Britannia Radio

The Daily Reckoning U.S. Edition

Home . Archives . Unsubscribe

The Daily Reckoning | Thursday, September 23, 2010 The Federal Reserve's ongoing battle to destroy the dollar, Measure for measure, Emerging Markets pack one helluva punch, Plus, Bill Bonner on the paradox of growth, Basel III and the road to hell... Clouding the Issues with Financial Euphemisms The problem with "policy measures" and "quantitative easing" Eric Fry Reporting from Laguna Beach, California... The Federal Open Market Committee (FOMC) is worried. Very worried. It is worried that it is not destroying the dollar fast enough. "Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability," the FOMC declared Tuesday. "Inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate." In other words, as every Ivy-League-educated economist understands very well, the Fed must nourish inflation if it is to have any hope of reviving the economy. Possessing merely a bachelor's degree from UCLA, your California editor naively maintains his low-brow economic ideas. He still suspects - poor, brutish lad - that debasing the currency is an ill-advised means toward a dubious end. Rather than debasing the dollar to repel the natural forces of creative destruction, as Chairman Bernanke and his colleagues advocate, your editor suspects that the best means toward sustainable economic growth is to allow failing enterprises to fail, so that stronger enterprises may take their place. (And leave the poor greenback alone, please). But the Ivy League intelligentsia sees it differently. The intelligentsia embraces an agenda of mere expedience, dressed in the eloquent vernacular of financial euphemisms. To wit: "Money-printing" is now "quantitative easing," while "throwing spaghetti against the wall and seeing what sticks" is now a "policy measure." Harvard grad, Ben Bernanke, insists that the Federal Reserve's most important near-term mission is to combat deflationary pressures by any and all "policy measures" available. The mission, in other words, is to produce inflation. (We're not making this up). In the FOMC's own words, "The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate." Your California editor is from Missouri on this one. The US economy does not need more inflation; it needs less intervention, coddling and do-gooding by central bankers and legislators. The US economy needs to suffer whatever wounds it must suffer, so that it may heal and resume growing. There is no shortcut...and there will be no shortcut, no matter how many Treasury bonds the Fed buys, nor how many FOMC meetings it convenes. And by the looks of things, the US economy still has a bit of suffering left to do. Housing prices and sales volumes continue to fall, foreclosures continue to soar, unemployment refuses to drop and business spending refuses to rise. Instead, we Americans are, collectively, retreating into our foxholes and trying to fortify our personal finances. We are saving more and borrowing less. But at the same time, our government is going on an unprecedented borrowing and spending binge...which makes all of us poorer, no matter what we do. These conditions - private sector caution, household frugality and government profligacy - rarely produce national prosperity. Instead, some form of stagnation usually results. We should not be surprised, therefore, if the US economy continues to muddle along for a while...and maybe for a long while. As we pointed out in yesterday's edition of The Daily Reckoning, the US, like many of its peers in the Developed World, are laboring under the weight of soaring government indebtedness - both those that are quantifiable, like Treasury debt, and those that are non-quantifiable, like Social Security obligations. Meanwhile, many of the world's Emerging Market economies are enjoying a very different circumstance. Government finances are improving and capitalistic initiative is flourishing. Today, we'll take another look at the contrasts between the has-beens and the will-bes. The column below features lightly edited excerpts from your editor's presentation to last week's International Living Real Estate Forum in Las Vegas. The Daily Reckoning Presents Buy the Emerging Markets, Part II by Eric Fry What's wrong with this picture? This chart shows the comparative fiscal trends of the US and Brazil during the last decade. Back in 1999, the US was running a budget surplus and Brazil was running a deficit equal to about 9% of its GDP. Over the ensuing 11 years, those conditions flip-flopped. Brazil is now running a very slight deficit and the US is running a very large one. Brazil is representative of many Emerging Markets. If we broaden out our analysis, what we find is not just a relative improvement in government finances, but also a dramatic improvement in the private sector. Half of global GDP is now produced by what we call the Emerging Markets. Looking farther out, the IMF expects the Emerging Markets to produce more than 60% of the world's GDP growth over the next four years - or about five times the growth the G-7 countries will contribute. The IMF is