The End of the Nominal Recovery

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Monetary and fiscal stimulus can halt a deflation spiral, but central banks and governments can’t print purchasing power.

In other words, one year after the official end of the recession, the economy shows no signs of booming. Emergency Keynesian policy measures taken to keep the debt crisis from devolving into a 1930s deflationary spiral show signs of losing effectiveness, and the self reinforcing economic growth story is giving way to talk of a “double dip” recession, as trouble in Europe is expected to slow the US economy by the end of the year. Confidence in the resilience of the recovery is waning.

CEO Confidence Survey noted the bottom of the recession and the beginning of recovery. CEO confidence dipped slightly in Q1 2010 for the first time since Q1 2009, to 62 from 64 in Q4 2009 (a reading of more than 50 points reflects more positive than negative responses). The Q2 2010 data are due out the week of July 5. A decline in CEO confidence below 50 points will strongly support leading economic indicators that are pointing to a second recession.

The last time the economy struggled under the weight of public debt taken on to stimulate demand after a private-sector credit collapse was during the Great Depression. Is the nation’s debt-heavy balance sheet able to finance ongoing stimulus spending without triggering a US debt and currency crisis? The question is once again divided along ideological lines. It’s 1937 all over again as Democrats and Republicans battled in the Senate last week over how to pay the $141 billion cost of new legislation that extends unemployment benefits to more than two million who remain unemployed a year after the recession ended.

What if a second recession arrives while we’re still arguing about what to do about the after-effects of the last one?

Even if we dodge a double-dip recession, conditions of the economy and debt markets are the opposite today of 1983, the last time new home and car sales were this slow. Without a tail wind of falling interest rates and low debt levels, for the next 20 years inflation and interest rates will rise as policy seeks to deflate debt against wages and the dollar; real housing prices and wages decline.

A year after touring the aftermath of the Housing Bust Recession, many retailers remain closed, windows once whitewashed are now broken, boarded up, and festooned with graffiti.

The same condition is true for the financial system that got a whitewash but has yet to receive even a partial renovation.

An optimist might conclude that home and car sales are thus only as bad as in 1983, except that the economy was only one quarter the size of today’s; this post-recession housing market contraction is proportionally four times worse than the housing downturn that occurred at the end of the early 1980s recessions.

The May 2010 collapse in new home sales to 1983 levels occurred despite 30-year mortgage rates at levels not seen since 1971. Today’s 4.69% rate on a 30-year mortgage is less than half the 13% rate paid by borrowers the last time new home sales were this weak.

In 1983, mortgage rates had only one way to go – down – as disinflation proceeded for decades, although they took a detour to 15% in the two years that followed.

The ultra low rates result from the Fed’s continued purchases of mortgage-backed securities from banks. With $1.1 trillion of MBS on its balance sheet as of early June, starting from zero in January 2009, the Fed can’t find private hands to offload the securities onto and instead uses them as collateral at full market value for new loans, despite the fact that the market value is virtually nothing, as evidenced by the unwillingness of private institutions to buy them.

Business Week reported recently:

Borrowing costs have tumbled in the past two months as concern that a debt crisis in Europe may spread boosted demand for the safety of bonds including mortgage-backed securities. The lower rates have failed to lift housing demand, which has tumbled since a tax credit for first- time and certain other buyers expired at the end of April.

The average price of $5.2 trillion of bonds guaranteed by government- supported Fannie Mae and Freddie Mac or federal agency Ginnie Mae climbed to 106.3 cents on the dollar yesterday, according to Bank of America Merrill Lynch’s Mortgage Master Index. That’s up from 104.2 cents on March 31, when the Federal Reserve ended its program purchasing $1.25 trillion of the debt.

MBS's Held by the Fed

But did the Fed really stop buying MBS?

The Fed planned to stop buying MBS at the end of this March, yet Fed MBS balances have increased by $45 billion since March 31. What will happen to the housing market when the Fed finally does begin to lower its MBS balances?

