February 24, 2014

What’s Inflation? It Depends on the Definition

Posted in asset inflation, Banking, Big Banks, CPI, Federal Reserve, Inflation, investment advisor, investment banking, Markets, Nevada, Quantitative Easing, Real Estate, Robert Barone, Wall Street at 8:55 PM by Robert Barone

One of today’s economic myths is that the money that the Federal Reserve has created through its quantitative easing programs has not found its way into the money supply, and, as a result, no significant inflation has occurred.

The theory is that QE has only resulted in bank reserve creation, but little new money. Money and Banking 101 takes students through the “money multiplier” concept, where $1 of excess reserves can turn into $10 of new money if reserve requirements are 10%. Because there has been little net new bank lending since the Great Recession, the conclusion has been that there has been little money growth, and, therefore, minuscule inflation.

Those who tout this theory simply don’t understand how the money creation process works. In addition, inflation isn’t just measured by the narrowly defined and downwardly biased Consumer Price Index. Inflation means prices are rising, and, as I show below, we have plenty of that.

Money Creation

To show how the process actually works, assume that Citizen X buys $100,000 of securities from Citizen Y, and pays for it with a check drawn on X’s account at Bank XX. Citizen Y deposits the check in Bank YY. In this example, no new money has been created. An existing deposit at Bank XX was transferred to Bank YY.

Now assume that the Fed is the buyer of the $100,000 asset from Citizen Y. When Y deposits the check into his or her account at Bank YY, reserves in the banking system do rise by $100,000 as Bank YY ends up with a new deposit at the Fed.

But, also note that Citizen Y now has $100,000 in a deposit at Bank YY, a deposit that did not exist in the banking system prior to the transaction. Going back to Money and Banking 101, while the $100,000 may not be “multiplied” into $1,000,000 because the banks aren’t lending, the first step — the creation of $100,000 — did, indeed, occur.

The explosion in the assets on the Fed’s balance sheet of more than $3.3 trillion since the beginning of the QE process has resulted in the creation of at least that much new money. Using a back-of-the-envelope calculation, the change in currency in circulation as well as demand and savings deposits at commercial banks since the start of QE has been about $4.2 trillion. Net loan growth at those institutions has been about $1.1 trillion.The $3.1 trillion difference is, as expected, close to the growth of the Fed’s balance sheet.

Asset Inflation

So, why haven’t we had inflation if the money supply has grown so much? Well, we actually have had inflation. The only place we don’t find it is in the Bureau of Labor Statistics’ CPI calculation.

But, rather than dwelling on this single measure, consider that the form that inflation — rising prices — takes very much depends on what Citizen Y does with the newly created money, and what those who receive the money from Y do with it. More concretely, the Fed purchases from the large Wall Street institutions. So, it is likely that we will find inflation if we followed the path of the newly created money from those institutions.

As I have been discussing, about 25% of the newly created money over the past five years has gone into net new lending. Where did the rest of it go? It is a pretty sure bet that, given that these are Wall Street banks, much of it went into the equity and real estate markets. Equity prices as measured by the S&P 500 have risen by 150% over the five-year period, and by 29.6% in 2013 alone. Meanwhile, real estate prices as measured by the Case-Shiller 20-City Composite rose 13.7% last year.

It is also a pretty sure bet that the newly created money found its way into the emerging markets, where interest rates have been higher and the Fed’s promise of low U.S. rates for a long period of time (known as the “carry-trade”) significantly reduced the risk of the trade.

The latest 12-month official data show that inflation in Brazil is 5.6%, in India 8.8%, in Indonesia 8.2% and in Turkey 7.8%. Of course, we are all aware that the currencies of these countries have been crushed over the past six weeks, as hedge funds and other large investors have, en masse, withdrawn their funds as the prospect of a Fed tapering has become reality, along with expected rising rates.

Despite the so-called taper, the Fed continues to create a huge amount of money each month. Currently it’s $65 billion. This money has to find a home. It appears to be more than coincidental that, despite a 5.75% mini-correction in the equity market in January, prices have once again continued their upward trek.

