Tuesday, May 12, 2009

Doing Stimulus Shots Can Be Hazardous To Our Financial Health

If you think the Obama/Bernanke Stimulus plan has saved the day, you'd better take a second look. Anyone who truly understands monetary policy understand that the billions being poured into the economy will perhaps make things appear better in the short run - but in actuality it is prolonging the pain and will actually make things worse down the line.

Ben Bernanke described potential first signs of economic recovery as "green shoots", but what we may be seeing are like the buds that appear before the final winter's frost. They won't get to blossom.

Peter Schiff writes:
Strike up the band, boys, happy days are here again! Recently released short-term economic data, including unemployment claims, non-farm payrolls, home sales, and business spending, which had been so unambiguously horrific in February and March, are now just garden-variety awful. With the Wicked Witch of Depression now apparently crushed under the house of Obamanomics, the Munchkins of Wall Street have sounded the all clear, pushing the Dow Jones up 25% from its lows. But the premature conclusion of their Lollipop Guild economists, that the crash of 2008/2009 is now a fading memory, is just as delusional as their failure to see it coming in the first place.

Once again, the facts do not support the euphoria. Over the past few months, the government has literally blasted the economy with trillions of new dollars conjured from the ether. The fact that this “stimulus” has blown some air back into our deflating consumer-based bubble economy, and given a boost to an oversold stock market, is hardly evidence that the problems have been solved. It is simply an illusion, and not a very good one at that. By throwing money at the problem, all the government is creating is inflation. Although this can often look like growth, it is no more capable of creating wealth than a hall of mirrors is capable of creating people.

We are currently suffering from an overdose of past stimulus. A larger dose now will only worsen the condition. The Greenspan/Bush stimulus of 2001 prevented a much needed recession and bought us seven years of artificial growth. The multi-trillion dollar tab for that episode of federally-engineered economic bullet-dodging came due in 2008. The 2001 stimulus had kicked off a debt-fueled consumption binge that resulted in economic weakness, not strength. So now, even though the recent stimulus administered a much larger dose, we will likely experience a much smaller bounce. One can only speculate as to how much time this stimulus will buy and what it will cost when the bill arrives.

My guess is that, at most, the Bernanke/Obama stimulus will buy two years before the hangover sets in. However, since this dose is so massive, the comedown will be equally horrific. My fear is that when the drug wears off, we will reach for that monetary syringe one last time. At that point, the dosage may be lethal, and the economy will die of hyperinflation.

As always, the bulls fail to understand that investors can lose wealth even as nominal stock prices rise. As a corollary, the bearish case is not discredited by rising stock prices. While there are some bears that mistakenly cling to the idea that deflation will cause the dollar to rise, those of us in the inflation camp understand that the opposite will occur.

In the meantime, stocks are not rising because the long-term fundamentals of our economy are improving. If anything, the rise in global stock prices is due to investors realizing that cash is even riskier than stocks. The massive inflation that is the source of the stimulus is essentially punishment for those holding cash. To preserve purchasing power, investors must seek alternative stores of value, such as common stock.

It is important to point out that despite an impressive rally, U.S. stocks have substantially underperformed foreign stocks. In the past two months, while the Dow Jones has risen 30%, the Hang Seng and the German DAX have risen by over 50% in U.S. dollars. Commodity prices are also rising, with oil hitting a five-month high. And gold is shining as well, with the HUI index of gold stocks up 30% during the past two months, and 2/3 of those gains occurring in the past month. If this rally really were about improving economic fundamentals, gold stocks would not be among the leaders. Further, during those two months, the U.S. dollar index fell by 7%, with commodity-sensitive currencies such as the Australian and New Zealand dollars surging 20%.

To me, the relative strength of foreign stocks and currencies indicates that perhaps the global economy is not as impaired as many have feared. It has been my view all along that after the initial shock wears off, the world will be better off – once it no longer subsidizes the American economy. The shrinking U.S. current account deficit is evidence of this trend in action. Renewed strength in foreign stocks and weakness in the dollar may indicate that not only is the world decoupling from the U.S., but benefitting as a result.

So let the Munchkins dance for now. But remember, the Witch is not dead; only temporarily stunned by an avalanche of fake money.

Interestingly enough - here is another analysis using historical false recoveries

There are a few other bubbles waiting in the wings.

1) Credit card defaults - People are out of work, and more are being laid off. Credit cards are the last things people worry about paying, and the banks are holding all of this unsecured debt.

2) Commercial Real Estate - With all of the retail stores closing, there aren't any stores filling those vacant spots. Mall owners, Strip-mall owners and other commercial realtors are barely hanging on by the skin of their teeth. Some have already filed for bankruptcy, and other landlords are having trouble paying their insurance policies as well as making their own mortgage payments.

3) We haven't seen the last of mortgage defaults, and as unemployment benefits will start to end for tens of thousands of people, that is still going to cause us problems. 22% of homeowners are still underwater.

4) US Treasuries - When the stock market crashed, many people pulled money out and flocked to "safe treasuries". China also holds a ton of American debt. They stand to lose a substantial amount of money with any sharp increase in yields, because that would send bond prices plummeting. If people sell off their Treasury holdings for other higher yielding investments, then there will be a collapse in the treasury bubble. Rule of thumb: for every 1 percentage point increase in yield on a 10-year note, investors would see a corresponding 7 percentage point drop in value… Even Warren Buffett is concerned.

Green shoots?
-The contractions have already begun as consumers are trying desperately to spend less - pay off some of their debts and try to save some money as well; and of course if they are employed or unemployed that has further implications.
-The US Government's massive debt and continued insane spending will be our demise.
-Banks and investors who have lent out money to people who can't pay it back will have to find a way to absorb the losses.

Ultimately we will have to pay for it all - one way or another.