Posted On: 2006-12-01
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Hello, this is your host Johannes Ernharth and welcome to today's edition of the Vigilant Investor daily. It is the Friday, December 1st edition, so here we are into December and an interesting day in the marketplace that was reflecting a lot of crazy news out there that keeps continuing to drip on out from the newswires that I watched today. The Dow Jones Industrial had an up and down day, it was down actually 120 points at one point and finished up with a strong rally towards the end of the day, still down about 27, 28 points, but only a quarter of a percent from being down about a percent earlier in the day so, a big re-gain there from it's earlier day's low. A lot of that was on some pretty crazy news today that came out more bad news for the week, the ISM factory index fell to 49.5 in November from 51.2 in October. That's the institute for supply management, that index shows basically how manufacturing is doing things, and any reading below 50 signals a contraction in manufacturing. And manufacturing in the U.S. accounts for about 12 percent of GDP. So you combine that with some of the other news that we've been getting relative to the consumer situation, the consumer representing 70 percent of GDP and some of the numbers we talked about in yesterday's episode and if you haven't listened to that, download that Podcast as well, it's available. You can subscribe to our Podcast by the way via iTunes and other services out there just go to their site at Talk Shoe and you can find that at vigilantinvestor.com just by clicking on our live daily and weekly Podcast button on the left side menu. But, in any event, with 70 percent of the GDP being driven by personal consumption and with home equity having been such a driver for that and with housing prices sliding at record paces and the housing market just basically getting to decelerate rapidly. We're looking at pretty much the entrance that we suspected into a recession and we were saying this about 12 months ago that recession was looming and it's only a matter of time and here we are, things are beginning to slow down. And the amazing thing from out perspective at Vigilant Investor is that so many other analysts out there, the consensus generally keeps getting surprised by these numbers coming in below what their expectation were and we tend to be surprised when they come in above expectations. One of the things we posted today was a summary of some of the things we're talking about on vigilantinvestor.com and we've been looking at the money supply growth in the U.S. and it has continued to chug along if we're monitoring things like M3 and there are services out there that will reconstitute M3, which is the broadest based money indicator that tells you what is going on in the broader financial economy and that's been generally increasing. If you look at Shadow Government Stats, you can go to their web site any time you want and take a look at their M3 continuation. M3 by the way was discontinued by the Fed back in February and fortunately John Williams and the folks at Shadow Stats have continued publishing that for us. Meanwhile, simultaneously the M1 and MZM money indicators showed a lot of contraction over that time. And while MZM has picked up a little bit more recently, it still has been down and generally, what you're looking at with MZM and your M1 are more of your base currency that actually has a claim on actual goods and supplies, the final end product, when somebody finally does sell something, they need to have that MZM type currency, you really can't be trading esoteric financial instruments that might represent an M3. So, at the moment, one of our big concerns is this begins to unwind and we're going to talk about the dollar in just a minute. What you have to watch is what happens with M3 as the dollar starts sliding in the face of a contracted money supply on the MZM side, which is pinching from the other side. A lot of weird currents here in unprecedented ways and it will be very interesting to see how that all comes together. Now, my co-host Stephan Ernharth, how are you doing today?
Stephan: Doing well Johannes, how are you doing?
Not to bad, we're just doing a little of a re-cap here, and any news that you have, I have noticed today, we were just talking about the manufacturing index coming in well below expectations, surprising a lot of people, of course we're not surprised. But, manufacturing show a contraction it's below 50, 49.5 and that follows yesterday's drop of the PMI which is the Purchasing Managers Index, which surprised of consensus as well coming in at below 50 from 53.5 in October. Both signaling a recession, which I mean, we've been talking about that for a long time.