Conclusion

More than $3 trillion of new money has been created by the Fed. It is sloshing around and causing prices to rise in equities, real estate and, until recently, in emerging markets. The money now coming out of the EMs will find another investment, causing those asset prices to rise.

We have inflation: asset inflation. The Fed continues to create money which finds its way into the financial markets. Is it any wonder why Wall Street loves QE and hangs on every word from the Fed? If history is any guide, asset inflation will continue as long as the Fed is printing. Just think what could happen to the money supply and inflation if the banks actually start to lend again.

And what might happen to asset prices if the Fed ever started to tighten?

 

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Contact Robert Barone or the professionals at UVA (Joshua Barone and Andrea Knapp) are available to discuss client investment needs.  Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

December 27, 2013

Part II: The Long-Term Outlook – Even a Strong Economy Doesn’t Change the Ultimate Outcome

Posted in business, debt, Economic Growth, Economy, Europe, Finance, Foreign, Inflation, investment advisor, investment banking, investments, Markets, National Deblt, Robert Barone at 4:46 PM by Robert Barone

If you’ve read Part I of this year end outlook, you know that it is our view that the underlying private sector is healthy and, except for the fact that the real rate of inflation is much faster than the ‘official’ rate, we could well have a short period of prosperity.

Unfortunately, our long-term outlook is not as sanguine as our short-term view.  The eventual recognition of the inflation issue, the dollar’s role as the world’s reserve currency, the bloated Fed balance sheet and the resulting excess bank reserves, and the freight train of unfunded liabilities and its impact on the debt and deficit are issues that have large negative long-term consequences.  Remember, the long-term unfolds slowly, and we don’t expect that we will wake up one day to find that all has changed.  Still, the changes discussed below could very well take place over the next decade, and investors need to be prepared.

The Dollar as the Reserve Currency

The dollar is currently the world’s reserve currency.  Most world trade takes place in dollars, even if no American entity is involved.  Because world trade has rapidly expanded over the past 20 years, more dollars have been needed than those required for the U.S. economy alone.  As a result, the U.S. has been able to run large deficits without any apparent significant impact on the dollar’s value relative to other major currencies.  Any other country that runs a large deficit relative to their GDP suffers significant currency devaluation.  Current policy in Japan is a prime example.  A weakening dollar has implications for the prices of hard assets.

In addition, the Fed’s policy of Quantitative Easing (essentially money printing) has disrupted emerging market economies.  Zero rates and money creation caused hedge fund managers to leverage at low rates and move large volumes of money offshore to emerging nations where interest rates were higher.  The initial fear of “taper” in May and June caused huge and sudden capital outflows from those countries resulting in massive economic dislocation in those markets.  In India, for example, the Rupee was pummeled as the hedge fund investors, fearing that interest rates were about to suddenly rise, all tried to unwind their Rupee investments at the same time.  And now that ‘taper’ has officially started and longer-term rates are expected to rise, these issues will continue.  Those countries have all taken defensive measures.  India, for example, imposed taxes on gold imports, which has impacted the gold markets but has reduced India’s balance of payments deficit.

As a result of such tone deafness on the part of the Fed, and because there now appears to be enough dollars in the world for the current level of trade, the international appetite for U.S. dollars is clearly on the wane.  Japan and China, the two largest holders of Treasury debt, have recently reduced purchases.  Most emerging market nations and large players like Russia and China have vocally called for an alternative to the dollar as the world’s reserve currency.  This movement is alive and well.

