Getting Back To Prosperity

The pace of job losses in is slowing. This is apparent looking at the 16-month payroll chart for the United States, which shows that although the economy lost jobs for the fifteenth straight month, the pace of those losses is up off it's lows. The picture in Canada is similar, although the data is reported slightly differently. There will probably be at least another 3-4 months of negative job growth but there are other signs of "green shoots". That being said much of the appreciation in equity values that we have seen this past month is due to inflation as I mentioned in the previous post. The same is true for commodity prices, which are also up sharply off their lows earlier in the year. This trend is likely to continue, and without cheap oil, the extent to which the United States economy can recover is really quite dim. While the emerging economies still have a long way to go in terms of manufacturing quality, the productive capacity and thus growth potential of these regions far exceeds that of the 'developed' nations and at a much lower labour cost.

One of the biggest delusions I've heard is that the health services sector (drug research, health care, stem cell research, and so on) will lead us out of recession. While it's true that everyone is willing to pay more for their health, the reality is that they can still only pay what they can afford. The aforementioned speculation seems to be largely based on the premise that people will pay anything for good medical treatment when practical realities dictate otherwise. Further to this, the government will need to spend less, not more, on health care costs. Even with the health care sector outperforming other sectors, it alone cannot single-handedly sustain any economy of scale.

"Well, first of all, it's our money. We paid the taxes. We're just asking for some of our money back." - Buzz Hargrove, former Canadian Auto Workers Union president on why the union should be bailed out (April 26, 2009)

The attitude of Buzz Hargrove and thousands others needs to change. Hargrove did not finish high school and yet he feels that compared to international workers, he is entitled to better pay for equal work, simply because he was born in Canada. This is an indication, unfortunately, that the 'correction' is not quite finished yet, and we'll need to see a subsidence of the corporate welfare state, reduction in entitlement expectations and a notable improvement in workforce value generation. This means better service and quality for globally competitive prices. This is where America has diverged so far away from it's founding principles in recent years. In a free economy, jobs can, and should be outsourced unless the domestic workforce provides greater competitive value. Not only is this a critical component of a free economy, but it is also critical in a free society and any protectionist government measures to artificially maintain jobs domestically will only hurt the economy in the long term. There are no shortcuts on the road back to prosperity.

USA: Success or Secession?

It's pretty hard to imagine why anyone would be willing to pay a 90% income tax rate without any improvement in public services. Especially if it's to repay debt incurred by somebody else. Anyone that has the means would simply pick up and move somewhere else. Investor Jim Rogers already relocated to Singapore for this very reason; many others will follow. Naturally, it will be impossible for 300 million people to do the same. The alternative therefore, will be secession. Canada had it's own debates about secession with Quebec trying to withdraw from the country. Americans will have similar heated discussions about the legal right of American States to secede from the Union. Nonetheless it is the most probable and perhaps even inevitable outcome, particularly if economic recovery does not happen sooner rather than later. As I've said before, I think crude oil prices of no more than $20 a barrel will be necessary for sustained economic growth to occur in the United States.

The bad news is that when a country splits up, the breakup is nearly always preceded and/or succeeded by some form of civil war. Debt holders could be wiped out or suffer significant losses. The good news is that the Soviet Union, the only nuclear power to secede, was able to keep it's inventory of nuclear weapons secure and unused during the process.

White Out

The White House, Wealth and the Economy

Larry Kudlow of CNBC always talks about mustard seeds in relation to the economy. The trouble is that his optimism, while refreshing, had been unrealistic over the past year. As I've said before, there is a difference between optimism, pessimism and reality. It's now becoming clear that some of those who were previously labeled pessimists are actually perpetual optimistic realists. Today however, it looks like the mustard seed is finally in the ground. It will need plenty of water, nutrients and time to grow, but the seed has been sown nonetheless. I've penned some Q&A-style perspectives below..



Isn't the market supposed to be forward-looking?!?
Many people have said the markets are forward looking and that the next 6 months are already factored in to the stock market. Obviously they were wrong if they said this three months ago. The reason they were wrong is that the stock market is not some kind of oracle but merely an indicator of economic sentiment and perception. The perception was wrong as CEO's and analysts were continually making downward revisions to their guidance leading to a negative feedback loop in the economy. The popular perception is now much closer to reality now, in my opinion, which means we are at, or near a bottom in the stock market.

