 | | The Daily Reckoning | Tuesday, August 10, 2010 |
- Five reasons GDP will likely approach zero by 2011,
- The trouble Hanky & Bernanke wrought, revisited,
- Plus, Bill Bonner on printing a few trillion more and cleaning out the garage...
| Rat-Infested Recovery
| The aftermath of Paulson's failed bailouts
| |  | | Eric Fry |
Reporting from Laguna Beach, California...
Inviting a little bit of government policy to interact with private enterprise is like inviting a little family of rats to interact with a bakery. Before long, you've got more rat droppings than chocolate sprinkles atop your cupcakes. And that's just the beginning...
Every day, the rats are more numerous, more rotund...and more brazen. Every day, fewer baked goods make it from the oven to the display case. Eventually, the baker is in business to feed the rats...and there is nothing he can really do about it.
Feeding rats is expensive.
It costs money to support a rat-friendly environment. It costs money to finance bailouts, stimulus packages, liquidity injections, quantitative easings, health care reforms, financial reforms, emergency lending facilities. It costs real money that comes from real people...in some way, shape or form.
To maintain a rat-friendly environment, you've got to raise taxes or print dollars...or both.
Two years ago, most investors cheered the staggeringly expensive bailout schemes of then-Treasury Secretary, Henry Paulson. Hank simply reached into his bag of tricks, pulled out a few trillion dollars of bailouts and guarantees and scattered them like pixie dust over lower Manhattan.
Within a few months, the stock market was rallying and the economy was showing signs of life. The crisis was averted and Hank's rescue mission did not seem to cost anything at all. But now we know that this rescue mission cost us everything...or almost everything.
Paulson's bailouts destroyed the nation's balance sheet, while also taking a hatchet to the legal precedents that had nourished American capitalism for more than 200 years. Without one single ounce of Constitutional authority, and without a demi-second of public debate between elected representatives, Paulson dispensed trillions of dollars worth of federal funds and guarantees to a handful of privileged and/or connected corporations. As such, Paulson did not change any longstanding laws or legal precedents, he simply invalidated them. After Paulson, what rules counted? What rules didn't? No one knew? No one knows even now.
And now, nearly two years after Paulson's hyper-active, Constitution- warping activities, what do we, the non-Wall Street portion of the American populace, have to show for the trillions he spent or authorized? An economic recovery?
Hardly.
The Paulson bailouts failed miserably. They double-failed. Paulson spent trillions to buy a feeble one-year economic rebound...while also saddling the nation with debts that will last decades. Even the Home Shopping Network offers better deals than that.
If a friend told you that he had cashed out his IRA and mortgaged his house to throw himself a birthday party, you'd think your friend was an idiot. But when the Treasury Secretary does something similar with the nation's balance sheet we think he is...well...an idiot.
Last week's economic data illustrate that the "Paulson non-recovery" is in full swing. Last Friday, we learned that the US economy shed 131,000 jobs during July. This grim report corroborated equally grim reports on consumer spending, personal income, pending home sales and factory orders.
Personal incomes fell last month for the first time since September. Meanwhile, the savings rate soared to 6.4% - the highest level in a year, as Americans reacquainted themselves with the ancient virtue of thrift.
When folks stop buying things they cannot truly afford, strange things happen. One of those strange things is that consumer spending dries up. Last month, therefore, consumer spending stagnated, while pending home sales tumbled. The National Association of Realtors' index of pending home resales in July dropped to its lowest level since data began in 2001.
Maybe governments can't buy economic growth after all.
| The Daily Reckoning Presents
| The "Road to Serfdom"
| |  | | Dan Amoss |
The stock market still has further to fall to catch up with the slowing economy. US GDP will keep decelerating - likely approaching a zero percent growth rate by 2011 - for the following reasons:
1. The long-term trend back towards consumer frugality and higher savings rates remains in full force. This will dampen consumer spending.
2. A double dip in housing prices is likely, because subsidies are ending and the backlog of foreclosure resolutions is about to accelerate.
3. The impact of the Obama administration's stimulus plan is fading, and is not leading to any real "multiplier" effects because most of it went to plug holes in state government budgets.
4. European and Chinese GDP are slowing for well-publicized reasons.
5. Those who create jobs in the US fear rising tax rates in 2011, rising energy prices from cap-and-trade legislation, the pro-Wall Street "financial reform" bill, and a laundry list of other anti- business policies. In short, if the status quo remains in place, the US economy will be lucky if it experiences a fate similar to post-bubble Japan. The US government is pursuing the same misguided strategy that has failed for twenty years to revive Japan's economy. This strategy consists of squandering taxpayer dollars on failed financial institutions, and prop up unaffordable federal and state spending programs.
