Free Markets, Free People
Today was one of those days when a couple of trends came together that should be making us think seiously about changing our current fiscal and monetary policies.
The first thing I was was this debt chart from John B Taylor that shows how our current policy will effect the national debt.
This what you call your unsustainable debt path.
Then, there was this:
Since the crisis began, the Fed has pumped more than $800 billon into the banking system, kept the federal funds rate near zero and purchased so many Treasurys and mortgage-backed debt that the amount of assets on its balance sheets has now swollen to $2.14 trillion.
“If you think the Federal Reserve had it tough devising a strategy to rescue the U.S. economy from of the worst recession in 70 years, just wait,” wrote Bernard Baumohl, chief global economist, at the Economic Outlook Group. “We think it is going to be hellishly more complicated this time to come up with a plan that encourages growth and keeps inflation expectations well anchored.”
All of which leads directly to this:
Chinese central bank governor Zhou Xiaochuan, who supervises more than two trillion dollars worth of dollar reserves, the world’s largest, raised the stakes by calling for a new reserve currency in place of the dollar.
He wanted the new reserve unit to be based on the SDR, a “special drawing right” created by the International Monetary Fund, drawing immediate support from Russia, Brazil and several other nations.
“These countries realize that they would suffer losses if inflation eroded the value of the dollar securities they own,” said Richard Cooper, a professor of international economics at Harvard University.
Here’s the problem. Because we are on an unsustainable debt path, we will eventually accrue more debt than we can possibly repay. There are many people who think that–since our debt, coupled with Social Security and Medicare obligations currently outstanding, are greater than the entire capital stock of the United States–we’re there already. We ill be unable to pay the debt, so our choices are to repudiate it outright, or to destroy the value of the currency and inflate it away, both of which amount to essentially the same thing. In doing so, the government will destroy the life savings of everyone in the country, save those that are in hard assets
The Chinese, whatever else they may be, are not stupid. they know this, and they want a new worldwide reserve currency now, before everyone realizes that the dollar is in very serious danger of becoming worthless. They don’t want to be stuck holding dollars when that happens–although their holdings in bonds will probably have to be written off.
I’ve written previously that China moved their gold reserves into the BoC a few months ago. Some international trade deals are already being denominated in gold, tool. It looks very much like the dollar’s days as the world reserve currency are numbered. In fact, the dollar’s days may very well be numbered.
And we’ve let it happen. Over the past 80 years, we’ve sat by and watched as the Fed–whose primary mission was supposed to be the stability fo the currency–has presided over a tenfold reduction in the dollar’s value. For the last 30 years, we’ve watched as the debt has mushroomed–yes, even during Bill Clinton’s presidency–and we’ve refused to either cut spending or to raise taxes to a level commensurate with our increased spending. In short, we’ve looted the system, and the looting is nearly complete now.
And now, with all the trumpetings of a coming economic recovery, the Fed has to try and figure out how to re-call the more than doubling of the monetary base we’ve engaged in in the past year without completely crashing the economy. Failure to do so, of course, means serious inflation–which will further degrade the value of the dollar.
In this podcast, Bruce, Michael, Billy, and Dale discuss the economy and the Sotomayor nomination.
The direct link to the podcast can be found here.
The intro and outro music is Vena Cava by 50 Foot Wave, and is available for free download here.
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Hugo Chávez is in the news again, appropriating and nationalizing more of the oil industry in his country.
That sort of move by him has become so routine that it almost isn’t news anymore. But this particular sentence caught my eye and reminded me of what we’ve seen here as well:
This move forms part of a broader assault against the private sector, which Mr Chávez has increasingly blamed as Venezuela slides into recession.
Vilification is a political tactic in use by a certain type of politician, and anyone paying attention to what has been going on in this country has seen it deployed in earnest against the wealthy and certain industry sectors in the US in the last few months. The health care industry is next. And, as in Venezuela, the government is being offered as the best alternative. Yet watching Venezuela, most understand the ramifications of moves such as Chavez is making on the long-term viability of Venezuela’s economy:
But analysts say that by shifting its problems onto its suppliers, PDVSA is storing up even bigger problems for the future. Not only does it lack the ability to operate as efficiently as the service providers, but it sends a grim signal to companies considering investing in Venezuela. Consequently, future oil production is under threat.
While the moves taking place here aren’t as drastic as those in Venezuela, they’re just as problematic. Government appointed board members on auto company boards and government calling the shots in the financial sector aren’t direct takeovers, but they portend a level of government meddling unseen here before. And health care and energy are next.
The key word in the quoted paragraph above is “investing”. Investors are very wary about both the auto and financial industries at this point. They’re wary of the auto industry because government is essentially throwing the bankruptcy procedures out of the window and those investors which should be guaranteed the first seat at the table for the recovery of their investment are now being vilified as “greedy” and pushed to the side. Any reason they or any other investor should take a monetary stake in either of the government controlled auto companies again? And given the experience with autos, don’t you suppose investors in the financial sector are having second thoughts?
