Sunday, April 19, 2009

Economic Cliff Diving - By the Charts…

The following charts, most of which come to you courtesy of the St. Louis Fed, paint a picture of the current economy that is very unstable at its base. Their “heroic efforts” to re-establish growth and inflation are simply not taking root as of yet.

Try as the Fed, the Treasury, and G20 might, as of yet they are simply peeing into the wind. The collapse of credit and wealth is simply happening much more quickly and powerfully than their reinflation efforts.

While you look out into the future and see that their actions are intended to be inflationary, keep in mind that timing is everything. We had an unprecedented period of inflation already, but we are now correcting the massive malinvestments that were created over years of abuse. Yes, the government actions are unprecedented in scale. They are attempting to reignite their ideal of nirvana which is never ending growth. As you know, if you’ve ever Spent Time with the Good Dr. Bartlett, never ending growth is mathematically IMPOSSIBLE.

In school we learn that curves generally come in the shape of a bell. In fact, in statistical analysis they teach a standard model that all you statistics students might remember is represented by the diagram below:

Nassim Taleb, author of The Black Swan contends that financial markets are too erratic to conform to this standard model. And he’s correct, but it’s not just the markets that don’t conform to a perfect bell shape distribution, ALMOST NOTHING DOES!

Waves in nature begin with slow and seemingly stable growth. The compounding math then begins to build into a more rapidly rising structure which eventually goes through a phase-transition to an exponential rise. The recent rise in corporate profits illustrates these phases very well:

While the front side of the curve resembles the standard bell shape, exponential growth in nature does not usually result in a mirror image on the backside of the curve. What happens in nature, and in the marketplace, is that parabolic curves collapse on the backside and head virtually straight down. Witness the collapse of our markets during the Great Depression, the run up of the Nikkei index in Japan during the late 80’s and subsequent crash, our own Nasdaq in the year 2000, etc. The collapse happens much FASTER than the growth.

And here's a chart showing the amount of Decline in Corporate Profits year over year:

Now that's cliff diving!

While the charts you are about to see are historic and jaw dropping, much of the collapse is not DIRECTLY reflected in Fed statistics due to the Shadow Banking System which is largely unregulated and untracked. Thus, you must infer the results where you can. Data can be “adjusted” and tweaked, like inflation and employment data for example, but what’s really happening in the economy will eventually leak out and be seen in other indicators.

What is happening right now won’t be seen in this data for quite some time and some of the data is leading while other data are trailing. Right now many people are claiming that this data is all water underneath the bridge and that the near future will see a return to growth. Okay, if they say so, but I would contend that you do not turn this type of data around on a dime. Getting in front of trend changes is dangerous, and there is a very powerful trend now in place. While the data may not be getting worse at the same rate, that’s because some of the data was in free fall and impossible for the trend to continue at that rate. Take last month’s fall in the collection of Corporate Income Taxes. It fell at the rate of 90% year over year in the month of March. Just because it only falls by 30% or 50% in the following months doesn’t mean that things are better, it means they are, in fact, worse but just not in free fall. That’s where I think we are now across the economy.

Here’s that chart showing the drop in Corporate Tax Receipts, by the way, it’s a U.S. Budget Disaster.

As the Fed attempts to force credit (debt) into the economy, they are finding that the velocity, or number of times money is exchanged, is falling to levels not seen since the Great Depression. A Velocity of 3 would be healthy, but what’s disturbing now is that the velocity of MZM, the broadest measure of money, is collapsing and is now just 1.6:

So, when you see charts like the M1 Money Stock and assume that all that cash is going to create inflation, you must keep it in context with the larger money supply picture and VELOCITY:

While there are all kinds of pretty formulas for money and velocity like M (V) = P (Q) (and many more that are much more complex), it’s really not that complex in the real world. The academics and their formulas often just miss the boat. The formula for velocity, for example doesn’t contain DEBT as one of the prime variables. While it may capture some of it indirectly, it doesn’t weigh it enough at the extremes, like we have now. Just take your own finances for example. If you have an extreme condition such as owing twice as much on credit card debt as you have income, then when you receive new money the odds are that the money received will not go into purchasing goods and services, it instead goes right back to the bank where it is used to pay interest on your debts and to discharge a minuscule amount of principle (lol, most likely).

