2009 - March Economic Brief

March – 2009 Economic Brief

"Today, we have three interrelated problems: a collapse of the real economy, a collapse of the banking system and rapidly shrinking world trade," said Jeffrey Garten, a professor at the Yale University School of Management. "If you treat one without treating the others, you are doomed." However, Obama’s stimulus plan makes the U.S. real estate market the main pivot in the whole economic mess we're in right now.

Is your house in order?

Over 60% of dentists in one survey acknowledge that the present economy means they now plan to work longer than they'd expected.

Though not the precipitating factor in the current crisis, the weakening of household balance sheets (fewer assets, same liabilities, less net worth, more anxiety) has likely had a significant effect in depressing consumption, which has been the single largest factor in our recent decline in GDP. Since the Federal Reserve Survey of Consumer Finances was conducted in 2007, median net worth fell from $120,300 to between $90,000 and $95,000 - back around 1998 levels ($91,300).
When you or I get in a debt bind, we are forced to make difficult budgetary decisions. We cut back on our spending. Let me know when you hear this happening on a national level.

On the other hand, there is a true disconnect between “the people” and this past year’s Wall Street bonuses: $18.4 billion, the fifth-highest total ever. Did I mention that: the official unemployment rate has now exploded to 7.8%, that U.S. home prices continue to fall (still 20% overpriced), that the current crisis is global is hitting the whole world simultaneously and providing no outside support to offset U.S. domestic weakness. Did I mention that earnings are falling and stocks are still far from cheap based on those earning, that debt and leverage are gone, or that in the undeniable history of speculative bubbles that things always return to their norm?

The reason for this crisis, in a word — CONFIDENCE — or rather, a dramatic loss of confidence and faith in our financial system.

Like many people, I was disappointed by the Financial Stability Plan announced on Tuesday the 10th. The devil is in the details and we shall see just what is disclosed (made transparent) because fairly or unfairly, many people think that Tim Geithner is in Wall Street’s pocket because he has said that being tough on the banks and top bankers would further worsen credit markets and thus deepen/prolong the recession. On the other hand, if he had forced banks to write down their book values (bad assets) based on actual market conditions—and then deal with the consequences—he would have ended the financial crisis, but it would be ugly - it’s kind of a catch-22 thing, your damned if you do and your damned if you don’t, I guess.

Can the U.S. afford this $789 billion major fiscal stimulus package? What’s this government to do? Cutting spending is not really an option given the economic crisis and given the growth of entitlement commitments in the future, (the total U.S. debt – including Medicare, Medicaid and Social Security – is more than $99 TRILLION!), and that’s not to mention our increasing military needs. In fact, the only way the debt can be paid off is by inflating it away which will drive interest rates up and the dollar down, or so economic logic predicts.
Add to this, the information that the International Monetary Fund said last month that Japan’s economy would shrink 2.6 percent in 2009, versus contractions of 1.6 percent and 2 percent in the U.S. and Europe. Are you starting to get the picture that this downward spiral is now engulfing all the world’s economies? I hope so.
So what happened to the stimulus package, why did it drive the markets, yet again, down?

First, the Fed will be expanding its Term Asset-backed Securities Loan Facility, or TALF. In this program the Fed will lend money to investors who buy securities that fund various types of loans. The Treasury will seed the TALF program with as much as $100 billion. The Fed will provide additional leveraged funding, up to $1 trillion.

Second, the Treasury is going to set up a public-private program to buy “bad assets” from the banks, up to $500 billion.

Third, Regulators will "stress test" bank portfolios, and inject capital into them, if necessary, through the purchase of convertible preferred securities.

Fourth, there was some talk about foreclosure mitigation and prevention at Fannie Mae, Freddie Mac, and private banks. Recently, Mr. Obama rolled out a $275 billion anti-foreclosure plan, so it’s not all talk.

Let’s go over this again, first, he got Congress to pass a $787 billion stimulus package ...

Next, he got Treasury Secretary, Timothy Geithner, to unveil the administration's bank bailout plan which he now admits could cost up to $3 trillion .

Sound good so far, it’s nothing new. Are you still wondering why the markets reacted by going down?

Add it all up, and it comes to more than $4 trillion, an amount nearly ten times larger than the budget deficit for all of 2008. All in just 32 short days! Without a doubt, the $4 trillion makes Obama the single most profligate spender in history — bar none. And still the government didn’t spell out exactly how, when, and why it would save the day. So the “plan” is still to come up with yet another plan. What kind of plan is that?

Wall Street certainly didn’t like the ambiguity after so much of a “save the day” rhetoric. It was more of the same old failed logic. Remember the TAF, the TSLF, the PDCF, the TARP and all the rest of those acronyms? Those programs have kept many "failed" financial institutions alive. Is the TALF any different, no! Are we are still on life support, yes!

