Sandpit

Despite the headlines, market panic and those wishing it might be so, Dubai is not going to bring down the world. Yes it has large borrowings and is a place of wild folly, but its demise is akin to your local theme park going bust - sure there will be some layoffs and a few creditors will take some pain, but life will go on - only without an outlet for frivolous spending habits. Paul Krugman is right, Dubai is sui generis.

Dubai 5 year bond CDS


Perhaps the biggest ramification, though, is the damage done to the Middle East, other emerging markets, and the collective perception of global economic recovery. Credit is going to be harder to come by for the Middle East and belief that economic life is sustainable in a post-oil world has taken a serious knock. Once oil runs out, you are left with a desert and a few gleaming marbles lying in the sand. What remains are an inhospitable climate, an inflexible government and Islamic fundamentalists at your left and right.

AS for the global economic recovery (GER) from the global financial crisis (GFC); we are again reminded that it is not a straight road. Indeed Dubai's sovereign crisis has been a stark reminder that markets scare very easily and the panic could be a good deal greater if the stakes are higher.

Congress and the Fed/Treasury cross swords

With midterm electioneering underway, it was only a matter of time before self-styled fiscal conservatives started grabbing the low-hanging fruit by bashing Wall Street, the Fed and the Treasury (WSJ link):

WASHINGTON -- Political frustration over the rescue of Wall Street and high unemployment erupted in the House Thursday, with one committee threatening to impose tighter scrutiny on the Federal Reserve and another trading verbal insults with Treasury Secretary Timothy Geithner.

The House Financial Services Committee voted, 43-26, to approve a measure sponsored by Texas Republican Ron Paul, vociferously opposed by the Fed, that would direct the congressional Government Accountability Office to expand its audits of the Fed to include decisions about interest rates and lending to individual banks. The Fed says the provision threatens its ability to make monetary policy without political interference.

...

Mr. Paul maintained that his amendment wouldn't hinder monetary policy, but instead remove a veil of secrecy at the central bank that's unique within U.S. government. At the Fed, "there's plenty of political influence going on now -- presidential politics, influence by Goldman Sachs and the banking industry," he said. "It's all done in secret."

Congressional auditors have been blocked from reviewing the Fed's monetary policy operations, its loans to foreign governments and direct lending to banks since 1978, when a law was passed to shield the central bank from politics. Auditors already have access to the Fed's operations outside of monetary policy, including bank supervision and the special loan facilities created to rescue specific institutions, such as AIG and Bear Stearns Cos.

GAO audits could publicly reveal reams of information that now remain private, sometimes indefinitely. The Fed doesn't identify banks to whom it lends directly for fear of sparking a disruptive run on the bank. It has suggested that it might be willing to release that information after a lag.

The Fed in the past has resisted calls to release information, only to relent. In the 1990s, for instance, after pressure from Congress, the Fed began releasing transcripts of its interest-rate deliberations after a five year lag. Mr. Paul's proposal would delay GAO access to Fed decisions for six months. A companion Senate measure has drawn support from about a third of that chamber.

"If there's anything worse than a secret Federal Reserve, it's Congress controlling it," said Sen. Jim DeMint, Republican of South Carolina. "But I do think that there's a wide majority of Americans who want to know what the Federal Reserve is doing and to make sure that it's achieving its primary purpose, which is to protect the value of our dollar."

To paraphrase the Senator from South Carolina, if there's anything worse than the myth that the US wants a strong dollar, it is the Fed and the Treasury's continued insistence that this is the case.

Covered stadium sells for US$583,000

http://www.detnews.com/article/20091117/METRO/911170327/1411/METRO02/Silverdome-sale-price-disappoints

A stadium in Pontiac, Michigan has just sold for $583k:

Nearly 35 years after taxpayers spent $55.7 million building the Pontiac Silverdome and a year after a $20 million sale fell through, city officials have sold the arena once called the most desirable property in Oakland County.
The price: $583,000.