What did the Obama administration have to do with the economy?
Thus far they haven't done anything measurable. The market correction paused to determine if the smart guys in the administration had a magic bullet that would stop the declines. They didn't, and when this fact became apparent, the declines resumed their course. Sporatic reactions to announcements and press releases are never a reflection of long term equity value with the very rare exception of events that act as a catalyst for catastrophic events (the Lehman Brothers failure for example).

So the Obama administration actually knows what it's doing?
Not really. In his testimony yesterday Treasury Secretary Timothy Geithner admitted that if the administration's GDP growth projections for the next decade are off, the public debt may no longer be serviceable. He emphasized that he didn't see any better alternative to the current direction given their inheritance. He's probably right and certainly transparent; but this does not inspire much confidence in their ability to fix the economic problems.

Is now the time to buy stocks?
Yes and no. One certainty is that anyone predicting a bottom will be wrong. However, my outlook several months ago was that the Dow Jones Industrial average would bottom out in the 4000-6000 range. My outlook has not changed (as it sometimes does), and the stimulus packages could help push this bottom higher than my estimate. I'd be ready to diligently put long-term investment capital to work. Traders beware of expecting large returns and high long-term growth rates. Profit taking will ensure that volatility remains in the markets for the next 3 months as the economy moves towards a rebalanced state. A structural debt problem that still exists in the United States economy should be considered very carefully.

Does this mean the economy is turning?
Yes and no. More job losses are on their way. House prices still likely have further to fall to eliminate the excess in homes. There is still more downside. When growth does resume it will not be a sudden dilation back to 2007 activity levels. On the other hand, the light at the end of the tunnel is becoming visible. Just realize that the path to get there will be a difficult one.

Every obstacle forges fortitude, every hurdle appraises fitness and every challenge tenders opportunity.

-You're smarter than you think.

The TARP, optimistically..

Some philosophical context


I think it's both timely and important to note the distinction between optimism, pessimism and reality. Most people think that forgetting reality is the way to remain optimistic. This is the wrong way to approach reality. The truth is that understanding reality is the only way to manage expectations and remain optimistic. Expectations are usually met for someone who has a tangible grasp on reality. The optimist also understands that they can mold their own reality but they can't choose the clay. On the other hand, the person who does not have a tangible grasp on reality finds themselves is always disappointed by unrealistic expectations. This psychological house of cards is sometimes made even worse as they create more undue optimism to fill their void in troubled times, which can only lead to a terrible downward spiral in the end.

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TARP (tar⋅pau⋅lin) - [tahr-paw-lin, tahr-puh-lin]

-noun

a protective covering of canvas or other material waterproofed with tar, paint, or wax.

When it comes to the economy, it's clear that many people still misplace optimism with optimistic realism, despite a notable improvement in this regard in recent days and weeks. Many people still believe the purpose of the TARP (Troubled Asset Relief Program) was to increase lending and stop foreclosures. It wasn't. The purpose was simply to stabilize financial markets and stall the market correction following the failure of Lehman Brothers collapse. Major banks were failing by the week at the time, with no clear end in sight. The system was collapsing and the fall had spread to the broader market. The economists that saw the current problems of the market predicted the fair (unadulterated) value level of Dow Jones Industrial Average was (and still is) about 4,000 (Thursday's close was 8,212). The program eventually passed congress and equity markets stabilized. The .DJI has been flat since October 10, 2008, about the time it became clear that the bailout would pass in some form or another. When the Obama and Bush economic advisers realized is that the correction was about to resume it's course, with more defaults coming from the retail sector in addition to continuing subprime loan defaults, they called for the release of the second $350B bale of the TARP.

The real objective of the TARP was to diffuse the full extent of a free market correction. Without the TARP funds, the mark-to-market net worth of nearly everyone with equity would fall by about half (this includes RRSP's, 401k's, home equity, etc.). Foreclosure rates would have accelerated in the opposite direction of equity. Citibank, Bank of America, Fannie Mae, Freddie Mac, Chrysler, GM, AIG would all obviously have failed with catastrophic consequences, along with many others. The economy would need a combination of pay cuts and job cuts; if fewer people willingly took pay cuts, more people would be forced into job cuts (this still holds true despite the TARP). It's no surprise that no acting government, republican or democrat, would be willing to face such a reality and opted instead for inflationary market interference instead.

