Consumer Credit Has Fallen Off a Cliff; Eric Fry on the Not-So-Risk-Free Treasury Bond
The Daily Reckoning Monday, October 12, 2009
Americans aren't borrowing...and they aren't buying either... It's the 'Age of Thrift' - but that message is lost on the market... The heavy hand of government blocks the course of correction... Eric Fry on the not-so-risk-free Treasury bond...and more!
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Consumer Credit Has Fallen Off a Cliff by Bill Bonner London, England
Here's a chart sent to us by colleague Justice Litle:
Interesting huh? Consumer credit has fallen off a cliff.
What does that mean exactly? It means Americans aren't borrowing...and they aren't buying either.
This weekend, The New York Times noticed:
"Americans stop buying; trade deficit declines" begins the headline.
This is the story we've been telling here at The Daily Reckoning for two years. Americans have to cut back. They are out of time and out of money. Ten years closer to retirement than they were in before the tech stock crash, Baby Boomers are not a penny richer. Now, they're facing a funky economy where housing prices are in decline, jobs are hard to find and lenders are reticent to lend them more money. Daddy has finally taken the T-bird away.
But wait...if the Baby Boomers stop spending won't it have, like, repercussions?
The NYT continues:
"For the first eight months of the year, the United States trade deficit with China is down by about 14 percent or $20 billion, compared with one year ago. The nation's trade deficit with Japan has shrunk by almost 20 percent, and its deficits with Mexico, Canada and the European Union are down more than 40 percent.
"The huge shift stems mainly from the staggering collapse in trade. With credit markets frozen and Americans facing the highest unemployment in more than 30 years, the United States suddenly stopped shopping overseas at anywhere near the volumes that had become normal."
Americans were the world's champion consumers. Just lend them money; they'd spend it. But when they stop spending it brings a hush to the entire planet. The malls go quiet...trucks slow down...ships are idled...and finally factories are shut down. Clerks, drivers, stevedores and assembly line workers all go home. That is what a depression is all about.
The feds are trying to get consumers to spend again. They've given them tax rebates, incentives, loans, and bribes. They've run a federal deficit three times higher than the previous record. They promise $1 trillion deficits "as far as the eye can see." And they put at risk a sum of money equal almost to the entire US GDP.
Still those hardheaded consumers won't consume like they're supposed to.
Suddenly, it's the 'Age of Thrift.'
But if it's really the age of thrift, the stock market doesn't seem to have gotten the message. The Dow rose 78 points on Friday, to a new post-crash high. Oil held at over $72. And gold lost $7 to close at $1,049.
What are stock market investors thinking? Are they thinking at all?
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More below, after the news:
"Pop quiz," writes Ian Mathias in today's issue of The 5 Min. Forecast. "Has the credit crisis decreased or increased the US economy's reliance on consumer spending?
"The logical person would say consumption is a smaller part of our economy now. After all, savings rates are up, unemployment is way up, incomes are down, and we've chronicled the fall of American consumption attitudes and spending many, many times.
"Heh, but since when is anything involving consumerism logical? Personal spending now accounts for 71% of US GDP, the Bureau of Economic Analysis speculates today. That's UP from 65% last year and the highest in the post WWII era.
"Personal spending in the second quarter (most recent data) actually fell $195 billion from last year, but its greater share of US GDP speaks volumes for just how bad other sectors were hit by the credit crunch. In percentage terms, that's a mere 1.9% decline...pretty resilient for a crisis of such superlatives.
"Still, how long can the American shopper hold on? For stocks, wages and the value of the dollar, this decade has been a bust...and it shows:
"We learned a long time ago not to bet against American consumption, but we'll be watching holiday shopping stats very closely this year. Almost three quarters of the American economy might depend on 'em."
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And more on rebalancing the world's big wheels:
If the consumer credit party is over...and the Baby Boomers are on the wagon...is it really possible for US businesses to grow...and prosper?
Yes, it is. America has great businesses with great brands. As the dollar falls it should be able for them to gain global market share in some sectors. But 70% of the economy is consumer spending. Until that changes, the US economy is hostage to US consumer spending. When consumers stop consuming, the US economy's wheels stop turning.
Okay, so you're thinking: "Well...maybe Americans have to cut back, but there are plenty of other people in the world. Let them do the buying for a while!"