The Fed’s Balance Sheet

As the economy expands, the size of the Fed’s balance sheet and the level of excess bank reserves will become a problem.  There are $2.3 trillion of bank reserves in excess of what are ‘required’  under the law and regulations.  (Required reserves for the U.S. banking system are $.067 trillion; so, the system has 34x more reserves than it needs.)  Under ‘normal’ conditions, and the way the system was designed to work, if the economy got too hot, the Fed could sell a small amount of securities out of its portfolio which would reduce bank reserves to the point where banks would have to ‘borrow’ from the Fed.  Because bankers are hesitant to do that, and because the Fed could raise the ‘discount’ rate, the rate charged for the borrowings, the Fed could control new lending and thus the economic expansion.  This isn’t possible today as the Fed would have to sell $2.2 trillion to cause banks to have to borrow.  Such a volume of sales would likely cause a crisis in the financial system, or even collapse.  Today, the only way the Fed has to stop the banks from lending is to pay them not to lend – this is exactly the opposite of the intent of the original legislation and the opposite of how the Fed has worked for most of its 100 year history.

Furthermore, given the growing lack of confidence in the dollar as the world’s reserve currency, if fiscal budget deficits grow in the future, the Fed may end up as the major lender (i.e., lender of last resort) for the U.S. Treasury.  That simply means more money creation.

Unfunded Liabilities-

The U.S. Treasury officially recognizes $85 trillion as the amount of unfunded liabilities of the Federal Government.  Other professionals set this number near $120 trillion.  For comparison, the annual U.S. GDP is about $16 trillion.  The budget deficit reported in the media is a cash flow deficit (tax collections minus expenditures).  The budget deficit doesn’t include promises made for future payments (Medicare, Medicaid, Social Security, government pensions) which have been running between $4 and $5 trillion annually for the past few years.  These amounts simply get added to the ‘unfunded’ liability number.

As the population ages, these payments will have to be made, and the budget may become overwhelmed. (You see the relevance of the remark made above about the Fed being the lender of last resort for the Treasury.)   This is the heart of the debate about ‘entitlements’ that has been front and center for the past decade.

 Solutions (none of which you will like)

 Philipp Bagus is a fellow at the Ludwig von Mises Institute in Europe.  He is well known in Europe for his work on financial issues there.  In a recent paper, Bagus says that there are several possible ways out of the current money printing predicament.  Any one or a combination is possible.  We have put them in an order of most likely to least likely to be used:

  •  Inflation – this is the natural outcome of printing money;
  • Financial Repression – this is current Fed policy; savers and retirees bear a disproportionately large burden as inflation eats at their principle but there is no safe way to earn a positive real rate of return;
  • Pay Off Debt – this means much higher levels of taxation, and is definitely a real possibility.  In Europe, the International Monetary Fund (IMF) has proposed a one-time 10% wealth tax.  As the unfunded liabilities push up the federal deficit, expect such proposals in the U.S.;
  • Bail-In – In ’08-’09 we saw ‘bail-outs’ where the government saved GM, Chrysler, AIG and the Too Big to Fail banks by buying stock or otherwise recapitalizing them.  A ‘bail-in’ refers to the financial system.  Banks and other depositories have liabilities called deposits.  The depositors do not consider themselves ‘lenders.’  But, in a ‘bail-in,’ it is the depositors who lose.  Their deposits are ‘converted’ to equity in the bank.  When they try to sell their bank shares, they find that it will fetch only a fraction of the value of their deposits.  A variant of this is what happened in Cyprus in the spring of 2013.  Because of the distaste the public now has for ‘bail-outs,’ if there is another financial crisis, this is likely to be the method used;
  • Default on Entitlements – when we talk about ‘entitlement reform’ in the U.S., we really mean at least a partial default.  It is likely that some people simply won’t get what they were promised.  We put this low on the list because we have witnessed a political process that won’t deal with the issue;
  • Repudiate Debt – Because the government can simply print money to pay it debts, this is the least likely of all of the possibilities in the U.S.

The long-term issues are serious.  And not addressing them simply means a higher level of pain when addressing them is required.   Remember, these are long-term issues.  They are all not likely to occur at the same time, nor will they simply appear overnight.  The first signs of trouble will occur when markets begin to recognize that the ‘official’ inflation rate significantly understates reality, or that the inflation data become so overwhelming that they can no longer be masked.  Even then, markets may come to tolerate higher inflation, as after 100 years of fighting inflation, the Fed and the world’s major central banks have embraced it as a good thing.