Stephan: Absolutely, I think there's really nothing to be surprised about right now simply because you know, the consumer as we've said has been maxed out. And as Fleckenstein always mentions, you know the home equity ATM is getting maxed out. And manufacturing is contracting and what that means ultimately, there's a demand issue. Alright? And, you know you read things like, well okay, our, you know, we had some activity because there were backlogs in inventory but when you have to unload inventory, you're selling it at a loss. Or you're selling it at not as high as you want it to sell it for. And that's not a good thing either. So what you're seeing are some interesting things right now, you're hearing comments like, well we're not heading to a recession but it's putting the economy into a lower growth trajectory. Well, that's spin, okay? Right now it's very uncertain as to whether we're headed to a recession at best and potentially we're really heading into a recession. So what you're seeing right now are really interesting things like gold at 650 up a few dollars from yesterday. Here's another interesting thing, look at the price of oil. Oil is at 63 dollars a barrel. And, you know, even Bernanke, here's what we have to think, remember this word Johannes, it's from the 1970's, and it sounds like nostalgic in a way, okay, you know Studio 54, disco and stagflation. And you have a scenario here where the economy is slowing down in certain key sectors, yet you have Bernanke still talking about an inflation potential. And what you're seeing is the classic case, which we have warned about repeatedly which is you can expand the money supply, you can expand credit, okay, basically it's all inflationary, and there's a lot of fun and there's a lot of money to spend newly created as it in fact is loaned to you, created out of thin air. So what you have is a lot of money out there right now causing the price of things, you know, you and I or anybody else out there listening, we're playing monopoly and all of the sudden we each double the money, take another hundred grand out of the till, doubling the money supply, we are going to double pretty much the price of everything on the board. The problem is now, this is the tail end of the spending spree, what you have is that increase, that vastly increased money supply over the last 10 or 15 years, it is causing things to go up. It's causing the price of gold to go up, it's causing the price of energy to go up and the problem is, is that wages are not really going up. Okay? And all of the sudden, the Fed has done things, they're in a, they've put themselves along with our government in a rough spot. The Federal Reserve tries to raise or lower rates, trying to expand or you know decrease economic activity, the problem is due to their loose money policy, due to the easy, you know zero percent home, automotive loans, low interest housing loans, low interest home equity loans, all this money is being created out of thin air as lent and now that created a lot of activity, these lowering rates. But the back end is you've increased the money supply and now as activity as you had inflationary issues, and the Fed therefore lowers rates trying to quell those things, you're seeing the housing industry dry up. You're seeing automotive dry up. You're seeing, let's just finish, you're seeing consumer spending dry up but there's still inflation and they can't raise interest rates, Johannes because that would just push things over the edge.
Well the interesting thing is at the same time, you're seeing that you can keep these interest rates low but who in their right mind is going to continue borrowing especially when you consider how tapped out a lot of the consumers are at this point. So, that's the real question is that even in the face of still very low interest rates for mortgages and so forth, you still are facing an environment where the housing bubble cannot continue the pace it was because interest rates just didn't keep going lower and lower and lower and lower. The point where interest rates remain low, that no longer sustains the bubble because money isn't getting, isn't flowing out as rapidly. And if you also look, and we talk a lot about M3, you and I, but also you need to take a look at some of the narrower based more pure money definitions. M3 includes a lot of the more esoteric financial instruments out there that are not more pure cash oriented. And in the end, when you take a look at the pure cash oriented money supply that's really the final claim, money supply. You might be able to pledge a ton of financial assets in the M3 department up against other things and really get the equivalent of demand, which drives prices up. But then what you have is that simultaneously, things like the M1 and the MZM which are more of that raw currency final claim currency that if you ultimately want to go out and buy something, that has actually been tightening and it was tightening for a little while in through 2005 the MZM, which is probably the purest of form and M1 had continued to tighten, it's been year over year, dramatically lower than it has been and I think that's where you begin to see, I think that is almost a better recessionary indicator because, it's the punch bowl gets put out the party gets going and the party immediately starts slowing down the minute you take the punch bowl away and that's something that's been said going back Freedman who was alluding to, you know in the end inflation is always going to be a monetary issue. The weird thing about today, the thing that alarms me most is there's this impression thanks to the, we call it success if you will, I would say the best temporary success of Federal Reserve Chairman Greenspan. Everybody believes that inflation has been conquered, there's nothing to be worried about with inflation, we have managed to develop you know modern alchemy where we can print money without any inflationary consequences and that is the general belief. And people are not putting together, adding one and two, when they start looking at the prices of commodities, they think of it as being purely a bubble, they look at oil they've been thinking of it as purely a bubble, they look at gold, they're looking at purely as just a bubble and just some reckless money going around. So, you know I think they're not necessarily making that inflationary connection, but at the same time, the weird thing is you also hear a lot of talk about a lot of money sloshing around trying to find a home. So, on one hand they're acknowledging it, but on the other hand they're not really connecting the dots. One finally point I'd like to make is that by increasing the money supply you are doing some very destructive things to your capital infrastructure in your country because any money that is printed out of thin air essentially is getting its purchasing power at the expense of existing holders. And that money therefore gets dropped, gets yanked out of some people's pockets, and gets pushed into other areas, and you do that in enough iterations, eventually the infrastructure starts getting weaker, you start eroding your capital base, and in a case of a country with a massive, severe deficit that we have here, consumption deficit with trade, you're looking at exporting a lot of that wealth abroad and transferring it. And meanwhile what we have here is a lot of debt and a lot of consumption as you were alluding to earlier. Any other news today specific that you came across on the wires?
