A Tough But Effective Way to Fix the Economic Crisis
07/01/10 Laguna Beach, California – Another day, another dismal performance on Wall Street.
The Dow Jones Industrial Average coughed up another 96 points yesterday – increasing its loss for the year’s second quarter to a hefty 1,082 points. In percentage terms, the Dow fell 10.0% during the quarter that just ended, which was only slightly better than the S&P 500’s 11.9% shellacking.
This is not the script the Wall Street seers had bestowed upon us when the year began. Back in February, Goldman’s Abby Joseph Cohen (remember her?) predicted that the S&P 500 Index would reach 1,300 by the end of 2010. Here at the halfway mark, the S&P sits at a 9-month low of 1,030.
An optimist might observe that the current S&P 500 level contains one “1”, one “3” and two “0’s – just like Cohen’s S&P 500 target price. Nevertheless, these digits would require a re-alignment – and a 26% rally – if Cohen’s prophecy is to come to pass.
To be fair to Cohen (or at least, less unfair), lots of Wall Street prognosticators were issuing bullish forecasts at the beginning of the year. Thomas Lee, US equity strategist for JPMorgan Chase agreed with Cohen’s 1,300 forecast, while the equity strategists from UBS, Deutsche Bank and several other investment firms pegged their forecasts slightly below 1,300. (Pimco’s Mohamed El-Erian was one of the lone dissenting voices with a prediction that the S&P would fall in 2010. So far, so bad.)
“Why is the stock market falling?” enquiring minds want to know. The answer, in all likelihood, is that the market should not have been rising in the first place. The “Credit Crisis of 2008” is not an archived historical event. It is an unfolding drama that includes the “Credit Crisis of 2009-2010.”
Maybe the worst is over, maybe it’s not. But whatever the case, crisis conditions persist. In fact, this crisis, like a virulent disease, is continuing to manifest itself in various forms and in varying intensities.
Even though the “high fever” that placed the US investment banks in ICU has abated, a sovereign credit “rash” has popped up on the other side of the Atlantic. Secondary symptoms include the incessant nausea of mortgage defaults, the septic shock of contracting consumer credit and the vertigo of soaring T-bond prices.
These symptoms tell us that we’ve still got a very sick patient on our hands…and that the recovery will not be easy. This patient suffers from life-threatening exposure to debt. The cure is known, but it is painful. In fact, in the early days, the cure can feel much worse than the disease. The cure often subjects the patient to sovereign defaults, currency devaluations, deep recessions, high unemployment and sharp reductions in standards of living. Eventually, however, the patient feels better…and goes on to live a healthy and productive life.
Consider the bizarre contrast between the successful World Cup teams from Central and South America and the unsuccessful teams from the Developed World. “The 2010 World Cup has started to feel more like a macro-economic metaphor than a sporting event,” we observed in Monday’s edition of The Daily Reckoning. “Of the six G-7 countries to field teams in this year’s World Cup – France, Italy, United Kingdom, Japan, Germany and the United States – only Japan and Germany remain.
“Meanwhile, all four nations from the core of South America’s Mercosur economic zone – Argentina, Brazil, Uruguay and Paraguay – remain in the competition. Indeed, Uruguay has advanced to the quarterfinals for the first time since 1970.”
As the World Cup has proceeded, the up-and-comers of South America have continued to dominate the has-beens of the Developed World. So, just for kicks, we prepared the chart below, which places the World Cup’s results-to-date in an economic context.
For starters, the “Round of 16” teams from Central and South America possess much better national finances than the teams from the Developed World. Uruguay, for example, has a lower debt-to-GDP than the US, England or Japan.
This “analysis” means nothing, of course. It is the ultimate faux science. That said, your editors were fascinated to discover that the six Central and South American nations that advanced to the “Round of 16” have an average debt-to-GDP that is only half as large as the average debt-to-GDP of the Developed Nations in the Round of 16.
