Wall Street Roundup: Climb continues. Unreliable ratings.

Gold: Trading now at $1,741 per ounce, down 0.6% from Thursday. Dow Jones industrial average: Trading now at 11217.59, up 0.7% from Thursday.

Climb continues. Stocks continued Thursday's upward climb this morning thanks to some good data about retail sales.

Unreliable ratings. The Wall Street Journal took a look at how often credit ratings agencies have managed to predict that a country would default on its bonds -- the results are not impressive for the agencies.

S&P probe. The Securities and Exchange Commission is the latest government body to probe last week's downgrade of the U.S. credit rating by Standard & Poor's -- this time they are looking at potential insider trading issues, the Financial Times reports.

Thoughts of a contrarian. Want to hear the arguments of someone who is shorting all the investments that have been going up in recent weeks, including gold, the Swiss franc and the volatility index? Look here.

--Nathaniel Popper

Credit: Getty Images/Stan Honda.

 

Consumer Confidential: Sentiment down, sales up, cars recalled

Here's your feets-don't-fail-me-now Friday roundup of consumer news from around the Web:

--Consumers are still feeling blue about the economy, but that apparently isn't enough to stop us from going shopping. Consumer sentiment worsened sharply in early August, falling to the lowest level since 1980, according to a Thomson Reuters/University of Michigan survey. High unemployment, stagnant wages and the ongoing debate over raising the U.S. government debt ceiling spooked consumers, who were polled before the U.S.' credit rating was downgraded last Friday. Two-thirds of all consumers reported that they believed the economy had recently worsened, and just one in five anticipated any gains during the year ahead. Yet a separate report from the U.S. Commerce Department showed that retail sales in July posted their biggest gain in months, tempering fears that the economy might be slipping back into recession. Nothing like a little retail therapy to chase away the blues.

--Heads up: General Motors is recalling some 2012 Chevrolet Impala and Buick LaCrosse models to fix safety problems. GM says 11,915 Impalas are being recalled in the U.S. and Canada because a power steering fluid hose gets too close to the catalytic converter. The hose can melt, and fluid can leak and start a fire. The company says it knows of no complaints or injuries. The large sedans were built from April 19 through July 29. GM also is recalling 4,293 LaCrosse sedans in the U.S. and Canada to fix software that runs a computer that controls the brakes. The software may not detect a malfunctioning sensor. If the sensor fails, it could change the way the car handles and cause a crash. GM says no crashes have been reported

-- David Lazarus

 

Consumer confidence at lowest point since 1980, report says

Consumer confidence in August took a swan dive to its lowest level in three decades.

Even as they pushed retail sales up 0.5%, Americans were the most pessimistic they’ve been since May 1980, according to a preliminary index of sentiment created by Thomson Reuters and the University of Michigan. 

The index slumped to 54.9 from 63.7 in July, as consumers fearfully took in seesawing stocks, high unemployment and politicians bickering over the country’s debt.

Perhaps sensing the queasy mood, U.S. companies kept tight watch over their inventories, increasing stockpiles just 0.3% rather than overload shelves, according to the Commerce Department.

Consumers’ perception of the financial environment and the wisdom of big-ticket purchases, measured by an index of current conditions, slipped to 69.3 from 75.8. They’re even less excited about the future, pushing an index of expectations six months down the road to 45.7 from 56.

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-- Tiffany Hsu

Photo: Shoppers arrive for a going-out-of-business sale at a Santa Monica boutique. Credit: Spencer Weiner / Los Angeles Times

More QE? Give us a break

A head of steam is building up for more quantitative easing in the US and the UK, though apparently not for the eurozone, which is the one place which really needs it. Here’s the case against more QE, which I was going to put on BBC Radio 4’s Today programme on Friday morning, except that we were diverted by the short selling issue.