One key difference: Japan's competitive export-oriented manufacturing base was strong enough to prop up the Japanese welfare state (until now, at least). The US manufacturing base is certainly powerful and efficient, but it's nowhere near profitable enough to support both itself and the ever-growing US welfare state.
What policymakers seem not to understand is that each dollar that funds so-called "stimulus" programs must be extracted from the private sector. And they wonder why the private sector is not recovering! A far more effective stimulus plan - as long as the bond market remains unworried about deficits - would have been to slash government spending and slash taxes even faster. While that would also have been fiscally irresponsible, at least we'd be seeing "multiplier" effects on GDP by now.
Big companies remain defensive for many reasons. The July 1 issue of The Economist ran a story on the growth in corporate savings. Capital spending at most big companies is running at a slower rate than depreciation, resulting in rising free cash flows (but at the expense of a deteriorating asset base):
Business investment is as low as it has ever been as a share of GDP. Firms run the risk that their stock of capital is too depleted to meet even sluggish growth in demand. The likeliest outcome is a hesitant recovery in business spending as firms balance the risks of inadequate investment and insufficient cash.
Some businesses aren't reinvesting because they dramatically overbuilt during the boom; some aren't investing because their customers are broke; still others aren't investing due to hostile government policies. These reasons for caution are all entirely rational. But corporate austerity is a worrisome trend for an economy that is struggling mightily to produce job growth.
To judge from this extremely cautious behavior, corporate leaders seem to fear that the US economy is heading towards Friedrich Hayek's proverbial "road to serfdom."
This road is now taking the global economy down one of two paths:
1. Painful austerity plans and deflation that salvage what's left of today's currency system by promoting savings and encouraging new capital formation; OR
2. Endless stimulus injections into economies with the promise of austerity "once the economy recovers." Unfortunately, most Western economies are now thoroughly addicted to government spending. Each fiscal and monetary injection into zombie banks will likely have to be larger in order to offset the withdrawal symptoms of losing the last stimulus plan. Entrepreneurs figure this game out and gradually withdraw from participating in the economy in a healthy, productive manner. This loss of entrepreneur confidence in the system will ultimately accelerate the demise of all paper currencies. The second path one is more likely in my view, because it's more politically popular - especially once the European "pro-austerity" camp discovers just how addicted their economies are to the welfare state. Hopefully, a critical mass of people who value freedom over the illusion of economic security can move to wean us off today's frighteningly powerful roles for governments and central banks. But based on the decisions we've seen in recent years - decisions driven mostly by political considerations - I'm not holding out much hope at this point.
Threats from Washington, DC, include everything from raising tax rates, to bailing out cronies at zombie corporations, to debasing the dollar, to implementing an energy policy that will have the effect of dramatically raising prices and worsening the US dependence on oil imports. Case in point: The answer to the BP oil spill is to take away the right for Gulf Coast oil workers to work on statistically safe drilling projects for the next six months, and then put them on BP- funded welfare checks.
No price was too high to bail out the financial terrorists at the "too big to fail" banks. There's not much desire for the current Congress and the Fed to end embarrassingly large subsidies and guarantees for the big banks.
Bottom line: This environment is dangerous for the stock market. When governments are spending money they don't have, while corporations are not spending money they do have, the resulting economic "growth" is usually a fraud. Sustainable bull markets require healthy risk appetites among those with capital to invest.
Dan Amoss,
for The Daily Reckoning
Joel's Note: Most folk don't like what Mr. Amoss has to say...and that's ok. Most folk won't know when the next leg down in the markets is coming...or why...or how to protect themselves and their wealth during the ensuing market turmoil. Dan's readers will. To avoid the "most folk" fate, check out Dan's Strategic Short Report research service here.
| Bill Bonner
| Monetary Avalanche
| |  | | Bill Bonner |
Reckoning from Ouzilly, France...
Yesterday's markets barely moved in any significant direction, so we will ignore them and go on to today. It's a big day for the men who rule us. The Fed's Open Market Committee meets to decide what to do.
On the table are a number of small steps...and one big one.
Barron's highlights the big one on this week's cover:
"Why the Fed will soon print $2 trillion," is its headline. The idea behind the headline is simple enough. The recovery is a flop. All that stimulus spending has done nothing. Unemployment is not getting better. Consumers aren't shopping. Banks aren't lending. And the money supply is actually falling.
What to do? The Fed has already shot off its monetary ammunition. It has been lending money without asking anything in return for the last two years. What else can it do?
Well, it still has some weapons it can use. Quantitative easing, for example.
The idea of QE is that it permits a central bank to fund its government's deficit by printing money. The Fed prints money. It uses the new cash to buy US Treasury debt (or anything else, for that matter.) Result: more money in the system.
Maybe it is fear of inflation that is driving the dollar back down. Have you noticed that after all the "end of the euro" talk, the European currency is actually back to $1.32?
