Thursday, May 5, 2016

Puerto Rico Needs Restructuring, not a Bail-out

According to an article published by the Cable, Puerto Rico is nearing the Brink of Bankruptcy, the Puerto Rico commonwealth has $72B in debt, some of which it claims it can no longer service, and therefore will default as early as May 2, 2016.  The Island government is asking creditors to forgive up to 45% of the principal on certain loans so that it can recover financially.  The U.S. Congress is now intervening in the crisis with legislation being reviewed which would give added power to the Puerto Rico government to restructure its debts to the detriment of existing creditors.  The public airwaves are currently buzzing with “tell Congress no bail-out for Puerto Rico” ads.

Although a 45% haircut to lenders this large is unlikely, many of the Puerto Rico Financial Development Authority General Obligation bonds are trading for $0.20 on the dollar out of fear about what the outcome will eventually be in the current crisis.  Just why is Puerto Rico in so much financial trouble?  There is a combination of factors which have led up to the current circumstances in which the current government is very likely to run out of cash.  First, the country never really recovered from the 2008 recession.  Unemployment on the island is remains high at 11.6%, and the labor participation rate is less than 40%.  In other words, Puerto Rico’s 1.1M labor force is not big enough or growing fast enough to service the loans.  Adding insult to injury, the island population base is shrinking at a rate of -0.6% per year.

Why has the Puerto Rico economy been shrinking?  One of the major culprits has been the expiration of a federal IRS statue section 936.  The section established tax exemption for U.S. corporations that settled in Puerto Rico, such as large pharmaceutical firms, to allow its subsidiaries operating on the island to send money to the parent company federal income tax free.  The island economy has been in persistent decline since this statute was repealed by the Clinton administration in 1996.  As the manufacturing jobs have vacated the island, new job creating industries have not been forthcoming.

The ability of the island to generate cash for loan servicing is indeed dire, but the island government is not a total victim in this situation.  There are major inefficiency problems in collecting the Puerto Rico Sales and Use Tax, with estimates showing the Treasury is incapable of collecting up to 44% of the tax.  Additionally, public salaries are much higher than the private sector on the island.  Per capita income on the island is $28,850, and public workers generally are paid more than average with legislative advisors for instance making $74,000.

The island economy could also be much more resilient if public policy took better advantage of its natural resources, and depended less on imported goods.  Puerto Rico imports 85% of its food even though 94% of its land is fertile.  The islands geography has many rivers which could be used for hydroelectric power, and yet the island must import all its fuel (coal, natural gas, oil) in order to produce energy.  Renewable energy sources are also heavily under-utilized even though Puerto Ricans enjoy 65% sunshine on average every day, and wind rates average 22 mph.  From an energy standpoint, island residents pay $0.26 per kilowatt hour for electricity compared to $0.11 per kwh in the U.S.

Puerto Rico needs a long-term plan, not a Washington bail-out.  Creditors are very likely more than willing to work with the island government if it truly wants to address the structural issues which are making its financial situation worse by the day.  However, the role of Washington in this situation should be minimal.  The island doesn’t need major loan haircuts which destroy the capital investment process, it needs a long-term economic plan and new direction, neither of which is being put forward currently.  If Washington intervenes as desired by the Puerto Rico government, then who will be next in line – Illinois?

Daniel Moore is the author of the book Theory of Financial Relativity.  All opinions and analyses shared in this article are expressly his own, and intended for information purposes only and not advice to buy or sell.
 

Thursday, April 28, 2016

Trump Appeal Growing on Realization of “Globalization” False Promises

Having started my working career in the mid 1980s, I can truly say I have witnessed from the ground level the destruction of the American working class economy described in the recent CNN Money article - Yes, China has won big from U.S. trade.  Back in the late 1980s, good jobs were plentiful as the tech and telecom sector were booming and Americans were the beneficiaries.  Income growth was likewise very strong.  And the internet as we know it today was not available.

But something happened after the Berlin Wall fell in 1988, and Bush I was elected as President.  The U.S. foreign policy began to emphasize, more than ever before, the concept of “Globalization.”  Simply put, the term is used to describe the processes by which people of the world are incorporated into a single world society.  Bush I use of the term “New World Order” remains vividly etched in my mind to describe the opening of trade relations with the developing economic countries known as the BRICs – Brazil, Russia, India and China in the early 1990s.

The “New World Order” is now rapidly turning into disorder for the U.S. economically, and Donald Trump is capitalizing on the discontent.  The “establishments” in both the Republican and Democratic parties have no intention of changing U.S. direction on this policy.  They were commenced under Bush I, the Republican establishment, and perpetuated under Clinton and Obama, the Democrat establishment.  In fact, the two parties are blatantly promoting the rules of their nomination process to favor candidates that will perpetuate the process.  A growing number of American voters are now getting suspicious about what is actually happening, as 50% of voters are now saying the nomination process is rigged.  The money trail into the campaigns is a likely at the root of voter suspicion, as international, not American interest are behind establishment candidates more than ever before, whether it is through the “Clinton Foundation” in the democratic race, or the large multinational business PAC money behind Cruz and Kasich.

