– President Barack Obama on the dangers of stimulus delay
The good news is, White House rhetoric has gone from soaring on the wings of hope to scraping the dark recesses of fear. Why? Because it shows a degree of economic seriousness that was sorely lacking before… during the Bush administration!
The bad news, we live in a world run by simpletons. All the Fed efforts thus far have been as if they are fighting a recession caused by the current financial crises.
Unfortunately, we’re in a depression, not a recession.
Let me be clear, economists have no sure way of separating the two. But they are profoundly different. In the few words that follow, I’ll explain why...
But first, we turn to the news. We’ll see what a depression looks like – just from reading the headlines.
- The Dow fell 380 points yesterday [now at 7,888]. That leaves only about 3,000 or 4,000 more to go... before the index reaches its depression bottom between 3,000 and 5,000. That could take a long time... depressions always take time. It might not happen before 2010... or even before 2012.
- The U.S. jobless rate hit 7.6 percent in January, the Labor Department said on Friday. Most economists see the rate peaking in the 8 percent or 9 percent range, still short of the peak of the 1981-82 recessions and far below the 20 percent plus rate of the Great Depression.
- Several bank failures announced every month.
- “The week ahead: Investors gear up for a deluge of weak earnings and the biggest plunge in GDP in 26 years.” -CNNMoney.com
- Oil held steady at $40. Oil seems to be stuck around the $40 level. The dollar/euro exchange rate seems stuck too… in the $1.28-$1.30/euro range. So is the gold, at about $940. Gold gained $39 yesterday bringing it back over $940.
- Credit card delinquencies are at a record high.
- The Chinese are now buying more automobiles than Americans.
In the face of this depressing news, President Obama has said that if Congress doesn’t get off its duff and pass his stimulus plans the consequences could be “catastrophic.”
At the foundation of President Obama's stimulus plan [or any of the others for that matter] is a simpleton’s approach that: “if consumers stop spending, government should take up the slack.” But if it were that easy, there would never be any downturns... because politicians are all too eager to spend money, all they need is an excuse.
The typical recession is nothing more than the economy taking a little breather after a brisk walk. A depression, on the other hand, occurs after a long, uphill sprint – when the economy clutches its chest and falls down dead.
Even in a recession, the Fed spring into action. Interest rates are lowered...government spending is increased (usually too late to make any difference) and the economy resumes its perambulation.
The policy makers take on a depression as though it were just a particularly bad recession. They cut rates further...and spend more money. But it has no effect – except to retard the necessary adjustments.
A depression is not merely a pause… it is the end. Unless the Fed can work miracles – such as raising the dead – they will just make things worse. Because, while they are trying to revive the dead, they are standing in the way of global change… the un-leveraging of debt by consumers and businesses!
Recessions are a natural feature of the inventory cycle. The economy gets a little over-stocked and has to clear the shelves. Prices are cut. A few people are laid off. And then, after a few months, everyone is back in business.
Depressions, on the other hand, are a natural feature of a much bigger cycle. A part of capitalism that people love to talk about when the going is good... but despise when it turns against them. We’re talking about what is described as “creative destruction.” Everyone loved “creative destruction” in the late ’90s – when they thought it added to their balance sheets. Now, they beg government to save them from it.
What we are witnessing in the economy is creative destruction at work. And what we are witnessing in politics is a bunch of simpletons trying to stop it.
What’s being destroyed? Trillions of dollars worth of asset values! Millions of jobs! Hundreds of thousands of businesses!
In a recession, the basic plan or formula for the economy is still valid. The economy just needs a little time... and maybe a little monetary boost... before it continues growing. Typically, inventories are sold down so a new burst of production can begin.
But in a depression, the problems are structural. Two such structural changes that are taking place…
- Permanent demand destruction from consumers.
- Massive de-leveraging of debt by consumers and businesses.
The consumer of today recognizes that the trillions of dollars poured into the US [from all over the world] and that is what supported their credit binge to spend and spend. The [almost] free money pushed the consumers to rush into buying products and services they did not really need, rush into tech stocks, then the rush into real estate, then the rush into commodities, and then rush into U.S. government bonds. Over the years all of these asset classes [except the U.S. Government Bonds for now] have blown-up in the consumers face. Not only that, the financial machinery that funneled trillions of dollars of the free worlds savings [from across the globe] into the US financial system has now blown-up as well and the money velocity has come to a screeching halt. Banks are over leveraged, they don’t trust each others financial health and they are not lending.