Stephan: Yeah, I think that it's really important to pay attention to the verbiage. You know, Bernanke in an address on the 28th you know quote said that, "inflation would be especially troublesome...i.e. it would be troublesome if it did not fall further." He added that the Fed officials were watching for signs that wage and salary increase would feed through to higher prices while noting that companies could absorb higher costs by trimming profit margins. Now, if companies, let's get real, you're not in business to trim your profit margins, okay? And unless you're in an utterly socialized economy where the government owns every business, but businesses are here to make profits, and they're not in the business to absorb higher costs by trimming their profit margins. So, this money that you had just mentioned Johannes and I had mentioned earlier, this money's out there, a lot more money is chasing the same stuff around. And the creation of this money through easy borrowing out there has driven prices up and that is a fact. And so you have stagnating economy with rising prices, and that is not a good thing. Another thing to take a look at, the labor department is scheduled to release their November employment report in early December, I think on the 8th, and you know economist surveyors saying that okay, 115 thousand jobs are likely created during the month but the manufacturing has lost another 13 thousand jobs, and that's the key thing. Because what kind of jobs are we creating here, okay, is it going to be a nation of nothing personal, is it going to be a nation of low paying jobs or burger flipping jobs? And are we going to continue to quit making things in America. And the manufacturing industry losing 13 thousand jobs in the past month is notable.
Well, and I think you also need to consider that it's not just the manufacturing industry that is bleeding jobs, you're beginning to see it happening in services as well. For a long time the apologists were all just were saying, yeah we don't have to worry about manufacturing, we'll think, let everybody else do all the sweat labor as if you know the Chinese and all these foreigners are a bunch of fools that are just out there to do our work. And the reality is that now were starting to see more and more tech jobs bleeding abroad, we're seeing that just the capital environment in the U.S. is just corrosive to being efficient and that there are so many other issues related that regulation and compliance issues, the tax structure, you know who on Earth wants to set up business in the United States. And the interesting thing is that you see investments that companies are supposedly cash flush and that's supposed to leave the economy after the consumer begins to quiet down. And, the reality is there's really not a ton of reasons to be expanding a whole lot in the U.S. because the opportunities are limited. And today I got a note, an e-mail from a law firm that, you know I know some of the partners down there and this was sort of their standard update, it's their employment law update and here we are getting the announcement for Pennsylvania, where we happen to be broadcasting from. Minimum wage increase is coming, new minimum wage requirements go into effect January 1st for employees and employers in Pennsylvania. And it's going to bounce up the minimum wage for 5.15 an hour to starting January 1st to 6.25 an hour and then by July 1st to 7.15. And if you happen to be a small business with less than 10 they're going to make it a little more gradual for you so that you only have to increase it by 5.65 in January and then to 6.65 by July and then the following July it's got to be to the 7.15. So they're giving you an extra 12 months to accommodate that. But, what on Earth are we thinking in the United States? You know granted it's not just Pennsylvania, a whole bunch of other states, I think 20 other states just adopted through the, either the recent referendum or another to increase their minimum wages. And, really all we're doing is pricing our labor further out of the market place, making ourselves less competitive on top of all these other structural problems. And I think as a closing note, or at least my personal closing notes, Stephan, it's interesting to see that the dollar has continued to slide, it's at its lowest level in 20 months. And you know the big question is of course is this the great slide here where the dollar really, really begins to take it on the chin and the slide that continued, that started several years ago, will it now begin to enter its second lag and get much deeper. I suspect it's going to happen it's just a matter of when if it isn't this cycle. But, with all these other factors all coming together at the same time it would not surprise me if this is it.
