Reducing Spending Not in the Feds' Plans

Yesterday, the rally on Wall Street slowed down a bit. The Dow rose 12 points.

Gold had a bad day – down $25. We had guessed that gold would be going down. But it is still too early to detect a real trend. For the moment, the financial markets and the economy are going in different directions. The stock market is signaling a boom. The economy and gold are signaling a bust. We’ll have to wait and see which direction prevails…

In the meantime, had a seer come to us a couple of years ago with a tale of back-to-back US deficits totaling $3 trillion over two years, his credibility would have been in doubt. Had he also foreseen US Treasury debt at record low yields – at the same time – he would have had no credibility at all.

One of the surest things we thought we thought we knew back then was that the government could not simultaneously run huge deficits and borrow cheaply. It was one or the other; that was all there was to it.

It turns out that Dick Cheney was right all along. Deficits don’t matter. At least, they don’t matter until they do matter.

And they don’t matter right now. Bloomberg:

For all the criticism of record budget deficits, President Barack Obama can take comfort knowing that for the first time in half a century, government bond yields are declining during an economic expansion and Treasury Secretary Timothy F. Geithner is selling two-year notes with the lowest interest rates ever.

The combination of record-low yields on two-year notes, 10-year rates below 3 percent and a deficit projected to surpass $1.4 trillion for a second consecutive year is a signal that the bond market is less concerned with government spending than with getting the economy back on track.

The last time yields were this low as the economy expanded was in 1955, when Ray Kroc founded McDonald’s Corp. and Bill Haley’s ‘Rock Around The Clock’ topped the music charts. The 10-year note yield averaged 2.65 percent that year, according to monthly data compiled by the Fed, while the economy grew 6.4 percent, consumer prices for the year declined 0.4 percent and the government ran a fourth consecutive budget deficit.

Why have yields fallen so much? Because the economy is not recovering. Investors look for a safe place to put their money. Bloomberg continues:

“Expectations of growth over the next couple of years have indeed come down,” Alan Blinder, former Fed vice chairman, and economics professor at Princeton University, said in a telephone interview. “There is still plenty of fear out there in the world financial markets, which has investors all over the world scurrying into Treasuries, even though they get paid very little.”

We opined – without doing any research on the subject – that Harley Davidson had probably peaked out. Only old men ride Harleys. The young prefer a different style of bike. We guessed that it was time to sell the stock.

Naturally, the company’s earnings have soared since then. But not because of increased sales. Instead, like the rest of corporate America, Harley is learning to earn more money without selling more merchandise.

The New York Times has the story:

Motorcycle sales are falling in 2010, as they have for each of the last three years. The company does not expect a turnaround anytime soon.

But despite that drought, Harley’s profits are rising – soaring, in fact. Last week, Harley reported a $71 million profit in the second quarter, more than triple what it earned a year ago.

This seeming contradiction – falling sales and rising profits – is one reason the mood on Wall Street is so much more buoyant than in households, where pessimism runs deep and joblessness shows few signs of easing.

Many companies are focusing on cost-cutting to keep profits growing, but the benefits are mostly going to shareholders instead of the broader economy, as management conserves cash rather than bolstering hiring and production. Harley, for example, has announced plans to cut 1,400 to 1,600 more jobs by the end of next year. That is on top of 2,000 job cuts last year – more than a fifth of its work force.

Everyone is doing the right thing. Households are reducing spending. Business is reducing its costs. GDP growth is falling and investors are taking shelter in Treasury debt.

So what’s the problem? Well, the feds can’t bear to see people doing the right thing. They want them to do the wrong thing – that is, they want them to spend money they don’t have on things they don’t need. Why? Because it makes the economy look good…and makes them look like they know what they are doing.

It’s all hokum and folderol, dear reader…all hokum and folderol…

Bill Bonner

for The Daily Reckoning

The Daily Reckoning