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CNB Weekly Economic Commentary: Nov 13

November 13, 2012

To: Everyone
From: Gregory S. MacKay, Senior Vice President & Chief Economist
Date: 11/09/12

I’ve been enjoying the peace and quiet around my house for the past several days… no annoying recorded phone messages… no annoying campaign ads. While I admire the scientific advances and approaches being made to measure voter direction, I am shocked at the amount of money being raised and spent on the election process, and find the intrusions into my home (particularly the negative ads) beginning to affect my voting preferences. Oh, well, just as I began to enjoy the relative tranquility of the post-election, the stock markets lurched downward like Disney’s Tower of Terror.

Some writers focused on a mantra of “no change”… same President… same division of power in the House and Senate… and concluded that the stock markets should remain stable. Many Democratic leaders touted the election as a mandate for higher taxes above the middle class. Republicans had little to offer, other than a spirit of possible compromise that was lacking for many years. Thus, the work on the “fiscal cliff” gets off on a rocky start, and stock prices got thumped. It’s much too early to offer any firm beliefs on the fiscal changes to come, but here’s my view at the moment:

1) The Social Security tax will increase by 2% across the board on January 1. Both parties ran up trial balloons on the issue, and found no substantial dissent from voters.

2) The remainder of the items included in the fiscal cliff are too complex, too unnerving, and too politically nightmarish to be dealt with before December 31. There should be some compromise made to temporarily extend some or all of the Bush tax cuts and to temporarily postpone some or all of the “automatic” spending cuts scheduled for January 1.

A worst case situation would be Congressional gridlock if Democrats tried to raise income taxes immediately with no give back. That could stall a process that desperately needs to begin. It looks like both Houses can point to an ongoing slow expansion of the economy to give themselves a little more maneuvering room. While both parties are talking “compromise”, the definition still seems to be “do what I want”. I’m hoping that both Houses heed the words of Chairman Bernanke and get some serious work done… before this expansion stalls. Longer term I’m hoping for enough compromise to see some very limited tax increases combined with some very careful budget shuffling that fosters GDP growth. While it’s easy to blame various government spending programs for the deficit, don’t forget that $7.5 trillion of the deficit has been an export/import imbalance since 1996.

Simply raising taxes and cutting spending just doesn’t work. May I offer Greece in particular and the rest of the EU as an example. I want to talk about the European situation, because it’s the second reason quoted for the stock market slide this week. This week, both European Central Bank (ECB) President Mario Draghi and the European Commission (executive body of the European Union [EU]) published GDP predictions for 2013 that are weaker than predictions of six months ago. Both bodies are predicting overall EU growth of much less than 1% for 2013, and Greece remains in play as the hopeless poster child of the slowing European economy. Greece is being squeezed again to cut spending and raise taxes in order to get more loans from the International Monetary Fund (IMF), the EU, and the ECB. Its citizens are taking to the streets again, and the world markets are shaky.

The problem in the EU has been often stated. Without an all-powerful central bank, nationalism trumps the greater good of the EU on a regular basis, slowing or even harming economic growth. The charter of the ECB only allows it to fight inflation, leaving silent any discussion of economic growth. Thus the ECB is much like a one-armed wallpaper hanger – someone with good intentions, but a faulty skill set. In the U.S., the Federal Reserve Bank has the ability to create money, thus stimulating economic growth. The ECB now has the power to buy the bonds of struggling countries (called Outright Monetary Transactions [OMT’s]), with the promise that the countries will submit to strict fiscal conditions and supervision. However, in its single minded crusade against inflation, the ECB then removes an equal amount of currency from the EU system – a process called “sterilization”. Thus the efforts of the ECB are limited to a bailout of sorts of its members, and is non-stimulative, as no increase in the money supply occurs.

Hence we have Greece being held to a doomsday path of lower spending and higher taxes with no monetary stimulation to reignite its economic engine. Greece is now in its fifth year of a recession, has unemployment above 25% (above 50% for 18-24 year olds), and its stock market has declined 80% since January 2008. That’s the absolute result of a “raise taxes, cut spending” program that does not pump fresh capital into an economy. Monetary stimulus, whether natural (discovery of oil, gas, gold, real estate boom, etc) or created (stimulus by the banking system) is an agent that speeds economic recovery. It’s not happening in Europe. Our Federal Reserve is ready to “hold the pedal to the metal”, guaranteeing it will continue to add stimulus to our economy until such time as job creation is deemed self sufficient. Two economies, two differing solutions. I like ours.

Stock prices are firming today after giving up a chunk of 2012 gains this week. Prices look a little oversold, but don’t forget that Wall Street infrastructure isn’t back to normal yet, either. At 12:11 p.m., for the week and year:

Dow Industrials 12865 -1.7% +5.3%
NASDAQ 2923 -2.0% +12.2%
S&P 500 1388 -1.8% +10.3%

There was a little buying in the 10 year range on Treasuries caused by the Euro concern. Munis continue to drift, with supply still an issue. 

  US Treasuries
Municipal Bonds
  11/9/12 11/2/12 11/9/12 11/2/12
2 year .25% .28% .32% .30%
5 year .75% .72% .62% .66%
10 year 1.63% 1.71% 1.63% 1.68%