And you are right. America has less than 5% of the world's population. But it consumes more than 20% of the total world's output - as measured by GDP. Clearly, Americans have been doing more than their fair share. It's time to let the foreigners belly up to the bar. Heck, they're skinny. They could use a good drink.
In time, foreigners will spend more. We don't doubt it. But rebalancing the world's economies won't happen overnight. Nor even in a couple years. It will take a long, long time. And a lot of investment in new tools, new training, and new techniques. Until that happens, when US consumers stop buying it slows wheels all over the world.
Every time finance ministers and heads of state get together they talk about "rebalancing" the world economy. They promise to take steps to make it happen. But so far, the market is doing all the rebalancing work on its own.
And instead of letting nature take her course...allowing the invisible hand of capitalism to direct capital to where it is actually needed...the heavy hand of government blocks the process of correction.
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Credit is still contracting. And Reuters reports that "small US firms face credit squeeze."
In theory, a genuine recovery in the United States could be led by exports. A cheaper dollar...and a cheaper workforce (in global terms)...would make the United States a better competitor.
But even a cheaper dollar is not guaranteed. Consumers may have stopped borrowing, but the US government borrows more than ever. This borrowing - in dollars - increases demand for greenbacks and may actually sustain the dollar at a higher level than it should be. The feds' appetite for borrowing could also force up interest rates - further restricting small businesses' access to easy credit.
There is a big difference between selling a few more Harley Davidsons overseas and real export-led economic growth for the US economy. The latter would require hundreds...thousands...of Harley Davidson enterprises, selling billions worth of goods and services to foreigners. And right now, those enterprises don't exist. They have no lobbyists trying to get TARP funds. They have no pet Congressmen slipping tax breaks for them into defense bills. They have no unions backing them. How could they; they haven't even gotten off the ground yet. And they may never get off the ground if they can't get financing.
The boomers are saving. They put their money into the safest possible place - US bonds! That is, they lend it to the government. They're the feds' biggest single source of financing - even bigger than the Chinese.
Meanwhile, the feds pump billions into the banking system. They supply the banks with capital for expansion and consumption. But instead of making loans to the private sector, the banks take the feds' money and lend it right back to them. They can borrow at a negligible rate...and then use the money to buy long-dated T-bonds yielding over 4%. Result: banks make money; the private sector has no money to create new businesses.
This weekend, we had a conversation with an English carpenter.
"It's rough. I remember just a couple of years ago, I could get work anywhere. Now it's off and on. I still find work, but I have a lot of free time too.
"It's not easy. Not with four children. We don't have any choice. We don't get any public benefits, you know...because I'm working. But I'm not working as much as I used to. And I'm not getting paid as much. So what can we do? We have to tighten our belts. We get by. But we're definitely not spending money they way we used to. In fact, I wish we hadn't spent so much back then. I'd like to have some of that money now."
A report in the Telegraph predicts British property prices - which have been in an upward trend for several months - are headed down again...with a 17% decline expected.
Bill Bonner The Daily Reckoning
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The Daily Reckoning PRESENTS: Today's offering comes from The Rude Awakening's Eric Fry...and our dear readers will be seeing more from he and Joel Bowman in the coming weeks. Stay tuned...
Risk-Free is Not Without Risk by Eric J. Fry Laguna Beach, California
"All things must pass," George Harrison mournfully crooned on his 1971 album of the same name. "All things must pass away... Sunrise doesn't last all morning... A cloudburst doesn't last all day"...and neither does a superpower's global economic hegemony.
America's dominance of the global economy is falling victim to self- inflicted wounds - namely, extreme and rising indebtedness. America's recent flood of red ink would make a banana republic blush.
As a result, risk-free Treasury bond may not be as "risk free" as they used to be. A few days ago, the highly regarded hedge fund manager, Julian Robertson, revealed that he is purchasing long-term put options on long-term Treasury bonds. His reasoning is persuasive.
"If the Chinese and the Japanese stop buying our bonds," Robertson explained during a CNBC interview, we could easily see [rates] of 15% to 20%...It's a question of who will lend us the money if they don't. Imagine us getting ourselves into a situation where we're totally dependant on those two countries. It's crazy."
