LANDY INVESTMENT MANAGEMENT BLOG

BANK RESERVES SOAR WHILE BANK LENDING SHRINKS & INFLATION STAYS TAME

The public is mad as hell at the banking industry for cutting back on lending after receiving government funds from the TARP and direct loans from the Federal Reserve .  Banks' fear of losses has led them to tighten lending terms and standards.  At the same time, demand for loans also has declined as employment, consumer spending and business inventories have all fallen.  So, despite public outrage, there is no sign yet of any revival in bank lending.  Indeed, the Fed reported on December 10 that net bank lending has contracted by nearly $1.5 trillion since the start of 2009, with $854 million of that decline coming in the third quarter. 

 Meanwhile, bank reserves  (banks' deposits at the Fed plus their vault cash) have exploded upward during the financial crisis, as the Fed has pumped money into the banking industry.  Banks used to maintain reserves, on average, that were just slightly higher than the Fed's minimum reserve requirements .  If they lacked sufficient reserves, they would borrow in the Fed Funds market.  If they held unneeded reserves, they would lend them overnight to other banks in the Fed Funds market, where they would earn interest.   But, in October, 2008, the Federal Reserve, itself,  began paying interest on excess reserves  for the first time. This gave the banks an incentive, based on the interest rate offered, to have some excess reserves accumulate beyond the minimum amount required by the Fed, and keep them on deposit at the Fed without making them available to other banks in the Fed funds market.  This change in Fed policy enabled the Fed to pump up bank capital through direct loans and Tarp injections, without having to worry about so much money getting out into the real economy via loans, where it would cause inflation.

      The Fed now uses the rate on excess reserves, as well as the Fed Funds rate  to influence both bank lending and growth of the money supply.  To date, the Fed has been content to see the banks retain excess reserves so as to bolster banks’ capital and improve their financial stability. 

 The Fed has not put any direct pressure on banks to lend out more funds.  To do so, the banks would have to either cut their interest rates, lend to less creditworthy customers, or ease their terms by accepting less collateral or collateral of lower quality as a basis for their lending.  Or, they could increase their financial leverage by borrowing more.  Any of these courses would put the banking system at greater risk, so an ease in credit will probably have to await an improvement in economic conditions and a resurgence in business confidence.

     Observers as diverse as the prominent economist Allan Meltzer   and gold advocate Peter Shiff   have expressed fears that the Fed will keep rates too low for too long while the expansion of excess bank reserves will be maintained and will stoke inflation. Economist Paul Krugman   counters that inflation will not necessarily take off, arguing that Japan’s quantitative easing caused rapid growth in bank reserves there, without boosting inflation.  

Data on the growth of bank reserves are startling  (from the Fed’s H.3 publication: Aggregate Reserves  of Depository Institutions and the Monetary Base ,” 11/28/2008 and 12/10/2009).  The figures show that in August, 2008, a quiet month in America - just weeks before Lehman's bankruptcy - total bank reserves were $45 billion, of which $2 billion were excess reserves.  As of November 18, 2009, total bank reserves stood at $1.1 trillion.   That’s up nearly 25-fold.  As Paul Kasriel of Northern Trust  has pointed out previously, the bulk of this year’s increase in bank reserves has been accounted for by the increase in excess reserves beyond what the Fed requires the banks to hold.  The recent Fed data goes on to show that excess reserves rocketed from $2 billion in August, 2008 to over $1 trillion, up 500-fold, as of November 18, 2009.

     How serious is the danger that banks will draw on the more than $1 trillion in newly created excess reserves and lend the money out into the real economy, wreaking inflationary havoc?  The answer is: no chance at all, as long as the Fed has the will to prevent it.  The Fed will use the Fed Funds rate as well as the interest rate it pays banks for excess reserves as levers to control any expansion of credit.  