Meanwhile, as set forth in Part I of this paper, the immediate outlook for the economy is upbeat.  Enjoy it while it lasts.

December 20, 2013

Robert Barone, Ph.D.

Joshua Barone

Andrea Knapp Nolan

Dustin Goldade

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp  and Marvin Grulli) are available to discuss client investment needs.
Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Part I: The Short-Term Outlook – A Strong and Accelerating Economy

Posted in Banking, business, Economic Growth, Economy, Federal Reserve, Finance, Housing Market, investment advisor, investment banking, investments, Markets, mortgage rates, Robert Barone at 4:41 PM by Robert Barone

Those who read our blogs know that over the past 6 months or so, we have turned positive on the underlying private sector of the U.S. economy.  We have had comments from several readers about this apparent change of heart, some of them almost in disbelief.  So, let us dispel any doubts.  There is a huge difference between the short-term and the long-term outlooks.  Let’s realize that long-term trends are just that, long-term, and that they take a long time to play out.  As you will see if you read through both parts of this year end outlook, our long-term views haven’t changed.  But, since the long-term doesn’t just suddenly appear, there really isn’t anything contradictory in being optimistic about the short-term.  As a result, we have divided this outlook up into its two logical parts, the short-term and the long-term.

Let’s start with the short-term.  First, at least through 2014 and probably 2015, the ‘fiscal drag’ that caused headwinds for the economy has now passed with the signing of the budget deal in mid-December.  In his December 18th press conference, Fed Chairman Bernanke indicated that four years after the trough of the ’01 recession, employees at all levels of government had grown by 400,000; but at the same point today, that number is -600,000, i.e., a difference of a million jobs.  Think of that when you think about ‘fiscal drag.’  The November jobs data shows that jobs at all levels of government have now turned positive.  No matter your view of the desirability of this, those employees receive paychecks and can consume goods and services.  So, from a short-term point of view, the ‘fiscal drag’ has ended, and, all other things being equal, this will actually spur the growth rate of real GDP.

Manufacturing and Trade

The institute for Supply Management’s (ISM) indexes, both manufacturing and non-manufacturing, are as high or higher than they were in the ’05-’06 boom period.  This is shown in the chart immediately below.

pic 1

Shown in the next chart is industrial production, which in November, finally exceeded its ’07 peak.

Pic 2

Now look below at the auto chart.  Sales are as frothy today as they were in the pre-recession boom.  Sales for the holiday buying period are destined to surprise to the upside.

Pic 3 

Housing

Part of the reason that the economy is not overheating is housing.  The chart clearly shows that housing starts are significantly lagging their ’05-’06 levels.  But, recognize that ’05-’06 was the height of the housing bubble.

Pic 4

November’s housing starts surprised to the upside.  But, they are still only 53% of their bubble peak.  Nevertheless, because new home construction has been in the doldrums for the past six years, the resurgence evident in the economy has pushed the median price of a new home north of what it was then.  In addition, the lack of construction has put the months’ supply of new homes at less than 3.  In the housing bubble, when everyone was in the market, the average level of supply was 4 months.  So, in some respects, the current housing market is hotter than it was at the height of the bubble.  And, while interest rates have risen and are a cause for concern, they are still very low by historic standards, and we have a Fed that on December 18th recommitted to keeping them down for a period much longer than the market had anticipated.

 Labor Markets

Because the popular unemployment index is a lot higher today than it was in the ’05-’06 boom (7% vs. 5%), the popular media assumes that the labor markets are still loose.  But, demographics and incentives to work have changed over the past seven years.  The labor sub-indicators imply a much tighter labor market than the traditional unemployment index would lead one to believe.  Recent new nonfarm payrolls are equivalent to their monthly gains of ’05-’06.  The weekly Initial Jobless Claims number for the week ending 11/30 was 298,000.  Except for one week this past September, you have to go all the way back to May ’07 to find a number that low.  The first chart below shows the definite downtrend in new and continuing jobless claims.

