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----------------------------------------------------------- Stocks on the march to 11,000...but that's not all that's rising, Eric Fry offers his thoughts on the rapidly advancing 10-year Treasury, Plus, Bill Bonner reexamines his basic thesis and finds we're quickly running out of time... The Daily Reckoning | Tuesday, April 6, 2010 Data Point Deceptions Why the strength of this recovery is in the eyes of the beholder Eric Fry Reporting from Laguna Beach, California... With all eyes on the Dow's advance toward 11,000 yesterday, your California editor fixed his eyes on the 10-year Treasury's advance toward 4.00%. By the end of the trading session, only one of the two had reached its target. The 10-year Treasury kissed 4.00% - up from 3.20% just four months ago and up from 2.05% during the panic lows of late 2008. What does this rapid run-up in rates signify...and should we care? "Don't know" and "Not sure," would be our responses. But let's try to read the economy's palm and see what we find. For starters, the economy's "recovery line" is very short and features multiple breaks. This is never a good sign. Additionally, the economy's "inflation line" is very long and pronounced. (Don't be upset with us; we're just the palm readers). Turning to hard macroeconomic data, a similar storyline emerges. The economy is recovering, but its recovery lacks vigor. At the same time, inflationary forces are stirring. "Private payrolls turned in a respectable 123,000 gain [in March]," observes economist David Rosenberg. "This was the third [private sector] increase in a row and brings the cumulative gain to 147,000. But let's keep in mind that the comparable findings from the ADP survey are far different - down 23,000 in March and down 255,000 in the past three months. "If you go back to the last jobless recovery," Rosenberg continues, "it was not rare to see such a divergence, but in the end, only when both measures were rising in tandem was it safe to call for a sustainable economic expansion - both rose together each and every month from August 2003 to June 2007. But in the sketchy period of 2002 and 2003, there were multiple months where private payrolls in the nonfarm payroll survey were solid at a time when the ADP failed to ratify (October 2002, December 2002, January 2003, May 2003), and each time the ADP got the call right... "Now, we are not going to dismiss the BLS data," Rosenberg cautions, "but wouldn't it be nicer if both surveys said the same thing? The ADP is a pretty simple concept - and does not have any 'plug' factors to try and assume how many new businesses were created or destroyed in any given month." Rosenberg's analysis reminds us that honest data points sometimes produce powerful deceptions. Based on data points like GDP growth and "Core CPI," the US economy is producing non-inflationary growth. Conversely, based on data points like U6 unemployment; Consumer Spending, before changes in the savings rate and; CPI, excluding rents, the US economy is producing more inflation than genuine growth. The "U6" measure of unemployment, which includes "underemployed" and long-term unemployed laborers, rose to a record-high 16.9% of the workforce in March. Not surprisingly, therefore, the "recovery" in consumer spending we have been reading so much about is a complete fantasy. "US consumer spending in the first quarter was higher," Rosenberg points out, "[only] because the savings rate slipped to 3.1% from 4.7% at the end of last year... without that unsustainable decline in what is already a low personal savings rate, consumer spending would have actually contracted 0.4% in January and 0.6% in February." Yet, despite these real-world indications of sluggish economic activity, inflationary forces are gaining strength. Yes, yes, we know, that's not what you're hearing on CNBC. But here's the skinny: the headline CPI numbers are subdued because the housing market is flat on its back. About 30% of the CPI calculation derives from an estimate of residential rents that - more or less - reflects conditions in the residential real estate market. (To see the scintillating details of this calculation for yourself, click here). So when the housing market is weak, so are the estimates of "owners equivalent rent," which represents about one quarter of the CPI calculation. (A separate "rent" estimate contributes another 5% to the CPI calculation). Generally speaking, the residential rent estimates track closely with other components of the CPI calculation. But that has not been the case lately, as the nearby chart illustrates. Instead, the headline CPI number, which includes residential rents, indicates that inflation is nearly nonexistent. However, the CPI calculation that excludes residential rents shows a very different picture. In fact, this calculation shows that inflation has been rising at