     The provision of credit though the banking system remains a demand-driven system. Borrowers apply for loans, depending on their desire for money and the prevailing interest rates.   Banks consider their requests, setting the rates and terms of any loans granted.  As credit expands, borrowers borrow more, with banks first using their own funds, then borrowing excess reserves from other banks in the Fed Funds market, as needed.  If increased borrowing puts upward pressure on rates in the Fed Funds market, the Fed, through its Open Market Committee, pumps new money into the Fed Funds market if it wishes to expand credit while holding interest rates stable.  Alternatively, if the Fed wants to rein in bank lending, it raises the Fed Funds target rate, which raises rates to borrowers and limits their demand for loans.   In this way, the Fed controls the expansion of credit.

  The recent piling up of excess bank reserves does nothing to diminish this role of the Fed because the Fed still sets the Fed Funds target rate, while its setting of the rate on excess reserves influences the amount of excess reserves the banks wish to retain.

     If banks, for some reason, failed to respond to the Fed’s strong interest rate incentives in favor of going wild with lending irresponsibly (would banks ever do that?) , the Fed could simply call in its loans to the banks, which would drain excess reserves from the system while impairing banks’ liquidity.  That would put a damper on excessive lending, wouldn’t it?  Furthermore, the Fed has the ability to "lock down" lending in the Fed Funds market by raising the rate it pays on excess reserves to a level that is higher than the Fed Funds rate.  Banks would prefer to lend risk-free to the Fed, rather than lend at a lower rate to other banks.  This would effectively freeze excess reserves and banks would find it difficult to secure additional funds in the Fed Funds market in order to lend amounts beyond their other sources of capital and their own surplus reserves. 

     The Fed’s challenge remains to get credit flowing in the economy again, without going overboard.  The accumulation of excess bank reserves has strengthened banks’ financial stability and it poses no special risk of an outbreak of runaway inflation.  As in the twentieth century, prospects for future inflation continue to reside in the Fed’s setting of the Fed Funds target rate, as it influences the flow of credit and money in the U. S. economy. 

      

      

     

THE DUMBNESS OF DIVIDENDS

     Dividends are not a positive factor in deciding whether or not to own particular stocks. That’s because dividends reduce the value of the underlying shares by the amount of the dividend. Suppose there exists a corporation that consists of a broken hot dog cart, with no regular place to sell hot dogs, and it has no other assets or liabilities. This company would not be worth much. But, suppose this corporation had $1 million dollars in its corporate bank account. Then, the company would be worth nearly $1 million.  A person could do very well buying the company for less than $1 million, then disposing of the hot dog stand, closing the business, then withdrawing the $1 million from the bank account. But, if the current owner of this business paid out in dividends to herself the $1 million that was in the bank account, the business would be left with roughly zero value. So, the business is worth a great deal before the dividend, but not much afterward. Likewise, publicly traded stocks trade at prices set by investors’ evaluation of what the company is worth. The value of any company depends on its earnings, prospects for the future, assets and liabilities. Cash is part of the assets. And each dividend paid out translates into either more borrowing or less cash on the balance sheet.

     Clearly, dividends do NOT provide a cushion under the stock price, as investors have found out painfully in recent years. And their payment has further weakened many companies already suffering from declining profits.

     However, paying dividends does make great sense when a financially strong company earns more than it needs to use for working capital or for its capital budget. Here, the cash would just continue to grow.  An example would be Microsoft (MSFT).   Better to pay out the excess cash in a dividend to shareholders (your maximum tax rate on dividends is only 15%) than to let it pile up in the company treasury while incurring the high corporate income tax rate on the interest that it earns.

     Dividend payments are fine for companies that are strong, financially.  Examples are:  Diamond Offshore (DO),  Intel (INTC), Lockheed-Martin (LMT), Lowe's (LOW), Microsoft (MSFT), Johnson & Johnson (JNJ), 3M Company (MMM), Stryker (SYK), Wal-Mart WMT), and Walgreen (WAG).   But cash is part of a company’s assets. Once paid out in a dividend, that cash is no longer part of what the company is worth. The bottom line: dividends are efficient and appropriate when companies have excess cash, but a dividend payment does not increase shareholder value because it subtracts a like amount from the what the company is worth, which is expressed in its stock price. Therefore, investors should not consider a dividend as a positive factor, in and of itself, in evaluating whether or not to own a particular stock.

