Tuesday, April 01, 2008

Financial Journalist's April Fool's Joke

Financial journalists pulled a real April fool's joke on the markets today when they claimed that the ISM Manufacturing index indicated a stronger U.S. manufacturing sector. However, first of all, even the headline index remained at 48.6 below the 50 threshold between contraction and expansion, and the rise from 48.3 wasn't exactly impressive.

Secondly, and even more importantly, if you look at the details, they show a stagflationary and not expansionary tendencies in the U.S. economy. The key new orders and production sub-indexes both fell significantly and both indicate contraction. One thing that however rose significantly, and indicates very rapid increases was the prices paid subindex. It rose from 75.5 to 83.5, which is the highest since October 2005. This again confirms rising inflationary tendencies in the U.S. economy even as real output contracts.


Anonymous Anonymous said...

Stefan, this is off topic, but have you covered the issue of derivatives? Until recently, I was certain that we were heading for deep economic trouble. Now that I've looked into derivatives a bit, I am frankly terrified. $500 trillion in notional value. Yes, I know that the actual value isn't that high. But there's a reason Buffet called them 'financial weapons of mass destruction'. They're probably the main reason for the government's Bear Stearns 'bailout' ($13 trillion in derivatives exposure, now added to JPMorgan's even bigger exposure). It's bad enough that all the other fundamentals in the US are horrible, but will derivatives completely destroy us?

5:51 AM  
Blogger stefankarlsson said...

The $500 trillion number is a vast exaggeration, as many holders of credit derivatives cover their risks by issuing new derivatives. If you buy $1 trillion of them and cover $600 billion of it with new ones, this gives you a net exposure of $400 billion, yet the notional value is $1.6 trillion.

Even more importantly, the derivatives are simply a transfer of risk from one party to another. No risk will be created by them that didn't already exist. The real problem lies in the dodgy debt upon which they are issued. If that explodes, the holder of the derivatives will lose. But if the derivates hadn't existed the primary lender would have been the one that lost the money (although arguably, the existence of these derivatives has likely emboldened some primary lenders to be more reckless, as they know they can transfer the risk to some clueless Wall Street investor).

10:54 AM  
Anonymous Anonymous said...

Yes, but the problem is counter party risk. This means that none of the Wall St. banks, with their stupendous derivative exposure, will be allowed to go under, even if they are all technically insolvent (which is an understatement). Will the Fed nationalize the entire banking system, the same way as in Scandinavia in the early 90s? Ambrose Evans-Pritchard at the Telegraph thinks that's a possiblity.

2:57 PM  

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