Investment is the road to recovery in recessionary times. The moves Hugo Chávez is making in Venezuela are exactly the wrong moves in terms of economic recovery (not to mention being a complete violation of property rights). While not as drastic as Chávez, the moves the Obama administration have made are sending a similar signal to investors. And that doesn’t bode well for a swift economic recovery.
Health care and energy are next.
The big Econo-boys are weighing in on the state of the economy, and providing a consensus opinion on the coming economic recovery. According to the Wall Street Journal:
Economists in the latest Wall Street Journal forecasting survey expect the recession to end in September, though most say it won’t be until the second half of 2010 that the economy recovers enough to bring down unemployment.
Gross domestic product was predicted to contract in the first and second quarters of this year by 5.0% and 1.8%, respectively, on a seasonally adjusted annualized rate. A return to growth — a modest 0.4% — isn’t expected until the third quarter. In the fourth quarter of 2008, the most recent period for which data are available, the economy contracted 6.3%.
The outlook for employment isn’t quite as good, though.
Just 12% of the economists expect the unemployment rate to fall some time this year. More than a third of respondents expect the jobless rate to peak in the first half of 2010, while about half don’t see unemployment declining until the second half of 2010. By December of this year, the economists on average expect the unemployment rate to reach 9.5%, up from the 8.5% reported for March. They do see the rate of decline slowing, forecasting 2.6 million job losses in the next 12 months, compared with the 4.8 million jobs lost in the previous period.
I’m a bit more negative on the above. As of today, weekly initial unemployment claims are still at 650,000 per week. If that keeps up, we’ll continue to see 0.5% increases in unemployment on a monthly basis. We might be at 9% by next month, nevermind December.
I’m also concerned about the implications of the rabid expansion of the monetary base over the last 7 months, during which it essentially doubled. If that impacts signifigantly on inflation by the end of the year, then we’ll be between a rock and a hard place with a weak economy, and signifigant inflation. Any Fed moves to contract the monetary base will crater the economy, in much the same way that Paul Volcker’s Fed did in causing the back to back recession of 1981-1982.
There are still treacherous shoals to navigate for the economy before I begin to get bullish on economic growth again.
It seems so hard to remember those halcyon days, long ago, when there was some optimism about the country’s economic future. Why, it seems like just last week, when Fed Chairman Ben Bernanke was telling us to be cautiously optimistic about the near future.
In his twice-yearly testimony to Congress, Bernanke conceded the economy was undergoing a “severe contraction”, but held out hope of recovery if the White House’s latest bail-out helped to unblock lending to households and businesses.
“Only if that is the case, in my view there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery,” he told the Senate banking committee, adding that healthier global markets would also be essential if the US economy was to return to health.
Some were willing to go even farther, in those happier days of February, 2009. Some chap named Bernard Baumohl of the Economic Outlook Group who seems really to believe that happier days are just around the corner.
“We are not doomed to a lost decade of the sort experienced by Japan in the 1990s,” Mr. Baumohl says. “Nor are we in a depression. We view the drop in GDP in the last quarter, which we may see repeated in magnitude this quarter, [as] symptomatic of a recession in its final convulsive stages, to be followed by a recovery in the second half of the year.”
Oh, wait. That was last week.
This week started off with the S&P 500 dropping another 4.66% today, closing at 700.82, and the Dow off by 4.24% to close at 6,763.29. Well, you can’t slip something like that past the boys at the Dallas Morning News.
“The number 7,000 is not what is important,” said Hugh Johnson, chairman of Illington Advisors in Albany, N.Y. “What is important to everyone is the message that the market is sending us with these losses.”
And that message is that the current recession probably will be longer and more severe than most people expected. For months, the consensus on Wall Street was that the low of 7,500 that the Dow hit in November 2008 would mark the bear market bottom.
Many market analysts predicted that while the Dow would “retest” that low, it would not break through it. They were wrong. The scary thing now is where the Dow and the broader Standard & Poor’s 500 index will make their next stand.
As I’ve mentioned several times, both on the blog, and on the podcast, the historical long-term trend is for the average P/E ratio to drop back to 15. Well, that implies that our equilibrium point is somewhere in the vicinity now of 6,000 on the Dow, and about 620 or so for the S&P. So we’ve still got a ways to go if that historical trend holds true.
Of course, we also have a tendency to drop below an average P/E of 15 as we pull back off the highs, so a 5,000 Dow doesn ‘t seem like an overly pessimistic prediction.
I know I’ve been consistently downbeat on the economy for the last several months, and nothing I’ve seen since I started writing about this in 2007 has changed my mind. I’m not counting on a recovery in 2009, or even in 2010.