     Disclosure: My clients or I own shares in: Intel (INTC), Microsoft (MSFT), Lockheed-Martin (LMT), Lowe's (LOW), Johnson and Johnson (JNJ), Stryker (SYK), 3M Co (MMM), Wal-Mart (WMT), and Walgreen (WAG).

INVESTING DURING RETIREMENT FOR MONTHLY INCOME

I.  Estimate your annual need for investment income.

      A.   Add up how much you spent over the past twelve months.  Get this from your checkbook or     your bank statements.  
              1.  Subtract unusual huge purchases, such as an outlay for a new car. 

              2.  Subtract monthly items that will disappear due to lifestyle changes, like if you sell your house, stop commuting to work, or if Medicare will reduce your health insurance bills.
              3.  Add any large future things you want to budget for, like an increased budget for travel.    

              4.  Subtract expected income from non-investment sources. 
                     a.  Social Security

                     b.  Property rental income

                     c   Allowance from rich uncle

               5.  Divide your "annual need for investment income" by twelve to determine your monthly need, which you will withdraw from your investment account each month.
             
                            

II.  Set aside enough money in risk-free investments that will provide five years of income during stock market meltdowns.
      A.   Multiply your "annual need for investment income" (calculated earlier) by five to tell you how much money to set aside to cover you for five years, if needed. 
  B.   Invest your risk-free money in either bank CDs (with at least 1/5 of the money accessible each year) or a money market fund or TIPS (U.S. Treasury Inflation-Protected Securities).

III.  Invest the balance of your investment money in a diversified portfolio of stocks or index funds, with no one stock initially accounting for more than 5% of the total.

       A.  Your monthly income depends on how much you arrange to be sent to you. 

       B.  Your monthly income does NOT depend on how much in dividends or interest you receive.  It depends on your total return, which includes dividends, interest and capital gains.

       C.  Total return from stocks has averaged 9 - 10% over the past 50 years and past 100 years.  Use this growth to fund your monthly income during the good years.

       D.  Avoid all high-fee mutual funds and closed-end funds.  Avoid all leveraged funds.  All funds, if any,  should be low-fee funds or low-fee ETFs.
               
 

IV.  Start monthly withdrawals for retirement income.  Withdraw from stocks when stocks are dear, but not when stocks are cheap, like in 2008.

      A.  Withdraw all monthly income from stocks when in normal times or in good times. 

                1)  Calculate the trailing ten-year average earnings for the S & P 500, adding an adjustment for inflation, and compare to the current level of the S & P 500.  Calculate quarterly.

                2) If the P/E calculated above is twelve or higher, make all monthly withdrawals from the stock portfolio.  In 2009,  the S&P must stay above 900 for this P/E to remain above twelve.

     B.   Withdraw all monthly income from your risk-free reserve fund when the S & P  P/E (based on ten year average earnings, adjusted for inflation) goes below twelve. Review quarterly. In this way you avoid selling stocks when they are low.

 

V.  Income tax considerations should be kept in mind.

      A.  Maximize holdings of stocks in taxable accounts to take advantage of maximum 15% tax rate on dividends and long-term capital gains.

      B.  Fixed income investments should be directed to tax sheltered  IRAs, 403Bs (teachers' annuities), and 401Ks, as much as possible.

            1.  Interest from fixed income investments is taxed fully, whether in a taxable account or when withdrawn from a sheltered retirement account.

            2.  Stock gains and dividends also are taxed fully when withdrawn from a sheltered retirement account and you miss out on the 15% maximum tax rate.            

 

V.  Confront Inflation

       A.  Avoid investments in long-term bonds, except for TIPS.

       B.  Fixed income investments recommended above will not be hurt by inflation

       C.  Stock investments will not be hurt by inflation, in the long run, as costs, selling prices, dividends, stock prices, and the value of assets owned by the companies you invest in will all rise with inflation.

   D.  Adjust your monthly  investment income need once a year, based upon expected inflation, your past twelve month's spending and your future plans. 