Look at it this way: If you were a very rich man living at the time of Christ ... and you could have started saving $1 billion per year every year thereafter, you'd still be only half way there! You'd need still another 2000 years to finance what Obama has committed to spending in just the one month since he began his presidency.

We haven’t even talked about failed commercial loan originations which dropped 80% year-over-year in the fourth quarter. EIGHTY PERCENT! Just think of the impact that's going to have on the commercial real estate business which is destined to collapse next.

I could go on, but the real point is that you can buy into Washington’s hype or you can prepare your portfolio for a long, low, lean time ahead.

That's why, despite $4 trillion in new spending schemes and guarantees, the Dow has plunged to new lows, that’s why every stock index in Asia and Europe have also cratered in unison.

That’s why gold — the world's crisis hedge of last resort — has once again shot for the moon. Did I mention that the Feds, Ben Bernanke, has admitted in the latest release of the FOMC minutes that there will be no recovery in 2009. The rationale for owning gold, as it once again approaches the $1,000 an ounce level, is the prospect of mounting monetary disorder. The long-term story for gold is as a remonetization play as investors lose faith in inflating currencies alongside monetary and fiscal policy measured up against the desire of Central Banks to keep asset prices relatively stable, if not volatile, but certainly not wanting the dreaded Deflation economic apocalypse.

Here, gold is a prime candidate to become a “mania asset” once its demand becomes chiefly financially driven.

How high can gold ultimately go?

Normally, Central Bankers see high gold prices as a lack of trust in the financial system (not to mention their ability as Central Bankers). We saw this in 1932 and 1980 when the Dow Jones Industrial Average/gold ratio was 2:1. Only nine years ago in 2000, this ratio was over 40:1. Arriving at 2:1 again does not necessarily mean the Dow must decline significantly from here; more likely gold prices will surge and the Dow will stay range-bound but volatile. For this reason, this is the first time I can see Central Bankers actually favoring a high gold price as it would suggest that their attempts to stave off deflation were starting to work. Central Bankers in favor of higher gold prices; my how things have really changed.

These are the three essential truths to be drawn from the market...

1. Analysts have consistently underestimated the seriousness of our current economic problems. Weren’t we supposed to have a turnaround by the end of last year? And then it was supposed to happen the second half of this year... and now it is not going to happen this year at all.

2. All the fundamental numbers are still worsening. Jobs, factory orders, housing, bank writedowns, economic growth, unemployment and so on.

3. Most of those who are predicting an imminent turnaround are doing so on the basis of the government’s bailout plans. But government actions so far have failed dismally. “Government as the answer” just doesn’t do it for me, how about you?

Let’s take a step back and look at the big picture.

Somewhere near $30 trillion has been lost in global stock markets. Global real estate has suffered a similar fate. This doesn't include bond, commodity or other market losses. These losses are only in markets that are fairly transparent. Who knows what has happened in the hidden and unregulated derivatives market, where somewhere near $600 trillion sloshes around, nothing good for sure. These toxic problems are at the root of what ails us, yet the public is left in the dark. You can't make any of these markets, businesses or individuals whole by throwing around a few trillion freshly digitized dollars. The scale is simply too big. With this in mind, perhaps it is useful to understand something about economic philosophy. Let me explain.

An epic battle being waged between "David vs. Goliath"

School of Goliath — The intellectual leader is Milton Friedman (Money Supply Theory). Milton Friedman believed that the government should flood the economy with massive amounts of money to enhance and increase consumer demand.

Basic Premise: In order to keep the current recession from turning into a depression as we witnessed in 1929, the government must stimulate the economy with massive amounts of money so that we can enhance and increase consumer demand.

This is where Mr. Bernanke, Mr. Giethner and President Obama's advisors reside.

School of David — The intellectual leader is Irving Fischer (Debt-Deflation Theory). Irving Fischer's Debt-Deflation Theory holds that the government must let the invisible cleansing hand of the market wash away the debt before economic growth can resume.

Basic Premise: In order to keep the current recession from turning into a depression as we witnessed in 1929, the government must step-back and let the invisible cleansing hand of the market let those business who fail, fail - and clear the debt before any real economic growth can again take hold in the economy.

The point where we are at now in this battle is the part where debt levels have reached such huge proportions in the economy, that due to the size of the money involved, pumping more money into the system is ineffective because the velocity of money declines as the size increases.

Let me explain the term "monetary velocity" and how important it is:

Monetary velocity means how fast money is circulated in the economy — the speed in which it is spent. And it is a key measure in the definition of economic growth and output.

