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A Time to Give Thanks

(November 25, 2010)

Note: Due to the U.S. Thanksgiving Holiday, there would be no commentary this weekend.  Thank you for all your understanding!

Dear Subscribers and Readers,

For my American subscribers and for those that celebrate Thanksgiving, I would like to wish everyone a happy and fulfilling Thanksgiving!  In times of uncertainty, having a “support group” is imperative—we all need one no matter how old we are and how much money we have.  I understand that many of us have complex personalities and work in fields that our families and relatives may never understand—but they are usually the first ones to help or listen to our problems (or us ranting why the Euro remains stubbornly high).  Today is the time to give thanks to those who have been there for us thick and thin!

Whilst driving back from Hollywood to West LA yesterday, I stopped by at a bakery in Beverly Hills for some coffee and croissants—and to catch up on my reading (quantum mechanics and string theory are my current favorite topics).  The Thanksgiving atmosphere and the views (palm trees alongside the main thoroughfare) were amazing—and then, I realized that not many people in this world could ever experience a cup of coffee in a nice place in the US, France or Italy (sorry if I missed anyone here).  It's an obvious observation, but one that we don't realize on a daily basis.  Despite the European sovereign debt turmoil (and the painful fiscal cuts endured by the Irish), the current Korean military crisis, stubbornly high unemployment, and general uncertainty, I am thankful that we live in truly the most enlightened and wealthiest time in human history.  In much of the world, rulers no longer hold absolute power.  Scientists (Giordano Bruno comes to mind) on the cutting edge—e.g. those researching string theory and advocating the concept of multiple dimensions and alternative universes—are no longer burned at the stake.  They are not just tolerated, but celebrated.  The scientific revolution and the emergence of Isaac Newton in the late 17th century as a driving force in physics finally gave us a concrete understanding of our 3-D world—and at the same time, propelled many of us from superstitions and religious dogma.  Interestingly, today's theoretical physics may potentially drive us back “full circle,” as more physicists study string theory and other concepts that advance the theory of things such as an 11-dimension (including temporal) universe, multiverses, the possibility of teleportation, etc.  Culturally, we are not only more tolerant of different cultures, but embracing of them (especially here in California).

Closer to home, the contentious $600 billion “QE2” policy from the Federal Reserve has largely been greeted by financial markets with a whimper, as the U.S. Dollar has gotten stronger (and inflation remained tame) over the last several weeks.  Subscribers should note that the Fed's QE2 policy is designed to be reactionary and adjustable as time goes on—meaning that the Fed's asset purchases could be scaled back at any time.  With the ECRI Weekly Leading Index continuing to improve, and with Asian central banks having largely ceased their tightening policies (we believe the People's Bank of China will cease to tighten sooner rather than later, as Chinese M1 growth peaked nearly 9 months ago), there's a good chance that global GDP grown will be respectable in 2011.  Assuming the European sovereign debt crisis doesn't blow up into a full-scale crisis, and that U.S. banks start lending again, it is likely that the Fed will scale back its QE2 policy before it purchases an additional $600 billion in Treasuries.

Of course—should U.S. banking lending remain dysfunctional, the Fed may ultimately need to expand its asset purchases to include those of riskier securities, such as those of AAA-rated municipal bonds, corporate bonds, or asset-backed securities.  Following is a monthly chart showing the state of U.S. bank lending—i.e. the year-over-year change in loans and leases by held by U.S. commercial banks for the period January 1949 to November 2010 (updated to November 10, 2010):

While bank lending has steadied in the last 12 months, subscribers should note that the plunge in banking lending in 2009 is unprecedented.  One would need to go back to the Great Depression to see similar stats (when one-third of all U.S. banks failed).  Note that the dramatic decline in bank lending came after the disintegration of the “shadow banking system.”  If the Federal Reserve and the U.S. Treasury had not provided support under its various liquidity facilities and its quantitative easing policies, there is no doubt that the U.S. and much of the developed world would have been in a second Great Depression.  Note that while bank lending growth has risen back to the zero line, we are not out of the woods yet.  In fact, the absolute amount of bank loans and leases outstanding (seasonally adjusted) has actually declined by $60 billion (to $6.78 trillion) from the end of August to November 10, 2010.  The Thanksgiving and Christmas Holidays are usually a slow time for bank lending—so we would not get a better picture of the state of U.S. bank lending until the end of January, at the earliest.

Signing off,

Henry To, CFA

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