a 3% clip since the end of 2007, despite the fact that the economy has been recessionary throughout most of this period. To be sure, deflation in the residential real estate market is genuine deflation. So we are not discounting the value of this metric. On the other hand, the 70% of the CPI that measures the cost of the goods and service is telling us that inflation is far from dead. The bond market is telling us the exact same thing. Like trying to fill a teacup with a fire hose, the Fed has directed massive quantities of new dollars and cheap credit into an economy that cannot efficiently utilize it. As a result, "too much money will chase after too few goods and services," to cite Milton Friedman's timeless definition of inflation. That's why bond yields are heading higher, no matter what the economy does from here. You may not have heard it here first, but at least you heard it here. The Daily Reckoning Presents The Great Correction...Still Pending Bill Bonner For more than a year, the "recovery" bounce in the stock market has refused to give up. The indexes have recovered more than 50% of what was lost. Technically, they look pretty good. What's more, the S&P sells at more than 21 times normalized earnings, according to Robert Shiller's latest tally. It seems like nothing can stop stocks now. Then there's the Treasury market. Overall, yields remain remarkably low. It is almost as if Treasury buyers are unaware that they are being asked to finance the biggest increase in sovereign debt ever. It doesn't seem to matter either that many of the applicants for money will be incapable of repaying it. Several sovereign debtors, including the US, have already reached the "point of no return," according to professors Rogoff and Reinhard. Still, the financial press is optimistic. Economists are irrationally confident. Investors and advisors are overwhelmingly bullish. And the American public seems willing to add a trillion-dollar health-care program to its burdens - a sign of remarkable faith in the nation's prospects. So, let's go back and reexamine our basic position. Is this really the "Great Correction" that we think it is? If there is one lesson we've learned over the years, it is that we need to be patient. Things that have to happen generally do, sooner or later. You just have to wait. And when they happen, they generally happen much faster than you expected. Even when you've been expecting something for years, it can come and go before you realize what is going on. You get used to being wrong...or at least premature. You wait. You watch. You think the time has come...and then: whoops...not yet. Pretty soon, you are overcome by anticipation fatigue. Then when the real thing finally does start to happen you don't believe it. You wait to be sure...you hesitate...and then it's over! Just what am I waiting for? I'm anticipating more evidence of this Great Correction, including another big swing down in the real price of stocks, bonds and commodities...further deterioration in the real estate market...a falloff in consumer spending...and a higher savings rate. I'm also expecting higher yields from government debt...and a dangerous intensification of financial problems in both the private and public sectors. If I'm right, those things must happen eventually. So far, we're still waiting. But this week the long-awaited turnaround in the bond market may have begun. Rates are rising along the entire yield curve, especially at the long end. "The bond market is now very close to saying, 'We've had enough,'" predicts the octogenarian stock market technician, Richard Russell. The 30-year T-bond's recent decisive move above 4.80% marks the end of a 25-year bull market in bonds, says Russell. Rates will be moving higher from here. Investors are starting to tune into how sovereign debt works. And they're starting to realize that even governments can default. In fact, almost all of them do default eventually. Yes, even governments whose debts are denominated in their own currencies default. And even when they have the power to print the currency themselves. How could that be? Well, it is very simple and worth spending a little time on. I want to make two points: First, governments will usually choose to default on their debt rather than risk hyperinflation of their currencies. Second, when they reach a "point of no return" they have no choice. They cannot cut back spending. Because even the most drastic cutbacks will not do the job. That would simply result in lower tax receipts and an even bigger deficit. At a certain point, the multiplier effect becomes the divider effect. I've made the point many times that democracy seems hell-bent on self- destruction. America's founding fathers noticed many years ago that when people realized that they could vote themselves money from the public treasury, democracy would be doomed. Most people presume that if