Consumers are not borrowing either; they are downsizing, de-leveraging debt and cutting cost…
- Banks are not lending to qualified consumers… but that could change;
- Consumers has little or no equity to borrow against… not going to change anytime soon;
- Days of free money are gone forever… because the savers from all over the world are now wise to the financial shenanigans of American financial wizards and are not looking to send their life savings to America any time soon;
- Consumers are now motivated, by the blow-up of almost all asset classes in their faces, to start saving money for their future commitments and retirement… going from negative savings to almost over 4% now;
- Consumers finally realize that they don’t really need three of everything [homes, cars, jewelry, minks/furs, TVs, cell phones, computers, and electronic gadgets].
- Consumers finally realize that they don’t need to buy a Hummer or new model car every other year;
- Consumer finally realizes the rising cost of energy for driving, heating and cooling… the present drop in cost is temporary we all know;
- Consumer finally realizes that the increasing cost of real estate taxes even though their homes are 40% less in value to-day… taxes always go up and not down;
- Consumers finally realize that they don’t need to re-model every five years and buy new appliances every three years;
- Consumers finally realize eating home can save them thousands of dollars over the course of the year;
- Consumers are loosing jobs left and right in all sectors of our economy… there are no safe heaven… not even in the health and consumer goods;
- Consumers are de-leveraging en-masse and there are no asset classes worth investing [speculating] at this time… and perhaps for a long time.
Businesses now see this consumer demand destruction as a clear reality and are adjusting their business models accordingly by cutting production, cutting CAPX, cutting operating costs, de-leveraging finances and letting employees go. And as such, eventually, after the initial denial period to accept demand destruction, there will be less demand for raw material, services, cash and credit from these businesses.
One way of understanding this is just to look at balance sheets. Whether you are a business or a family, you can only afford so much debt. When you get too much, you have to stop and pay it down. And when it becomes so great you can’t pay if off – because you don’t have enough income – you have to declare bankruptcy.
A depression is when a whole economy declares bankruptcy...or it should… because it can’t pay its debts. Businesses, for example, have been built for a level of demand that no longer exists. It is not a question of waiting a few months. By the time consumers are ready to buy again, the whole economy will have moved on. Imagine, for example, a guy who built a nationwide chain of stores just to sell high-tech gadgets to the 20 something. It may have been a great success – for a while. And he took out huge loans so he could expand... and take advantage of the demand. But then comes the demand destruction… the depression. He says to himself: "I’ll just get some more financing and wait it out.” But who’s going to lend to him? By the time the kids begin buying again, these high-tech gizmos will be just like the VCRs. His business is history. His lenders have lost money. The loans should be written off and the business should be destroyed, not mummified and preserved.
A depression is when the whole economy changes its business plan, in other words. And that takes time and creative destruction.
How much time? Well, in the United States alone there is about $6 trillion too much private debt... $1 trillion too much output capacity... and millions of “excess” workers. How long will it take to retrain, retool, and re-absorb these excesses?
I don’t know. The last depression took about 20 years... and a major war (WWII)! Then, the United States was making the structural shift from a Japan-like capital investment-led economy to a post-WWII consumer-led economy.
In Japan itself, its post-WWII capital investment-led boom hit a wall of creative destruction in 1990. Now, 19 years have gone by and Japan is still adjusting to the new world economy.
In last weeks morning paper is a front-page article describing how Japan “wasted trillions” on its various stimulus programs.
The International Herald Tribune:
“Japan’s rural areas have been paved over and filled in with roads, dams, and other big infrastructure projects, the legacy of trillions of dollars spent to lift the economy from a severe downturn caused by the bursting of a real estate bubble in the late 1980s.”
Public spending was so aggressive it boosted Japan’s government debt to 180% of GDP – more than two times the current U.S. level. But did all that steel and cement buy Japan out of its slump? Answer is NO.
All I know so far is that this depression has wiped out more than $30 trillion of dollars’ worth of investors’ capital. I suspect it will wipe out another $30 trillion worth before its creative destruction is over.
My guess is that it will also destroy the U.S. consumer-economy model and the dollar-based world monetary system.
Our current financial crises are not an inventory-driven recession; this is a balance-sheet depression. The problem is not really an absence of credit, but an excess of debt. Throughout most of the post-WWII period, private sector debt in the USA, for example, equaled about 80% of GDP. In the ’90s and ’00s, debt rose to 140% of GDP. The difference is about $7 trillion. Until this debt is reduced, Americans will be reluctant to borrow or spend.