Review of "Globalizing Capital" by Barry Eichengreen

Economist Barry Eichengreen offers great insights into the workings of the international monetary system from 1850-2008 in the second edition of Globalizing Capital, published 2008 by the Princeton University Press . While it does not exactly read like a great novel, it is well worth the effort to uncover the great influence that the monetary system has had on the world economy at various points in history. For example, beginning in 1929, nations’ rigid reliance on the gold standard facilitated the spread of the Great Depression from country to country. Under the gold standard, the major countries of the world were linked by a common policy whereby nations pledged to convert their currency into gold at a fixed price upon demand by anyone who would present it for such an exchange. This system maintained the value of paper money relative to gold and relative to the currency of other countries. Countries saw that maintaining fixed currency values facilitated trade with other countries, as importers and exporters were freed from the risk of financial ruin that might otherwise result from fluctuations in currency values between the time of an order and the receipt of payment. The rigid link of currencies to gold was thought to prevent trade imbalances among countries. If a country imported much more than it exported, the flow of money outward would cause the general price level to drop, which would make additional importing less attractive and make one’s exports more competitive. Another benefit of the gold standard was that the promise to exchange for gold gave the public confidence in paper currency printed by central banks. Unfortunately, this became a double-edged sword.

Here is the Eichengreen script (simplified) of the Great Depression. In 1927, the U.S. Federal Reserve began to raise interest rates in order to curb stock market speculation. The increased rates attracted savings from overseas, which caused declines in economic activity in Europe, which had previously been awash in loan capital from the U.S. This, in turn, caused other countries to raise their own interest rates in order to keep their capital and their gold (gold was money) from fleeing to the U.S and to the other countries that had already raised their rates. Rising interest rates spread from country to country and depressed economic activity. The economic decline led to bank failures which shrank the money supply and led to deflation, which further suppressed the economy. Nations hesitated to step in as lender of last resort to banks because that required them to print quantities of money, which would detract from their ability to maintain the link between their currency and gold (there’s that pesky gold standard, again). In fact, rescuing banks might have been counterproductive, as the printing of money not backed by gold would lead to fears of devaluation and cause investors to withdraw their national currency - denominated bank deposits, which would worsen the crisis further. In other words, reliance on the gold standard threw the world into what would now be called a negative feedback loop.

Eichengreen finds confirmation of the gold standard’s role in transmitting the Depression among countries, as he ties the eventual recoveries by various countries to their abandonment of the gold standard, together with reflation and their embrace of flexible exchange rates: first the U.K., then the U.S., then France.

Later chapters in the book cover the Bretton Woods Agreement (1944-1973, the subsequent breakdown of pegged exchange rates, and the various currency crises through 2008. Bretton Woods was an attempt to peg currency exchange rates within a 1% range, while providing mechanisms for cooperation and policy coordination among the member countries. Its purpose was to facilitate trade. It broke down for the same reason that all such rigid systems break down - it failed to accommodate the changing economic experiences and political needs of its members. The Asian currency crisis of the late 90s was similar to earlier crises in that it consisted of the cracking of a framework of pegged exchange rates. This book also provides brief, but instructive treatment of countries that have used currency boards to peg their exchange rate to the dollar (like Argentina, which did it until pressures caused them to devalue and abandon the peg, and Hong Kong). There is also some discussion of our ongoing trade imbalance with China, wherein China exports goods to the U.S. and keeps its currency exchange rate low by investing in U.S. government debt.

Eichengreen summarizes the factors surrounding the creation of the Euro currency, whose purpose (which has succeeded) was to promote trade and economic growth among its members. He provides an insightful case for its continued survival, even as individual members may find themselves under strain from time to time, unable to accelerate the printing of money to prime the national economy. His point is that any country that seriously considers pulling out of the Euro family in order to engage in monetary stimulus will experience an outflow of funds from its banking system as investors will want to avoid having their Euro bank deposits converted to a new national currency that will almost certainly lose value. The decline of bank deposits would depress that nation’s economy even further. This scenario will likely keep the Euro family together for the foreseeable future.

Globalizing Capital presents a comprehensive story. Eichengreen’s insights on the mechanisms by which the Great Depression traveled from country to country have been quoted extensively by such experts on the Great Depression as Christina Romer and Ben Bernanke. Overall, reading this book requires some effort, but it gives the reader a good understanding of how evolving changes in the international monetary system have directly affected the course of economic history.

