Themes: Stock Market, Recovery, Debt, Banks, Feds
It is a gray morning, here in London. We sit in the building with the golden balls, look out the window, and wonder...
...how does it all work? We’re doing some serious thinking this week. What is it that actually causes a depression? A stock market collapse? Or too much debt? How come government can appear to cure the problem sometimes – 2001-2007 – but not other times? How come the Japanese were not able to increase consumer prices? Even now... Japan’s inflation rate is negative. And how come, despite the most massive effort at monetary inflation ever undertaken, the US bond market still forecasts an inflation rate of less than 2%?
An interview with Richard Koo, author of ‘The Balance Sheet Recession,’ and a new book by Ken Rogoff and Carmen Reinhart are helping us understand what it going on. More to come...
In the meantime, the Dow went down 42 points on Friday. Gold dropped $7. Still no sign of the Chinese coming to the rescue in the gold market.
“Global rally shows signs of running out of steam,” says the Financial Times.
Reuters says the job data will “test the rally.” The New York Times says the ratio between job seekers and jobs available has never been worse.
The Wall Street Journal, on the other hand, tells us that greater than expected profits will support the rally. So far, the increase in stock prices has not come from increased earnings. It’s come from increased P/Es... based on the hope of higher earnings. In terms of forecast earnings, the Dow is selling at a P/E ratio of 27. But in terms of actual, reported earnings... the ratio is 180.
A friend made the mistake of asking us what to expect from the economy. We said it would go do down.
“You mean, you expect a W-shaped recovery,” he said... “a double-dip recession?”
“No... we expect no recovery at all. It’s a W without the last stroke... ”
Of course, we were exaggerating. But not much. We do not think that the economy of the Bubble Era can ever be revived. It will never recover; because it is dead.
But that doesn’t mean we will march backward forever. The economy may lose 10% of GDP... maybe 20%. But we do not expect to be slithering in the mud of the Middle Ages, with each man planting his own wheat and brewing his own beer. No, not at all. It only means that the depression must continue until it comes to an end.
“But when will it come to an end?” you ask.
“When it is over.”
A depression ends when it has done its work. It must correct mistakes. It must punish errors. It must destroy the bubble economy... and the mindset of the Bubble Era. Only then can new real, sustainable growth begin again.
So far, in 2009, 95 banks have gone broke. How many more need to go broke before the depression is over? We don’t know. This is where is gets complicated. Because the feds are determined to keep us from finding out!
Here’s how it works. The Fed lends the bankers money. Then, the bankers turn around and lend it back to the feds. The banks are happy; they’re making money on a risk-free trade. The regulators are happy; what could be safer in a bank’s vault than US Treasury bonds? Investors are happy; it looks like the financial sector is making money again. And the feds are happy; they’re able to finance their deficits.
Who’s not happy? So far, so good. But hold on...
“This is not a sustainable recovery,” says fund manager Crispin Odey in the Financial Times.
What a spoilsport! You mean, you can’t build a lasting recovery on debt and shell-game finance?
Nope. Apparently not. Just look at what has happened to the auto industry. The feds borrowed money to help Americans pimp up their rides. And this Thursday, when September sales figures come out, we find out how sustainable that boost was. Many Americans got new wheels. But now they don’t need new wheels. And now the feds are out of the auto-incentive business. So now we get to see what happens next.
Stay tuned...
*** Across the river is the great “City” of London... where finance is the #1 industry...
... where earnest men and women toil long hours in glass towers. What are they doing?
... ‘Look at this chart,’ they tell clients. ‘It shows how much you can expect to make at different risk levels... And see this curve? It is what we call the ‘efficient frontier,’ where the risk/reward relationship is optimized by proper asset allocation.’
‘Wow,’ you say. ‘You must have some pretty smart cookies working for you.’
‘Well, we do our best... ’ says the young man modestly.
In a normal economy, ‘finance’ performs a useful function – helping to match up people who have capital with people who need it. But even when it is on the level, the profession is full of bombast and flimflam.
Those numbers, presented so confidently to customers, were 9/10ths smoke and 1/10 th mirror. The new book by Rogoff and Reinhart confirms a point made by our friend Nassim Taleb: both the theory and practice of modern portfolio analysis were flawed. The theory was flawed because people are not reliable. They don’t always react in the way their models predict. What they did in the past may or may not be what they do in the future. And the practice was flawed because the past that the number crunchers looked at was limited to the last 25 years; it was the period since 1980, for which they had the figures! In other words, their models were based on numbers only from the boom years.
*** “Oh Daddy, I felt so sorry for Annabel... ”
Maria was on the phone. She was telling about one of her friends... and money worries...
“She was sitting on the couch. And all of a sudden she burst into tears. She was crying because she is out of money...
“Her car broke down and she doesn’t have the money to get it fixed. And she had to go and have some medical work done. She just doesn’t have any money left...
“And she’s already working all she possibly can. She works with me at the studio. And she picks up bartending jobs on the side. She works all day... and then works at night too. But I think it is getting to her. She just can’t go on...
“I asked her if her folks could help her out. But she said that her father lost his job in the recession... and they don’t have any money to lend her.
“Honestly, I felt so lucky to have you behind me. I don’t know what I would do if I didn’t have the family supporting me. I guess I just wouldn’t be able to keep going either. I’d have to give up the idea of being an actress because it’s almost impossible to support yourself and still go to all the castings and try-outs.”
Elizabeth added a comment:
“I was talking to [a French friend]. He thinks it is typically American to expect each generation to make it on its own. Americans think they should put aside enough money to pay their retirements, and that’s all. They don’t worry about their children. They think the children should take care of themselves. Anyway, that’s what he thinks Americans think... and he’s probably mostly right about it.
“The French attitude is much different. They keep the children closer... and help them more. He’s got five children and he wants to be able to leave them something. He’s just begun a new business venture, because he says he wasn’t able to earn enough in his job.
“He makes a good point: when you have to start from nothing, you just won’t get as far. You know, it’s a bit like what Newton said. He was able to make spectacular progress because, as he put it, he could ‘stand on the shoulders of giants.’ But that’s true for everything. One generation stands on the work of the one that came before it. And if there is nothing to stand on... they have to start from scratch. They are able to do more... if they have a firm foundation to stand on. And there are somethings they couldn’t do at all without it. Maria, for example, would be forced to get a more serious job, if we weren’t helping her with her bills while she’s getting established. And Jules, too. He wants a career in music. But if he couldn’t count on us to help him, he’d probably have to do something that pays better now.
“There’s a lot to be said for the American can-do emphasis on self-reliance. But there’s something to be said for the French attitude too. The ideal is to give your children the spirit of self-reliance and the confidence that comes from making it on their own... but also to give them something to work with... so they don’t have to start at the very bottom.”
Until tomorrow,
Bill Bonner
The Daily Reckoning
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