The 80,300-seat stadium opened in 1975 and has largely remained empty since the Detroit Lions left for Ford Field in 2002. The sale included 127 adjacent acres.

Now obviously the real cost is the conversion of the stadium into something useful. Furthermore, there's no mention of any debt. It's fair to say, however, that this is a sad reflection of commercial real estate and the Michigan economy (once the, ah, engine of the US economy)

Friday reading

Moody's may cut Deutsche Bank ratings on credit risk (link)

Moody's cuts UBS, cites loss of client confidence(link)

Some T-Bills Due Jan, Feb Are Trading With Negative Rates (link)

Goldman warns of near-term downside risk in WTI (link)

John Paulson's Q3 letter to investors (link)

SocGen's worst case senario (link)

I tried to look for some good news...

Reality check Thursday

I get a certain letter every day, and today when the guy signed off with, "I just have this feeling after two days of fading in the afternoon session the xxxxx will have a good day today, led by resources.", I decided that a look at some hard facts was in order. (emphasis added)

I'll begin with this little story:

Wire: BLOOMBERG News (BN) Date: Nov 19 2009 13:01:45
China Iron Ore Imports Exceed Demand by 63 Million Tons

By Bloomberg News
Nov. 19 (Bloomberg) -- Iron ore imports by China, the
world’s largest buyer of the steelmaking ingredient, exceeded
real demand by 63 million tons in the first ten months, the
China Iron & Steel Association said.

Port inventories have exceeded 70 million tons, Vice
Chairman Luo Bingsheng said today at a conference in Beijing.

For Related News and Information:
Top Stories:{TOP}

I have been saying - ad nauseum - that I believe that China is building what amounts to another Great Wall in overcapacity. The metaphor is obvious - a vast application of resources, money and time towards the unnecessary. I'll direct readers to Ambrose Evans-Pritchards in The Telegraph:

"The inherent problems of the international economic system have not been fully addressed," said China's president Hu Jintao. Indeed not. China is still exporting overcapacity to the rest of us on a grand scale, with deflationary consequences.

While some fret about liquidity-driven inflation, Justin Lin, World Bank chief economist, said the greater danger is that record levels of idle plant almost everywhere will feed a downward spiral of job cuts and corporate busts. "I'm more worried about deflation," he said.

By holding the yuan to 6.83 to the dollar to boost exports, Beijing is dumping its unemployment abroad – "stealing American jobs", says Nobel laureate Paul Krugman. As long as China does it, other tigers must do it too.

...

The reality is that much of Beijing's $600bn stimulus has been spent building yet more plant and infrastructure so that China can ship yet more goods, or has leaked into property and stocks.

Credit has exploded. Allocated by Maoist bosses for political purposes, it has become absurd. China is rolling as much steel as the next eight producers combined. It is churning more cement than the rest of the world. Fixed investment is up 53pc this year. Once you know that Hunan authorities have torn down two miles of modern flyway so that they can soak up stimulus by building it again, or that the newly-built city of Ordos is sitting empty in Inner Mongolia, you know what must come next.

Finally there have been reports from serious Chinese insiders on fears of a property bubble (reported in the FT). The Pivot Capital report that I have referred to in the past is scathing on property investment as it is on overcapacity and return on investment:

The gradual increase in China’s investment ratio that started in 1998 has now reached unprecedented levels. As a result, capital spending has become the dominant growth driver. We estimate that GFCF accounted for 70% of China’s growth in 2008 and close to 90% of China’s H1 2009 growth.

Amazingly, the ratio of GFCF to GDP is expected to exceed 50% this year, which would be well above the highest GFCF to GDP ratio any Asian country reached in their mid 1990s booms. Another salient observation is that the longest period any country maintained GFCF to GDP in excess of 33 % was nine years (Thailand 1989-97, Singapore 1991-99). China is now in its twelfth year of investment boom.

...