not omniscient. It has been known to make a mistake from time to time. But its forecast is probably close to the target in this case. And yet, despite data like these, many investors - both professional and individual - carry massively "overweight" positions in US stocks. They just can't seem to break that bad habit. Why? Because US stocks are familiar! They are IBM and GE and McDonald's. The argument in favor of Emerging Markets is easy to embrace clinically, but not easy to implement emotionally. US stocks simply feel safer than Emerging Market stocks. In response to such anxieties, William Shakespeare's Measure for Measure provides an insightful counterpoint: "Our doubts are traitors, and make us lose the good we oft might win, by fearing to attempt." The time has come to cast aside our fears and to embrace the world as it actually is, not as we might like it to be. In the world as it actually is, for example, Emerging Market stocks are performing much better than Developed World stocks - both in absolute terms and in so- called "risk-adjusted" terms. Emerging Market stocks aren't just producing higher returns, they are producing these returns with very modest amounts of volatility. Over the last decade, for example, the MSCI Emerging Markets Index has tripled, while the S&P 500 Index has produced a loss...including dividends. More recently, if we compare these indices from the bear market lows of March 2009 to the present, we see that Emerging Market stocks are up more than 120%, compared to a gain of only 60% for the S&P 500. But despite producing double the return of the S&P during the last 18 months, the MSCI Emerging Markets Index was only slightly more volatile than the S&P 500. More intriguing is the comparison between Emerging Market stocks and the traditionally risky sectors of the US stock market - things like homebuilders and bank stocks. It used to be that these risky assets would all trade very closely with one another. Emerging Markets were considered risky, just like homebuilders and bank stocks. So they all went up and down together...especially down. That's not happening anymore. The risky stuff in the US is still plenty risky...and doing poorly. But the "risky" Emerging Markets are doing very well. This divergence has become particularly acute over the last four months. Since the first week of May, the MSCI Emerging Markets Index has advanced 10%. But over the same timeframe, the ISE Homebuilders Index is down 15% and the KBW Bank Index is down 20%. Net-net, it has become more important now than perhaps at any other time during the last 30 years to ask, "What am I getting for the risk I am taking?" For the last 10 years, the US stock market has delivered lots and lots of bumps, lots and lots of volatility, and absolutely zero return. That's not good. There is no way of knowing, of course, whether this recent past will also be prologue. But there is a way to guess...intelligently. Simply stated, the economies of many, many Emerging Markets are performing much better than their counterparts in the Developed World. And this trend seems very likely to continue for many years. And yet, Emerging Market valuations remain below those of the Developed World. At the current quote, the MSCI Emerging Market Index sells for about 13 times earnings, while the MSCI EAFE Index (non-US Developed World stocks) sells for 16 times earnings. For additional perspective, the NASDAQ Composite Index currently trades for a hefty 25 times earnings. Thirteen times earnings is not what one could call "dirt cheap," but it is certainly "cheaper than" the EAFE Index or the NASDAQ Composite. There are many ways to capitalize on the future relative strength of the Emerging Market economies: Foreign stocks and/or real estate are a couple obvious examples. That said, please invest very selectively. Do not invest in Emerging Markets - or in any market - because you feel like you have to, or because you have some vague idea that you ought to. Invest in the Emerging Markets only when - and if - you recognize a very specific opportunity that is worth taking a very specific risk. Thank you. Eric J. Fry, for The Daily Reckoning Bill Bonner Recession Officially Over... Someone Tell the Unemployed Bill Bonner Reckoning from Delray Beach, Florida... Yesterday, the Fed's FOMC group announced that it was standing pat. Yes, it might have to do something in the future. But for now, it is neither exiting its stimulus monetary position...nor is it adding to it. The stock market didn't know whether that was good or bad...so it didn't do much of anything. The Dow went down 24 points. But gold soared to a new record - up $17. Officially, the recession is behind us. That's the good news. Officially, it ended in June of '09. The bad news is - so what? Recession or no recession, people are having a hard time finding jobs and making ends meet. The US economy continues rumbling and trundling along. It is a Great Correction... According to the latest figures, there are more people without jobs today than there were when the recession ended. On Tuesday, the Labor Department