asiseeitblog

If nothing else, you have to give credit to the Tea Party to have been able to change the dialogue in this country from “how to stimulate the economy towards more growth” to “how to reign in and reduce the deficit”. It usually takes many years to manufacture such a change in a national dialogue, and this has been done in about a year’s time.

What no one is talking about is how the deficit is measured. We owe approximately $14.3 trillion with a Gross Domestic Product of about $14.8 Trillion. That’s why you hear that the US debt is almost 100% of GDP and that such a percentage puts us in the company of the PIIGS in the European Union (Portugal, Italy, Ireland, Greece and Spain).

While that is a convenient truth, it really does not speak to the core of the matter. Approximately $6+ Trillion of that debt is owed to the American people: think of that, perhaps, as loans from family members. Approximately $8+ Trillion is owed to others such as China and Germany: think of that as the bank.

If you only consider how much of the debt is owed to foreign entities, then that percentage drops to 57% which is quite manageable.

It does no good to demonize all debt. That is inaccurate, and inaccurate representations can lead to poor decisions. The easiest and most efficient way for this country to pay down its debt will be by employing its citizens: productive citizens pay taxes and buy things that employ other productive citizens. Yes, we must control our spending along the way, but we should not be taking that step in preference to those actions which will enhance our productivity.

The direction of the US Congress over this past month has reminded me of what happened during the 1930’s when we were trying to extricate our economy from the clutches of the Great Depression. We had made some progress by 1937. Unemployment was down to 20% from 25% , and the economy was showing signs of growth. And then the Federal Reserve got “cold feet”: it feared the rise of inflation so it raised interest rates. The result? By the eve of WWII, we once again had 25% unemployment.

This time there is, in my opinion, no doubt that the US economy, as it struggles to gain some traction, needs more stimulus. Perhaps many of you remember when cars had carburetors. If you ran out of gas, what did you have to do to get it started? Yes, you had to add gas, but if you wanted the engine to start without having to crank it for a long time, you also took off the air filter and added a little gas to the carburetor. Remember that?

That’s how I envision the US economy. We need to add gas to the carburetor, but now the whole discussion has been changed to controlling the deficit because many politicians have gotten “cold feet”.  I fear this may mean that we’ll still be trying to work ourselves out of this depression for many more years.

I think this must have been a very unusual recession. And I am using the past tense as our government would like me to do.

First off, a recession is declared following two quarters of negative “growth”. But not this one. This recession was declared based on unemployment numbers rising even though the economy was still generating a positive rate of growth.

Now the end of the recession has been declared by a positive rate of growth and not a decline in unemployment. Doesn’t that seem a bit strange? Shouldn’t a single measure be used to declare the beginning and the end of the recession? This just seems like a blatant attempt to politically manipulate the reality that Americans are feeling: there is no end yet to this recession.

Is the economy recovering? Are we getting better? I would say that that is indeed the case. The patient is recovering, but slowly. It will take several years before this patient is back to his old self, and even then he will be different.

So how to proceed? Well, I think that investments are going to generate some positive returns this year…unless we have another unforeseen crisis. Could that happen? Could we have another Black Swan so soon? Anything is possible in this world, isn’t it?

The future, of course, is not clear. Industrial Production has been falling as has been Global Shipping. These measures are often seen as the “canaries in the coal mine.” They are often precursors that everything is not as it may seem. In addition, Interest Rates and Fuel Costs have been rising which can hobble this fragile economic recovery.

I for one don’t believe this economy will experience a full recovery until housing and autors pick back up. We all know about housing, but if you have kept track of auto sales, you’ll notice that, at its worst, the industry was selling at a rate of about 11.5 million vehicles per year. Now it looks like it will be close to 13.5 million in 2010. At the top, it was 17 million. So we’re not back yet.

As you read this, the election cycle for 2010 will have mercifully come to a close. Now we should get about 12 months before the next onslaught of electioneering begins for the presidential election.

This sure is tiresome. However, I guess it’s one of the privileges of having a democracy.

I do think that one thing that has not been addressed in this election, aside from all the issues that have been ignored in favor of negative advertising, is the worsening income inequality in our country.

This negative distribution of wealth essentially started with the Reagan Administration. Since that time, about 40% of all household income gains over the last 30 years has gone to the richest 1% of Americans.

Do you feel like you’re part of that 1%? If not, then essentially you’ve been in the same place for a generation.

I always say that people will not willingly starve to death. They will fight, claw, cheat and do anything they can to survive. There are some problems, then, that such an unequal distribution of wealth in this country can begin to create.