a politician offers benefits, "someone else" will pay for it somehow, someday. In practice, the money doesn't come from additional taxes. Taxes are already, at least theoretically, at their optimal level. Higher tax rates produce lower economic activity, which lowers tax receipts. So instead of raising taxes, governments borrow the money. Then sovereign debt loads become larger and larger until, as Greece has recently discovered, they are impossible to carry. America also has public sector debt problems - of about equal measure to Europe - and she has huge private sector debt problems as well. For the moment, the skies over the American financial markets are clear. But out at sea a hurricane is spinning faster and faster. There is a huge wave of debt defaults/foreclosures in the private sector that will hit the markets soon. This wave, combined with record borrowing from the US government, is bound to push up bond yields...making it harder than ever to get needed funding. The situation with the US government is more complicated than it is with private borrowers - or even with Greece or California. The federal government can print money. But it, too, is ultimately at the mercy of the bond market. Last year Uncle Sam borrowed $2.1 trillion. This year it will borrow $2.4 trillion. Without this money, US government spending would have to come to a halt. The US counts on lenders. It needs lenders. Without them it would be forced to make cuts equal to about 10% of GDP. Think you've got de-leveraging now? Just imagine what that would do. Typically, of course, government bond buyers don't cut off a lender altogether. They merely demand a higher rate of interest to offset what they see as an increased level of risk. The higher interest rate adds to the borrower's cost - increasing his deficit and forcing him to borrow more. This is where it gets interesting. You might say that a government can "print its way out" - it can just print the money it needs rather than borrowing it. But what would happen if the US chose to print $2 trillion this year? It would risk hyperinflation. Lenders would run for cover. Prices would shoot up. The damage to the economy would be severe...so severe that only governments under extreme pressure - think Weimar Germany or Mugabe's Zimbabwe - are willing to risk it. Instead, they try to muddle through, as Greece is doing now - promising budget cuts, making special financing deals and pushing up the rate of inflation a bit, but not so high as to cause panic in the bond market. See, as long as the bond market permits it, debt levels continue to grow. But at some point - the point of no return - a government can no longer save itself from disaster. How does that work? Well, when deficit/debt levels are too high, the cuts necessary to bring the budget back in balance are so great that they squeeze the economy hard, reducing output and decreasing government's tax revenues. In this case, the government cannot escape. It has to print money. Or default. Most often, it will choose default, because it is the less painful solution. Either way, the government finds that it will be cut off from the bond market. Hyperinflation is merely an additional and unnecessary aggravation. (That said, I agree with Nassim Taleb, that hyperinflation remains an underestimated black swan risk.) The underlying story of the economy has not changed. We are in a Great Correction. We don't know exactly what it is correcting...but it looks as though it will at least reduce some of the leverage that has been added to American and British households over the last 60 years. So far, the process is tentative...and unsure of itself. From a peak of 96% of household income in 2007 debt has fallen to...94%! The drop is so small that it makes you wonder if it is a trend at all. But if it is, it has a long way to go. Ten years ago - at the peak of the dot-com bubble - household leverage was only 70% of income. At the present rate it will take another 24 years to get back to 1999 levels. Albert Edwards of Societe General has examined the non-financial leverage in the system. There is excess leverage of about 60% of GDP, he says. He calculates it will take a decade of "Japan-like pain" to eliminate it. Either way, you're talking about a long process of getting back to "normal." The Great Correction is also what is keeping housing and unemployment down. When the banks aren't adding to the nation's credit, you just can't expect many new jobs or many new house sales. Nothing has changed in the last week - except we have moved one week closer to whatever crisis lies ahead. Bill Bonner for The Daily Reckoning Joel's Note: "Bill writes a lot about what's wrong in the markets," people often say to us. "But what is he doing with HIS money?" Well, now you can find out. Recently, Bill sent out an invitation to a select group of long-time readers, offering them the chance