At the same time, the effectiveness of domestic credit in generating growth is collapsing. In the period from 2000 to 2008, it took on average $1.5 of credit to generate $1 of GDP growth in China. This compares very favourably with the peak $4 of credit for $1 of GDP in USA in 2008. However in H1 2009 in China this ratio was already at around $7 to $1. Credit might be going into the luxury property and stock markets, but the trickle down to the real economy is
very poor.

There is much more besides in the full report (link again)

President Obama has also taken to economic forecasting and yesterday warned of a potential double-dip recession. Perhaps those who ignored his call to buy equities in March (me included) should listen up. His comments also prove that the demand for mawkish catch-phrases is still high:

“It is important though to recognise if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the US economy in a double-dip recession,” said Mr Obama.

Joe six-pack is currently lost between green shots and double-dip, wondering what all the bubbles are about.

In case your bad news file on US unemployment wasn't full enough, there was this report from the NY Times that over 1 million people will exhaust their jobless benefits by January:

About one million laid-off workers will see their unemployment benefits end in January unless Congress acts quickly to renew existing federally paid extensions, according to a new survey and legislators and state officials.

...

According to projections released Wednesday by the National Employment Law Project, an advocacy group that worked with state officials to develop the numbers, 474,111 unemployed workers will exhaust their state benefits in January and, in the absence of Congressional action, not receive any extensions.

Finally, Calculatedrisk has a good look at the frankly awful MBA Mortgage Applications number:

It appears the post home buyer tax credit slump is in full swing. The tax credit was extended and the eligibility expanded, but interest will probably wane (you can only pull so much demand forward).

According to the Mortgage Bankers Association (MBA) report:

The seasonally adjusted Purchase Index has declined for six consecutive weeks and is at its lowest level since November 1997.

That's probably more reality than anyone can stand on a Thursday.

Double-speak, non-speak, and changing your tune

Donald Rumsfeld to a press conference at NATO Headquarters, Brussels, Belgium, June 6, 2002:

Now what is the message there? The message is that there are known "knowns." There are things we know that we know. There are known unknowns. That is to say there are things that we now know we don't know. But there are also unknown unknowns. There are things we do not know we don't know. So when we do the best we can and we pull all this information together, and we then say well that's basically what we see as the situation, that is really only the known knowns and the known unknowns. And each year, we discover a few more of those unknown unknowns. "

The inaugural weekly Rove Rumsfeld Double-Speak award goes to Ben Bernanke. After a full twenty minutes of saying nothing during his speech at the Economic Club of New York on Monday, he had this to say in the Q&A session regarding recent asset appreciation.

Bernanke said it was "inherently, extraordinarily difficult to know whether an asset’s price is in line with its fundamental value or not."

And he added: "It’s not obvious to me in any case that there’s any large misalignments currently in the U.S. financial system."

It does take a special amount of skill to put those two sentences together whilst keeping a straight face.

However, Vice-Chairman Donald Kohn made similar remarks on the same day:

As I've already noted, our abilities to discern the "correct" values of assets is quite limited. At present, however, the prices of assets in U.S. financial markets do not appear to be clearly out of line with the outlook for the economy and business prospects as well as the level of risk-free interest rates...

...Moreover, money and credit have been quite weak, suggesting that asset price movements have not been fueled by increased leverage that would leave financial intermediaries vulnerable to a reversal of recent gains. The improvement in the spreads and functioning of securities markets has not been accompanied by any loosening of very tight credit conditions for bank credit; indeed, banks have continued to tighten terms and standards in recent months, albeit at a slowing rate.

Still, my current assessments could be wrong--asset prices may in fact be in the process of rising excessively.

He is absolutely right, asset prices have not been fueled by excessive leverage, merely by the hundreds of billions parked in banks by the Fed.

Goldman Sachs, however, have begun to change their tune in a number of oft-performed standards. Firstly, GS Chief US Economist Jan Hatzius warned that "a V-shaped recovery remains unlikely in the US:

Despite the sharp pickup in real GDP growth since the dark days of early 2009, we estimate that real final demand—net of the boost from fiscal policy—is still contracting at an annual rate of around 1% in the second half of 2009. Although we expect a moderate recovery of around 2% by the second half of 2010, such a 3-percentage-point improvement would be insufficient to offset the loss of 4-5 percentage points of stimulus from fiscal policy and the inventory cycle. Hence, real GDP growth is likely to slow anew to a below-trend pace.