Pic 5

The next chart shows that layoffs and discharges are lower than they were in ’05-’06 and that both the “Job Openings” and “Jobs Hard to Fill” sub-indexes are in up trends and are approaching ’05-’06 levels.

Pic 6 

The Aggregates

So, while auto sales are booming, the labor markets are tight, and manufacturing and services are expanding at or near boom levels, why do the aggregates (Real GDP, for example) appear so depressed?  One explanation that we think has some credibility, is that there has been an expansion in the underground economy (barter; working for cash, etc.).  The ‘fiscal drag’ headwinds discussed earlier, have, no doubt, had a large impact on the sluggish growth in the aggregates.  On a positive note, the latest revisions to Q3 ’13 Real GDP show a growth rate of 4.1%, which, on its face, supports our short-term optimism.  And until mid-December, the markets had discounted this as resulting mainly from growth in unwanted inventories.  But Black Friday and Cyber Monday sales along with upbeat ongoing retail reports tell us something different, i.e., the inventory growth was not unwanted at all.  While the markets expect a 2% Real GDP growth for Q4 ’13, don’t be surprised if it is much higher.

Short-term Implications

The underlying data, at least for the next 6 to 12 months, point to a strengthening economy.  Certainly, a stock market correction is possible.  We haven’t had one for more than 2 years.  But, while possible, a significant downdraft like those of ’01 or ’09, don’t typically occur when the economy is accelerating (1987 is an exception) without an extraneous and unanticipated shock.  With the signing of the first budget deal in four years, and with the Fed clearing the air about tapering and actually extending its announced period of zero interest rates, almost all of the short-term worries appear to be behind us, except one.

 Inflation – The Potential Fly in the Ointment

The ‘official’ Consumer Price index (CPI) was flat in November, dominated, as it has been all autumn, by the fall back in gasoline prices.  Somehow, while we all know that everyday prices are rising at a significant pace, the markets have bought into the deflation theme.  Perhaps the belief is that if the markets play along with the Fed’s low inflation theme, the Fed will remain easier for longer.

In his December 16th blog, David Rosenberg (Gluskin-Sheff) has the following to say about inflation:

I have a tough time reconciling the ‘official’ inflation data with what’s happening in the real world… the .7% jump in retail sales in November on top of +.6% in October – these gains were all in volume terms?  No price increases at all?  Restaurants are now registering sales at a double-digit annual rate… No price increases here?  The BLS tells us in the CPI data that there is no pricing power in the airline industry and yet the sector is the best performing YTD within the equity markets…  global airline service fees have soared 18% in 2013… these [fees] are becoming an ever-greater share of the revenue pie and one must wonder if they are getting adequately captured in the CPI data.

Inflation could be the fly in the ointment for 2014.  As long as the markets play along with the Fed’s deflation theme, as we expect they will as long as they can, the economy and markets will do just fine (this doesn’t mean there won’t be a correction in the equity markets, as we haven’t had a meaningful one for two years).  But sooner, or later, something will have to be done about inflation.  We will close this Part I with a quote from Jim Rogers, the commodity guru (Barron’s, October 12, 2013):

The price of nearly everything is going up.  We have inflation in India, China, Norway, Australia – everywhere but the U.S. Bureau of Labor Statistics.  I’m telling you, they’re lying.

December 20, 2013

Robert Barone, Ph.D.

Joshua Barone

Andrea Knapp Nolan

Dustin Goldade

 

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp and Marvin Grulli) are available to discuss client investment needs.
Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

 

 

September 23, 2013

The Fed Has Lost Its Cred 09.23.2013

Posted in Federal Reserve, Markets, Robert Barone, Uncategorized tagged , at 7:59 PM by Robert Barone

NEW YORK (TheStreet) — After nearly eight years of trying to make the Federal Reserve more transparent, in one stroke Chairman Ben Bernanke has undone much of that effort.
In May, he telegraphed the “taper” of the Fed’s “Large Scale Asset Purchase” program (known as LSAP to Fed economists and quantitative easing, or QE, to Wall Street) based on a strengthening economy and labor market.

