What is wrong with the U.S. economy can be easily surmised from reading the opening paragraphs in this story from the Associated Press, however, to most, this merely passes as conventional wisdom, wisdom that few realize is often wrong.
Stocks are shaking off a two-week slump after a report on retail sales wasn’t as bad as economists had predicted.
The Dow Jones industrial average, the Standard & Poor’s 500 index and the Nasdaq composite index are all on track to have their best day so far in June.
The government said Tuesday that retail sales edged down 0.2 percent last month, the first decline in nearly a year. That was slightly better than analysts were expecting. Americans bought fewer cars during the month, but the decline reflected temporary supply chain disruptions caused by the earthquake and tsunami disaster in Japan. Excluding weak car sales, retail sales rose 0.3 percent.
“The good news is the consumer is hanging in there,” said Rob Lutts, president and chief investment officer of Cabot Money Management.
At some point in the future, historians will marvel at how ordinary Americans watched the stock market go up and down – cheering its rise along with the mainstream financial media and lamenting its fall – in the mistaken belief that their economic well-being was somehow inextricably tied to it … well, it’s not.
Another mistaken belief these days is that, somehow, the over-leveraged U.S. consumer is still the main growth engine for the U.S. economy simply because, during the credit orgy of the last few decades, personal consumption rose to account for 70 percent of the economy.
During that same time, bank shares grew to record levels as a share of total stock market capitalization and, even after the events of the last few years, for some reason, most people think that we’re supposed to just pick up where we left off in 2008.
The era of economic growth fueled by expanding credit and consumer spending is over, yet so few seem to realize it (though another really good asset bubble could forestall a broader realization of this yet again).
Clearly, there are intense efforts underway to reduce the requirement for banks to carry more capital, and the FASB has now effectively abandoned even modified versions of mark-to-market, which could have included reasonable approaches such as 3-year averaging. From our perspective, the problem in the economy is not that banks are over-regulated, but that they are quietly holding a large amount of non-performing assets, and remain unlikely to expand their risk portfolio further. Either we subsidize these assets for years through interest rate spreads that are hostile to depositors, small savers and the elderly, or we initiate approaches to allow the existing debts – particularly mortgages – to be reasonably restructured. Policy makers seem to be on a fairly strong course in favor of the first option – essentially allowing a zombie banking system like Japan’s. It’s a choice, but it comes with the consequence of anemic economic prospects.
THE notional amount of outstanding over-the-counter (OTC) derivatives stood at $601 trillion in December 2010, up from $583 trillion six months earlier, according to the Bank for International Settlements (BIS). That is marginally below December 2009’s figure of $603 trillion, but far lower than the record $684 trillion outstanding in June 2008. Interest-rate contracts, which make up the bulk of the market, reached $465 trillion in December 2010, exceeding their pre-financial-crisis level. While notional amounts are one measure of market size, the BIS says that gross market values, which measure the cost of replacing all existing contracts, more accurately assess the amounts that are actually at risk. The gross market values fell by 13% in the six months to December 2010, to $24.5 trillion….
This unpleasant round trip and Bernanke’s acute appreciation of central banking mistakes of the past are why the Fed will risk another round of political mudslinging to try to prop up the economy again. No one, after all, wants to be the guy who sat idly by as the economy slips into recession in a 
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