If You Think Things are Getting Better, Think Again

With the market continuing to move higher in recent weeks, the onus lies squarely on the bulls now to produce evidence of an economic rebound in the coming months.  The powerful rally in global equities has forced the staunchest bears to take notice of, at the very least, rising asset prices and a thawing out of credit conditions.  Throughout this rally, the major theme we have heard from the bulls is that “the pace of the decline is slowing”.  But does a slower rate of decline necessarily warrant a near 40% move off the bottom for the S&P 500, one of the biggest moves in the history of the index?  Are we really starting to see “green shoots” in the economy like the media says and the government would like us to believe?  Unfortunately, due to the massive government intervention in the markets, asset prices may be improving, but the global and domestic economy are still very weak, and don’t look like they can improve anytime soon.  With the astronomical amount of money the Federal Reserve has thrown at the economy, it’s no surprise that asset prices have been moving higher in recent months.  The total amount spent by the government, in addition to all of the loan guarantees, 0% interest rates, and treasury purchases is in now the range of 5 to 6 trillion dollars   To put this into perspective, less than 8 years ago our entire national debt was 3 trillion dollars.  It is my strong view now, that sooner (rather than later) the markets, most likely the currency or bond market or a combination of both, will force the Treasury and Federal Reserve back into the same precarious position of making the tough choice they should have made almost a year and trillions of dollars ago, which was to just let the market work this mess out on its own, so the country and world can truly begin the process of rebuilding.  The unintended consequences of the actions the government has chosen to embark on are just now starting to show in our economy through the troubles seen at the regional banks, or the continued funding and pension crunch in the state and local governments, and of course the daily decline in the dollar that we are all getting used to now.   Not to mention the overwhelming evidence of a credit card implosion that can further derail economic recovery.  While we applaud President Obama’s new efforts on the credit card pandemic, no one wants to really open the Pandora’s Box of the staggering amount of principal credit card debt that will never be repaid.   In my opinion, while the markets may have improved, the improvement was mainly due to the money printing by the Federal Reserve and is not reflective of the real economy which is still very weak and struggling with mountains of debt at the household level.

For those who haven’t read my previous post which refers to a potential currency crisis at home and abroad, please do so.  Already at the time of this writing, Standard and Poors is warning that the United Kingdom may lose its AAA credit rating and rumors abound that the US is next.  Immediately on these rumors, yields on US Treasury debt spiked higher to prices we haven’t seen in almost 6 months.  This is in the face of Mr. Bernanke’s continued bond purchase plan in an attempt to keep rates low.  The cat is now out of the bag.  The entire world knows now that the US and UK will do whatever it takes to save already insolvent banks, including and especially devaluing the currency.  Readers of the LRG Capital Report knew the time would come where US debt would come under pressure but that day has come quicker than anyone has expected.  We are now pushing our forecast for an outright currency crisis to sometime this fall or winter as the world begins to slow its purchases of US Dollar denominated assets that are losing money due to a declining currency.  We would caution investors who believe, like our friends at the Fed and Treasury, that a devalued currency would increase exports and stoke just the right amount of inflation.  The truth is that throughout history governments have NEVER been successful at what the Fed is attempting (reinflate a bubble without causing high inflation in other areas of the economy).  In fact, now the odds are more in favor of higher prices for food and energy and interest rates.  The cross currents the market has shown recently have been extremely negative.  The normal movements we have been used to since 2001, (or about the time the dollar began its secular decline) was on days the dollar falls, stocks would move higher due to higher commodity prices and in turn more profitable energy sector.  Over the past week or so however, we have seen the dollar decline, but at the same time commodity and US stocks falling.  This has mainly been due to the rumors that the US will lose its AAA credit rating (due to excessive debt and money printing by the government) which in turn would make it more difficult for everyone, government and private sector included, to borrow at favorable terms.  I want to personally congratulate Mr. Bernanke for potentially ruining the dollar, and now bonds, and thus the equity markets to save Wall Street. 

As far as the real economy is concerned, we must now wait and see just what kind of recovery we should expect.  We have been told by the Federal Reserve and Treasury that we should not expect to see jobs come back any time soon.  A recovery without jobs is like a birthday party with no cake.  The truth is that over the past year or so it has been the state and local governments that have done most of the new hiring.  Now, as Californians know all too well, some states are facing huge deficits and some face cash shortages.  After delaying state refund checks earlier this year, the Golden State is on the verge of running out of cash again as early as July.   With the resounding defeat of Props 1A and 1E, voters essentially told lawmakers that its time for them to finally take responsibility for their budget and stop the tax increases.  The idea of raising taxes or borrowing more money only to delay the inevitable is complete lunacy.  Three areas where the state needs to address its problems are the overpromises on pensions, union wages and a bloated budget.  The day of reckoning for decades of wasteful spending has arrived for California as well as other state and local governments across the US.  Until these structural problems are addressed by legislators, we are only delaying a worse outcome down the road.

Finally, the free markets seem to be working with respect to the Chrysler bankruptcy and inevitable General Motors bankruptcy.  Maybe the real green shoots are that the bankruptcies of Chrysler and GM (as they are bankrupt) are now showing what markets are supposed to do: stop rewarding failure so smart and productive industries, whatever they may be, can successfully compete on any level.  I applaud the Obama administration, along with the executives and counsel at Chrysler who are moving at warp speed to complete the Chrysler bankruptcy.  It’s hard to imagine that a company with the size and reach of Chrysler could complete a bankruptcy filing within 30 days, but they seem to be pulling it off.  Bankruptcy has always been the best course for both Chrysler and GM.  This will allow the companies to truly restructure labor contracts that don’t make sense and in GM’s case, may even allow it to possibly survive as a functional company.  Without bankruptcy, it will just be the same old, same old and we the taxpayers will be forced to continually fund the company’s shortfalls. 

Comments

[Anonymous]

Agree with everything you said in your latest blog, except for praise of the Chrysler and GM bankruptcies. They are not real bankruptcies in the traditional sense, since they've been structured by the Obama administration to reward the UAW for political support in the election by minimizing damage to the UAW and its members, rather than to focus on creating a GM and a Chrysler that can compete in the marketplace after bankruptcy. They will both still be saddled with unsustainable cost structures and are doomed for Chapter 7 liquidations in the not too distant future.

[Larry Goldfarb]

It seems prescient that only a few days after my post above, Bernanke came out with the following comments as reported in the WSJ and the New York Times,

“Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth,” he said. “Even as we take steps to address the recession and threats to financial stability, maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance.”

I also found the below posting which compliments my previous post: http://finance.yahoo.com/tech-ticker/article/259145/Bernanke-Freaks-Out-About-Obama%27s-Spending-and-Debt-Plans?tickers=xlf,dia,spyf

Just today, Nouriel Roubini, who I’ve applauded many times for his accurate observations and predictions about the economic mess we are in, commented on his views of where we are at and where we are heading: http://finance.yahoo.com/tech-ticker/article/260080/Roubini-Scoffs-at-Green-Shoots-Sees-Dangerous-Complacency?tickers=dia,spy,qqq,xlf?sec=topStories&pos=9&asset=&ccode.

We at the LRG Capital Report are hoping that as these ideas become popular, opinion will shift, taxpayers will get fed up and the government will begin to realize what it should have done almost a year ago: let the market correct itself. We can only hope that this will happen sooner rather than later.