The market reacted by pushing 10-year Treasury yields to nearly 3% from 1.6%, one of the most rapid backups in yields on record. Then, in the face of that strengthening economy and labor markets, last Wednesday, Bernanke pulled the rug out.

The Data: Except for the Bureau of Labor Statistics’ (BLS) August unemployment report, almost all of the underlying data underscore a strengthening economy. Both ISM manufacturing and non-manufacturing indexes for August were strong, with the non-manufacturing index setting a record high. The employment sub-indexes were no exceptions. Initial unemployment claims have been in a steady and steep downtrend since 2010.

The week of Sept. 7 saw this number at 294,000, a number not seen since April 2006. The four-week moving average, considered more reliable, at 314,750, hasn’t been this low since October 2007. The Fed’s own economists have indicated that concerns over “structural” employment issues (i.e., labor force drop-outs) have been overdone. Job openings in the private sector are higher than at any time since 2008, and employers complain they cannot find qualified candidates.

Thus, based on labor market conditions, which Bernanke indicated was key, in conjunction with the lack of success of the LSAP programs in stimulating economic growth (also according to the Fed’s own economists), the “taper” should have occurred.

After months of “taper” talk and years of trying to promote transparency, last Wednesday, something else happened. We don’t know what it was — yet. Maybe we will find out soon, or maybe we will have to wait for Bernanke’s memoirs.

Here are some possibilities:
•The Fed misread the August employment report. This doesn’t seem possible. As outlined above, all of the underlying employment data are much stronger, not weaker than last spring. Also, the Fed knows that the BLS heavily massages the employment releases.
The concurrent seasonal adjustment process used by the BLS, where each month the entire year’s series is recalculated but not released to the public, makes it not only possible but highly probable that the weaker August release simply reflected catch-up from the frail first and second quarters. So, while the August BLS numbers could be used as an excuse, they surely cannot be the underlying reason.

•The market reaction to the May “taper” announcement was more than the Fed anticipated and interest rates backed up too fast. The Fed may be concerned over the impact of higher rates on the nascent housing recovery. After all, the QEs seem to be aimed squarely at housing (the purchase of Mortgage Backed Securities in QE3) and the equity markets. But if this were the case, the Fed could easily jawbone rates lower, even in the face of the initial taper. In fact, many market pundits thought that rates would fall if the “taper” amount was as anticipated ($10 billion to $15 billion).
•There is a third possibility, one that is purely speculative on my part: Bernanke has decided that he wants another four-year term as chairman. Of course, that requires a White House nomination. Recognizing that nothing happens in Washington that isn’t manipulated or controlled, the events of the past 10 days surrounding the Fed seem too coincidental not to be related.
It is clear that while the markets want Janet Yellen to be the next Fed chair, the White House is not keen on her. Perhaps the “no-tapering” announcement was the quid pro quo between Bernanke and the White House and that Lawrence Summers’ formal withdrawal of his name from consideration (quite unusual, since there was no formally announced candidate list) was part and parcel. After all, a rising stock market is always desirable for the White House’s occupant.

Conclusion: History will eventually sort all of this out. Meanwhile, one thing is clear: The eight years of effort to make the Fed more transparent and credible have been dealt a serious blow. Last Wednesday, with the “no-taper” announcement, the Dow Jones Industrial Average rose 147 points. Since then, it has fallen 226 points, with a loss of 185 on Friday, as the markets have begun to rethink the implications.

In the end, without Fed credibility, markets will be more uncertain and, therefore, more volatile.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs.

Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

December 31, 2012

Barone: 2013: Forecasts for the unsettled road ahead

Posted in Economy, Markets, taxes, Uncategorized tagged , , , at 7:59 PM by Robert Barone

Forecast 1: Slow economic growth in 2013’s first half; second half could be better.