The significantly stronger recovery that is now anticipated by a number of forecasters would require a much sharper acceleration in underlying final demand, along the lines of prior recoveries from deep recessions. But this ignores some key differences between the current situation and the aftermath of prior slumps. In particular, bank credit is tighter, the personal saving rate is much lower, the labor market is less cyclical, there is much more excess housing supply, and state and local budget gaps are deeper.

In Friday’s US Economics Analyst, we noted that several key indicators of final demand—including retail sales, capital goods orders, and exports—continue to look “L-shaped with a slight upward tilt,” to use the expression of San Francisco Fed President Janet Yellen. This remains true after today’s retail sales report. While “core” sales excluding autos, building materials, and gasoline rose a stronger-than-expected 0.5% in October, this was offset by a cumulative 0.3% downward revision to the prior two months.

Indeed, net of the fiscal policy boost from fiscal policy, we estimate that final demand is still declining at about a 1% (annualized) pace in the second half of 2009.

The second tune change from Goldman was to the key of humility major. In conjunction with Warren Buffet, GS announced a fund of 500 million dollars to help 10,000 small businesses over the next five years. Buffett is known for his philanthropy, GS have their "Foundation" which seems more like a hedge fund and are desperately in need of some good PR. US$500 million over five years seems quite small compared with nearly US$17 billion in bonuses over 9 months.

Finally, after enabling the explosion of credit in the US over the last decade through an artificially weak currency and the hoarding of US$-deonominated reserves, the Chinese warned:

"The continuous depreciation in the dollar, and the U.S. government's indication that, in order to resume growth and maintain public confidence, it basically won't raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation," Liu Mingkang, chairman of the China Banking Regulatory Commission, said Sunday in Beijing at the International Finance Forum, according to news reports.

Low U.S. interest rates and a weaker greenback have "seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies," Liu said.

It is strange that such a large creditor is surprised that the consumption machine they helped create is starting to backfire.

"Dust and ashes, dead and done with, Venice spent what Venice earned." Robert Browning.

The Asymmetric trade and Gold

ASYMMETRY

Crowded trades have their utility if you able to chase momentum whilst maintaining an easy exit option. Some OTC trades don't represent that easy option, as witnessed by the short-squeeze in Japanese bonds in the last few day. The trade was right for nearly three months until suddenly, and quite violently, it wasn't. Expect some large holes in P/Ls the world over.


Nearly, the entire world is in agreement that Japan is in a terrible fiscal state, 200% debt-to-GDP is not sustainable, and the bonds and yen can't hold up. However, it merely took one successful bond auction to take all the shorts out to the barn. Often, it doesn't pay to be right, or you need deep pockets to follow intellectual rigour.

For those unwilling to bear short term losses, or indeed cannot weather margin calls that can lead to position liquidation, the idea of the asymmetric trade is a compelling one. It is way to take a view without having to spend a great deal of time and money on a hedging strategy.

Short ¥en and JGBs is not the only way to play the Japan fiscal crisis theme. Certainly corporate and sovereign CDS are cheaper to hold, as are interest rate swaps. I'm sure your friendly local OTC desk will be happy to oblige.

GOLD

No asset class is capable of generating more polarising points of view, tinfoil hat conspiracy theories, or down right superstition that gold. It has the weight of history reinforcing its role as a store of value, yet beyond that it has little utility. It has been variously described as an inflation hedge and a currency of last resort. However, the price went nowhere during the great inflation episode in the 1970s. Furthermore, what did the price of gold do in the great panic of October 2008? Did it spike as investors searched for a safe haven? No, it collapsed as investors stampeded for the US dollar.

