It looks like a recovery. It feels like a recovery. So is it really a recovery? Or is it a big financial market fake out?
Your editor scratched his chin over this question while thumbing through a copy of the Financial Times over the weekend in the shadow of the le Grand Arche de la Defense west of Paris. You know the one. It’s a modern, shiny, gleaming version of the Arch de la Triomphe.
Just why we chose to stay in the business district of Paris rather than down in the middle of the city…well it had to be a cost saving decision. It certainly wasn’t aesthetic. This is Paris without the charm, pretty trees, and rich smelling coffee. In fact, with all the glass buildings and paved pathways, it could be any city anywhere during any credit boom. It’s just another example of finance dominating the global economy.
And that returns us to the big question as we open the week. The financial markets have clearly rallied. If it’s true that markets lead economies, markets are telling us that things are going to get much better. The FTSE index of emerging markets is up 99% from its March lows. The S&P 500 is up nearly 60%. And gold itself is up 25%, with much of that move coming in the last few weeks. This is what happened in 2003, all asset classes went up simultaneously, riding the global money tide.
David Rosenberg, who used to work at Merrill Lynch but is now the chief economist and strategist at Gluskin Sheff, says that something is fishy about this rally. It’s come, at least in the U.S., as the economy lost another 2.5 million jobs. “Typically, by the time we are up 60%, the economy is well into the third year of recovery; we are not usually engaged in a debate as to what month the recession ended.”
Fine, you may be thinking. Employment is a lagging indicator. It will be the last thing that picks up. But it will pick up. In the meantime, how can you ignore what the markets are saying?
One answer might be that the markets are rigged. Or, if that is too indelicate, you could say that the surge of liquidity provided by central banks has allowed banks to load up on assets again, producing paper gains which boosted earnings and justified-in the minds of some insane people-higher valuations for stocks. The bull is back baby! The economy should quite being such a party pooper and get with the program.
For example, during the same time that the U.S. economy has shrunk by about $400 billion in terms of GDP, the balance sheet of the Federal Reserve has grown by over $1 trillion. Japan has the same problem, a shrinking real economy and an expanding central bank balance sheet. GDP has fallen by £16 billion in the UK, but according the FT’s Lex Column, the Bank of England has injected ten times that amount into the economy.
What does it all add up to? Why isn’t an increase in credit leading to growth in the real economy? All that new money is not leading to a lending boom with renewed business investment that creates jobs and a recovery. Instead, it’s leading to forced speculation in the stock market which is driving asset prices higher. This is the famous problem Alan Greenspan had with low interest rates. You can turn the credit spigot on, but you just never know where the money is going to flow.
Right now, it’s flowing into stocks. Lex says that since Lehman collapsed, “US banks have increased their assets by 10 percent to $14.2 trillion.” Rather than shrinking their balance sheets, the banks seem to have escaped the push for regulatory reform and actually loaded up again on free money for a credit-fuelled bender. Leverage is in vogue again, as are risk assets.
But we have no reason to believe this is going to end any differently than the last leveraged boom. We know how those end. We’ve seen bubbles popping steadily since 2000. First it was Internet and telecom stocks. Then emerging markets. Then common stocks. Then the commodities sector got pounded. And don’t even get us started on how bad an investment sovereign government bonds issued by debtor countries are going to be.
All of that might sound unnecessarily grim for an Australian-based investor wandering the streets of Paris in late September. Can’t we manage to say anything positive? Well….yes, we can! For example, last night’s dinner of simple farm-style chicken in the shadow of the Sorbonne was…well it was excellent.
But what about investing? If you’re going to have a plan for the next five years that takes into account this attempt to reflate the financial economy, there are a few things worth keeping in mind. First, it’s going to fail, and probably spectacularly so. That failure will be accompanied by an even greater expansion of government debt.
For example, the Times of London is reporting that Britain’s net debt is growing at a rate of nearly six thousand pounds per second. Tax receipts are plunging. And politicians, jack asses that they are, are actually making even more promises to deliver things they can’t begin to pay for now.
We think they key idea in all of this is that you’re going to witness a transfer of ownership in the underlying capital assets of the global economy. The big question is will you profit from it or be victimised by it? We reckon that if we’re right-and if you can anticipate the general progression of events-you can stay one step ahead of the curve.
Easier said than done, right? So for the remainder of the week, we’re going to go back and review our proposal for a “Permanent Portfolio.” It will be based on a forecast of more debt deflation…and then rapid inflation.
Yes, it sounds tricky. But this isn’t the first time this sort of thing has happened. Tomorrow, we’ll take you back to one of the first “Great Inflations” Europe experienced and show you how it literally capitalised a new entrepreneurial class for the next three hundred years. Until then!
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