announced that total joblessness fell in 3 out of 4 states during August. Overall, the US economy lost 54,000 jobs, net, driving the unemployment rate up to 9.6%. Those who lack work are unlikely to enjoy their leisure; they have too much of it. The jobless today are likely to stay unemployed much longer than any in US history. In the '70s downturns, the typical unemployed person remained without a job for 10-15 weeks. In the '80s, it was more like 20 weeks. Now, idleness has stretched to 35 weeks. The young are traumatized by it for life, says a new study cited by The Telegraph. For the old, it is like baldness or arthritis; they may be stuck with it for the rest of their lives, says The New York Times. Even since the recession officially ended, more people have gone into the poorhouse than have come out of it. Not only do they lack jobs, their major asset - the value of their homes - is falling. And it will probably fall much more, as inventories of foreclosed houses are dumped onto the market. Here's the latest report from Bloomberg: US home prices dropped 3.3 percent in July from a year earlier, the eighth consecutive decline, as foreclosed properties flooded the market. Prices fell 0.5 percent from June, the Federal Housing Finance Agency in Washington said in a report today. Economists had projected prices to fall 0.2 percent from the previous month, based on the average of 15 estimates in a Bloomberg survey. The agency revised the previously reported May-to-June decline to 1.2 percent from 0.3 percent. Foreclosures are boosting the supply of available properties and reducing prices, even as mortgage rates tumble to record lows. The time it would take to clear the market of homes for sale was 12.5 months in July, the highest in more than a decade of data, according to the National Association of Realtors. Banks seized a record 95,364 properties from delinquent borrowers in August, according to RealtyTrac Inc., an Irvine, California-based seller of housing data. Nationally, sales of existing homes in July plunged 27 percent to a 3.83 million annual pace, the lowest level on record, NAR said Aug. 24. July sales of new homes dropped to an annual pace of 276,000, the fewest since data began in 1963, the Commerce Department reported Aug. 25. "I had a house a couple of blocks from here," said a friend in Delray Beach. "I sold it in 2006 for $295,000. It wasn't much of a house. On the edge of a bad neighborhood. But I fixed it up. "Well, the guy who bought it couldn't pay his mortgage. So another friend is buying it back. Guess how much he's paying for it? Seventy- five thousand. I'm glad I sold that when I did." And more thoughts... Dear readers may wonder at a definition of growth so slippery that it permits people to grow poorer, even as the numbers are positive. Is it a paradox, an oxymoron or a damned lie? How come the economy is "growing" while the key measures of a household's financial situation have not improved or are getting worse? Joblessness is the same or worse than it was a year ago, depending on how you measure it. Housing prices are clearly going lower. People are not earning more money. And their major assets - their homes - are declining in value. So, what does it mean to say the economy is improving? It is merely an outward sign of an inner rot. Last week, just to remind regular readers, we touched upon the institutional imperative. Nothing wants to die. Not a hound dog. Not a bank or a business. Nor even a whole profession. Given an opportunity, it survives by cunning...and it uses a crisis to expand its influence, power, and wealth. The SEC, for example, is clearly incapable of preventing major fraud - as in the Madoff case - even when you rub its nose in it. The regulators are also incapable of noticing the biggest bubble in human history. Of course, that could be said of the Fed too, which not only failed to spot the bubble, it - along with Fannie Mae and Freddie Mac - had a hand in creating it. Well, now the SEC has new enforcement powers, says a headline. And the Fed does too. They've "adapted" to the new challenges, say the news reports. Progress has been made. Yes, progress on the road to Hell! If the NBER is to be believed, the longest correction since the Great Depression caused a total backsliding of only about 4% of GDP - maximum. Piddly... So the authorities have to get credit for that too. As Charlie Munger puts it, the "bailouts were absolutely necessary to save our civilization." And they worked. And Munger's partner Warren Buffett is ready to give them credit for another great success. There will be no double dip, he says. Another big success for the home team. To these wonders you can add further improvement. The world's central bankers and Treasury secretaries agreed on new banking standards at what is known as "Basel III." In light of these achievements, who can help but be optimistic for the future of the human race? Readers are encouraged to see the process in a new light. More to come... Regards, Bill Bonner, for The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor atjoel@dailyreckoning.com