to get on the "inside" of his world-class investment contact list. Today, we're offering you that same opportunity. To learn more about the Bonner & Partners Family Office, simply follow this link. Bill Bonner Summers to the US Economy: Bang, Zoom, Straight to the Moon! Bill Bonner And now the rest of today's reckoning from Baltimore, Maryland... "Here's your new iPad," said one our tech wizards. "It looks great. Of course, you've got to use your iTunes account to use it..." "Your what?" "Uh...don't you have an iTunes account?" "I don't think so..." Your editor is checking out the new technology...more below... Meanwhile, no matter how absurd things get, they can always become more absurd. "Summers: US nears 'escape velocity' That's the headline on the weekend Financial Times. Summers is jubilant. He got the latest employment figures on Friday. They tell the story of an economy that he thinks is headed into outer space, with 162,000 new jobs created in March. Hallelujah...all this intervention by the feds is paying off! Thank God Summers was on the job. If he hadn't been...well, the economy would have had to get along on its own...right here on planet earth...just like it did for all those centuries up until the feds got control of it during the Great Depression (or shortly after). Heck, you know how terrible it was back then. People would go broke... Speculators. Bankers. Promoters. They would be wiped out. Jobs would be lost. Businesses would go bankrupt. And then, a few months later, they'd have to get back on their feet...begging, borrowing, or stealing enough capital to make a fresh start. But now things are different. Now, we have a better world, designed in part, by Mr. Summers himself. Now, people don't go broke. Well, at least, major campaign contributors don't go broke. They get bailed out. They stay in business. The feds give them money so they can keep doing what they did before. And then, the feds put a booster rocket under the whole economy... Yes, dear reader...this is a happy day for Summers. But it also marks a giant stoop for mankind. Finally, man is free from the discipline of the market system. Now, Werner von Summers et al are on the case. So you can forget about anything really bad happening. Now, it's to the moon and beyond...growth and prosperity from here to kingdom come. Summers is not crazy. He is merely lost in space. He thinks you can manipulate the economy all you want...like solving an engineering problem...well...like sending a man to the moon. But you could say that about almost all modern economists. At about all those that don't agree with us. The other 2 or 3 are muttering to themselves while rummaging through trashcans hoping that someone left a little liquor in the bottle before throwing it away. At least our president has his feet on the ground. Obama believes the US has "turned the corner" on the jobs issue. But wait. The private sector added 123,000 jobs last month. According to our sources it needs to create 100,000 just to stay even with population growth. So, we're not at all sure that 23,000 jobs is really that great after two years, 8 million job losses and $10 trillion of stimulus. Let's see, at that rate, it will take approximately 320 years to get back to full employment...doesn't sound like 'escape velocity' to us. We've seen Amtrak trains going faster. Maybe we're missing something. And more thoughts... This kind of marginal job performance is not likely to have a major impact on consumer spending. Speaking of which, we wondered how consumers could increase spending when their incomes weren't going up. Comstock Partners explains it: The answer is surprisingly simple once you look at the savings rate. As we mentioned, consumer spending has climbed 3.7% since May; that amounts to $373 billion of increased spending in the period. During the same span consumer savings declined by almost the same amount - $374 billion-while disposable income - was basically flat, dropping by 0.1%. It is therefore easy to see that the entire increase in consumer spending for the nine months was due to reduced savings. For some context let's look briefly at the household savings rate as a percentage of disposable income in the past. From 1955 through 1992 the savings rate stayed mostly within a range of 7%-to-11%, and then began a steady decline. The decline was slow at first, dropping to about 5% in 1998. After that the rate of decline accelerated, first with the bursting of the dot-com boom, and then with the boom in housing later in the decade. By 2007 the rate had dropped all the way to an average of 1.8%. The period of decline coincided with below average growth in wages and employment compared to prior decades. To maintain their standard of living, consumers went heavily into debt, aided and abetted by extremely easy monetary policy, soaring home prices, rising net worth and lax borrowing terms that