forward) of government debt of these nations?

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Cash and Capital Caches (3-6-12)