But, in this epic battle, eventually, when debt levels become so huge, as they are now, people get scared. They save, hoard and use their money to pay down debt. They don't take on more debt or run out and spend more just because the money supply has been increased magically (digitized dollars) by the government.
In fact, the more money pumped into the system only adds to the total debt in the economy, and therefore prolongs the downturn.

We will be locked in a sustained period of risk aversion (rising unemployment, deflation, and sovereign debt defaults) as this crisis plays out. And at a time of major risk aversion, the world will flock to its reserve currency — the U.S. dollar, until inflationary pressures (more digitized dollars) move the herd to gold. Why? Because the endgame to this crisis will eventually bring much higher interest rates to keep the herd feeding on US dollars, a downgrade of the US government's credit status, hyperinflation, and the destruction of the dollar.

If demand for money rises faster than supply, then prices for other goods will fall because people want cash rather than assets. This is what's happening right now. The feds are increasing money supply by the trillion. But there's huge demand for that money, too, people want to be in cash, not assets because of the downside risk in the recession/deflation environment based on the total debt and the inability to efficiently service it due to its size. That’s why the US treasury is able to sell short-term bonds at 0% interest, because people want the cash more than any risk associated with some return.

Money demand is all about people's confidence and sentiment. It could change rapidly at any moment (herd mania). When confidence returns and when people start spending money as fast as they get it, watch out: because we're headed for a huge inflation and you should turn your paper money into gold and silver because all of a sudden money will be worth less making prices for goods and other assets worth more.

In fact, if you go back to my March and April 2008 posts you will understand that the US Empire has been insolvent, and run on debt for many years. We've long had the privilege of issuing the primary currency in international trade because of demand for the US dollar. No other nation has been able to print money out of thin air and purchase goods and services with it from abroad (Thank you China, it’s our money, but it’s your problem).

Here’s the rub

The US needs over $2 billion per day coming in from foreign sources to balance our trade and budget shortfalls. We have been and remain at the mercy of foreigners. A total of $1.5 billion was all that came in for the entire month of October. November actually saw a negative $21.7 billion. That means $21.7 flowing out of the US and nothing flowing in on a net basis. Who exactly is going to pay for the trillions in spending the US has on the agenda this year?

Yes, the Fed will have to do this deed. They create money (digitized dollars) in which to fund our debts. (Don't try this at home, it’s illegal to print money.) In whose behalf is the US Treasury piling up all these debts? Taxpayers; of course, you and me and your grandchildren’s children for many generations out. It's little more than a house of cards at this point. The amounts of debt are too astronomical (In god we trust!) to be repaid, ever.

The US is insolvent by any reasonable method of accounting. The debts cannot be paid. When they can no longer be serviced, it's over!
I'm not trying to depress you, though that has likely happened. This is all really ugly. Maybe it's the darkest night before dawn, but it's hard to imagine how all this can pass us by and leave the world unchanged.

Some good news:

If this stimulus package doesn't work, there will probably be Stimulus Plan II.
Interestingly, one neat effect of this coming US dollar inflation is that it will reduce our trade imbalance with China at the same time.

The price of gold has jumped from $737 to over $995 an ounce, a gain of more than 35%! This situation makes gold the de facto reserve currency. Gold alone cannot be devalued or manipulated. It is the safe haven standard of value today, just as it has been for the last 5,000 years.

It would be hard to pick a more interesting time to be alive.

Thankfully, despite all the bad news, we still have efficient free transactions — not only in goods, but also in services; not only in assets, but also in debts; not only for private-sector securities, but also for government securities.

And Canada is now the largest single supplier of oil and refined products to the United States. Northern Alberta is sitting on the biggest petroleum deposit in the world. It has 300 billion barrels of proven reserves ... and another TRILLION barrels that are just waiting for recovery technology to improve. That's eight times the oil in all of Saudi Arabia!

Some Bad News:

Economist, Paul Krugman, a recipient of the Nobel Prize in Economics, said in a speech at the University of Pennsylvania on February 19th that the U.S. economic-stimulus program doesn't deliver enough stimulus to pull the U.S. out of its downturn.

On the dame day at a Columbia University dinner reported by Reuters...

George Soros said the financial system has effectively disintegrated, with the turbulence more severe than during the Great Depression and with the decline comparable to the fall of the Soviet Union, while ...

Paul Volcker said he could not remember any time, even in the Great Depression, when things went down so fast and quite so uniformly around the world.

Another point of view out of the blue:

Did you know the exhalations of breath and other gaseous emissions by the nearly seven billion people on Earth, their pets and livestock are responsible for 23% of all greenhouse gas emissions? Like it or not, we are the problem!