I’d never say there are no circumstances in which another dose of it would be needed, but the only real justification is the sort of extreme deleveraging, deflationary threat that we saw post the Lehman Brothers collapse in the autumn of 2008. Things look very serious in the eurozone, but we have not yet had that extreme event. Market closure to a major sovereign such as Italy, with no mechanism in place to prevent default, would certainly be the trigger I’m talking about. But as I say, we are not there yet.

In the meantime, it is very hard to argue that in Britain at least with inflation heading towards 5pc and real interest rates deep in negative territory that anything would be gained from further QE. Bond yields are already as low as low can be. If the purpose of QE, by which is meant the creation of new money by central banks to purchase government bonds or other assets, is to depress bond yields, thereby forcing higher risk investment and spending, well, how much lower can they go? They are already at their lowest level in more than 100 years. There’s nothing to be gained by pushing them even lower.

It’s true that money growth in the UK economy is much lower than is consistent with reasonable growth, but it’s been at that level for a year now and it has not driven us back into recession. Anecdotal evidence is that velocity of money, which is the key indicator of economic activity, has fallen quite steeply recently, but let’s see it in the figures before spraying the economy with newly printed money again. In the US, meanwhile, money growth has picked up quite sharply, pointing to significant recovery a year from now. That doesn’t mean it is going to happen, but it is an encouraging sign.

About the only other piece of good news around at the moment is that commodity and fuel prices are falling again, taking the pressure off inflation and putting a little bit of money back in people’s pockets. Do we really want to stoke these prices up again for some kind of short lived and probably quite marginal boost to growth.

QE is like a drug. The first dose was quite potent, but the more frequently it is used, the less effective it becomes and the more the addict demands. QE2 in the US, launched in response to a soft patch in the recovery similar to the one we are going through today, was almost certainly a mistake. Sure enough, it boosted asset and commodity prices, but it did very little for ordinary people. To the contrary, by raising food and fuel prices, it only made them poorer.

To maintain negative real interest rates over such a sustained period is unfair on savers and therefore morally and socially questionable. It certainly softens the deleveraging process, but only by punishing those who have been prudent with their money. Enough is enough. There’s no case for further QE right now. I’ll tell you when that changes.

Retail sales send stocks up again

Stock markets rose again this morning after the release of surprisingly good news from the retail industry. 

The Dow Jones industrial average rose more than 100 points in early trading after the Commerce Department reported that retail sales grew 0.5% in July, the biggest bump in four months. The data suggested that consumer spending, one of the main drivers of the economy, may not be slowing down as much as feared.

The news gave support to economists who have said that fears of a new recession may be overblown.

"The rise in retail sales values in July supports our view that there will be at least some rebound in economic growth in the third quarter and that another recession will, in all likelihood, be avoided," Paul Dales, with Capital Economics, wrote to clients Friday morning.

The early gains were tempered later in the morning when the University of Michigan announced that its index of consumer confidence fell more than expected, from 64.7 in July to 54.9 in August.

The Dow was recently trading up 104.44 points, or 0.9%, to 11,247,75.

Markets in Europe are trading up even more sharply, encouraged partly by a ban on short-selling that was imposed last night in several European countries. Leading indexes were recently up 2.7% in France and 2.3% in England.

The market rally built on Thursday's 424-point surge in the Dow, and helped chip away at some of the losses the markets have sustained over the last two weeks.

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U.S. trade deficit jumps

Gas prices expected to fall

Whiplash for stocks may be the new norm

--Nathaniel Popper

Photo: Trader on the floor of the New York Stock Exchange Friday morning. Credit: Reuters

Banning short-selling is shooting the messenger. But can Europe’s banks handle the truth?

Stock market prices are displayed at the Athens Stock Exchange (Photo: Bloomberg)

A number of countries have introduced short-selling restrictions today. This is a classic tactic in bear markets. Back in 2002, I wrote a paper analysing in some detail the economic role of short-selling and the impact of various proposed regulatory restrictions upon it.  It’s worth observing the following points, in the light of today’s events:

1. Companies and countries complain about “damaging speculators” when they are selling, but not about speculative buying (which is just as common). Yet in economic terms, going “long” – e.g. having positive holdings of shares – is just as much a form of speculation as going “short” – e.g. having negative holdings (i.e. has sold shares one does not yet own). Indeed, some forms of short-term speculative “long” positions can be thought of as being “short” in cash.