What is the false promise of globalization? Simply put, there is no such thing as “free trade”, just as there is no “free lunch” in economics.  The whole process being under-taken by the establishment in both political parties at the expense of the American people has a cost.  And that cost has a price tag that is easily measured – it is the U.S. budget deficit of over $19.2T dollars, and a debt to GDP ratio of over 106%.  In 1988 the U.S. budget deficit was $2.4T and the debt to GDP ratio was a reasonable 49.8%.  And to top it off, it is foreign governments and multinational companies that are financing the tearing down of the U.S. middle class.  In 1988 foreign direct ownership of the U.S. publicly traded debt was only 16.7% of market traded Treasuries (TLT) (SHY).  Today foreign ownership of marketable U.S. Treasury debt is $6.2T, or 45.1% of the debt outstanding! (see graph)

The U.S. deficit, driven by large trade imbalances between the U.S. and its world trading partners, is only possible to correct if U.S. policies structurally defend the U.S. workers who pay taxes rather than continuing to finance the false promises of “free trade” on the backs of the U.S. taxpayer.  Multinational corporations are expertly dodging their responsibility to pay their share and foreign governments assume no responsibility for U.S. financial problems.  It is time for the U.S. represent its own interest in the global economy.  Otherwise, the U.S. goes bankrupt and globalization dies a more horrible death.

Daniel Moore is the author of the book Theory of Financial Relativity: Unlocking Market Mysteries that will Make You a Better Investor.  All opinions and analyses shared in this article are expressly his own, and intended for information purposes only and not advice to buy or sell.

Thursday, April 7, 2016

Odds Rising for a Return of Stagflation


Stagflation is an financial market phenomenon in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high.

Since President Obama was elected in 2008, the U.S. financial market has traded with a haunting fear of a return to much higher levels of inflation combined with low economic growth.  The low growth part of the prediction has been born out throughout Obama’s now seven plus years in office.  However, inflation fears have turned out to be overdone.  When President Obama took office, the CPI index stood at 211.4.  As of year-end 2015 the index stood at 237.85.  (See CPI Data)  Inflation thus far in the Obama years has been on 1.68% annually.

Meanwhile nominal economic growth as measured by the Gross Domestic Product was $14.6T at the end of 2008, and measured $18.2T at the end of 2015, a growth rate of 3.19%.  (See GDP Data)  Nominal GDP is calculated including inflation, so real economic growth during the time period has been growing at an anemic pace of approximately 1.51%.

If you look at the recent trends in the economic statistics, the growth versus inflation performance is actually better.  In 2015 the CPI increased by only 0.72%, while GNP expanded by 3.12%.  Again, the numbers have trended toward very low inflation, and low to moderate growth.

A recent MarketWatch article on 3/24/2016, Stagflation could be latest 1970 trend to make a comeback, raised the specter that risk is increasing that U.S. economic growth is headed for a slowdown, meanwhile inflation is likely to head higher in the next year and beyond, just as Obama exits office.  For stagflation to recur, according to Bank of America’s standards, GDP growth would need to slip below 1.4% while the quarterly growth rate for core inflation (ex-energy and food price changes) rises above 2.3%.

Looking at general economic trends, the forecast for stagflation this time around, versus the false alarms throughout the Obama tenure in office, now has greater likelihood of being borne out in future economic results.  Why?  Here are 3 market signals which investors should follow which are trending toward higher inflation in the future, and lower economic growth:

Oil Prices:  At $38 per barrel, the price o f oil is down 17.80% over the past year, and down substantially since June of 2014 when it traded at over $100 per barrel.  However, the trend in prices is definitively upward since February of 2016, and forecasts are for oil prices to return to $50-$60 per barrel in 2017.  With the major cutbacks in drilling investment throughout the world, it should surprise no one if the current forecasts underestimate the price rebound strength of oil once the current over-supply in the U.S begins to dwindle by year end 2016.  Just as in the 1970s, a spike in oil prices was the precursor to a very serious bout of stagflation.

Corporate Cut-backs:  The U.S. economy is currently past peak in the employment growth cycle.  In the latest monthly total non-farm employment data, new job creation was 215,000.  This data was accompanied by a tick upward in the unemployment rate from 4.9% to 5.0%.  Many economist view the current U.S. government employment data as severely over-estimating the health of the current U.S. economy due to the magnitude high number of workers excluded from the survey because they have stopped looking for work.  More concerning data, however, is visible in the increasing number of company lay-offs in 2016.  For instance, in its recent report, Challenger reports 63% rise in layoff announcements on oil-price collapse.  The strong U.S. dollar is also wrecking havoc in many U.S. tech firm operations like Hewlett, Intel, Microsoft and Unisys.  (Tech Sector Shed Over 79K in 2015, 13 Percent of All Cuts).

