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THE BLUE MONEY REPORT.
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The Blue Money Report
"Money clarifies one's speech greatly, while no one listens to the poor."
~ Chinese proverb.
Welcome to the Blue Money Report
Today's Commentary: 09.26.02 Last week, I mentioned the late Richard Feynman who had an interesting take on the path of particles. The analogy is simple. According to Mr. Feynman, the path from point A to point B is not always a straight line, but the path that remains after all other paths have been eliminated.
Let's take a look at the economic path and it's fickle if not erratic journey from point A to what is beginning to seem like a disaster at point B.
Most of this week, I had one of those rare events when I was too sick to work at anything. Usually I can muster some function, produce something, but when I am hit with those sorts of head colds, I am rendered quite useless. It gives me an opportunity to watch mindless television. I watched the stock market rally in an end of the quarter charge that simply seemed to have little or no enthusiasm. Even those that comment on the markets throughout the day appeared less than impressed.
What I did notice is that we have a major problem ahead of us economically and there are some folks, especially banker types that are discouraging Japanese comparisons. When Greenspan decided to leave rates unchanged while leaning towards weakness, he left himself politically neutral while appearing undecided. Two members of Federal Open Market Committee chose to vote in favor of a rate cut, while Greenspan seems to be holding that card for dramatic effect.
In a perfect economic model, or one that has clear sight of point B, rate cuts take their full effect on the economy in six to twelve months. As we close in on the anniversary of the last cut to 1.75%, we have seen little in the way of economic health. The reasons are simple. Businesses are still not interested in expansion using the money supply available. Instead, the bond markets, as well as the housing and refinancing arenas have taken full advantage of this influx of cash. Neither one of these moves will bring the economy roaring back to predicted health.
Refinancing has caused the greatest difficulty in this sort of recovery. Houses are still quite pricey, but not abnormally so. With cheap money, consumers are making their way into cash back refi's which do little for the long term fate of the economy. A cash back loan allows the consumer to lower their monthly mortgage payment, take money out of their home's equity, and spend it, creating a false pop in economic activity. When that stops, and it will, the last prop holding this wobbly economy will no longer be able to provide support.
The consumer, who has been looked upon as the pillar of strength is beginning to wonder if this growth in the economy will take place despite the high rate of joblessness. Eroding confidence numbers for the last four months seem to ask the question: "what growth, where?" This will hold off the efforts of many to purchase a home with dim prospects of better jobs, or even confidence in their own current jobs dipping somewhat.
Fears of deflation seem to have fallen to the wayside for the time being as inflation rose slightly. This causes the dollar to weaken. Rising inflation and a weak dollar are only good in tandem when the federal budget is running in surplus. We all know that surpluses are not in the near term future and the deficits continue to mount. To some economists, this is an ideal environment to run a country. But a $357 billion dollar swing can not be healthy. Imagine your personal finances going from cash rich to debt poor. Drawing this kind of analogy is risky business but there seems to be no sleep lost as a result.
Bonds, which we all know operate in a sort of reverse way, have seen their yields go down while their prices go up. The reason is simple: housing. When the consumer refinances, the effect of paying off one mortgage in favor of a lesser interest mortgage unbalances the asset to liability ratio among mortgage banks. Fannie Mae, the nations largest, is faced with this problem. In an effort to rebalance their books, which have gotten so bad, that according to sources, the negative duration is now 14 months, they are buying these high priced bonds by the bucket load.
The short term interest rates are not very attractive but are the only thing available. Should the Fed decide to cut rates further, the effects on this company will be devastating. Folks will once again rush to refinance causing further duration gaps, causing yields to drop, and quite possibly pushing this bank to insolvency. This spells bailout, which writes the book for further and deeper deficits.
So how do we get to point B given so many possibilities of divergent paths? Point B is going to be an unpleasant place to stop on this journey. It will mean that the dollar has lost much of its appeal. Foreign investors will have no interest in putting money in an economy that our own administration has ignored. It will mean many of these current mortgages will find themselves in default as long term interest rates rise to combat inflation. Point B may not be where we want to go in the first place.
Cash could be the point B we are looking for in this economic massacre. War isn't the answer, and there is a goodly amount of historicity to back up that point. It doesn't drive economies into prosperity but instead, provides adequate distraction to how bad things have become. The question is, how bad can it get?
Unless we all agree that some sort of market bottom has been reached, we will not see any bounce at all. The bottom seems to be bought into as soon as it seems to occur. Weak rallies are not the signpost that bulls are looking for.
The market is not yet reasonably valued. A friend of mine asked me about a stock today and the first question that came to mind was the company's debt. When the return question is an interest in the company's growth, then we will be more confident as investors and see some sort of reasonable value.
So there you have it. Aren't you glad I got out of my sick bed?
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