However, it has become part of the new anti-dollar asset class (just about everything). It is our fascination with the precious metal, a wonder that has existed for millennia, that keeps every new price record on the front page. Perhaps because it has no large scale industrial use like copper, any substantial trend in its price is scrutinised with great intensity.

Regardless, gold is becoming a very crowded trade. There is limited gold in vaults, limited quantities of the stuff in the ground. Gold rush, gold fever - history is littered with mania. The 2009 gold rally: asymmetric it ain't. pets.com?

Further reading on Japan

I have attached some links to this post for further reading on the fiscal predicament that Japan currently finds itself in. Take from them what you will, but here is a thought primer:

a) What does the future hold for JGBs and the yen?
b) Is the US doomed to follow Japan into a liquidity-trapped decade of misery?
c) How might an affirmative answer to (b) affect China and the continued expansion of its production capacity?
d) Japan brought US commercial property and built bridges to nowhere at the height of its mercantalist boom. China has bought US Treasurys and is currently building bridges and railways to everywhere.
e) Property prices went mad in the 1980s in Japan and have since collapsed despite limited supply. Property is currently going mad in China despite a flood of supply.

Links:

Dr Paul Krugman's old but still relevant analysis of Japan's liquidity trap.

I urge you to read Hugh Hendry's (Eclectica Fund) latest letter to his investors.

FT Alphaville has a good collection of links and analysis on Japanese bonds in this entry.

William Persek of Bloomberg takes a look at David Einhorn's (Greenlight Capital) warnings and subsequent bets on Japan.

Japan Q&A No. 2

Following on from yesterday's brief look at Japan's national debt and demographics, today I would like to look at potential yen effects.

Q: How might a sovereign debt crisis in Japan play out?
A: It is true that the cost of insuring Japanese government debt has risen lately. Although I don't place a huge amount of faith in CDS, it is a clear sign of sentiment as Japan hovers around the appalling 200% of debt to GDP. It also looks particularly bad against the CDS for US 10 year notes.



Currently, however, bond yields in Japan don't warn of an impending sovereign crisis. Thursday's bond auction in Tokyo revealed robust demand, which is certainly tonic for the new government who intend to finance a huge amount of spending through bonds:

TOKYO (Dow Jones)--Demand was solid at Thursday's auction of five-year Japanese government bonds, a sign that the market has been reassured by recent signals that global central banks will keep monetary conditions easy.

The market has also factored in concerns that the Democratic Party of Japan-led government may increase bond issuance to finance new policy measures, analysts said.

Japan's Ministry of Finance sold Y2.186 trillion of five-year JGBs at a lowest price of 100.03, higher than traders' forecast of 100.02, to yield 0.693%. The average price was 100.05, yielding 0.689%. The new issue carries a coupon of 0.7%, reopening the September note.

JGB yields have climbed recently on worries that increased fiscal spending by the new government will lead to oversupply in the market. The benchmark 10-year JGB yield rose as high as 1.485% Tuesday, though it came down to 1.375% earlier Thursday. The five-year JGB's yield also rose. Today's auction indicates that yields may have peaked for now.

"The results were positive, confirming solid demand for mid-term JGBs from domestic financial firms, probably on speculation that central banks will keep implementing easy monetary policy," said Naomi Hasegawa, a senior fixed income strategist at Mitsubishi UFJ Securities.

In addition to their higher-than-expected price, other factors indicated firm demand for the five year bonds.

The bid-to-cover ratio, which tends to be higher when there is strong demand, was 3.70, compared with 2.17 at the last tender in October. Bids totaled Y8.078 trillion.

And the tail--the difference between the average price and the lowest accepted price--was at 0.02, compared with 0.04 at the previous five-year tender. The tighter the tail, the more demand there is, and 0.02 is the narrowest reading since September's auction.

Here is the yield graph for the last two months:


Another favourable factor for Japanese bonds is that nearly half are owned by the public sector and only about 10% by foreigners. Just how long this can last is the real question and here demographics comes into play.