There is the possibility that the American public, faced with the possible development of an economic aristocracy that will be able to create legislatures which are sensitive to its needs, will begin to act aggressively against it.

Here are some possibilities that come to mind:

1)      Legislation to require those with great incomes to fund certain social measures. We have already had that occur in California.

2)      Candidates who run for office on a populist platform of taking from the “rich” and supporting the “middle class.”

3)      Demagoguery in the form of a charismatic “leader” who channels the feelings of anger and unfairness against a segment of our society. We’ve seen some of that process occur when referring to those who continued to received large bonuses on Wall Street even though our economy was imploding.

Perhaps some of these things won’t be that bad, but before we even get to that point, there will be even more anger expressed in our culture. That can never be a good thing. The last thing that any of us would want is an ”us-and-them” mentality that pervades our decision-making. It just makes it that much more difficult to develop good solutions.

H.L. Mencken once said that, “For every complex problem, there is an answer that is clear, simple and wrong.”

I love that quote because there is a desire among a certain segment of the electorate who would just like to see a simple answer to all of our problems. That segment would like us to return to the “good old days.”

But, of course, that is never, ever possible. It reminds me of the nostalgia that often surrounds the decade of the 1950’s which was a good decade if you were a white Protestant Male. Not such a great decade, though, if you were black (especially in the South) or a woman or Jewish or any other minority. Then it was a much less generous time.

Many people worry about the deficit, and how it’s just spiraling out of control. There’s no doubt we’re going to have to corral this Hydra-headed monster. But how?

Well, in 1937, the Federal Reserve wondered about the same thing and decided to raise interest rates in order to control inflation. What happened next was everyone’s nightmare: the economy, which had been struggling to come out of the Great Depresssion for 5 years, was plunged back into it. Since the coming year was a midterm election year, the Administration decided to call it a Recession. But the facts were the same, no matter what it was called. Unemployment increased back up to 25%, just as it had at the depth of the Great Depression.

And don’t forget, we never solved the Great Depression. We got WWII, but who wants to lose 400,000 men to try to straighten out the economy? In 1944, we were spending so much money on the war that it was the equivalent in today’s dollars of injecting 7 trillion dollars into the economy. That’s certainly not going to happen this time.

Here are the bald facts: the Federal Reserve, in its efforts to keep the economy from a death spiral into another Great Depression, has incurred far more debt than any stimulus bill has done to date. The markets are feeding off of this stimulus right now so there’s nothing that I can see in the stock market that looks like a good reason for it to grow, even if you look out 6-9 months.

Somehow, we’ll need to pay down that debt. How should we do it? There is a phenomenal amount spent on subsidies in the form of tax breaks. For example, how about being able to deduct the interest on a second mortgage. You have to ask yourself, how many people in America can afford two places. Even being able to deduct the interest on a mortgage on your residence is a subsidy.

When people talk about how to balance the budget and how to pay down the debt, they’re almost always talking about expenses and subsidies that effect someone else. Not ourselves. Sure, it’s easy to point to the agricultural subsidies because most of those dollars go to the top 10% of farms, which are corporate farms. Won’t that then translate into an increase in the cost of food? Probably.

Well, then, how do we pay this debt down?

Now, obviously, I’m not in the business of designing tax policy, and like everyone on this earth, I would love to see lower taxes for myself first and then for others. But no matter how many programs are cut and how soon we get out of the Middle East, there will be, in my humble opinion, no way to reduce this deficit without some form of scaling back, without some form of sacrifice from everyone.

I’m sorry. I wish the news were different. Just remember Mencken’s quote: “For every complex problem, there is an answer that is clear, simple and wrong.”

 Economic policy is always about Winners and Losers. In essence, it’s what can be called a “zero sum” game in that when one person wins, someone else has to lose. Now, that “loss” may not mean that someone lost money but that an opportunity was lost. It can still be a loss just the same in how it effects a person’s finances.

 If you look at the Fed’s policies at this time, the Fed is choosing the “Winners” and “Losers”. It always does. And it has chosen Savers to be the losers in this scenario. It is saying that all those who’ve saved their money will not earn much interest on that money in order to make money more easily available to those who will buy things…homes and cars, for example. Is that fair? Well, not really. It means that all of those who are using savings for income have had a dramatic pay cut over the past two years. And that pay cut is continuing even as I am writing this blog.