Debt expands and grows the economy via leverage until it reaches a critical mass at which point it turns into a black hole and sucks the productive juices back from the economy.

So, while the smaller measurements of money are zooming due to Fed pumping, the broader measurement of money, MZM, is also growing, but the rate of growth is falling slightly:

Yes, the strict definition of inflation is an increase in the money supply. BUT, there are variables that affect the outcome of inflation, such as its velocity. Another variable is the growth or contraction in population, or more correctly stated the size of the population in their peak earning and spending years.

So, we have money supply increasing (as measured by the Feds, but which does not include all effects of the shadow banking system), and velocity falling. Now let’s look at some other economic indicators to see what’s really going on. Of course keep in mind the exponential growth of debt in the backdrop, the drop in consumer savings (which is now reversing), and stagnant wages.

Let’s take a look at the official reports of inflation without offering a critique of what’s wrong with this data (which is plenty but would require an entire book just to explain). The Producer Price Index is not showing that prices on the wholesale level are increasing despite a rising supply of money. Quite the contrary, have a look…

Here is the PPI for Finished Consumer Goods. These charts are showing the index value change from one year ago and not percentage changes, but you can see that at no time since the 1950’s has the drop in PPI been as great:

Here’s the PPI for all Commodities:

And here’s the PPI for Industrial Commodities:

And for Energy Materials:

And for Finished Energy Goods:

The CPI (Consumer Price Index) tracks price moves a step higher on the consumer level. Here is a chart that Mish has been showing. You do not see rising prices here:

Here’s the index change in the CPI for all items:

And here’s the CPI for food. Note that food is rising rapidly in the index, but not as quickly as it was:

Now, let’s take another look at money and capital flows. Remember that if you push money into a CLOSED SYSTEM, you will get rapidly rising PRICES. However, if your system is OPEN, then the capital (money) is free to leave to seek the best returns. The charts I’m about to show paint a picture of slowing credit creation and of money leaving the United States except in U.S. Treasuries which is a trend the TIC data shows is reversing.

Here’s a chart of Total Bank Credit of all Commercial Banks. Note that the number is positive but the rate of creation has fallen off the proverbial cliff:

The chart of U.S. Assets Abroad paints a picture where assets WERE entering the U.S. faster than they were leaving, that is until about the middle of 2007 when this flow completely reversed trend as total assets are leaving this country (fed creates money, money leaves or pays back debt):

Now note that the foreign Assets in the U.S. has just gone negative on whole:

However, also note that Foreign Assets in U.S. Treasuries is rising rapidly. This move of foreign money into U.S. Treasuries may be reflective of a flight to safety:

But the chart of Net Capital Inflows shows the overall trend (which would include flows out of the stock market and other assets) is negative as has also been indicated in the recent TIC flows:

And get a load of the chart of U.S. Foreign Currency Holdings… charts like this show just how drastic the changes underlying our economy are relative to the stability we have enjoyed for decades:

Here are a couple of charts showing our Imports Balance of Payments, the first being the raw number and the second being the YOY change:

And here’s our Exports of Goods and Services:

BOTH imports and exports are falling showing that it’s a global slowdown. The chart that follows shows the collapse in trade which is historic:

Now let’s take a look at some employment charts. Of course I’ve been showing the standard chart from John Williams at which you’ve probably seen:

But now let's view some charts the Fed keeps that you probably haven’t seen. Here’s the Total Non-Farm Payrolls ALL EMPLOYEES:

Total Non-Farm Payrolls change year over year (YOY - while this is the largest drop in raw numbers, keep in mind that the size of the population is much larger):

Unemployed Change from one year ago:

So, that’s a lot of charts and they all show deep and rapid changes are occurring in our economy now. Again, most of these charts and thousands of others can be found here St. Louis Fed.

This type of instability is simply not desirable. Growth always feels good when it’s young and just starting out. The largest credit bubble in history was blown and the destabilizing effects of it and the further attempts to “fix it” by our government will ultimately only lead to further destabilization. The math already does not work, and we are still not addressing the underlying toxicity of debt (Death by Numbers).

Like a drug addict or alcoholic seeking to feel the high of the first few times, our aging government is shooting up in an attempt to return to the good old slow and steady inflation days, when I was young…

Eric Burdon & The Animals - When I Was Young (1967):