The increasing ranks of retirees are starting to eat into pension funds and the savings rate of both corporations and individuals has fallen. Long term this means there will be increased competition between the public and private bond issuers, resulting in higher interest rates. Good for the yen? Probably only briefly, because it is likely that investors will start to lose faith in the Japanese economy. Furthermore, interest repayments on bonds already take up a quarter of the national budget and so the government is unlikely to favour the idea of higher yields. This, certainly, would be toxic for the yen as the printing presses would have to be cranked up to help inflate away the debt.


So short yen looks to be a good trade, but against what? This issue is further complicated in that it is not clear if the yen's previous role (prior to the USD) as the carry currency of choice has been completely reversed. Analysis from Pi Economics as reported in Forbes suggests that $400 billion has yet to be unwound. The USD has potential to be an enormous resource for borrowing because it is likely that low rates will persist into 2011 and the USD accounts for over 60% of global foreign reserves. The euro is the obvious answer as a currency pair to short yen but problems persist in some eurozone economies such as Spain. Perhaps the safest strategy is to pick a basket of currencies that would probably include the EUR, AUD, NOK, CHF and CAD. As a long term trade it might well be a very bumpy ride.

Structurally things are starting to look very bad for Japan and much of this stems from poor decisions coupled with demographic issues. Certainly the total lack of an immigration policy is a glaring error. More bad news to come. A good weekend to all.

Japan Q&A No.1

I'm going to focus on Japan for the next couple of days. I was at the launch of a design school last night and the head of the company that is sponsoring the school called Tokyo the New York of Asia with respect to design. I am sure that this is true, but is this where the similarities end? How much chance is there of a lost decade "Japan style" in the US. More importantly, will Japan be able to arrest its extraordinary debt burden and avoid another lost decade?

I will be examining Japan in detail over the next week and whether the US is committed to make the same mistakes that Japan made in the 1990s. Let's begin with a quick look at public debt and populations.

Q: What is the percentage of debt to GDP of Japan and the US?
A: Roughly 200% and 90%, respectively.

Q: What do the populations of the US and Japan look like?
A: USA's growth rate is 1%, fertility rate of 2.1 per woman. Japan's growth rate is 0.2%, fertility rate is 1.2 per woman. The USA is projected to have 357,452,000 people by 2025 (307,212,000 now), Japan 117,816,000 (127,079,000 now). Source: US Census Bureau.





Given that future generations have to pay off the national debt, it is quite clear that Japan is going to run into some difficulty. Currency impact analysis will come tomorrow.

Reinvention

"Any man who is a bear on the future of the United States will go broke." J.P. Morgan

Today I would like to take a step back from the markets and examine how the US might return to growth and what its exit velocity is likely to be. The two short answers are with difficulty and rather slow, respectively. [As aside, please for give the current US-centric nature of my posts but, in these foggy times, if you are going to attempt to understand anything it might as well be 1/3 of the global economy. Furthermore, America's sphere of influence plus market-leading significance make it all the more important. I might add that I am not in the camp that the US will pale into insignificance in this century - far from it.]

In the past, recovery has been led by consumption or the inflation of asset bubbles. I put it to you that consumption is definitely out of the running this time, since consumer credit is weak and the old fashioned facilitator - mortgage equity withdrawal - is tapped out.


The extreme employment weakness doesn't help, either. Yet the weak dollar offers a platform for an export-led, job-loss recovery. "Job-loss" because it is likely that unemployment will rise beyond the first half of 2010. Here's a fantastic entry on unemployment from Calculatedrisk.




This leaves asset bubbles, and these are most often created by easy credit and loose monetary policy. Unfortunately, monetary policy has run out of bullets with interest rates in the US at zero and likely to stay there for an "extended period" (to use a Fed phrase). Lending in the broader economy is still suffering ongoing effects of credit deleveraging, and it is clear that much of the stimulus money has failed to get beyond Wall Street.