2. Outside financial circles, in real economy businesses, short-selling is commonplace and uncontroversial. If a plastic resin manufacturer takes a pre-paid order to supply a plastic bottle manufacturer with resin in a month’s time, it has gone “short” that much plastic. Is that wicked speculation?

3. In financial markets, speculators make money by being better informed than other participants, so they see opportunities to make money when other participants catch up and prices move. It is highly desirable that market players should be able to make money by analysing data so as to get ahead of the Market. Curtailing that has the effect of making market prices less reflective of how the world really is – they become less “efficient”, in the jargon. Virtually no one is going to analyse data if there is no money to be made by doing so, because proper analysis is difficult and expensive.

4. Short-sellers make money by identifying situations in which the world is worse than the Market thinks. They expose cases where managements or governments are disorganised or lying or have themselves been deceived. Given the events of the past few years, it would seem very foolish to try to deter people from properly analysing companies or governments to see whether they might actually be less robust than they claim. Surely we want more such analysis, not less!

5. In developed economy markets, volumes are vastly beyond the level at which speculators can move prices “artificially” by the volumes of their trades. Price movements reflect changes in opinions. There is no such thing as speculative “attack”, in that sense.

6. However, once we understand that analysis is costly, and market players differ in their analytical skills and specialisms, it is inevitable that many market players will not carry out their own analysis, but, instead, follow the trades of those they consider better informed.

7. Because markets inevitably have this follower-leader structure, that means that those that are better informed will be able to move prices sometimes, even if they do not actually know anything – they can create “uninformative volatility”. That is to say, it is an inevitable feature of financial markets that not all price movements reflect genuine new information or new analysis. (Note: my claim here is completely orthodox – this is the standard theory, not some “irrationality” claim or rejection of efficient markets theory (in its standard “weak” form). Real nerds might look at this classic paper, in which the orthodox position is set out.)

8. The more regularly speculators are moving markets without actually knowing anything better, the less they will move markets, and vice versa.

9.Even though better-informed speculators do generate uninformative volatility, their net effect is to increase the informedness of prices. That is to say, markets are (much) more efficient when speculation is permitted than when it is forbidden.

10. There is, however, a caveat to all this. The flawed way in which bank prudential regulation works creates a discontinuity – i.e. sudden change. If bank capital, as measured by regulators in particular ways that include consideration of market share prices, falls below the regulatory threshold, regulators might respond by intervening in the bank - perhaps by shutting it down or even by nationalising it. That could cause the bank’s shares to lose further value. So once a bank’s capital comes close to the threshold, the bank becomes vulnerable to short-sellers that might often actually be better informed moving prices, just enough, to drive it below regulatory thresholds, triggering intervention and a collapse in its share prices. These short-sellers can then clean up. This can make short-selling under these circumstances close to self-fulfilling – the short-sellers can exploit the flaw in the regulation.

Personally, I would recommend improving the prudential regulation to correct the flaw. But it is understandable that regulators unwilling to engage in this wider task prefer instead to adopt the short-term expedient of banning short-selling once bank share prices get close to the danger level. Doing so can even create a quick bounce, as other short-sellers are “squeezed” (i.e. have to buy out of their short positions quickly, bidding up prices meaning they make big losses).

Overall, then, short-selling (and other forms of speculation) are extremely valuable. They improve market efficiency (as well as liquidity – for reasons I don’t have space to explore here) and they expose errors made by the management of companies and by governments, early, when those companies and governments might still have a chance to rectify things. Banning short-selling is a classic case of shooting the messenger because one does not like the truth he tells. But unfortunately, bank prudential regulation is flawed and a number of European banks are at risk – as Col Jessep might have said, were he a financial regulator, “You can’t handle the truth“.