    Review by Arnold Landy   

 

RISK MANAGEMENT IN STOCK MARKET INVESTING

    Investment portfolios should contain a minimum of twenty stocks, with no single industry accounting for more than 15% of the total value at the time that the portfolio is constructed. Even with such diversification, a portfolio of stocks is vulnerable to the risk of at least a 60% loss from peak to trough (there have been several 50 - 60 % stock market declines in my lifetime, but feel free to pick any number between 60% and 99%, depending on how nervous you are about investing in stocks). I hope to avoid major market declines by pulling out when I correctly foresee a recession, but even　 successful economic forecasting does not protect against all bear markets.　 Some investment pros advocate limiting a portfolio's loss to say, 20%, at which point one liquidates and walks away.　 But this method is effective only if one never goes back into stocks.　 For example, a 20%　 trigger point would have produced a 20% loss in 2008.　 But if one re-entered the market in, say, January, 2009, one would have liquidated by March, 2009 with another 20 % loss. Indeed, one potentially could string together a whole series of 20% losses.　 All that does is spread the loss over a longer time period, without limiting the total loss.　 And during the periods between liquidation and re-entry the investor remains on the sidelines with no chance of recovery.
　　 Another problem with liquidating upon some predetermined loss percentage is that it fails to protect against a rapid market meltdown.　 During the 1987 crash, stock prices dropped about 5% one day (a Friday), then another 23% the next day that the market opened.　 The total decline from the peak was about 1/3.　 If one's portfolio is already down by, say, 10%, another 23% decline in one day puts you well below a 20% loss threshold in a flash.　 Indeed in the 2007-2009 bear market, there were several days when the market opened 5% or more below the closing prices from the night before, so there was no chance to liquidate at points in between. In 1987, stocks rose to new highs by the end of the year. So any investors who liquidated after the crash and stayed away from stocks would have missed out on the recovery. Likewise, most who liquidated after the drop in early 2009 likely missed out on the recent 50% rise to new highs for the year. In both cases, liquidating to prevent further loses had the unwanted effect of making impossible the recovery of the investors’ assets.
　　　　 Corporate and government bonds are also subject to considerations regarding risk.　 Corporate bonds are subject to the risk of default (like if one owned Lehman Bros. or Six Flags bonds).　 Both corporate and government bonds are subject to the risk that their value will decline if interest rates rise or bond ratings decline.　 The most serious risk of all, however, is that inflation will erode the purchasing power of the fixed interest payments each year and will decimate the purchasing power of the principal upon maturity.　
　　 The best risk management method is to place some assets into Treasury Inflation-Protected Securities (TIPS). These are U.S. Government bonds that pay a low rate of interest, but the interest payments and the principal are both guaranteed to increase with the rate of inflation.　 Both the interest received and the increased principal value that accrues each year are taxable income.　 In IRA and other tax-deferred accounts, tax is not payable until the money is withdrawn.　 These bonds can be purchased directly from the U.S. Treasury or through a bank or broker.　 Also, there are mutual funds that invest in TIPS and exchange traded funds (ETFs) that invest in TIPS.
　　 Risk management in stock investing cannot be achieved simply by selling as stock prices decline.　 Nor can risk management be enhanced by sticking to stocks of safe companies. (Define “safe”: Citigroup? GE? Fannie Mae? Freddie Mac? AIG? Polaroid? General Motors?)　 The bottom line is that the best risk management program for stock investing is found outside the stock market: in the government securities market through the purchase of TIPS.　 For funds not needed over the next few years, the lowly stock market, after getting beaten up over the past decade, remains a good bet to resume its　 long-term (100 year) pattern of providing a　 9.5 % rate of return.　 And, even after their recent run-up, stocks remain on sale at prices 1/3 below the highs of two years ago.

IS EMPLOYMENT A LAGGING INDICATOR ?

Employment is NOT a lagging indicator, although duration of unemployment IS.  The Conference Board, a not-for-profit economic study organization, publishes three popular indexes: 1) the Leading Economic Index (LEI), which foretells turning points in the economy before we move into or out of recessions, 2) the Coincident Economic Index, which measures current economic conditions, and 3) the Lagging Economic Index, which changes direction following the others.

