No Doubt About the Road Ahead

Why the US Economic Outlook is Only Facing One Direction

Another week gone by. Nothing has been learned. Nothing has been proven. Nothing has been decided.

In the markets, we mean. It looks like the stock market is finally rolling over. After a big drop on Wednesday, the Dow followed up with a modest drop yesterday – down another 58 points.

Is the market really headed down? We’ve been wrong about it before. About the timing, that is. But we still have little doubt that this market is headed down. Why? That’s just the way it works. After hitting extraordinary highs, we must have extraordinary lows in the forecast. Winter follows summer, no?

You can imagine as many reasons why stocks might want to go down as we can. Households are de-leveraging. People are getting older and shopping less. Savings rates are going up. Housing is underwater and sinking. Unemployment is nearly 10% officially…much higher than that in reality. The US is broke. The empire is probably rolling over too. Emerging markets are leaner, faster, more solvent and more competitive. We now have to compete on both ends – sales and raw materials – with 3 billion people who do not have to carry the burdens of success on their backs.

Do we have to go on?

Of course, Mr. Market can do what he wants. He won’t get any argument from us. But we’re pretty sure he’s ready to take a long walk down a long, lonely road.

Want to see the roadside attractions? Just look out the window. The New York Times:

During the great housing boom, homeowners nationwide borrowed a trillion dollars from banks, using the soaring value of their houses as security. Now the money has been spent and struggling borrowers are unable or unwilling to pay it back.

The delinquency rate on home equity loans is higher than all other types of consumer loans, including auto loans, boat loans, personal loans and even bank cards like Visa and MasterCard, according to the American Bankers Association.

Lenders say they are trying to recover some of that money but their success has been limited, in part because so many borrowers threaten bankruptcy and because the value of the homes, the collateral backing the loans, has often disappeared.

The result is one of the paradoxes of the recession: the more money you borrowed, the less likely you will have to pay up.

For two years, we’ve been talking about US household de-leveraging. Some of the debt is paid off. But much of it just disappears. Here’s how; the TIMES continues:

“When houses were doubling in value, mom and pop making $80,000 a year were taking out $300,000 home equity loans for new cars and boats,” said Christopher A. Combs, a real estate lawyer here [in Phoenix], where the problem is especially pronounced. “Their chances are pretty good of walking away and not having the bank collect.”

Lenders wrote off as uncollectible $11.1 billion in home equity loans and $19.9 billion in home equity lines of credit in 2009, more than they wrote off on primary mortgages , government data shows. So far this year, the trend is the same, with combined write-offs of $7.88 billion in the first quarter.

Even when a lender forces a borrower to settle through legal action, it can rarely extract more than 10 cents on the dollar. “People got 90 cents for free,” Mr. Combs said. “It rewards immorality, to some extent.”

The amount of bad home equity loan business during the boom is incalculable and in retrospect inexplicable, housing experts say. Most of the debt is still on the books of the lenders, which include Bank of America, Citigroup and JPMorgan Chase.

Yes, dear reader, we are on a long, lonely road. Want to know where that road leads? More on that, after today’s column…

And where does that long and winding road lead, dear reader? To Japan! Here’s Bloomberg:

The US is no longer an engine for the global economy and may suffer deflation sometime in the next three years, said Genji Tsukatani, head of fixed income at the Japanese unit of Schroder Investment Management Ltd.

Ten-year Treasury yields slid to a 16-month low after the Federal Reserve said yesterday the US economic recovery will be “more modest” than previously anticipated. The spread between yields on US and Japanese 10-year debt is at the narrowest since May 2009.

“The aftereffects of the credit bubble along with the aging population mean it’s possible that the US will slip into deflation” in the next three years, said Tsukatani, whose company manages about $211 billion in assets globally. “If real interest rates fall in the US, it’s likely to drag down those in Japan.”

Tsukatani said he derives real interest rates by subtracting inflation rates from 10-year bond yields. Deflation increases the value of the fixed payment from bonds.

Scott Mather, head of global portfolio management at Pacific Investment Management Co., wrote in an article this week that “the risk is rising” that the US will follow a similar path to Japan’s. St. Louis Fed President James Bullard wrote in a report released last month that the US is “closer to a Japanese-style outcome than any time in recent history.”

“The US hasn’t been an engine for the world’s economy since around 2005 but it’s being driven by countries like China and India whose economies grow 8, 9 percent,” Tsukatani said. “With slowing population growth and more emphasis on debt reduction, the US economy probably won’t grow that much.”

A total of 12.8 percent of the US population was 65 years or older at the end of 2009, up from 11.3 percent in 1980, Bloomberg show. That compared with 22.2 percent in Japan.

Meanwhile, the price of gold took off yesterday. Up $17 to $1,216. It didn’t make much sense. The rest of the news is recessionary, deflationary and dreary. Why does gold still glitter?

We don’t know. Maybe investors are thinking what we’re thinking: that the feds will get desperate, sooner or later. They won’t be able to resist the allure of free money. Then, even in the midst of a de- leveraging cycle, the price of gold will soar.


Bill Bonner,
for Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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