Reviewing my thoughts on August 8 th 2011

wild monday.

1) the s&p downgrade affected fixed income instruments across the US except for the very thing that was downgraded.

2) floating rate bonds are down 7%, yielding nearly 7%

3) High yield bonds are down 3 to 4%, yielding 7%+

4) municipal bonds are down 5%, probably yielding nearly 9% on a tax equiv basis

5) equities are down 3.4% and down 15% in a month

6) many stocks, e.g. Siemens, Dow chemical are now yielding nearly 4%.

If you consider the # of unemployed + # of discouraged workers and assuming their contribution to GDP was maybe half the average GDP per capita for the USA, this means that US GDP should be lower by  $1.2 to $2 trillion dollars so not $14.12 but maybe 12.1 to $12.9 trillion in GDP. (This is all assuming a natural unemployment rate of 5% or so).

The last time the US was at those GDP levels was 2004 to 2005 when the S&P 500 ranged from 1,000 to 1,150, pretty close to where it is today.

GDP contracted from 14.37 to 14.12 over the 2008 2009 period.

Now if GDP contracted another 8 to 13%, this should result in a stock market valuation of 1000 to 1150 but you can bet we'd first see a market crash unlike anything we've ever seen in history. Government deficit spending has made up this 1 to 2 trillion dollar gap over the last few years (Unemployment benefits, medicare, social security, military spending etc...) but it seems congress, S&P, etc are more willing to stop this spending, which can only mean a contraction in GDP is imminent assuming inflation rates around 2%.

Another route is a coordinated (or not) devaluation of the dollar to monetize the debt, which will oddly result in chaos in Brazil, SE asia, China, etc.. where rampant inflation or currency appreciation will result in companies shifting production to other countries. Quite baffling how US efforts to create inflation shows up in emerging markets but this is the result of neo-mercantilist policies in these countries. Neo mercantilism doesn't work if there are multiple nations attempting to weaken their currencies.

Bank of New York Mellon's fee on cash balances over $50 million is a taste of what's to come. In a sense this fee is equivalent to some measures Brazil has taken to limit inflows that are forcing Brazil Reais appreciation--a  tax on inflows. This is a currency war between the neo-mercantlists and free trade countries.

In this nightmare scenario, the US should charge a fee to secure investments in treasuries, given the revolts and instability likely to ensue in neo-mercantilist and 3rd world countries, the relative safety of treasuries, whose 'collateral'  or 'assets' is/are ensured by our military.

Anyway, I hope we don't go down that route, neither does any other nation, there has to be a global accord here soon to coordinate a 'rebalancing'.

u6 vs u3 vs u6 - u3 vs s&p 500 etc

Strategic default

Home prices have to go down, banks need to reduce prices they ask for foreclosures until market accepts the new level, only then will people be willing to risk both their capital, future income, and be willing to subject themselves to the rigorous underwriting process.

This is a deflationary trend. These are underutilized assets. Bank assets, fnma, freddie mac, and any mortgage assets held by gov't overvalued. Bofa's zombie bank creation should reflect this deflationary trend through write-offs going forward.

Gov't is trying to inflate away debt problems and show a USD based profit on the mortgage assets (or break-even) all the while the dollar is losing it's value, and inflation is rearing it's ugly head elsewhere. The Bernank sees inflation is already out of control but is too scared to raise interest rates too quickly. Sadly this divergence between home prices declining and food/fuel costs increasing will net a weird CPI that will vary based on two conflicting trends.

Optimistically at some point economies recover from defaults (which is what printing money amounts to) jobs return at a lower salary base but at least people are employed. Banks must write-off losses and reduce home prices. Local governments have to figure out where else to obtain tax revenue other than property taxes.

“At this point new homes are likely to continue to lose to existing homes because distressed properties pose a better bargain for buyers,” said Millan Mulraine, senior U.S. strategist at TD Securities in New York. “We’re not seeing a strong rebound in the horizon because permit approval is just marginally above starts.”

“Many potential home buyers are finding mortgages difficult to obtain and are also worried about additional declines in house prices,” Bernanke told lawmakers March 2.

For housing, employment “is the most important part today or biggest impediment,” said Larry T. Nicholson, chief executive officer of Ryland Group Inc. (RYL), a Calabasas, California-based homebuilder catering to first-time buyers.

Whether potential buyers “have a job and they’re going to keep their job or whether their hopes of employment are out there is still the biggest challenge for us today,” Nicholson said at an investor conference March 8 in Orlando, Florida.