Federal Reserve Easy Money:  In December of 2015 the U.S. Fed increased short-term interest rates for the first time since 2006.  Many critics of the Fed have voiced opinions that the Fed left rates too low for too long, and continues to be too slow.  However, the Fed is mandated by Congress to respond with easy monetary policy as long as inflation is low and unemployment is considered too high.  The statistics show that this has been the case in the U.S. economy since Obama took office.

The real issue is whether the Fed extreme policy of leaving rates at 0% for so long has set the stage for the stagflation to now return.  In the 1960’s and 70’s, the Fed monetary policy was very similar in approach to the current policy – they lowered interest rates substantially to encourage unemployment to fall.  The technique is based on an economic theory known as the Phillips Curve.  The results in the early 1970s were disastrous, as President Nixon found out, and his predecessors in office until 1980 when Paul Volker assumed the Fed chairmanship took the painful steps to extract the country from the misguided monetary policy measures.

Policies in place for Stagflation to make a return


Will the upcoming bout of stagflation, if it occurs, rival the intense high interest rate, high inflation rate scenario encountered in the 1970s.  My research which is published in the book, Theory of Financial Relativity, predicts that the outcome will depend largely on the U.S. government policy going forward, in particular the U.S. Treasury demands for low rates to finance the U.S. deficit relative to the rate of growth in federal budget expenditures.

In November of 2015, Republican Paul Ryan took over as House Speaker, and ironically his first action was to lead the approval of a 2016 budget that dramatically increased federal spending levels when compared to the previous 5 years.  When this action is combined with a Federal Reserve that is hesitant to take action to return interest rates to a historical normal level, the odds are now much higher for stagflation to return as it did in the 1970s.  All this said, the U.S. economy has a long way to go before the situation can return to the extreme situation faced in the 1970s.  These issues take time to materialize.

In this financial environment, I favor commodity based investments and gold, which have been severely beaten down over the last several years.  Note the correlation in the decline in these sectors to the very low growth rate in the U.S. fiscal expenditures.  Now that these sectors have all been severely reduced in value, and U.S> policies in the process of changing, these investments will be much better stores of value than U.S. stocks (SPY) (DIA) (QQQ), or U.S. Treasuries (TLT).

Daniel Moore is the author of the book Theory of Financial Relativity: Unlocking Market Mysteries that will Make You a Better Investor.  All opinions and analyses shared in this article are expressly his own, and intended for information purposes only and not advice to buy or sell.  He holds no positions is securities referenced in this article.

Saturday, February 13, 2016

What would Negative Interest Rates Mean for America?

Negative interest rates (NIRP) in Europe and Japan are a function of central banks out of control defending their country banking systems by cornering the market in so-called "risk-free" government bonds. The lack of lendable collateral in these economies at low rates is a function of poor fiscal policy (a.k.a. crony socialism), not a failure of the central banks since they are really only taking their cue from hopeless government leaders and entrenched, concentrated wealth pools, who own the banks. The utter failure of this scheme was predictable, and the repercussions on the country stock markets that have been affected are an appropriate market response. Likewise, both the EU and Japan currencies have suffered greatly in this race to the bottom.

Fast forward to a world in which the major reserve currency in the world today, the U.S. dollar, is positioned through Fed policy to have a negative carry interest rate, to all the holders of dollars throughout the world. Chaos is the predictable outcome. It is the equivalent of both a default on the U.S. debt, and a tax on all foreign capital which is funding the U.S. debt. Cue up a major flight to hard assets, like gold, and anything else bolted to the ground, and a major run on the U.S. debt. This issue is far more critical to the potential economic outcome of such a decision than the effect on U.S. savers who are hopelessly tied to the policy decisions of their brain dead elected, and appointed in the case of the Fed, leaders. The problem is, the U.S. people alone do not have the $6.1T in funds needed to fill the gap left if the foreigners leave town. And if they do, they probably don't want to give $100 to the government to get $99 back, or even less, every year.

If you want less of something, tax it. A NIRP direction in the U.S. is a stepping stone to an outright depression, not only in the U.S., but world-wide. The upcoming election is critical to making sure this path is not chosen by the U.S., assuming Obama doesn't make this his final nail in the coffin for the U.S. economy as he departs silently out of town.

Thursday, February 4, 2016

Can Cheap Oil Trigger a U.S. Recession?

Historically, major drops in oil do not equate to causing a U.S. recession. However, cheap oil can tear down an over valued stock market, which is what is happening right now.

For recent evidence, look at Black Monday in October 1987.  Twenty-one (21) months after the Saudis started a similar oil pricing strategy as the market faces today, where the Saudis raise production to maintain market share, the U.S. stock market plummeted 40%. But there was no U.S. recession.

Fast forward to 1998, oil prices plummet 55% over a two year period (1997-1998) as emerging markets faced a currency crisis. Russia defaulted; however, there was no U.S. recession. The stock market swooned in sympathy intra-year by over 20%, with the peak of the decline happening 20 months after oil prices began to crater. We are now at month 18 of the time frame in which oil prices started their decent starting in August of 2014. I estimate that $20-$25 per barrel in oil would force a similar emerging market crisis today, and trigger a similar U.S. stock flash crash as experienced in 1998.