And it is not just the debt itself that must be eliminated. There are too many factories producing too many goods for too many people who can’t pay for them. You can see excess capacity in the unemployment lines too. Suddenly, the world seems not to need so many sales clerks, or welders, or brokers, or financial engineers. The United States alone may have $1 trillion of excess output capacity and 20 million people too many in the workforce.
Debt and excess capacity can be liquidated quickly – as they were in the panics of the 19th century – through bankruptcies and defaults. But, today, liquidation would have to take place over the dead body of U.S. Fed chief, Ben Bernanke. And that's not going to happen.
Another way to eliminate debt and excess capacity is to work your way out of them. Unfortunately, that process takes a long time – especially with the Fed keeping zombie firms alive and fighting the correction every step of the way. Japan has been working off its excess capacity for the last 19 years. Property prices in major Japanese cities began going down in 1991. They fell for the next 13 years, bottoming out in 2004, 87% below their peak.
Few policymakers will want to follow the Japanese example – certainly not the policymakers in the USA. Americans lack several things the Japanese had... such as patience, a favorable trade balance and a thick cushion of domestic savings. On the other hand we have one thing the Japanese did not have; America can pay its debts in a currency it alone controls. If it chooses, it can resort to a third way to get the traffic moving; it can inflate away the debt.
“We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation,” wrote Bernanke. But with $8 trillion in excess debt and spare output capacity, neither business nor labor has any pricing power.
Normally, it would take a long time before inflation returns. However, if a government [like the US] is determined enough... it can flood the economy with printed or borrowed money... and destroy its own currency. Only a few weeks ago, Zimbabwe produced a monetary freak – the world’s first one trillion dollar note. Then, it had a value of about 26 euros. Now, you can use it to buy a cup of coffee in Harare – provided you also have $3 US. On Wednesday of last week, banks were supposed to begin distributing the new currency – in which all 12 zeros on the trillion-dollar note have been lopped off.
The architect of this monetary madness [Mr. Gono of Zimbabwe] was recently asked his views:
“I sit back and see the world today crying over the recent credit crunch, becoming hysterical about something which has not even lasted for a year, and I have been living with it for 10 years. I had to find myself printing money. I found myself doing extraordinary things that aren’t in the textbooks. Then the IMF asked the US to please print money. I began to see the whole world now in a mode of practicing what they have been saying I should not.”
Mr. Gono added so many zeros to the Zimbabwe national currency that he practically gave inflation a bad name. But now it is inflation that people want in the US… desperately.
The Fed has embarked on several ways to inject money [freshly printed or borrowed] into the US economy in the hopes of re-inflating the bubble economy. If America were to follow Japan’s example, it would have to leave its interest rates near zero for the next decade... and add about $10 TRILLION to its public debt to fund the TARP 1 [$700 billion], stimulus plan [$1 trillion], asset backstops [$1 trillion], bad bank [$6 trillion], TARP 2 [$1 trillion] and so on. And if it got the same results as Japan, you’ll be able to sell your house in 2025 for the same price you paid in 1992.
You be the judge? Housing prices in Japan are now back down to where they were in 1975… nearly 90% below the late ’80s peak. And for the stocks? The Nikkei index is back down to where it was a quarter century ago. Stocks sell for half their book value – and they’re still considered too expensive for beaten-down, hyper-fearful Japanese investors. The downturn began in 1990. Over the following 19 years, it did more property damage than the Great Tokyo Fire of ’23 and the Enola Gay A-bomb combined, wiping out wealth equal to three times the country’s GDP. This was despite interest rates at zero... and trillions of dollars in stimulation.
But the simpletons in Washington have no other idea.
Consumers are saving more and spending less. It is likely that US consumers are going to push the savings rate back up to 6% (or more). Total US net worth decreased by $7 trillion through the third quarter of 2008, from housing and stock market losses. The trend suggests that could easily be up another $6 to $7 trillion by the end of 4th quarter. Speculations are that is could easily be $15 trillion by the end of the cycle. That is a massive amount of wealth destruction. And while the absolute numbers are not as large in the rest of the world, the relative magnitudes are. This is a truly global recession. Economists say that anything below +2.5% in world growth are a global recession. We are down to -0.5% and falling.
Little by little, the word “depression” is creeping into the press. Yesterday, GE’s CEO warned that the downturn could turn into a depression. And Britain’s Prime Minister, Gordon Brown, let slip the d-word during a parliamentary session.
