Happy days are here again! Enjoy them while they last…
“Optimism builds,” says a headline in the Financial Times.
As predicted, the world markets are enjoying a bounce. People who had no idea there was anything wrong with the world financial system two years ago, now say the problem has been fixed.
Who fixed it? The people who had no idea what was wrong with it, of course.
What did they fix it with? The same thing that caused the problem they didn’t see – debt.
Who makes sure it won’t break again? The people who didn’t notice the wheels coming off the last time.
Yesterday, the Dow rose 214 points. Oil closed over $54. Gold ended the day over $900. And dollar sank to $1.33 per euro.
Most interesting…bond yields, though still pathetically low, are rising. The U.S. 10-year note yields more than 3%. The long bond yields more than 4%.
The longer these trends go on, the more reasons people will find to believe that it is not just a bounce…but another major boom.
New York-based Economic Cycle Research Institute says, “The U.S. is on the cusp of a growth rate cycle upturn,” the article explains.
Let’s look at whether this optimism is justified.
On the housing front…U.S. houses are down 30% from their highs. The Case-Shiller index of housing prices has fallen for 30 months in a row. Isn’t that enough?
Maybe. The latest data shows more sales – of new, as well as existing houses. And there are more housing starts too. But in the former boomiest states – California, Nevada and Florida – about half the sales are of foreclosed properties. These properties are hitting bargain prices…but pulling down the value of the entire housing stock. And there are still lots of houses to sell. So don’t expect any major turnaround in prices. If prices have hit bottom – which we doubt – gains are likely to be very small…and they’ll come very slowly.
When the housing crisis began, we estimated that prices needed to come down about 40% in order to make the average house affordable by the average person. But that was before the average person’s income came down. If the depression continues, as we think it will, house prices should come down a further 10% to 20%.
And don’t forget about the second wave of defaults headed our way. The Richebächer Letter’s Rob Parenteau tells us that in 2011, the “Option ARM” and “Alt-A” home loans will reset at a higher rate…and some unlucky homeowners could see their mortgage payments as much as double. Millions will see their wealth disappear…and the ripple effect it will have on the banks and economy as a whole will be devastating.
Besides, if the United States is entering the “worst downturn since the Great Recession,” who will have the money to buy a house? But that’s the issue. Maybe the world is not entering a major downturn, after all. Maybe it was just a case of mass hysteria…a panic, like the Y2K bug…or terrorism…or swine flu. Maybe people are now getting over it…and getting back to business, just like they did before.
Consumers are becoming bolder. Consumer confidence measures are about 20% below the baseline metric of 1985…but that’s a big improvement; they had been nearly 40% below the ’85 standard.
There is some evidence that consumers are returning to their bad habits, too. Consumer spending is picking up – at least, that’s what recent numbers from the discount stores show. They’re taking up cheap thrills and necessities again. But luxury shops are still reporting drops of about 20% per year.
Major stock markets have rebounded 20% and more. But the real excitement has come in emerging markets. A few months ago, it looked as though China would be unable to decouple from the developed world. They were stuck, said analysts, like a rusty sink drain. The Middle Kingdom was headed towards recession just like everyone else. But then those clever Chinese seem to have found a wrench big enough to pop the joint. Almost unbelievably, China seems to have pulled off the much desired “V-shaped recovery.” Instead, of contracting, China’s figures show it expanding at a more than 8% rate.
China might be lying, of course. It seems very unlikely to us that China could have recovered so quickly. This is not a recession, we keep saying. It’s a depression. And depressions demand structural changes – the kind that takes time.
Besides, eyewitness reports tell a story that sounds like a cross between “Grapes of Wrath and a repeat of Mao’s Long March.” That is Elliot Wilson’s description after a recent trip into the heartland of the communist giant.