Stephan: The point I'd make Johannes is this, and I'll pose a question back to you. I think the dollar is being propped up by certain countries that are buying our dollars, they're buying our bonds, i.e. lending us money. They're going to prop it up until they've extracted what they can extract out of our economy via borrowing, via American consumers borrowing. And what are you seeing, I think the key there Johannes is, what are you seeing as to consumer borrowing out there? Is it continuing to go up or is it slowing down?
From what I can tell, it's slowed down. Mortgage applications and so forth. Now this adjusts from week to week, and depending on what all you know, with all these adjustable rate mortgages, you know that borrowing is going to pick up again but the question is, is it just going to be refinancing and so forth. My expectations with the credit expansion credit with the consumers are, has a finite capacity there and we've seen that slow down already.
Stephan: Have you seen it in home equity loans?
Home equity loans, absolutely.
Stephan: Well that's they key, okay? Because that has driven a shockingly large amount of our GDP, okay, or our economy. The spending via home equity extraction. And when that dries up, I expect, we expect to see all of the sudden, noticing by certain countries that sell us a lot of things, they're going to notice that, as the Japanese, as we noted the other day Japan's, you're on your trade surplus ending in October, prior October, is down 25 percent due to their largest trading partner, America with far less demand Far less spending by Americans who have bought their goods. Once Japan, once China realize there's no need to prop up our dollar, that's when you will see divesting from the dollar. And if home equity extraction, home equity loans decrease, and we are seeing them decrease rather dramatically from crazily high levels, expect the dollar drop to become very real and the flight from the dollar to become real. So this could be the next big lag without a doubt. So, you know what I would say you know, I guess I would close it this way. You're seeing declining bad economic news, you're seeing manufacturing contracting but prices going up. In normal, in common sense or Austrian economics that's not normal right?
Stephan: And you if manufacturing is contracting, prices should go down. That shows you that there is so much money floating around out there.
One last issue is that it was announced today that the Chinese government or their central bank is going to begin doing less and less with the U.S. dollar. I mean that's something that they have been talking about for a while and I suspect it is going on in China and Russia or divesting of dollars and it's only a matter of time. There is that element of you know between a rock and a hard place where they have so many dollars that they begin selling in mass, then they are going to take it on the chin as well, but in the end, it is a little bit of a blink contest, who is going to, you know, it's like chicken eventually somebody is going to have to move. And someone's going to have to take it on the chin just because it is really a lousy arrangement that has become the U.S. deficit, the trade deficit, you know driving at, I think it's 60 percent, 65 percent of all trade deficits globally are U.S. driven and it's just such a lopsided global economy with the consumer in the U.S. that is overly [...] everybody's grown so dependent on that, they just don't know what to do after it, and it's got to unwind and when it does, it's not going to be pretty. Well, we should wrap up Stephan -
Stephan: Sounds great.
We're gone along here, everybody have a good weekend and tune in Monday, 4:15 for our next update. We'll talk to you then, we're on everyday 4:15 eastern time. You can also subscribe to Vigilant Investor daily via iTunes, and you can find that by going to vigilantinvestor.com, click on our live daily, weekly Podcast menu, and that will take you to talkshoe.com where you can subscribe using iTunes or any one of your Podcast subscription tools that you want.
Stephan: And if you miss the live Podcast, you can download them or just open them up on your computer and listen to our daily wrap up at any time of the day.
Alright, take care everybody, until next week, have a good weekend.