The Daily Reckoning
We’re heading for the hills…really!
Last week, stocks went up. Stocks went down. Not much was proved one way or another. The week ended in a draw, as near as we can tell.
But we think we are making progress in understanding what is going on. The private sector is de-leveraging. Now, it’s the public sector doing the heavy lifting. It is leveraging everything it can.
Leverage in the private sector led to the banking crisis/bear market of 2007-2009. Debt always leads to trouble. Next up: a crisis in the public sector.
But wait…hold on…not so fast…we haven’t reached the end of the private sector crisis yet! Bank lending is still falling. House prices are still falling. Unemployment is still falling. Soon, stock prices will be falling again too…
First, let’s see what’s in the headlines. Last week there was a lot of press about the pay czar and his efforts to limit compensation in the companies that the feds bailed out. The public and the news media love this sort of thing. It’s a battle between the greedy rich and the public interest, or so they believe. The public hates bankers. But they don’t want to see just pay capping; they want to see knee-capping. We’d like to see it too. Or maybe public flogging. Or at least a lapidation or two.
But our true sympathies are with the greedy CEOs. After all, they stole the money fair and square. They should be allowed to keep it. The feds wanted to leverage up the financial sector by giving money to the banks.
What’d they expect? The bankers took it.
Yes, the financiers are paid outrageous amounts of money – far beyond anything they are worth. In fact, if you studied it carefully, you’d probably discover that their net contribution to the betterment of mankind is now negative.
The bankers are betting that the money they were given by the feds will be worth less next year than it is this year. So they exchange it for everything and anything, confident that when it comes time to pay it back it will be even easier to come by than it is now.
So far the bet has gone their way. Copper has doubled. Gold is up 20%. Stocks markets all over the world are up 60%. Foreign currencies, too, have beaten the dollar.
Will the wager against the dollar continue to pay off? Well, that’s the big question. If so, you should stay in stocks, gold and commodities. If not, you should move to cash.
But it hardly matters to the gamblers. They’re playing with someone else’s money! If the bets go well, they pay themselves huge bonuses. If they go badly…well…hey…gimme a bailout!
In the long run, bets against the dollar are almost sure to turn out okay. All paper currencies go to zero, eventually. But in the short run, who knows? The whole world is betting against the greenback. With such a massive short position against the buck, it would be just like Mr. Market – aka Mr. Mischief- maker — to send the dollar up.
But you can’t blame the bankers. They’re performing a very valuable service. They are helping to separate fools from their money. Too bad we taxpayers are the fools…
Among all the whiners and kvetchers about bankers’ huge bonuses hardly a single one draws the obvious conclusion:
That them that deserve to go bust should be allowed to do so.
“I remain of the view,” writes Martin Wolf, a bit pompously, in The Financial Times, “that the only thing worse than rescuing the system would have been not rescuing it.”
He’s welcome to his opinions. And if he used his own money to bail out the bankers we would have no objection. In that case, it would just be a futile and foolish act. Instead, he insists upon using our money…which raises the charge from stupidity to larceny.
Another message that came through last week was that the real economy is not improving. Good news came in from several quarters. But the news that really counts – housing prices and jobs – was bad.
“It’s all bad. That’s all we know,” said John Stepek, editor of MoneyWeek. “People ask if we’re going to have inflation or deflation. The bulls think we’re going to have inflation. The bears bet on deflation. But I’m not sure it matters. We’re probably going to have both.
“The point is, whichever we have, it’s going to be the bad sort. Neither inflation nor deflation is necessarily bad. Prices have to adjust. That’s how the market conveys its signals. When prices rise, it tells producers to get busy and increase output. When prices fall, it tells them to lay off. In the natural order of things prices usually fall. Or, they should fall. This is ‘good’ deflation. It just means that producers are becoming more efficient, as they should. There’s good inflation too – when prices rise due to increased real demand. When people earn more money, they can buy more things; prices rise.
“But what we’re going to see is bad. Bad inflation. And bad deflation. It is the result of monetary problems and mismanagement. And it is going to send all the wrong signals and inevitably make things worse. First, the deflation is bad because it is result of a massive de-leveraging accompanied by a write-down of debt and assets. It’s a depression. Or a major recession. Or a ‘great contraction.’ Call it what you will. It’s a deflation in which prices fall…and it’s not going to be any fun.
“Then, there’s most likely going to be bad inflation too – caused by the central banks printing too much money. This is bad inflation because it is just an increase in the quantity of paper money, not an increase in real demand.
“We don’t know exactly what is coming. But whatever it is, it will be bad.”
Another big item in last week’s financial press was the “Cash for Houses” scheme. The feds give new house buyers an $8,000 tax credit. But since not all new buyers buy because of the credit, the actual cost to the government per additional new house purchased is much higher than 8 grand. For each additional house purchased because the credit taxpayers are paying as much as a quarter of the entire cost of the house.
And now there is a proposal to extend and broaden the credit. Soon it may be “Cash for Everything.”
This sounds crazy, but there are a lot of economists who think more stimulus is necessary. Nobel prize winner Paul Krugman, for example. And Richard Koo, mentioned here last week. They’ve seen what happened in Japan. And they see that the real economy is not recovering as they hoped it would. Now, they warn that America might have a “Lost Decade” if it doesn’t continue to stimulate the economy.
How long must it continue bailing out and stimulating? Until consumers have finished de-leveraging, they say. How long will that take? Maybe another 5 years, by our calculation…maybe much longer.
But wait…the whole problem is too much debt, right?
But the only way the government can stimulate is by going further into debt, right?
And isn’t the budget deficit already at $1.6 trillion…or 11% of GDP…the most it has been since WWII?
Well, then where’s the benefit? Won’t the public sector have to de-leverage too?
How does the public sector deleverage?
Two possible ways – honestly…and dishonestly. It can pay down its debts to a level at which they can be carried even if interest rates go up sharply. They did it after the War Between the States…after WWII…and even during the Clinton years. Believe it or not, when the Congressional Budget Office looked ahead in 2001, it saw a budget SURPLUS for 2008 of more than $600 billion. Surpluses had been coming in for years during the Clinton administration. They thought it would keep going like that. Instead, 2008 saw a DEFICIT of nearly $500 billion.
The higher the debt and deficits go the harder it is to pay them down honestly. Eventually, the feds reach the point of no return…like a guy who’s so deep in debt he can’t possibly work his way out. Then, you get another crisis…either in the form of default…or (hyper) inflation…or both.
The Daily Reckoning
The Daily Reckoning