Whether we go over the “fiscal cliff” or not, the first part of 2013 will be quite slow with the possibility that even the “official” numbers could show up as negative. At this writing, it does not appear that the Washington politicians will reach any sort of meaningful deal by year’s end. But, even if they do:

• Economic confidence already has plummeted.

• There are significant 2013 tax increases in Obamacare and a return to normalcy in the employee portion of the Social Security tax; furthermore, the end of extended unemployment benefits is a significant hit to consumer income.

• The job market remains weak; much of it due to a skills mismatch, which is a very long-term structural issue.

• Consumers’ real incomes continue to fall.

The second half of the year might be a different story. If some fiscal certainty is delivered in January, U.S. business investment spending, currently at a six-decade low, easily could pick up and spur the economy above the 1 to 2 percent growth rates we have seen in recent years.

Forecast 2: Nevada’s housing market will continue to struggle.

The housing market in Nevada appears to have been a bright spot for 2012. Realtors indicate that the rise in the median price is due to a shortage of supply, not an increase in demand. Nevada’s AB284, effective in October 2011, all but halted foreclosures. There remains a dearth of first-time and move-up homebuyers. I suspect this scenario will change in 2013 as the Legislature, prodded by the powerful banking lobby, deals with the technical issues in AB284 that now make it difficult and dangerous for mortgage holders to foreclose. That means more supply in 2013’s second half, and, perhaps, a plateau in home prices.

Forecast 3: Europe will sink further in 2013.

The markets are thrilled that Europe is uniting to save its insolvent banking system. While the immediate crisis has been averted through the injection of liquidity, the insolvency issues remain. The chosen path for Europe is to inflate its way out.

In 2013, the European Union will continue to be ensnared in a significant recession (depression in Greece, Spain and Portugal). France, considered to be part of the strong northern European core, also will enter recession in 2013. Even the mighty Germans will be hard-pressed to show more than a flatline.

Forecast: We have not yet seen the last of the European Union implosion. It has just been placed on the back burner with the European Central Bank’s adoption of Bernanke-style money printing policies.

Forecast 4: The Chinese miracle will continue in 2013.

China avoided a “hard landing” in 2012. The reason: A one-party political system doesn’t end up in policy gridlock. There is hot debate as to the sustainability of the current Chinese turnaround, but one thing is for sure: Economic policies, be they right or wrong, are carried out quickly and the economic impacts are felt with minimal time lags.

Forecast 5: The currency race to the bottom will intensify in 2013.

All of the world’s major central banks (the Fed, Bank of Japan, ECB and Bank of England) are printing money at breakneck speed.

The Fed is printing at least $85 billion per month, which, at least temporarily, allows the Washington politicians to shirk their fiscal responsibilities. After all, even if foreign demand for U.S. treasuries (i.e., Japan and China) dries up, the Fed will purchase any new debt due to the tax and spending imbalance.

The same scenario is true in Japan where the newly elected Prime Minister Shinzo Abe has successfully attacked the independence of the Bank of Japan, which now appears willing to print enough to cover the fiscal deficits on which Abe campaigned. Ditto for the U.K.

All of this money printing is really a form of mercantilism, i.e., policies aimed at producing a positive trade balance, resulting in higher factory output and employment levels at home. China is the world’s role model in this regard.

I call this the “race to the bottom,” because when every country does this, as is the current situation, not only is it a zero-sum game (i.e., no one wins), but there are significant unintended consequences. We see this throughout the world with zero interest rate policies penalizing seniors and savers.

Forecast 6: Precious metal, art and gem nominal prices will rise in 2013.

After 10 years of strong gains, the prices of precious metals recently have seen downward pressure due, in part, to profit taking ahead of inevitable capital gains tax increases in the U.S. in 2013. There also is a rumor of significant liquidations in a large hedge fund (Paulson), which has heavy gold investments.

Nevertheless, the underlying demand for precious metals, art, gems and other hard assets is strong, especially in the face of the “race to the bottom.” My forecast is for the nominal prices of these assets to continue their upward trajectory as every country in the industrialized world has chosen inflation over fiscal austerity.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.