I'm not personally in favour of these bailouts unsustainable tax cuts, debt loads, deficit spending and stimulus handouts. They will ultimately just prolong and extend the natural correction as well as stagnate longer-term growth for years, perhaps even decades. Political stability will become rather precarious as it becomes clear that debts cannot and will not be repaid. The greenback will have questionable value as the dollar becomes mortgaged (also see America's Fundamentals). Nonetheless, it's important to be onside with reality. This is the only way to see the glass as being half full.


You're Richer Smarter Than You Think.
Kent Carter

America In Recession

The United States has already conceded it's title as the world's most powerful nation. Of course, it still has the World's most technically advanced military, most martial firepower and the largest and most capable nuclear arsenal. It still has the World's reigning currency, highest volume of wealthy people in the world and largest GDP (excluding the European Union).^{[1], [2], [3]}

Waning Superiority
The military superiority is a bit misleading because it hinges on America's ability to both finance and fuel the technologies. The massive energy and cost requirements of the U.S. military are becoming increasingly reliant on foreign oil and foreign debt. Even economic superiority is decreasing because of huge deficits and debt. Economic debt is, in principle, no different from social debt: an obligation requiring future reparation (usually with interest). In the decades immediately following the first two World wars, the United States was the lender, mostly to European countries in ruin, giving it unprecedented power as a recipient of Europe's future financial obligations. The United States did had large debts of its own at the time, but the debt holders were largely domestic, leaving its own citizens in control of its own destiny. In 1988, about 13% of the government debt was foreign-owned.^[4]. Currently, about half of the public U.S. debt load is owned by foreign investors. This percentage is certain to rise social security, health care and other entitlements on the rise while the GDP shrinks. The president elect forecasts trillion dollar deficits "for years to come."^[5]

Iran Example (image)
China has formed a strategic alliance with Iran. The arrangement allows China to receive Iranian oil at a discount in exchange for economic support that allows Iran to circumvent UN sanctions. In the spring of 2008, China and Russia blocked a UN Security Council resolution to increase sanctions on Iran in response to Iran's defiance of calls to abandon its uranium enrichment program. ^[6]

The 'Nuclear Option'
Knowing it cannot count on United Nations support, were the United States to decide to attack Iran unilaterally, Iran could plead with China to use its economic nuclear option in order to prevent such an attack. The economic nuclear option is the scenario where a large foreign owner of another nations public debt threatens to stop lending thus crashing the currency value of the indebted country and plunging it into economic ruin. The United States used this approach to help end the Suez Crisis in 1956. In short, president Eisenhower threatened to sell the U.S. reserves of British Pounds and Sterling Bonds and collapse the British Pound if they did not withdraw troops from the region. This tactic coupled with other pressures forced Britain to withdraw it's troops from the region and is regarded by historians as an egregious point in the decline of the British Empire.

Precarious Positions
Tactics such as the 'nuclear option' are not without significant economic risk to the powers considering it's use however. An estimated 70% of China's currency reserves are held in the U.S. dollar (the administration does not make these figures public).^[7] Trying to convert (sell) large amounts of these holdings will inevitably cause the U.S. dollar to fall, leading to a write-down of their remaining domestic currency reserves. Instead, they will likely try to divest these holdings over a period of years or decades, leading to a gradual decline in the value of the greenback rather than a violent plunge. China, India and other emerging economies are also in the rather undesirable position of having large populations but limited domestic resources. The world simply does not have enough natural resources to bring the average standard of living up to the same average level of the wealthy western nations. One of the reasons America was able to become so prosperous was that the country was awash in natural resources: coal, oil, water, minerals and fertile agricultural land. Now that those resources have mostly been exploited domestically, America has tried to create a knowledge-based economy without conceding any reduction in annual economic growth. I think the current economic environment is a reflection of the reality that the global economy was supersaturated with overpaid knowledge-based employees and thus became reliant on inflation and artificial Madoff money to provide illusory growth. Is there really nowhere to go but down? America and the rest of the world certainly face the challenge of finding real and significant growth in a globe that appears increasingly finite. What the world needs is some good ideas on how to succeed in this feat.

You're Smarter Than You Think.
-Kent Carter

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1. International Monetary Fund Report
2. CIA World Factbook
3. World Bank Statistics (2007).
4. Final Monthly Treasury Statement, U.S. Treasury (September 30, 2008).
5. Obama Predicts Years of Deficits Over $1 Trillion, Washington Post (January 7, 2009).
6. Russia, China block UN resolution on Iran; MSNBC (March 4, 2008).
7. China Losing Taste for Debt From U.S., New York Times (January 7, 2009).