There are two employment indicators that are incorporated into the LEI, namely Initial Claims for Unemployment Insurance (inverted), and Average Weekly Manufacturing Hours.  Like other leading indicators, we do not normally recognize these things as obvious improvements in the economy.  After all, if over 500,000 workers file claims for unemployment insurance, as was the case this week, this is still a relatively large number and the fact that it is much lower than was the case a few weeks and months ago does not mean that the economy is improving.  But it DOES mean (with history as our guide), along with improvement in the other leading indicators, that the economy is going to improve soon.

What about total employment - the actual number of workers on payrolls?  That is the figure most people relate to as a measure of the health of the economy.  That is not a lagging indicator, either.  In fact, it is a Coincident Indicator. The first Friday of every month the Bureau of Labor Statistics of the U.S, Department of Labor releases monthly data showing nonfarm payrolls.  This figure is one measure of how the economy is doing right now.  It is one of the Coincident Indicators tracked by the Conference Board.  In addition, it is one of the four indicators examined by the National Bureau of Economic Research (NBER), which is widely recognized as the group responsible for determining the dates of the beginning and end of recessions.  The other three indicators that the NBER considers are sales,income and industrial production.  Employment typically rises when recessions end.  However, in our most recent recovery from recession, 2001, employment did not rise until over a year after the NBER called the end of that recesssion based on improvement in the other three indicators.  Indeed, that period of time was dubbed, "The Jobless Recovery."  That lag in employment was unusual and it did not knock Nonfarm Payroll Employment off its perch as one of the Conference Board's Coincident Indicators.  And Employment remains one of the four indicators considered by the NBER in fixing the ending date for the current recession. 

The Unemployment Rate has no official status as part of any broad index of economic conditions.  Observers have pointed out problems in drawing conclusions from changes in the employment rate.  For one, as labor market conditions worsen, unemployed workers may become discouraged and stop seeking jobs.  Their dropping out of the labor force makes the unemployment rate fall, disguising worsening conditions.  Conversely, as the economy improves, discouraged workers tend to become optimistic as they hear reports of hiring, then enter the labor force where they add to the unemployment rate while they actively seek work.  These leakages plus changes in the calculation of unemployment over time have brought much criticism to the use of the Unemployment Rate as an economic indicator.  The Unemployment Rate does tend to lag the ups and downs of the economy cycle.

There is one additional measure of unemployment that is a Lagging Indicator, as defined by the Conference Board: Average Duration of Unemployment (inverted).  This measure looks at people who have recently found jobs and tells us the average length of time they had been unemployed.

What are the labor market indicators telling us now?  Of the Leading Indicators, Initial Claims for Unemployment Insurance peaked in March and the four week moving average of claims has fallen steadily since April.  Average Hours Worked in Manufacturing began a small improvement in June.  These indicators and the overall LEI point to an early end to the recession, and the recovery may well be underway, already.  Nonfarm Payrolls, a Coincident Indicator, has continued to deteriorate in recent months, but we are well past the peak in net job losses.  This year's massive declines in manufacturing inventories argues for a pick-up in factory hiring, as has recently occured in the auto and steel industries.  Thus, the outlook is becoming more positive for gains in Average Weekly Manufacturing Hours this month and next, soon to be followed by gains in nonfarm payrolls during the fourth quarter.

The Unemployment Rate and the Average Duration of Unemployment have continued to worsen, and they can be expected to improve only after the economic recovery is well underway.  To summarize: Average Duration of Unemployment and the unemployment rate are lagging indicators, Nonfarm Payrolls is a coincident indicator and Initial Claims for Unemployment Insurance and Average Manufacturing Workweek are leading indicators.  The last two of these have already turned for the better.  The next one to improve, as the economy recovers, likely will be Nonfarm Payroll Employment.

A CHICKEN IN EVERY POT, AS THE ECONOMY GETS HOT

It is time to smash the myth that the U.S. financial crisis will cause any recovery from the current recession to be slow and unimpressive.  In fact, history tells us the opposite.