“Once-bustling malls are now empty,” Wilson continues. “Plaza 66 in Shanghai, owned by Hong Kong-listed Hang Lung Properties, is a case in point. On a Friday afternoon, the 51,700 square meters of high-end retail space boasted exactly 11 customers…
“Everywhere’s the same. I talk to the concierges of Shanghai’s leading hotels, always men in the know. At the JC Mandarin, occupancy is at 40 percent in early February, against 80% a year ago. At the vast JW Marriott, it’s even worse; just 25%…”
Office complexes too are “empty, empty, empty…Gemdale… 50 floors of office space completed last summer are all empty…”
But what the heck? Maybe we’re wrong. Maybe China is already recovering. It may be a structural depression – but only for the developed countries, particularly the United States. Maybe it’s only a recession for China. And maybe it’s over. Seems almost unbelievable…but now, with so many wonders to wonder about we wonder why we bother to wonder at all.
Besides, other developing economies are reporting the same things – increases in exports after a catastrophic collapse at the end of the last year. You can measure the collapse easily just by looking at the Baltic Dry Index – which keeps track of bulk shipping rates. It fell by more than 90% last year. From its low, it’s doubled – up 100%. But that still leaves it down 80% from a year ago.
Stock markets in emerging markets show similar increases. Brazil’s stock market is up almost 90% from its low. South Korean stocks are up 71%. And Chinese stocks – those listed on the Shanghai exchange – have gained 50%.
Apparently, someone thinks the worst is over. Maybe that person is right. But we doubt that this rebound is the sign of a new, healthy boom. Credit expanded for half a century. The Bubble Epoch at its end caused trillions of dollars worth of errors. Many of those errors have already been corrected. But the economy the bubble built remains unreconstructed. Same mismanaged companies…same mismanaged regulators…same mismanaged banks. Exporting nations had gotten into the habit of earning net sales from the U.S.A. of $2 billion per day. Those earnings provided much of the speculative capital that created the Bubble Epoch prices. But that money has all but disappeared. And there’s not much chance that it will return anytime soon.
Instead of a healthy new boom, our guess is that the world is enjoying a sick echo of the old one. Governments, led by the U.S.A., attempt to reinflate the bubble with guarantees and giveaways equal to an entire year’s annual output of the world’s largest economy. Since every penny of this money is borrowed, it makes sense that every penny will have to be withdrawn from the world economy at some point.
In fact, economists are already looking ahead to the moment when deflation fears give way to inflation fears.
“Inflation Nation,” is the title of an editorial in today’s International Herald Tribune. In it, Alan Meltzer argues, “If President Obama and the Fed continue down their current path, we could see a repeat of those dreadful inflation years [the 1970s].”
Professor Meltzer reminds us that cutting off the inflation of the ’70s wasn’t easy. The feds turned the screws…and let the prime rate go above 21%. Of course, today’s Fed has this information. And Paul Volcker, who was Fed chairman during that period, is now an economic advisor to Barack Obama. Still, “I do not worry about their knowledge or technical expertise,” continues Mr. Meltzer, “What I doubt is the commitment of the administration and the autonomy of the Federal Reserve … Under Bernanke, the Fed has sacrificed its independence and become the monetary arm of the Treasury…”
“The Fed’s job is to take the punch bowl away,” said an Eisenhower era chief. But we have come a long way since the Ike and Dick years. This time, the inflationary party is likely to get out of control, happy days will be here for a while…and then some very sad days are likely.
When the I.O.U.S.A. team interviewed Paul Volcker in December of 2007, he said, “…when I look back on my lifetime, it is obvious that letting inflation get a little bit out of control and not dealing with economic problems effectively in the’70s led to a very uncomfortable crisis. We don’t want to have to go through big recessions again to teach people fiscal responsibility. Instead, we should anticipate what needs to be done while maintaining the growth of the economy. And the threat will always be an unstable economy and an unstable currency. And that’s not just destructive to economic life, but it can be destructive to America’s position in the world, which to me is the greatest concern.”
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