Not Only Our Grandchildren Should Worry

Good Evening: U.S. stocks advanced for a second straight day, which is quite an achievement considering the S&P 500 hasn’t put together back to back up days since April. That the gains themselves and the volumes behind them were somewhat muted is not surprising in light of tomorrow’s unemployment figures, nor is it a shock to see the VIX close back below the 30 level with market volatility starting to ebb. Expectations for tomorrow’s jobs report are all over the map due to the impact of census hiring, but how the markets finish to end the week will indeed be interesting. Having experienced a mini-crash in May, as well as a retest of those lows, the S&P 500 is now at a crossroads. It closed above resistance at 1100 but still sits below its 200 day moving average of 1105 or so. Perhaps Mr. Market’s near term direction will be revealed by tomorrow’s close, but a recent speech by David Einhorn reminds us all that there are longer term issues that need to be addressed.

Equities around the world were very firm overnight following yesterday’s rally on Wall Street. The Nikkei was up more than 3%, but even Europe enjoyed decent gains, despite signs that the financial plumbing on the Continent is still leaking like a BP oil well. LIBOR continued to rise, and the size of bank funds left on deposit with the ECB climbed to a record today (see below). Today’s flurry of U.S. economic statistics came in on the weak side, with chain store sales, jobless claims, the ADP employment report, U.S. productivity, factory orders, and ISM services survey all coming in below expectations. Still, the downbeat statistics couldn’t prevent the major averages from posting gains of nearly 0.5% at today’s open. Those gains evaporated by lunchtime when K.C. Fed president Hoenig reiterated his desire to see fed funds at “1% by summer” (see below). That a regional Fed president asking for a 1% policy rate during an economic expansion is today considered on the lunatic fringe of hawkishness indicates just how much we’ve become addicted to easy monetary policies since Mr. Greenspan took over for Mr. Volcker.

With the S&P failing at the 200 day moving average near 1105, sellers briefly took over and forced prices down across the board. When no further damage was exacted, the averages staged a comeback that left them up on the day ahead of tomorrow’s payrolls report. The Dow’s fractional gain trailed the other indexes, while the 1%+ gain in the Russell 2000 set the pace. Treasurys also spent much of the day marking time ahead of Friday’s BLS announcement and yields were a mere 1 to 3 basis points higher by day’s end. The dollar rose by 0.6% against its major competitors, a result which (for once) didn’t hurt commodity prices. Aside from some heaviness in the precious metals, most components of the CRB rose and left the index itself 0.75% to the good on Thursday.

Though there undoubtedly were others who preceded them, Ronald Reagan (during his 1980 campaign), Paul Tsongas (1988), and Ross Perot (!992) all told prospective voters about the dangers to our grandchildren of the fast accumulating pile of U.S. government debt. These worries were all but forgotten when the U.S. reported cash (i.e. non GAPP) surpluses during the last years of the Clinton administration. The new Millennium, however, has spawned a continually rising tide of red ink. Recessions and low tax receipts, bailouts and stimulus, new federal spending and new healthcare benefits have all done their part to increase the ongoing structural budget deficits we face beyond 2010. And, at almost every turn, easy monetary policies by the Fed either caused or exacerbated the imbalances that led to the supposed need for all these Keynesian “solutions” to our economic woes.

Unfortunately, the prescription by Lord Keynes that government deficits during periods of weak aggregate demand be financed by surpluses built up during periods of excess demand have only rarely been followed. And how have ever-easier monetary policies by our central bank contributed to our economic problems by encouraging excessive risk taking? When do appropriately counter-cyclical policy measures go too far? How can we tell when too much deficit spending becomes a Keynesian form of steroid abuse, or when monetarists risk overdosing on moneyprinting?

These questions and other weighty economic issues are the subject of a recent speech by Greenlight Capital’s David Einhorn (see atttached PDF). Unlike the strictures imposed by a nighttime essay to a voluntary electronic audience, this speech by Mr. Einhorn takes full advantage of the indulgence a captive room of listeners will afford a smart man who’s made a lot of money. In short, it’s a long speech — but well worth the time spent. I urge readers to take the time to read and reread Mr. Einhorn’s speech. Many of his observations about the Great Recession, its root causes, and its potential aftermath (including a Greek-style funding crisis) are spot on. We may not be the generation of grandchildren Mr. Reagan, Mr. Tsongas, and Mr. Perot worried about, but these problems won’t wait. More stimulus and more debt monetization will only lead to bigger problems down the road. I don’t know if David Einhorn is a regular reader of Bill Fleckenstein’s Daily Rap, but I think he’d agree with Bill’s assertion that “we can’t print our way to prosperity”.

— Jack McHugh

Stocks, Oil Advance on Economic Outlook; Forint, Euro Retreat
Banks’ Overnight Deposits With ECB Increase to Record
Hoenig Urges Fed Rate Hike to 1% by ‘End of Summer’

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