 So who’s winning? Well, if you are looking to buy a house or to refinance, the rates are at historic lows. In some ways, the lowering of the interest rates has been uneven in whom it has benefited. Has your credit card interest been a lot lower? No, it has not, though it should be because the banks are paying almost nothing for the money. But on the other hand, the banks are beginning to show healthy balance sheets from earning all that interest while borrowing it from the Fed at almost no interest rate. So a winner, in this sense, is the bank with you, if you owe money on a credit card, the loser. Not so much fun, is it?

 Now I’m hearing that a lot of our problems are the fault of this administration. I get confused by that argument. First, the economy tanked during the last 8-year administration. Both heads of the Fed were appointed by the last administration, Greenspan and Bernanke, and are Republicans, and yet Bernanke was confirmed by a Democratic Congress. So I find it difficult to ascribe our difficulties to the present administration, or really, to any one party. Why do I say that?  Because Bernanke is a Republican and Obama is a Democrat, and yet they both have the same view of the economy. Actually, there is a measure of bipartisanship being exercised, just not in the Congress.

 All of us (with the exception of a very, very few) are in this “boat” together. We all must bail it out together to survive. Some cannot refuse to help bail out the boat because they don’t like the way it’s being done and they would prefer another way to organize that activity. We don’t have the time, and, really, we cannot afford the luxury of finger-pointing, political gamesmanship, and insults.

 This is going to be a very tough election season to endure.

The first point that should be made is that the US economy is not experiencing a “recession.” That term was “cooked up” by the Roosevelt administration in 1937 to explain why the US economy was re-visiting the Depression. However, it would have been politically unpalatable to have told the American public that the economy had slid once again, five years later, into a depression. So the term “recession” was coined.

But make no mistake about it. This is a depression. However, it’s not a Great Depression, which is what we experienced in the 1930’s. Unemployment is expected to continue to trend upwards, and we all know that the unemployment figure is “rigged” to not look anywhere as serious as it is. It doesn’t, for example, take in all those business owners who do not pay into unemployment for themselves and therefore have no claim to make on the government. It doesn’t take into account those who have exhausted their unemployment benefits. It doesn’t take into account those who have just given up trying to find work. So when we’re told that unemployment is 9.5%, we all know that it is considerably higher.

Now there are different letters used to represent a recession/depression. A “V” denotes a quick and violent contraction and then a quick and forceful recovery. (We should only be so lucky!) A “U” denotes a quick and violent contraction, but a slower recover with time spent in stagnation. An “L” denotes a quick and violent contraction and then stagnation. And finally a “W” denotes a quick contraction and recovery followed by a relapse and recovery.

So what letter represents this business cycle? No one knows. We’ve certainly had a violent, though not necessarily quick, contraction. The market seems to think this is a “V”, but many of us suspect that we’re looking at a kind of a “W”. And why is that? Because there’s little out there in the US economy and the global economy to suggest that buying power will return any time soon. Where, for example, will the increase in assets come from? Certainly not real estate in the short term. It’s still contracting. Not the market because it won’t move higher until it can see that the recovery is solid, which it is not. Exports can’t power us out of this depression because so much of the world economy has, and is continuing to, contract. So the chances are that the market will suggest a recovery, then be disappointed and go back down to test the previous low of around 6500 in the Dow, and then wait to see if another more extensive recovery can be achieved.

This is a process that could take many years; so I wouldn’t wait around to see how long this rally will last. I’d take what you can and save it on the sidelines. There will, in all likelihood, be at least one more chance, if not several more chances, to buy all those funds and all those stocks at steep discounts.

Any time that someone makes a prediction on the direction of the stock market, they should be ever so humble because the chances of their being wrong is astronomical. And yet, there are those of us who will keep lining up for that particular “punishment.”

I do not believe that this is an enduring market rally and the beginning of a new Bull Market. Now as many of you may be aware, there are really only two kinds of “markets”…Bear and Bull. If the market is going up, it’s a Bull Market; if it’s going down, it’s a Bear Market. But within these two types of “markets”, there are variations. Thus, if the Bull Market declines by less than 20%, it’s referred to as a Technical Correction and the Bull Market is still considered to be intact. Conversely, if a Bear Market experiences a rally, it can be a “dead cat bounce” (very descriptive, I must say) or a Bear Market Rally and does not alter the fact that the Bear Market is in full swing.

This rally that has begun has all of the earmarks, in my opinion, of a Bear Market Rally. Why do I say that? First, this rally began on good news, and in my 30 years of experience I’ve never seen the beginning of a Bull Market begin on good news. Usually, the news is so terrible that no one wants to touch the market. That’s when the rally begins which no one believes is the beginning of the next Bull Market; so most investors never see that early and quite dramatic gain coming off of a Bear Market low.