Do Congress and the White House Deserve an AA+ Rating?

Uwe E. Reinhardt is an economics professor at Princeton.

There now appears to be general agreement that the downgrade issued a week ago by Standard & Poor’s on the “Political Risks and Rising Debt Burden” of long-term United States debt was not a statement on the probability of default on Treasury bonds at all. Instead, it appears to have been intended as a reminder that something has gone seriously wrong with the style of governance put in place by the Founding Fathers.

Today’s Economist

Perspectives from expert contributors.

Whether the current style of federal governance deserves the second highest grade S.&P. assigns (AA+) can, of course, be debated. I would be more inclined toward a plain B rating, that is, the governance equivalent of a junk bond.

Perspectives from expert contributors.

Be that as it may, one manifestation of the decay in the federal style of governance has been the discovery that American voters can be pleased by providing them with a growing array of government services and financial transfers and by underwriting these with deferred taxes — that is, current deficits. The deferred taxes are to be paid off by generations not yet born or still too young to vote.

In the words of Doug Elmendorf, current director of the Congressional Budget Office, in a presentation last year, “The United States faces a fundamental disconnect between the services that people expect the government to provide, particularly the benefits for older Americans, and the tax revenues that people are willing to send to the government to finance those services.”

To make politicians comfortable with this approach to governance, a theory was needed that “deficits don’t matter.” That theory reportedly was proposed by Vice President Dick Cheney to Paul O’Neill, then Treasury secretary, who in late 2002 had protested the Bush administration’s evident addiction to debt. A fascinating account of the debate surrounding this proposition can be found in Jonathan Weisman’s “Reagan Policies Gave Green Light to Red Ink” in The Washington Post, written in 2004.

The economics profession did not entirely endorse Mr. Cheney’s theory; neither, however, did it line up against it. Instead, as usual, it had a nice intra-professional, two-handed debate on the issue, accompanied by learned papers. Then, as now, the pronouncements of macroeconomists add up to confusion.

The footprints of this new style of federal governance can be seen in the following chart, which is featured in updated form year after year in the Congressional Budget Office’s well-written long-term budget outlook.

It is instructive to reflect on this chart, along with the two charts shown below. The data for those charts can be found in Table B-79 of the Economic Report of the President, February 2011.

The first shows the gross federal debt as a percentage of gross domestic product from 1976 to 2011. It is the most inclusive measure of the Treasury’s obligations, which ultimately are, of course, the obligations of the American taxpayer. The colors of the bars indicate presidential terms.

The gross federal debt includes debt owed to other government accounts — for example, the Social Security Trust Fund, the Medicare Trust Fund and other retirement or government trust funds. Cash surpluses accumulated in these funds are invested in Treasury securities.

Of the total gross federal debt of $13.6 trillion in 2010, $4.6 trillion was owed by the Treasury to these government trust funds and only $9 trillion to the public, which included international investors (47 percent), domestic private investors (36 percent), the Federal Reserve (9 percent) and state and local governments (8 percent).

The next chart shows how the fraction of publicly held debt as a percentage of total gross federal debt has fluctuated over time. Note again that purchases by the Federal Reserve of Treasury debt, of which there have been many in the past few years, are counted as debt held by the public rather than intra-governmental debt.

Readers of this blog will draw their own inferences from these three charts. My own is that recklessness in United States fiscal policy is not a recent phenomenon, especially if one considers the devastating effect that the recession, starting in 2007-8, has had on federal tax revenues, now at a historical low as a percent of G.D.P., and on federal spending, now at a historical high. In fact, the federal deficit for 2009 had been projected by the Congressional Budget Office at $1.2 trillion even before the current administration moved into the White House.

The problem is much less the current budget deficits, which can be explained by the current recession, but that budget balance does not seem to be in sight long after the recession, we hope, is over.

It is that problem that the White House and the Congress must solve. We must hope that care for the nation’s future — evidently now taking a holiday — will return someday soon to their minds and souls. Perhaps then they will merit an AA+ rating.