This leaves stimulus, which is about as popular amongst conservatives in the US as universal healthcare. Ending stimulus now will be like trying to put the shavings back on the pencil, and Brad DeLong argues that, despite the deficit problem, it is worth the risk. Here's his reasoning:

A Macro Policy Catechism

From my perspective, deciding whether to tighten or ease is easy. It involves asking and answering a few questions:

Q: What is the current forecast for unemployment? A: It is that unemployment will stay around 10% for a year or more, and then slowly decline.

Q: Is that the path that we want unemployment to be on? A: No. We wish that unemployment would fall more rapidly.

Q: What should we do to make unemployment fall more rapidly. A: We should stimulate the economy through one of three tools--monetary expansion, support for the banking system, or larger short-term fiscal deficits--depending on which would work.

Q: Would monetary expansion work? A: Almost surely not. With short-term Treasury rates at zero, monetary expansion is all tapped out.

Q: Would further support for the banking system work? A: Quite possibly--but at the cause of greatly reinforcing incentives for moral hazard in the future, and voters appear really unhappy with the idea of giving Lloyd Blankfein more of the public's money to play with.

Q: Would larger fiscal deficits work? A: Almost surely yes.

Q: But wouldn't they greatly increase the national debt and exceed America's debt capacity? A: No. You know that the debt capacity of a country is about to be exceeded when the term structure of interest rates slopes upward very steeply--when interest rates on government debt are high and expected to keep rising. There is no sign of that right now.

DeLong is with Krugman is suggesting that regardless of fears that bonds are in a bubble and that yields need to blow out soon, more stimulus is the only answer for now. Refinancing this debt is going to be horrible, but the alternative is a deflationary spiral and a lost decade like Japan, which is a classic example of aborted stimulus measures.

As for how the American future might look, one clear route is the leveraging the unassailable lead that the US has in technology into green technology. The political will is there, money by the trillions can be made and preserving the health of the planet for future generations exists as a moral imperative. Will, capability, and urgency might well be the perfect ingredients for another asset bubble.

Lifecycle

It is a most uncertain time, but should you (like me) exist in a state of total confusion, don't feel too bad. The ducks are so far out of line that even the brightest of us are left scratching their heads. Professor Robert Shiller was most recently quoted:

“this is a time of great uncertainty.... Things seem to be working right now but we’re in a GRAND experiment... I am terribly conflicted. This is the most uncertain time that I can remember. Things are violating the laws that I learned. The turn around in real estate is so dramatic. The whole country is experiencing an upsurge but I don’t know what to make of it.”

I think he is being a little disingenuous regarding house prices, because the effect of tax credits, government-insured FHA loans and trial modifications has created an artificial market in some areas. However, his reference to the wider economy is telling.

Moreover, it is our perception of the health wider economy that is important here and it depends on where you take take your cues from. Certainly, the most referenced measure of economic health - one that gets a few minutes on every news bulletin - is the level of equity indices. This of course relies on the assumption that you are gainfully employed, because joblessness reduces every arcane piece of economic analysis and all flashing soundbites to a singular threat against a way of life. Regardless, many rightly or wrongly take their cues from the DOW, the FTSE, the S&P so long as it is their neighbour that is unemployed. Friday's shocking 10.2% US unemployment figure - far from sending the DOW to the canvas - gave it a fillip when it became clear that the proverbial punchbowl was likely to become part of the furniture, part of the permanent collection at the Museum of Financial Folly.

Trading in the current market is not for those prone to overthought or unwilling to suspend disbelief. It is best to look at equity markets for what they are: a measure of easy money, risk taking and accountability. However, if you still believe in the efficient market hypothesis, then I can't help you. Equity markets are also a measure of pain as it works in either direction. Currently most investors are still taking pain as the market moves higher. This is either through a hole in their P/Ls if they are short, or the kind of psychological pain that accompanies the feeling that you are missing out on something big. The anguish at a lack of participation, coupled with the fear of joining too late, plus the latent pessimism in the system, equals a grind up in equities. It seems that simple, so think like a cold-calling broker and get stupid: the pain trade is up.