Regards,

Eric Janszen
for The Daily Reckoning Australia

Eric Janszen
Eric Janszen is Founder & President of iTulip.com, the online economics and financial markets community that CNBC's Bill Griffeth calls "...the place to go for a contrary view of the markets," and The New York Times credits for accurate forecasts of economic developments. Eric is author of upcoming Portfolio Hardcover book, The Post-Catastrophe Economy, and co-author of America's Bubble Economy, from John Wiley & Sons.
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11 Comments on "The End of the Nominal Recovery"

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watcher7
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Good news for a stockmarket rally. Headlines of varies articles ‘linked’ on PrudentBear website suggest positive environment for stocks: Weak Housing Data Signal That Economy Is Losing Steam Manufacturing Shows Weakening From China to Europe Jobless Claims in U.S. Increased Last Week to 472,000 Economists Will Scour Private Sector in June Jobs Report Pending Sales of Existing U.S. Homes Decreased 30% in Ma CBO tells Obama deficit panel that forecast remains bleak Manufacturing Weakens From China to Europe as Economic Recovery Moderates Fears mount over slowing global demand Peterson’s $1 Billion Bet Shows Return as Deficit Concerns Rise New Vehicle… Read more »
Ross
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OK watcher give us the contrarian news on the market direction. You forgot the big negative in the consumer sentiment survey this week and the revised downward past month. And maybe you can see your way to explain how p/e’s can be sustained when extend and pretend means the balance sheets have all sorts of bogey’s in them?

Ross
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Watcher, check also the 20 day rate of change on the Baltic dry index
http://investmenttools.com/futures/bdi_baltic_dry_index.htm

Hope my statement above doesn’t read dismissively, it wasn’t supposed to be.

Lachlan
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Maybe watchers points are buy signals for central planners trying to engineer markets with a printing press. I wont be betting on it but. Anything can happen anytime. Who knows their minds at any one time and who knows when the inevitable fail will arrive.

AnnoyingOrange
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That Baltic Index page says everything is sweet at the bottom, there are some excerpts below suggesting trade is booming … am I missing something? I am keen to have this explained. 6/18/10 Maersk, the world’s biggest container shipping group, is warning of an unprecedented shortage of containers in the run-up to the peak shipping season on the back of a strong rebound in global trade. 6/10/10 Container traffic at major ports in India for the April-May period increased by 21 % YoY. 4/9/10 Oppenheimer analyst Scott Burk said the very large crude carrier day rate was about $59,000 Friday,… Read more »
Justin
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“But did the Fed really stop buying MBS?” Interesting, one would think that if the government wants to keep ‘bond prices’ high it will have to keep buying. Evidently the market thinks they will.

AO, I was under the impression that the Baltic Dry Index was a measure of the cost of shipping ‘dry’ as opposed to ‘wet’ i.e. oil, raw materials. Maybe Maersk is a short opportunity?

Ross
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@Lachlan, maybe so. Watcher was talking about a run up all this year. Out of the BDI charts you can see the S&P500 would have to sharply turn and run. That position is not the traditional sell in May and stay away. @Justin, the BDI is for bulk shipping based on the hourly hire rates. Merchandise shipping is analysed on the lay up rates and the container freight costs and size of the peak season surcharges. Intra Asia air and ocean have been up since Q3 09. Without me making any particular statement, air freight can be seen as a… Read more »
Ross
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watcher7
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Ross, you maybe right. The next month or two things will be revealing. Barton Biggs has become less bullish and sold about half his stock investments this week. “Ralph J. Acampora, a market analyst with more than 40 years of experience, said he moved entirely out of stocks and into cash late last month. Now a partner at Alverita, a wealth management firm in New York, he said recent setbacks suggested that the market would drop another 10 or 15 percent, probably until September or October, before resuming another “meaningful rally” (Jeff Sommer, A Market Forecast That Says ‘Take Cover’,… Read more »
Stillgotshoeson
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Ross
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Watcher, Paulson is not of my favourites – he talks out the side of his mouth like Buffet. I don’t agree on his comments on the US consumer and that is the heart of the double dip as I see it. I agree though that US real estate might be at fair value as long as the local conditions have unemployment around the national average. The worst and best thing about the US is portability. You know the thing that allowed Greenspan to get away with his “small isolated areas of housing irrational exhuberance” (para). When a US town or… Read more »
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