But not to worry... the simpletons are on the case. The price tag on President Obama’s emergency stimulus plan had risen to nearly $800 billion last time I looked. The Senate bowed to global scorn and ridicule, taking out many of the “Buy America” provisions. Of course, they didn’t do it as a matter of principle. Instead, someone must have warned them that if Americans insist on “buying American” the Chinese might insist on “investing Chinese.” And then the whole game would be up. The Ponzi scheme that is U.S. finance requires new money from foreigners in order to pay off the old money that foreigners put in last year and the year before.
So, the Fed are on the case. And they’re going to spend, spend, and spend... until the world finally wakes-up and stops buying [and parking money at] 0% T-bills by the trillions.
Yep, the Feds are on the case. But haven’t they been on the case for the last 18 months... ever since Bear Stearns went broke? And weren’t they on the case when they decided to let Lehman Bros. go broke... while saving AIG… and folding Merrill Lynch into BOA?
And aren’t the Feds’ new plans to save the economy little different from their last plans? Bailouts, stimulus, tax breaks, new, looser credit, bad bank... aren’t these the same things that were used not only for the last 18 months... but also in the Great Depression of the ’30s... and in Japan in the ’90s? Have they ever worked? Nope… never!
Of course, there’s a good reason why they don’t work. As you will see, you can’t really buy your way out of a depression. Because the problem is much deeper than just the short recession! The economy is not just taking a rest. It is dead. It needs to be restructured, not revived. And for that, the old structures must be destroyed. That’s what Schumpeter’s "creative destruction" is meant to do. But the Fed don’t appreciate it. They talk “change,” but the only change they want is for things to go back to the way they were. So, they’re trying to stop the correction. And they’re using every worn-out trick, every blunderbuss weapon and every pompous theory they can think of. Bailout the banks... create a ‘bad bank’... nationalize the banks... stop the foreclosures... send out checks... lower interest rates... build roads & bridges to nowhere – they’ll do it all. But it won’t work.
“From the Great Depression, to the stagflation of the seventies, to the current economic crisis caused by the housing bubble, every economic downturn suffered by this country over the past century can be traced to Federal Reserve policy. The Fed has followed a consistent policy of flooding the economy with easy money, leading to a misallocation of resources and an artificial ‘boom’ followed by a recession or depression when the Fed-created bubble bursts.”
“Though the Federal Reserve policy harms the average American, it benefits those in a position to take advantage of the cycles in monetary policy. The main beneficiaries are those who receive access to artificially inflated money and/or credit before the inflationary effects of the policy impact the entire economy. Federal Reserve policies also benefit big spending politicians who use the inflated currency created by the Fed to hide the true costs of the welfare-warfare state. It is time for Congress to put the interests of the American people ahead of special interests and their own appetite for big government.”
All these Fed bailout and stimulus measures are designed to encourage consumption... in order to support the old structures. But more consumption is just what the economy doesn’t need. It is in trouble because people have spent too much already and are in debt to their eye-balls. Now, they have to cut back and save... and when they do, every enterprise, speculative investment, and household that depended on excess consumption is in trouble.
And that’s where we are. In trouble!
At the beginning of a period of depression! The old structures must be swept away to make way for new ones.
Change! Can it be stopped? No we can’t!
“So, what’s the solution?”
“The solution to a depression is a depression.”
Businesses Beware:
The message for those businesses which are dependent on the US consumer: “your world is going to be smaller for a long time.” We are in a period where the economy is going through what economists call rationalization. We are going to have to reduce the number of retail stores, coffee shops, automobile plants, fast food restaurants, car dealerships, etc., until we get to a level that makes rational sense for the size of the economy. We just built too much stuff, launched too many stores, and created too much capacity for almost everything.
The idea for the business person today is to still be standing when we get through this, as we will. That is what free market economies do. The day will come when we get back to over 3% GDP growth. But it will be a rational growth based on real fundamentals, one that will last a long time. So hope is not a business strategy. You need to be planning for a lengthy recession [perhaps depression] and a very slow recovery.
And if your business is one that helps the producers cut costs… or improve production… then this is your time to shine? It is not clear what the stimulus plan will be like, but look at it to see if there is something you can do to get in the flow of that money. There are opportunities out there.