Bearishness, as measured by the American Association of Individual Investors is up in the last month and bullishness is down. The wall of worry is there to climb.

What if this is as good as it gets?

There was always going to be a point in the life of the current rally in equities where second derivative-type news (that oblique area of things being not as bad as expected) would have to be replaced by actual good news as a primer to further upside. This issue was clouded by October's extreme dollar weakness and the demand for all anti-dollars.

Yet, as with all crowded trades, short dollar staged a dramatic reversal and took risk assets of all colours down. So with the obvious trades no longer there, market participants, naturally wary of how far equities have risen, have begun to to look at such old fashioned things as fundamentals.

Now is the time in this supposed economic recovery where data pointing to the exit velocity from the recession should be perceived as more important than that which says the sea in which we are currently drowning is becoming shallower.

Today we wait for some over-analysed words from the Fed. Ben Bernanke, after every word of his speech has been poured over for potential alternate meanings, will say very little yet it will mean very much. I expect for more words along the line of, "significant risks remain...unchanged for the time being...signs of recovery...etc., etc." The indebted, jobless US consumer might also shout at Ben Bernanke in the words of Melvin Udall in As Good As It Gets: "I'm drowning here and you're describing the water."

Despite encouraging ISM numbers this week, loan growth is still poor in the US economy. Congress and the Senate are very likely to extend the housing tax credit (from the New York Times). There was also testimony from Jon D. Greenlee, Associate Director, Division of Banking Supervision and Regulation at the Fed on Tuesday:

[T]he condition of the banking system is far from robust. Two years into a substantial economic downturn, loan quality is poor across many asset classes and, as noted earlier, continues to deteriorate as weakness in housing markets affects the performance of residential mortgages and construction loans. Higher loan losses are depleting loan loss reserves at many banking organizations, necessitating large new provisions that are producing net losses or low earnings. In addition, although capital ratios are considerably higher than they were at the start of the crisis for many banking organizations, poor loan quality, subpar earnings, and uncertainty about future conditions raise questions about capital adequacy for some institutions. Diminished loan demand, more-conservative underwriting standards in the wake of the crisis, recessionary economic conditions, and a focus on working out problem loans have also limited the degree to which banks have added high-quality loans to their portfolios, an essential step to expanding profitable assets and thus restoring earnings performance.

This all leads me to believe that Bernanke will say very little today and leave much of the Fed's policies unchanged except perhaps more idea of when MBS purchases will be wound up. Herein lies the title of today's post - it is my belief that the "new normal", as descibed by Bill Gross, is becoming a reality. The tepid recovery may indeed be as good as it gets for some time. Dr Paul Krugman has an excellent post on the latest Q3 US GDP figures. Furthermore, consider this post from Ryan Avent:

And consider this: the last time the unemployment rate hit its current level was during the recession of 1981-1982 (during which the unemployment rate actually peaked at 10.8% during the final quarter of the recession). Here are the quarterly growth rates for the six quarters immediately following the end of that recession: 5.1%, 9.3%, 8.1%, 8.5%, 8.0%, 7.1%. And at the end of that period, the unemployment rate was still above 7%. For the last recession, which ended in the fourth quarter of 2001, quarterly growth in the next six quarters looked like this: 3.5%, 2.1%, 2.0%, 0.1%, 1.6%, 3.2%.

Essentially, we are looking at a situation in which, absent some significant and surprise change in the economic outlook, American unemployment will remain near 10% through the end of 2010, at least. It is difficult to predict the political fall-out from that kind of sustained level of joblessness, but I can imagine some of the probable effects, including growing anger at Wall Street and foreign exporters, particularly China. The seeds will be sown for an unpleasant populist uprising, which might well do a lot of damage to American economic policy.

It's not a happy place to be. And I don't really understand why there isn't more visible concern in Washington (or on Wall Street, for that matter) about this state of affairs.

The demand for real good news is increasing - reality now needs to catch up to expectations. Economic optimism, now matter how robust, requires validation or it will never survive its own success.