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The deal to raise the debt ceiling, agreed to last week, obviously wasn’t enough to calm markets and no wonder. The deal was just more of the same smoke and mirrors we’ve come to expect from the small, petty people who populate the halls of power in Washington, D.C. Finding anything in this deal that remotely addresses our long term budget issues is like trying to find the proverbial needle in a haystack. The "spending cuts" do no such thing, merely reducing the rate of growth by a rounding error. And even that assumes that some future Congress actually adheres to the plan, the economy continues to grow and interest rates don't rise, none of which is assured by any stretch of the imagination. The fiscal commission set up to find the other half of these mythical budget savings was given a wake-up call by the market last week and a slap in the face late Friday by Standard and Poor's downgrade of US debt to AA+. Let's hope they take it seriously.
The issues facing the global economy did not change last week. US and global economic growth is still waning. We still have no long term plan to reduce the deficit or reform our byzantine tax code. Europe is still in the throes of a debt crisis that neither the ECB nor the member states of the EU seem to have a clue how to solve. Emerging markets and China specifically, are still fighting an inflation problem. The world's major fiat currencies are still falling against the sin qua non of money, gold. What did change was that any remaining confidence in government to address these problems was completely and utterly destroyed.
The finger pointing that ensued after the S&P downgrade Friday gives one little confidence that the politicians have gotten the market's message yet. Democrats blamed Republicans for not raising taxes. Republicans blamed Democrats for not cutting spending enough. This problem will not be solved by raising the tax rate on the wealthy by a few percentage points. It won't be solved by taking more capital out of the private sector for politicians to spend on pet projects that benefit their largest campaign contributors. It can be solved by a real "“ and large - cut in government spending but that path without offsetting pro-growth policies is unnecessarily cruel for the millions who have become dependent on government for their very existence. Americans need not don a hair shirt of austerity to atone for the sins of our politicians. Policies that enhance growth will naturally reduce the need for government spending.
We need wholesale changes in our economic system from the tax system to the monetary system to the social safety net. We are long past the point where tinkering around the edges will be sufficient to restore growth and provide opportunity for all Americans to be productive members of society. The tax system as it currently exists is a labyrinth of social and industrial policy that has failed miserably. It is a product of political influence, corruption and disinformation. It is inefficient, riddled with loopholes and incomprehensible to even the IRS. Meanwhile the social safety net is fraying and will eventually fail completely without reform that puts Social Security, Medicare and Medicaid on sound financial footing.
The monetary system is, in my opinion, in the most dire need of reform and it isn't even on the radar of the political class with the exception of a few like Ron Paul. The market was rife with rumors last week of a new quantitative easing program from the Federal Reserve. The first two efforts were miserable failures for the economy, raising both commodity prices and interest rates. Why anyone except speculators would welcome a third round is beyond me but hope springs eternal among traders and ivory tower economists alike. The expectation that the Fed can and will ride to the rescue for any economic ill needs to completely excised from the market and the minds of politicians. Reform needs to acknowledge the limitations of monetary policy. The only suitable role for monetary policy is to provide a stable value for the dollar "“ preferably in terms of gold.
We at Alhambra will be watching the coming debate of the fiscal commission closely. It is still possible that the shock delivered by the markets and S&P will be sufficient to convince the politicians that large scale reform is not only needed but necessary. The global economy is not yet in such dire condition that better long term policy would not produce immediate results.
The economy, while not great, continues to muddle through despite the dithering of the politicians and a new recession is by no means assured by last week's market rout. Stocks are fairly cheap "“ not that they can't get cheaper of course "“ and sentiment is extraordinarily negative, conditions that would normally have us salivating with our fingers on the buy button. The S&P downgrade after the market close Friday and the situation in Europe does give us pause though. We see little reason to rush at this point. Our cash, short term Treasury and gold positions have served us well over the last few months and missing the bottom is not our greatest concern at this point.
The economic data last week continued to be on the weak side but not extraordinarily so. The trend of a slowing but still expanding manufacturing sector, steady consumer activity, a housing market bumping along what we hope is a bottom and a jobs market that is just good enough to keep the unemployment rate from rising, continued.
The ISM manufacturing survey dropped to 50.9 primarily due to a drop in new orders. That is still above the 50 level that represents expansion though and in the past it has taken readings under 45 to signal outright recession. Employment was also down but still at 53.5, indicating continued hiring. Factory orders were down 0.8% in June with all the drop in the durable category. The ISM non-manufacturing survey was a bit firmer at 52.7. Taken together these reports indicate slow growth, not a recession.
Construction spending was slightly higher, up 0.2% in June led by private non-residential outlays up 1.8%. Residential construction fell 0.3%. Year over year the rate of decline in construction spending slowed to 4.7% from 7.1% last month. Low interest rates led to a rise in mortgage applications last week, up 5.1% and 7.8% for purchases and refinancing respectively. Housing and construction are slowly healing but these readings are not robust enough to get excited about.
Personal income and spending were both soft in June up 0.1% and down 0.2% respectively. The spending side was mostly affected by a drop in motor vehicle sales and falling gas prices. It isn't a rosy picture by any stretch but neither is it recession territory. More recent data on motor vehicle sales and chain store sales were a bit more upbeat. Of course, there is no way to measure the psychological impact of the US debt downgrade and how that might affect future activity. That is something we'll be watching closely in the coming weeks.
The news on the jobs front was mixed. Challenger reported a rise in layoffs but jobless claims were flat and the employment report Friday showed a gain of 154,000 in private payrolls. Jobless claims remain elevated at 400k but that is still consistent with the job growth reported Friday. The layoffs from Challenger have yet to happen in most cases though so an uptick in new claims in the coming weeks would not be surprising.
As I said at the beginning of this section, the economy continues to muddle through. For now, I see no reason to expect a renewal of recession but the psyche of the public is fragile and the future is, as always, impossible to predict. We are facing a crisis of confidence as much as anything else and the antics of the politicians don't help in that regard but our economy and the American people are resilient. Hopefully that is enough to keep us muddling through until we get real reform.
With Alhambra's recent expansion we have added some new features to our weekly lineup. John Chapman's weekly column, Thinking Things Over, has its third installment this week. Doug Terry joins the weekly lineup with Contrarian Alert. Joe Gomez provides a report on market technicals and details of various market indicators.
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