Deadlock

Why are we writing? Maybe we just missed it, or we freed up sometime, or we could be in a deadlock situation with our brain telling us to go left, while our heart is telling us to make a right. Its a deadlock situation because we can't make a decision, because one variable, is waiting for the other variable to make a decision. That's our current reality, but let see if we can use another example. "When two trains approach each other at a crossing, both shall come to a full stop and neither shall start up again until the other has gone." That actually was a statute passed by the Kansas legislature in early 20th century. Or we are just fed up with one of our Econ classes. Whatever the reason is, we are in front of our screen.

What we remember was in 2008, the global economy stopped breathing.  The cause? Very simple, real estate prices went up a lot at first, and then crashed. That's suppose to have a ripple effect in the economy, at least that's what the experts told us. Next big thing we can think of, hmm.. maybe U.S governments unwillingness or inability or not wanting or whatever word that fits you, but it's issue of its debt obligation. So far, the underlying cause, or the main issue, has not been the main cause, for the great recession. What caused housing prices to go up? A belief that house prices will go up forever, how did that belief turn into reality? Simply more people demanded and bought more houses. With what money, did they buy? They borrowed to finance a belief. When that belief wasn't true anymore, the cost of maintaining their belief was greater than, the utility they expected to gain from rising house prices. So what did the common inhabitants do? Simply walked away. Which also had a ripple effect, because not only they weren't paying back what they borrowed, but also they weren't mailing checks to the local tax authorities. This according to the experts was bad. On the other hand, our suspicion is that "Mr Market" detected a borrowing binge, which caused resources to shift in one sector, and gave false hope of ever rising house prices. Which led local governments to almost solely depend on property tax revenue, rather than industry or businesses. According to "Mr Market", a correction was needed to destroy the old model, and, create a new one.

So, not only was the real estate market in a bubble, but we suspect the feds on the federal level also have created a bubble of their own? After all they are spending more, than they take in. In other words deficit spending. Why is that? Maybe just a bad habit , after all they are all grownups, they should be able to balance a checkbook? As if that's not bad enough, you might say they might have some money saved up for a rainy day and conclude, they might be dipping from their savings account. But at last count, we noticed the feds were in the red, meaning negative balance. They owe the world trillions, in fact, so far the total amount due is somewhat a cool $16 trillion on the national account. The Feds are in a battle, to stop "Mr Market" from its natural course. The economy needs a cleansing from excessive debt, but the feds say, they can't let that happen, other wise, there won't be such thing as economy, they argue. So, first they cut interest rates to 0%, in the hope, people will spend, rather than save. Since that wasn't enough, they argued, there is a lack of demand from the private sector, so they said government spending can replace private demand. Thus they initiated a stimulus package, worth almost $800 billion. Of course they borrowed, and had to borrow even more for bailouts, to guarantee/subsidize loans, Unemployment checks, Food stamps, and too keep the lights on, in Washington D.C. Whats the return on investment so far? Or shall we ask in a different manner, did the marginal benefit exceeded, the marginal cost, to save the economy ?

         "U.S. Treasury debt held by China at the end of 2012 nearly equaled $3,887 per American citizen or $918 per Chinese citizen. A 2009 working paper from the Council on Foreign Relations called China's U.S. debt financing a "$1.7 trillion bet." They also noted that "never before has a country as poor as China provided so much financing to a country as rich as the United States."

 Keep in mind that's just your share for the Chinese, you also owe the Japanese, Saudis, Russians, and, the list goes on. What's new and interesting is, the new lender on the block, that's financing the U.S government.
                                 

                         

                               U.S. Treasury securities held by the Federal Reserve: All Maturities
  

What you see in the above is the central banks lending activity to the U.S government. In Just few short years, beginning from early 2009, the central banks, balance sheet grew from $800 billion to $2 trillion. Is that a good thing or a bad thing, we will let history judge that. What we know is that, no civilization in the past, has survived a debt crisis without some type of national pain. Especially if the medicine is the same as the poison. In other words the cause or the main cause of the issue is borrowing money we can't afford to pay back. And if the proposed solution is to borrow more, to solve a borrowing issue. Then, we are clueless as you might be. But then, the feds say if we don't do this, the economy will stop functioning, We aren't sure what they meant by that, so we speculated to see if there is any relationship or correlation between, the Federal Reserves activity of buying treasuries and unemployment rate. So we pulled up the chart below to compare, which according to the data, unemployment got worse and leveled at 8% recently.  

Clearly as the feds bought more bonds or let the US Government borrow more money, however the feds in the first place got the cash, there isn't any benefit to the average Joe, on Main Street. On the other hand, Wall Street is enjoying the life support system the feds have implemented on the economy. Low interest rates, Money printing, and calling it names such as Operation Twist,  QE1, QE2, and Then QE3, And now QE forever. How is Wall Street report card looking like? Take a look at the following charts.

Not the type of grade you get in the classroom, in case you thought we were looking for a F. More so, Wall streets measure of pass or fail is the Stock Market. Just looking at the chart below, The S&P 500 is up 44.81% YTD. If we compare it, from early 2009, which was when the index  hit the lowest point, which was also when the Feds began their money schemes. We aren't saying or suggesting the cause for the Stock Market boom is the Feds action or why unemployment is stuck at a high level . Instead, we are solely interested in knowing If the Feds policy is benefiting or even working, or maybe to know if there is a correlation between the feds action, and the real world economy.

Dow Jones Industrial Average is up 37.73% YTD. Compare to its lowest point in 2009, the index has more than doubled, and even tested new record highs!

            And last is the tech sector which is measured by the NASDAQ index, which is up, a cool 53.59% YTD. 

What we may able to conclude is that the trend in Main street is down, and up in Wall Street. In Simple terms, as Academia likes to simplify variables, by Ceteris paribus, meaning everything else held constant, we can measure progress of Main street using unemployment rate, and the Stock Markets investment return using the major Indexes performance. Result Main Street F, while Wall Street Report can be translated as an A. Relative to whats out there, meaning you earn zero-percent interest in the bank. You earn less than 3% interest if you're willing to lend money to the government for 10 years , but stocks today have a forward "earnings yield" of 7%-plus. Despite the economy being weak, the Stock market is heading higher. That's  till the feds recognize their policy is ineffective, and change course, which won't be the case for few more years, expect the Markets to keep climbing higher.


Regards,

Eskinder Haile