It may surprise readers to learn that during the  Great Depression, after collapsing from 1929-1933, our economy actually expanded sharply from 1934-1937 (industrial production regained its prior peak), declined during 1937- early 1938, then began another robust recovery that lasted beyond the end of World War II.   

As  summarized by Christina Romer, Chairperson of the Obama administration's Council of Economic Advisers, the early 1930s saw the failure of nearly half the nation's financial institutions, yet the recovery years of 1934-1936 displayed increases in real GDP of 11%, 9% and 13%, respectively and the unemployment rate fell from 25% to about 15% during that period.  Clearly, that financial crisis, which was far worse than that of today, did not prevent our economy from recovering rapidly.

During 1937- early 1938, our economy fell into another decline.  Most monetary economists, like  Milton Friedman,  Anna J. Schwartz and Allan Meltzer, placed blame for this on the Federal Reserve Board, which tightened money by raising banks' reserve requirements in late 1936.   Keynesian economists, like  Paul Krugman, tend to blame the federal government's cutting back on fiscal stimulus, which also occured.  Christina  Romer sides with the monetarists in crediting the subsequent expansion of the money supply with pulling us out of the Depression, while stating recently that the New Deal was too small a program to have been effective.  She points out that the current stimulus package's fiscal effect is about twice the size of FDR's New Deal, as a percentage of GDP, and will last twice as long.

By 1938-1939, fiscal and monetary policy had turned expansionary, again, and the economy expanded rapidly through and beyond the Second World War.  Examination of economic data from the Great Depression and its aftermath shows that a financial crisis can cause an economic calamity, but there is no evidence that recovery from such a debacle is necessarily sluggish, indeed the evidence is to the contrary.  Due to the cloud of pessimism overhanging our national outlook as expressed by most observers, I look for the nascent economic recovery to surprise on the upside.  In other words, a chicken in every pot, as the economy moves from cold to hot.

It may surprise readers to learn that during the  Great Depression, after collapsing from 1929-1933, our economy actually expanded sharply from 1934-1937 (industrial production regained its prior peak), declined during 1937- early 1938, then began another robust recovery that lasted beyond the end of World War II.   

As  summarized by Christina Romer, Chairperson of the Obama administration's Council of Economic Advisers, the early 1930s saw the failure of nearly half the nation's financial institutions, yet the recovery years of 1934-1936 displayed increases in real GDP of 11%, 9% and 13%, respectively and the unemployment rate fell from 25% to about 15% during that period.  Clearly, that financial crisis, which was far worse than that of today, did not prevent our economy from recovering rapidly.

During 1937- early 1938, our economy fell into another decline.  Most monetary economists, like  Milton Friedman,  Anna J. Schwartz and Allan Meltzer, placed blame for this on the Federal Reserve Board, which tightened money by raising banks' reserve requirements in late 1936.   Keynesian economists, like  Paul Krugman, tend to blame the federal government's cutting back on fiscal stimulus, which also occured.  Christina  Romer sides with the monetarists in crediting the subsequent expansion of the money supply with pulling us out of the Depression, while stating recently that the New Deal was too small a program to have been effective.  She points out that the current stimulus package's fiscal effect is about twice the size of FDR's New Deal, as a percentage of GDP, and will last twice as long.

By 1938-1939, fiscal and monetary policy had turned expansionary, again, and the economy expanded rapidly through and beyond the Second World War.  Examination of economic data from the Great Depression and its aftermath shows that a financial crisis can cause an economic calamity, but there is no evidence that recovery from such a debacle is necessarily sluggish, indeed the evidence is to the contrary.  Due to the cloud of pessimism overhanging our national outlook as expressed by most observers, I look for the nascent economic recovery to surprise on the upside.  In other words, a chicken in every pot, as the economy moves from cold to hot.