We were in a similar period of malaise in the late ‘70s. Everyone wondered where the new jobs would come from. The correct answer was, "I don't know, but they will." As it turned out, we saw the creation of whole new industries, which the government had little to do with. It is still the right answer: “I don’t know, but they will.”
The new industries that we will see next decade… biotech... energy… a new wireless telecom build-out? The correct stance is to be cautiously optimistic.
Consumers Beware:
So what’s on Obama’s plate? “Well, the first thing the new administration has to do is stabilize the banking system.” Things are still precarious with the banks. Liabilities exceed assets by a large margin. We will probably see more bank failures – small and even some large banks. That would hurt worldwide investor confidence and lead the stock markets going down. We could test the old lows of last fall… November 2008.
“The housing crunch still has more rope to hang out, as well. A lot of the problem is isolated in a few states and regions of states – California, Arizona, southern Florida, the New York City metropolitan area, Massachusetts and a few other places. But it affects a lot of people. We’re dealing with populous, overbuilt places. We are also on the cusp of a lot of failures of government entities, from localities and school districts to counties. We’re going to have a lot of municipal bond defaults. We’re going to see municipal bankruptcies. Some large states are insolvent. California can’t meet payroll.”
“The next big wave will be that consumer spending dries up. This will lead to a failure of retail businesses all over the country. It’s going to be a huge unwinding. We spent the past 25 years spending more than we could afford. Now we as a nation have to pay some big bills. It’s time to save. It’s a good thing, in the big scheme, for people to save. But it’s going to put a lot of pain into the retail sector of the economy. We’ve overbuilt retail, and everything that goes with it. We have:
- Too many retail stores.
- Too many buildings.
- Too much inventory.
- Too much production and shipping capacity.
- Too many container-ships unloading too much stuff made in China and elsewhere.
- And a lot of people are going to lose jobs. I mean a lot of people. Everywhere! There are no safe heavens… not healthcare… and not consumer goods.
“The next two years are going to stink for the economy. Obama will face one financial crisis after another. He’s going to hate Wall Street. He’s going to hate bankers. Every time he turns around, the money people are going to be screwing him. He’ll try to fix one problem, and five more problems will spring up like weeds.”
“The coming financial issues will test the ability of the legislative branch to act with integrity in the face of a media-driven clamor. States will be lining up to borrow money from the Fed just to pay unemployment compensation, let alone to fund Medicaid and road maintenance. It will test the legal system as well. Expect more petty crime and a lot more bankruptcy. But fewer people will get divorced. Who can afford that anymore?
“And think about the foreign policy issues that the financial crises will cause. Just think in terms that when US prosperity declines, it takes the world down with it. The economic contraction is going to set some societies back by decades. Will people take that lying down? Or will they riot in the streets and burn down the capitol building(s)? Expect a rash of failed states. I’ll be surprised at some of the names that fall off the map. Wow, we might look back and wish for the days when the world hated us (Americans) just because we invaded Iraq. Now they’ll blame us for stealing their future.
“Democrats will probably lose seats in the House and Senate in the 2010 elections, as well as in state legislatures and governorships. But Obama will be working his own game of building consensus. He’s from a new generation of politician. He’s not nearly as in-your-face confrontational as the Democrats of the 1960s and 1970s era. Obama will build coalitions out of whomever he can get on board. You might not like him on issues like gun control or abortion, but you’ll deal with him on tax cuts and energy investment.”
So where do we go from here? Well, here’s my [humble] advice...
- Build up some cash reserves. Got that? Hold Cash! Cash in the mattress. Cash in the bank. Don’t try to get too fancy. Just save some cash where you can get hold of it in case you need it pronto.
- Next, buy some precious metals like gold and silver. Bullion coins or bars are my favorites. Don’t get spooked out of precious metals if we see a price dip in the near to medium term. The dollar is in serious trouble, and eventually the precious metals will come back. Precious metals are a way of preserving your purchasing power over the long term.
- As for stocks, in the near future, we could see some severe market declines. Initially, this might look like large trading spikes up and down. Unless you are a serious trader, be careful about trying to “play” the swings. Don’t be afraid to sell any stock that makes you nervous. You have to be able to sleep at night.
- If you have a job, hang-on to it. Work extra time and find ways to help your company cut costs. Propose a [temporary] salary cut to help others keep their job.
- Try to preserve your current income stream with all your might and find ways to add a passive income stream from your savings, investments and other assets.
The idea for every person today is to still be standing when we get through all this, as we will.
That is what free market economies do.
Until we meet again,
Anant Goel