What’s more, the four teams with the worst national finances failed to advance to the quarterfinals. These results probably indicate nothing important or relevant about the state of the world’s finances. But wouldn’t it be funny if these results meant something? Wouldn’t it be interesting if the 2010 World Cup foreshadowed unfolding economic trends?
Don’t rule out the possibility. The 2010 World Cup is all about the failure of established powers and the emergence of new challengers.
Global investors, are you listening?
Gold and Government Debt: The Only Two Things Going Up
07/01/10 London, England – Let’s see…what’s in the news today?
Stocks went down again yesterday. The Dow got trimmed by 96 points.
Gold, on the other hand, went up $3 to $1,245.
The first half of the year came to a close with the S&P 500 down 6%, global stocks down 10%, oil down 5%, Chinese stocks down 27%, the euro down 14%.
What was up? Gold. Plus 13%.
There are two major pieces of unfinished business in the markets. Stocks have still not completed their bear market drop. Gold has not fully realized its bull market either.
Typically, markets move from excess to excess, passing sensible prices like a cross-town bus crossing main street. Back and forth, from over-valued to undervalued…and then back again. And passengers tend to get off on the wrong end!
Gold was very cheap at $260 in 1998. It will be very expensive sometime in the future. Perhaps at $2,600?
Stocks were very expensive when the Dow was at 14,000. Where will they be very cheap? At Dow 6,000? Or Dow 3,000?
We don’t know. We don’t even no for sure what direction the markets are heading. All we know is that we’re somewhere between the top and the bottom. And gold seems to be heading up while stocks seem to be heading down. Until they’ve run their course, only a fool would bet against these trends.
And here’s another trend we wouldn’t bet against. Government debt is going up. In the US, the national debt is now officially at its highest level since WWII.
Yesterday, a film crew caught up with us on the banks of the Thames and posed the question:
“What’s the big deal about debt? The US had as much debt after WWII. The next years were among the best the country ever had…”
We sat at a sidewalk eatery near the river, with a camera focused on us. People walked by and stared. They figured we must be somebody. They looked disappointed when they couldn’t place us.
“The big deal is that we’re going broke,” we explained. “Until very recently debts of this magnitude were always associated with war. From time to time countries went broke. But they almost always did so because of emergency expenses driven by war. In other words, they were spending money for what looked like a very good reason – self preservation.
“For the first time in history, almost all the developed nations of the world are running regular, structural deficits. They’re going deeper and deeper into debt, as though there were a war…but there is no war.
“We have emergency budgets, but no emergency. You may think that they are fighting the emergency of a recession or the threat of a depression, but you would be wrong. Most of the deficits have little to do with stimulus or bailout efforts. They are just the ordinary results of social welfare programs that have gotten out of control.
“For the first time ever, countries are going broke just in the normal course of business. Without an emergency.
“The nice thing about WWII is that it came to an end. But there is no victory in the fight against old age. The pension burden won’t go down. It will go up. There is no VE day for national health programs. There are no tickertape parades…the troops are never de-mobilized and sent home…and the spending never goes down.
“We can never pay off the debt, in other words, because the debt never stops growing.
“National leaders at the G-20 conference over the weekend pledged to bring their deficits under control. Some governments are taking this seriously. The government of Britain, under David Cameron, seems to have the right idea. But we are still waiting to see what happens next.
“The modern welfare state was only invented about 150 years ago. The Romans tried it and it didn’t work out very well. The modern version is still an experiment.
“And currently, in America, there are more people getting money from the government than there are people paying taxes. Forty million people get food stamps. Millions more depend on federal tax credits and so forth. Still others have jobs that are either paid directly by the government or by a contractor for the government.
“All these people have the right to vote. Which is a shame. Because they are likely to vote for more social welfare spending. Then, governments will go broke. “
Yes, dear reader, the welfare state is another piece of unfinished business. So is the dollar-based monetary system. Both of them are approaching the end of the road.
Bill Bonner
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