MORE THAN JUST GREEN SHOOTS

Several recent economic reports showed real growth in some areas of the economy.  The green shoots famously noted by Ben Bernanke were mostly signs of optimism for the future, but lacked immediate realtime impact on our economic wellbeing.  Or they were a slowing in the rate of decline (such as for auto sales), instead of actual increases.  So, here is a list of signs of real growth reported within the past thirty days:

1)  Housing Industry: 

    (A) Housing starts rose, both single-family and multi-family

    (B)  Sales of existing homes rose

2)  The Consumer:

     (A)  Consumer spending rose (although retail sales,within that, continued to fall)

     (B)  Personal income rose

3)  Manufacturing:

     (A) Durable goods orders rose

     (B)  The factory production component of the ISM survey rose above 50, implying expanded production (although the overall index is merely contracting more slowly).

     (C)  Average manufacturing workweek hours rose (even as average workweek for the overall economy fell).  This manufacturing component of the monthly employment report is one of the two employment indicators within the Index of Leading Econmic Indicators.  The other one is initial claims for unemployment insurance, which has been improving since April.

As these and other indicators continue to strengthen, the economic recovery, which has already begun, will become more apparent.

EMPLOYMENT DATA BULLISH FOR STOCKS

Recent employment data supports optimism regarding both stock prices and the economy.  While the U.S. shed over 400,000 jobs in June, job losses typically continue for several months after recessions end.  Job figures like employment and  the unemployment rate do describe current conditions, but tell us nothing about the future course of the economy. 

For guidance on when the economy will turn up, we look to the Leading Economic Index (LEI).  This predictor of economic turning points is comprised of ten indicators, two of which are stock prices (we can see these every day) and initial claims for unemployment insurance (announced weekly at 8:30 every Thursday morning).  Here, we find our basis for optimism.  The LEI has risen sharply two months in a row.  And the major employment indicator within the LEI has also performed positively.  Initial claims for unemployment insurance (four-week moving average) peaked in early April at 660,000.  They have declined choppily ever since, and last week recorded a recent low at 615,000.  The other labor market indicator within the LEI, average weekly hours worked in manufacturing, improved slightly in June, as well.

So, here is the stock market/recession/employment  sequence:  1) stock prices rise, the LEI rises and intial claims for unemployment insurance decline,  2) the recession ends, then, a few months later... 3) employment starts to increase and the unemployment rate falls.  Stock prices likely will rise as unemployment claims continue to fall and the economy pulls out of recession.  When employment losses turn into gains and the unemployment rate begins to fall, the March low in the stock market and the end of the recession will be distant images in the economy's rear view mirror.

FORD FACES FIGHT FOR ITS FUTURE

In the old days, Ford Motor Co. (F) faced  relatively minor threats to its profitability :  the UAW, legacy medical and pension costs, a crushing debt load, retooling costs to meet safety and environmental standards, rising gasoline prices and high quality foreign competition from titans Toyota and Honda.   But now, things are going to get REALLY tough.  After seeing its two American competitors go down the financial drain,  Ford now must compete with streamlined versions of GM and Chrysler, which are having many of their contractual burdens (previous labor contract provisions, inefficient dealer networks, huge debt repayment obligations, etc.) swept away by the bankruptcy process.  This is all reminiscent of the challenges facing the airline industry over the years.  As airline after airline declared bankruptcy (some more than once), rather than liquidating, most continued to function under Chapter 11, then emerged leaner and meaner to compete with and weaken the survivors.  The result has been that airline stocks and bonds  have remained a wasteland for investors over the decades. 
A similar scenario is now facing the auto industry, but with one crucial factor that makes their situation potentially worse than that of the airline industry: the bankrupt auto companies have financial backing from the U.S. Treasury.  This is a problem going forward, not only for Ford, but also for Honda (HMC), Toyota (T M) and Nissan (NSANY), which sell widely in the U.S.   Indeed, the competitive problem is made worse by the fact that the U.S. Treasury is providing $12.5 billion of TARP funds plus additional TALF funds to GMAC, which is now offering relatively easy low-cost  financing to buyers of GM and Chrysler vehicles. 
If I owned a hardware store (as I used to), I would not want to have even the most incompetent government-owned competitor nearby if it had an unlimited source of funding.  We have no way to know whether our government will be able to successfully pull out of its financial involvement in the auto industry, as it intends.  But, until Treasury starts to dial back its involvement in GM, Chrysler and GMAC, investors would do well to turn their attention to other industries for investment opportunities