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Denninger: Enjoy The Rally, But Keep Your Eye On The Door And Your Path To It

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Monday, August 3. 2009

Posted by Karl Denninger in Musings at 08:34

Pump Monkey Orgasms

The Pump Machine is in full swing this morning; apparently England's manufacturers bought into the "green shoots" meme and expanded production. Building inventory is going to be interesting down the road, and I'm grabbing the popcorn for this one.

Why?

The reason is quite simple: The GDP report showed exactly what was going on, and none of this has anything to do with an "economic recovery." We had two distortions that made the first quarter look worse than it should have, and the second quarter (much) better!

Here is the adjusted 2Q GDP:

spend.png

Now let's go through it.

Government spending in the previous (first) quarter was down at a 4.3% annual rate. The government is 30% of the economy, so we must either (1) add back in that to the 1Q report or (2) subtract it from the second quarter.

But in the second quarter government spending increased at a 10.9% annual rate! So now we must take 30% of that and subtract it off the GDP to get consumer and business activity.

When you do, you find that the "adjusted" (that is, apples to apples in the private economy) GDP shrank at a 6.46% rate.

This, by the way, is more reasonably comparable to the following numbers:

•Revenues across the firms that have reported thus far, which are down some 11%.

•Sales tax receipts, which are down double-digits virtually everywhere.

•Goods shipped (rail and truck), along with port statistics, are all showing double-digit declines averaging 15-20%. You can't sell what's not in the store and to get it in the store you have to ship it.

Since both of the above are actual numbers, that is, not subject to "adjustments" and "seasonality", they are trusted figures. But we can indeed get reasonably close when we look at GDP with the government ex-ed out, yes?

Some will argue that the government can't be ex-ex out, since the government spending is real. Sure, it is.

For how long, and what happens when the stimulus capacity (either due to political will or ability to borrow at a reasonable cost) disappears?

All that additional pulled-forward demand disappears, right?

Steve LIESman mentioned this on the Sunday news shows. Funny how he didn't mention the government distortion Friday when the GDP report was released though, right? Funny indeed how it wasn't until I brought it up on Dennis Kneale's show that it had been completely buried by the mainstream press, and then, only mentioned in passing.

Now add into this the FDIC mess. After I posted my missive yesterday I was sent a table showing the FDIC's remaining funds. I have not done a comprehensive analysis on this but I did eyeball it and the quick check appears to be good; I can't vouch for this on my own detailed analysis but if this is accurate the FDIC is down to $800 million dollars, and a failure of any of the three "seriously in trouble banks" - Colonial, Corus or Guaranty - would blow that tiny little pile of money to Mars.

FDIC.serendipityThumb.png

And oh, by the way, Colonial (which closed at 60 cents Friday) is trading premarket at 48 cents, and reported a stunning loss of $3.02 a share after the market closed Friday - or some five times its per-share price. They also announced that a rescue financing pact they were working on has collapsed, making a FDIC take-over almost certain (if the FDIC ever does its job!)

Inquiring minds are wondering if the correct meme is in fact something like this:

The economy is "improving" because the government showered borrowed money in the form of massive handouts into the economy. However, the government also allowed banks to hide stupendous losses - a trillion dollars or more - by intentionally overstating the value of assets.

"Prompt Corrective Action" is supposed to insure that when the FDIC takes over a bank it suffers little or no loss. This has worked well for over a decade and justified the FDIC holding only $50 billion in cash to insurance $8 trillion in deposits.

But the government's policy of allowing these outright lies in relationship to asset values has now resulted in the FDIC taking 40% losses against assets on average for the banks it has closed since this crisis began.

The consequence is that what looked like a reasonable policy - holding some 1/2 of 1% in insurance, or a leverage ratio of almost 160:1 - has now been shown to be insanely reckless.

These losses are almost entirely as of yet unrealized, but they are real and they are inescapable. They WILL be taken. The FDIC has a "credit line" with Treasury but there is no possible way for it to be able to absorb $400 billion - a rough estimate of the amount that will be absorbed - without a tremendous burst of new debt issuance and the risk of an all-on collapse in both the stock and credit markets.

Enjoy the rally, but keep your eye on the door and your path to it.

The curtains are on fire.

http://market-ticker.org/archives/1284-Pum...ey-Orgasms.html

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Some interesting breaking news about Colonial bank mentioned in the OP by Denninger.

ORANGE COUNTY, Fla. (WOFL FOX 35) - - FBI agents from the Washington, D.C. field office have raided a building in downtown Orlando.

The building raided is the Colonial Bank building on Pine Street. The FBI is working with the Office of the Special Inspector General for the Troubled Asset Relief Program which was established by the Emergency Economic Stabilization Act of 2008.

FOX 35 has a crew at the scene. Check back for updates.

http://www.myfoxorlando.com/dpp/news/orang..._raids_building

:blink:

Edited by MOP

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I doubt all will end well, the longer this rally lasts the more likely it is I think we will see a black day.

Are we witnessing a game of chicken? Trading volumes it is said are low, for me this would suggest that one a big player blinks and dumps there shares the herd mentality will kick in and everyone will follow as something must be wrong or this is the time to cash in.

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Denninger has posted some great analysis but his drama queen tendancies may distort his appreciation of keeping a balanced viewpoint throughout erratic markets - case in point, his short-term outlook seems to miss the inverse relationship between the $ and stockmarkets of late

He had the following to say about the dollar following release of the GDP results:

What is this all telling us?

It appears to be that traders in the FX market (who by the way tend to be smarter than the average equity or bond trader) have deduced that the entire "improvement" in 2Q GDP came from government spending.

Well that's not hard to figure out - it did.

They also appear to be making a bet that the US Government will attempt to continue this, along with The Fed monetizing the debt through its buyback programs to destruction of both the government and currency.

This is not positive for our economy. At all.

But this is the meme today - traders are piling into bonds expecting more Fed buybacks, they are shorting dollars like crazy, and Gold is of course reacting to these two facts.

This is a "collapse of government due to spending into bankruptcy" play folks, or at minimum "currency crisis around the corner."

Right or wrong this is the trade being put on in size; the dollar selling in particular is especially pernicious and troublesome - that chart is essentially straight down since the GDP release this morning.

link

Since he wrote that, the dollar has continued its downward trajectory

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He had the following to say about the dollar following release of the GDP results:

link

Since he wrote that, the dollar has continued its downward trajectory

yes, but the point i was making in the other thread is that other commentators have pointed out that stock markets & commodity markets will more than likely benefit from the weak dollar, whilst denninger thinks otherwise (as far as i can see)

edit - clarity = a weakening dollar from here forward rather than a weak dollar per se

Edited by p.p.

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I think trashing the dollar is deliberate. Possibly a race to the bottom with the Chinese (or to be more competitive than Eurozone economies). The government has replaced the consumer for spending and hopefully this will be temporary (it can hardly go on for very much longer). Imports will obviously be more expensive. I would think the hope is to get some export led growth going but it doesn't seem to be happening (yet). UK is doing something similar and does appear to be restocking.

Edited by HostPaul TAFKA Rover2000

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yes, but the point i was making in the other thread is that other commentators have pointed out that stock markets & commodity markets will more than likely benefit from the weak dollar, whilst denninger thinks otherwise (as far as i can see)

edit - clarity = a weakening dollar from here forward rather than a weak dollar per se

It will be interesting to see how this pans out. A weakening dollar in a world of weakening paper money simply means energy and food costs more. I don't believe that will be good for consumer economies

I agree with you that the dollar and stock markets seem inversely correlated. They have been since the crisis began.

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