"The U.S. financial markets, especially the credit markets, benefit greatly from both familiarity and reputation, more than merit; past reputation, more than future reliability. But 'reputation' doesn't pay the bills."
Crazy, yes, but true.
The US financial markets, especially the credit markets, benefit greatly from both familiarity and reputation, more than merit; past reputation, more than future reliability. But "reputation" doesn't pay the bills.
The growth of emerging economies is "symbolic of the relative, less dominant position the United States has, not just in the economy but in leadership, intellectual and otherwise," Former Federal Reserve Chairman Paul Volcker said in an interview with Charlie Rose recently.
"I don't know how we accommodate ourselves to it," Volcker continued. "You cannot be dependent upon these countries for three to four trillion dollars of your debt and think that they're going to be passive observers of whatever you do."
The US government, like one giant General Motors, is technically insolvent. And yet, it borrows at AAA rates because of its long-term legacy of world-beating economic success. NOT because of its recent history of extreme indebtedness.
The fiscal condition of the United Sates has deteriorated dramatically during the last several years. On the basis of current obligations, US indebtedness totals "only" about $12 trillion. But when utilizing traditional GAAP accounting - the kind of accounting that every public company in the United States MUST use - US indebtedness soars to $74 trillion. This astounding sum is more than six times US GDP. (GAAP accounting includes things like the present value of the Social Security liability and the Medicare liability - i.e. real liabilities.)
Perhaps this mind-blowingly large debt load would seem less mind- blowing if it were DE-creasing. But it is not. Instead, the current US administration is amplifying the long-standing American habit of spending money it does not have.
The chart below tracks the federal budgets for both America and Brazil as a percentage of each country's GDP. Back in 1998, the US ran a budget surplus, while Brazil was running a deficit equal to 9% of GDP. But the two nations have traded places. At last count, the US budget deficit totaled an astounding 9% of GDP, while Brazil's deficit totaled only 3.3%.
And yet, The US government pays only 3.28% in interest per year to borrow money for 10 years; while the Brazilian government must pay 5.05% to attract investors to its 10-year bonds. Thus, the yield spread between these two borrowers is 1.77 percentage points - or 177 "basis points."
A brief tutorial may be in order at this point...
Like a polite dinner guest, the bond market does not express its opinions in absolute terms. Rather, it renders a relative judgment. Its prices specific bonds relative to other bonds, or specific credit instruments relative to others. This relative pricing is known as the "yield spread." (A very common yield spread comparison is made relative to Treasury bonds). So for example, if a certain 10-year bond issued by a corporation or a foreign nation's yielding 6.50% at the same time that the US 10-year note is yielding 4.50%, that bond is said to be trading 200 basis points (i.e. 2.00%) over Treasurys. The higher the spread over Treasurys, the riskier the debt is perceived to be.
But this is where our story takes an interesting turn. The yields on foreign sovereign bonds (i.e., government bonds) have been falling closer to US yields for several years. This process has been unfolding gradually, and in fits and starts. But over time, the trend is clear. What's not clear is who is moving closer to whom. Are foreign sovereign issuers becoming MORE credit-worthy or is the US government becoming LESS credit-worthy? Or is it a little bit of both?
Whatever the case, the nearby chart illustrates the result. Using a four-year rolling average of yields (to smooth out the trend), it is easy to see that Developed World interests rates are converging toward US rates. Canadian and French sovereign 10-year interest rates, for example, have been moving closer to US rates for several years. (And in fact, French rates have dipped below US rates several times during the last several years).
This narrowing of yield spreads is not only evident among issuers like Canada and France, but also among emerging market issuers, especially the rapidly emerging market issuers like Brazil. Some investors might infer, therefore, that emerging market bonds are too expensive, relative to Treasurys. We would take the other side of that trade.
Risk-free Treasury bonds are not as risk-free as they used to be.
Eric J. Fry for The Daily Reckoning
Editor's Note: Eric J. Fry, has been a specialist in international equities since the early 1980s. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling. Mr. Fry launched the sometimes abrasive, mostly entertaining and always insightful Rude Awakening.
His views and investment insights have appeared in numerous publications including Time, Barron's, The Wall Street Journal, International Herald Tribune, BusinessWeek, USA Today, Los Angeles Times, San Francisco Chronicle and Money. He appears regularly on business news stations like CNBC and Fox.
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