Stocks, too, may be reacting largely to fears of inflation. If you think higher rates of inflation are coming, owning a piece of a real business is surely better than holding cash. Cash (or bonds) can become totally worthless. A business - if it can survive the financial crisis - will still be worth something...and maybe even more than it was before.
But inflation is no sure thing - at least not anytime soon. The Fed increased the monetary foundation of the dollar-based world by $1.25 trillion when it bought up Wall Street's toxic debts. Still, for the most part, prices continued to fall.
How so? Because money wasn't changing hands...because people preferred to hold onto their cash rather than spend it. Which is what people do when they're worried about the future. Unless, that is, they're worried about inflation. Then, they spend money as fast as possible.
Therein lies a big conundrum for the Fed.
"Damn the risks of triggering a bit of inflation and some modest investment bubbles," saysBarron's. "The alternatives are far worse."
But that's just the problem. The alternatives are not worse.
The Fed cannot really create a "bit of inflation"...not when the market is scared, and generally de-leveraging. People save. They buy US Treasury bonds. They watch their money and worry. The velocity of money slows, so that even if you add more money to the system, prices still do not rise.
It is like adding snow to the top of a mountain. As long as it remains cold, it just builds up. But when it melts...watch out!
There is nearly $60 trillion worth of dollar-denominated debt in the world. The value of that debt rests on the value of the money in which it is calibrated. As long as people think the dollar is more-or-less okay, they're willing to have and to hold US dollar debt. The snow stays where it is.
But what would happen if the Fed really did print $2 trillion? Maybe nothing. Or maybe something. Maybe something that was worse than the soft depression we're experiencing now - an avalanche or a flood.
People might suddenly want to get rid of dollars - in all forms. Then what? Consumer (and probably asset) prices would soar. Bonds would collapse. You could forget about financing any more deficits. Then, in order to restore faith in the dollar and the Fed's credibility, you'd have to do what Paul Volcker did in '79. You'd have to get ahead of the inflation rate, with Fed-imposed interest rates even higher than the CPI. Those rates would send the economy into a tailspin of de- leveraging, debt cancellation and depression. When Volcker did it, America had its worst recession since the Great Depression. And that was without quantitative easing, derivatives, subprime, trade deficits, trillion-dollar federal deficits, housing bubbles, or any of the other maladies we suffer today. The next downturn would be much, much worse.
In other words, the effect of printing trillions more dollars would probably be to cause an even deeper depression than the one the authorities think they are trying to avoid.
They won't do it...not yet.
And more thoughts...
Too much stuff.
People come to think what they must think when they must think it. With stagnant incomes, towering debts, and no real hope of increasing their purchasing power, they're beginning to think that they don't need so much stuff.
"Rethinking the pursuit of happiness in a recession," is a headline from The New York Times. The article talks about people who live quite happily and comfortably with little stuff and little income. One couple has an income of $24,000 per year - and no debt. They make a point of having 100 personal items - or less. They could earn more money, but they don't need to. Because they are no longer supporting so much stuff.
"The idea that you need to go bigger to be happy is false," says the woman in question.
"Studies of consumption and happiness show that people are happier when they spend money on experiences rather than material objects," says the Times.
And when people downsize their lives intentionally they end up with more time and money to spend on experiences - such as vacations. Or tennis lessons. Or reading a good book.
You take a vacation. Even if it isn't perfect, you tend to remember the good parts for a long time. An object, on the other hand, gives its satisfaction very quickly...and then becomes a source of expense and nuisance.
We spent the last week cleaning out the garage and the workshop.
"I just can't believe it. I mean, how fast things fill up. We bought this place 15 years ago. It was huge. It was empty. I thought we could fill it with junk for the rest of our lives. But now it's so full, we have to throw things out. Besides, I've had enough of this. I want to get rid of all this. From now on, I want to lead a simpler, more organized life."
Elizabeth seemed ready to take up the "less is more" chant herself.
"No, I don't necessarily want less... I want better. And that means being more choosy and getting rid of junk. We keep things for years and years thinking we'll need them. Then, we don't need them at all and have to throw them out."
Damien (our gardener) backed up a big wagon in front of the garage. Old paint cans. Bicycles with broken wheels. Pieces of steel. Cardboard boxes. A rusty barbecue. Everything went into the wagon.
"Wait...Damien...what's that you're throwing away...?"
Once he gets started, Damien is hard to stop. In his hands was an antique - a hoe-like metal object used for raking the coals out of a brick bread oven.
"Wait a minute...let's save that."
"Why, what good is it?"
"I don't know...it's an antique..."
"Well, if we wait long enough, everything will be an antique..."
"Good point." The hoe went into the wagon too.
Regards,
Bill Bonner,
for The Daily Reckoning
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