enabled millions to borrow more than they could afford. As we know, during the recession consumers were hit by high unemployment, lower incomes, tight credit and rapidly declining net worth. By May of last year they had raised their savings rate back to 6.4%. Since then, however, the savings rate has dropped back to 3.1% in February, thereby accounting for all of the increase in consumer spending in that period. In our view, therefore, the prospect for further substantial rises in consumer spending rests on an extremely shaky foundation. - Here's more of Summers' razor sharp mind at work. Is China a currency manipulator, he was asked? "We think countries with large surpluses need to be focused on shifting the pattern of demand towards reliance on domestic demand." Hey wait a minute. If China needs to focus on domestic demand, shouldn't the US change its focus too? Shouldn't the US switch its focus to domestic supply? Let's get this straight. China has been manipulating its population - actually holding down wages so that it could gain market share. The US, of course, is free from all sin...washed in the blood of Keynes, as it is. But there's no question that its citizens and denizens got a little carried away too, during the bubble époque. While the Chinese made things to excess...Americans bought them to excess. So if the Chinese are supposed to put the kibosh on their exports - by encouraging domestic consumption - it stands to reason that the US should put the kibosh on its imports, by encouraging domestic production, right? Yes, makes sense. But that would mean lowering the value of the dollar (the opposite of the remedy advised for China) which would have the effect of lowering wages and consumption in the USA. If you're going to be a manipulator, in other words, you've got to manipulate in a way that is consistent with some theory. Otherwise, you're just a random manipulator...which is to say, you're crazy. - Charles DelValle does research for us at our family office. He reports that households are going broke faster than ever: The 149,268 consumer bankruptcies filed in March represented the highest monthly consumer filing total since Congress overhauled the Bankruptcy Code in 2005, according to the American Bankruptcy Institute (ABI) relying on data from the National Bankruptcy Research Center (NBKRC). The March filing total represented a 34 percent increase from the February filing total of 111,693 and a 23 percent increase from March 2009 total of 121,413. Chapter 13 filings constituted 25 percent of all consumer cases in March, representing a 2 percent decrease from February. Well this makes sense. More stimulus. More jobs. More spending. More bankruptcies...! What the heck? Wait...it makes some sense... Here's Charles' comment: Bankruptcies are good for people (bad for banks) in a deflation. There are more people who aren't burdened by debt payments. These people are now free to spend in the economy as they wish. This also helps reduce outstanding consumer credit, and any other debt related figure relating to consumers. - And what's this? The Wall Street Journal reports that "multi- generational households" have returned, forced together by joblessness. Another report in the WSJ tells us that the "bank of Mom and Dad" has had to close its doors. Apparently Mom and Dad don't have the reserves they used to have...and they're not supported by the Fed the way other banks are. And here's another item: "Office vacancies at 16-year high." What to make of it all? For the present, we're just going to assume that our Great Correction theory is basically right. The numbers are confusing. And the facts are contradictory. But that's just what you'd expect in a Great Correction...a lot of adjustments to a new financial world. - Most new technology is a waste of time. Even successful technologies are often huge net negatives for human society. TV, for example. Yes, television has given much pleasure to many people over the years. But it has also dulled the senses, imaginations and intellects of two generations. We can't prove it, but can't believe there's not a connection between TV watching and modern politics. We're not saying there is a direct connection. People who watch a lot of TV may not be dumber, but they are much better indoctrinated. Nevertheless, experts tell us that the media is headed in the direction of Amazon's Kindle and Apple's new iPad. We decided to get one of each so we could check them out. We'll let you know if we figure anything out. But so far, we don't have the time for these time-savers. Regards, Bill Bonner, for The Daily Reckoning Editor's Note: If you happen to have one of these time-saving devices, you might want to check this out... Our tech gurus here at the DR have just launched a brand new Daily Reckoning iPhone Application! Downloading it is easy...and completely FREE. Just click here for all the info.