This market started rising when the Treasury said it was going to buy up the toxic assets from the banks so they could begin lending again and credit could flow. That’s like putting a great big sign out that says that the market is going to be going up. I’ve never seen it rise when everyone thought it would be going up.

Second, this market will have to re-test the low of 6500. Bear markets will do that at least once if not several times so that the bottom can be confirmed. That’s usually what scares away all of those who don’t want to entertain the possibility of more losses in the portfolio. Yet, we’ve not see that re-test yet. In the 2000-2002 Bear Market, the low of 8500 that everyone thought was the bottom in October 2001 (after September 11) was not really the low. There was a powerful rally for the next 6 months, then a decline down to 7500 by October 2002. It took a whole year to reach the true bottom after investors thought the bottom had been reached. That could easily happen this time.

Finally, I personally don’t see any progress in the economy that would tell us that things will be substantially better in the next 6-9 months. The economy is still in a state of contraction, and the only good thing that can be said is that it isn’t contracting quite as fast as it had during the first quarter of 2009. Well, that’s not all that much progress.

So I would caution the investor to be careful in here. I’m not so sure that the market is so cheap. On the other hand, if the investor is willing to take the risk and is thinking long term (and by that I mean about 8-10 years), then there will not be that many more opportunities to get into the market at these levels. 

One of the questions that seems to be on everyone’s mind these days is, “What happened to the banks”? We all grew up thinking of the banks as a safe place to save money. How did they get involved with bad mortgages?

Actually, the answer to that question was created back in the 1970’s. That’s when the big wirehouse brokerage firms created Money Market Funds. Actually, Merrill Lynch had the first one called the Cash Management Account. Other brokerage firms followed quickly.

And that’s when the banks began to lobby to change the Glass-Steagall act that was passed in the 1930’s. That bill separated the banking and brokerage functions because, with the collapse of the banks, the recession of 1929 became the depression of 1932.

Now, however, with the creation of the Money Market Funds which had no FDIC insurance but which offered safety (from diversification) and a higher yield, the banks believed that the turf that was theirs had now been invaded. And, in the interest of fairness (a very American “doctrine”), the banks believed that they should be allowed into the brokerage business.

In 1999, Congress agreed, finally, with the banks and repealed the Glass-Steagall Act with the Gramm-Leach-Blibley Act. That meant that the banks could now get into the brokerage business, and they proceeded to do just that in a very big way. And, just 10 years later we can see how that decision turned out.

In the end, after all of this is cleared up, if not before, Congress will once again have to define the roles of a brokerage firm and a bank. The two should not be combined. Twice now, in the last 80 years, we’ve seen that combining the two has virtually destroyed the financial system, and we really can’t permit that to happen again. Maybe this time, Congress will be more attentive to the lessons of history.

One of the questions I’m beginning to hear from listeners is a fear of hyperinflation on the order of what afflicted the Weimar Republic in Pre-Nazi Germany during the 1920’s and early 1930’s. And the question I’m asked is if this could happen in the U.S.

That is a legitimate concern. After all, the Federal government is trying to put as much stimulus (the word of the day?) into the economy to keep it afloat so we don’t go into a massive deflation. That is usually the worst case because when there’s a deflation, there are fewer dollars around and prices keep declining because consumers have no need to go out and buy right away. After all, the price will probably go down and it will be cheaper in the future. That also means that assets decline in value as well.

Right now, we’re right on the edge of deflation; but, if we’re successful in keeping the economy afloat, then we could get through it within the next 12-24 months. And what awaits us on the other end? Well, that could well be inflation. There could be too many dollars chasing too few goods and that results in inflation which could force the Fed to raise interest rates to depress economic activity.

That’s exactly what happened in the 1930’s. By 1937, the US was beginning to come out of the depression when the Fed got worried about inflation and raised the interest rates. That sent the economy back down so that, by the dawn of World War II, the economy was still only 9% larger than it had been in 1929 and unemployment was 14%.

Now the Fed is always reactive and not proactive. It will need to see that there is indeed inflation before it begins to act and that means that inflation could gain some steam. I have no doubt that it will be controlled, no matter how painful it is for the citizens and business of this country. So I don’t see hyperinflation. But I can see dipping back down into a recession again in 4 or 5 years.

And just so you can appreciate the nature of inflation, after WW II and the massive amount of stimulus poured into the economy to fight that war, inflation raged. In some months, it got as high as 30%. But we never got to a hyperinflationary state. And we won’t now either.

Our worst scenario still includes deflation followed by inflation followed again by another, though shallower, recession and about 10 years of our lives trying to get back what we had in 2007.