Thursday, September 23, 2010


I am encouraged that we have the productive capacity to care for ourselves.

Still, the challenge of redeploying the unemployed is a far more difficult than many realize.

Paul Volcker, chairman of the president's Economic Recovery Advisory Board, is speaking today, and will likely attract some attention after recent comments that he considers the world economy to be in a depression at the moment.

Reuters reported his comments:

We live in an amazing world. Everybody has big budget deficits and big easy money, but somehow the world as a whole cannot fully employ itself. It is a serious question. We are no longer just talking about a single country having a big depression, but the entire world. If the world as a whole cannot employ everyone who is ready and able to work, it raises some big questions.

Ironically, although we can't employ everybody at the moment, we can support them. I am not at all discounting the economic pain, but I am encouraged that we have the productive capacity to care for ourselves, even with 15%-20% of our workforce being un- or underemployed. Making the unemployed productive again will drive real growth. Contrast this with parts of Africa, where they really can't feed themselves.

Having said that, the challenge of redeploying the unemployed is far more difficult than the public debate would suggest. I offered my own view on the problem last spring. My key point was (and is) that our economic model for the last 30-40 years was flawed, in that we used consumer credit, rather than wages, to give workers the ability to buy what they produced. The credit game is over, so absent paying more, aggregate demand will cease to grow.

There are longer-term issues as well, such as how to retrain now-obsolete workers with new skill sets, and how to fund the start-up businesses that are the only source of job creation in our economy. But that's more that can be addressed in one post.

Claims Benign

The claims number was essentially unchanged and within the range of expectations.

U.S. interest rates imply that confidence is high in the nation's ability to repay its debt. Is this justified? Morgan Stanley issued a great piece on sovereign debt, where the firm noted that the metric of government debt compared to government revenue (not GDP) is far less flattering to the U.S. In fact, Greece is in a better position than we are!

Of course, the Greeks can't print their way out of it like we can. Conversely, if printing is our main relief valve, that implies inflation down the road, which is inconsistent with rates where they are now. To my eye, U.S. government bond investors seem oddly complacent.

For borrowers, the current environment is a bonanza. Watching the headlines after the close last night, corporate issuance was robust.

Look at the roll:

1. "Windstream prices private offering of $500 million of its 7.75% senior notes due 2020"
2. "American Financial announces the pricing of $132 million of senior notes"
3. "Titan International prices and increases size of senior secured notes offering"
4. "Gannett announces pricing of $500 million of senior notes"
5. "Liberty Property Trust prices $350 million of 4.75% senior notes due 2020"
6. "Microsoft prices debt offering"

Headlines source:

Microsoft was especially notable, as the debt is funding the modest increase in its dividend. (A cash flow machine such as Microsoft should be levered far more highly, but being a tech company, an aversion to debt is in its genes.) Microsoft is only paying 0.875% for three-year money; the most expensive note was 4.5% for 30 years.

Bloomberg recently reported that "the top 10 lowest-yielding U.S. corporate new issues in history have been sold in the last 14 months".

Economists always caution that fiscal and monetary policies take quite a bit of time to be felt. Policy action often requires 18 to 24 months to impact its target. For instance, the Fed first slashed interest rates in the fall of 2007, and 18 months later, the stock market bottomed, right on cue.

We may be reaching the end of the lag period for the aggressive rate cutting over the last two years. The headlines above are but one small indication that the Fed's "pushing on a string" is finally getting traction. I am looking for a veritable flood of new bond issuance in the next two quarters, as companies succumb to the irresistible lure of very cheap money. Of course, what they do with it is an open question.

The market implications are inflationary. Deflation is the issue du jour, but we need to keep the lag effect in mind. Commodity inflation is in full force, with various basic necessities such as grains, cotton and coffee surging to all-time highs. Gold may be signaling that by next spring inflation may be back on our minds.

Inflation does not mean a poor market. In fact, companies with pricing power will do fine as inflation revives. But the specter of renewed inflation should catalyze investors to examine the names they hold now, and shift their holdings into names that can price at will.

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