Our subject yesterday was the destruction of our civilization. Today, we take up a related question: So what?
You’ll recall that we’ve been reporting on the work of Richard Duncan, who is currently chief economist at Blackhorse Asset Management in Singapore. We went down the road with him, from the causes of the stock market boom to the inevitable bust… thence to the Fed’s inevitable reaction and to another leg up in the stock market. But here is where we part company.
Duncan believes a credit deflation would be devastating. We have come to rely so heavily on credit from the Fed, he says, that taking it away would mean chaos, depression and war.
“In all probability, our civilization would not survive it,” he concludes. Faced with such a calamity he believes there is no way to go back to the sound principles of 19th century banking and finance. Instead, we have no choice but to go ahead.
But to where? And how?
Staying the Course
Hold on. One question at a time, please.
To where? Japan!
How? By using the same policy tools the Japanese used. It worked there, didn’t it?
The Fed is fully committed to staying the course. If credit deflation returns to the US, it will have to be over Janet Yellen’s dead body. Which is not a bad idea. But Yellen is not likely to let it happen… not if she can prevent it.
But there’s the rub. If credit is going to keep expanding, someone has to borrow more – a lot more.
Household debt topped out in 2007. With total US household debt at more than 600% of disposable income, and mortgage debt far out of proportion to rents, households were tapped out. They had spent so much in the past they had nothing left for the future.
Since then, US households have managed to reduce their debt levels, although the last few months they have started to borrow again. In any case, they won’t be able to borrow much… because they don’t have the disposable income to support it. And there is no sign that incomes will increase substantially.
No More Juice in the Lemon
If households can’t continue to add debt, who can?
Next in line is the corporate sector. Corporations have been doing a manly job of borrowing lately. As if to show that the guys who get the big bucks are no smarter than anyone else, they are borrowing money on an epic scale largely to buy their own shares at record prices. That’s right: Buy high! At least it helps raise the bonuses.
But there can’t be much more of that juice in the lemon, either. The Street’s consensus for S&P 500 earnings growth for Q1 has gone from 4.4% year over year in early January to -0.4% today. Like a household’s disposable income, lower corporate earnings leave the sector with less money to pay finance charges.
That leaves government. Bless their greedy little hearts, politicians can be relied upon to do the worst thing at the worst possible moment.
What is the worst thing a highly indebted government can do? That’s right, borrow more. When is the worst time to do it? When there is no real reason to do so – when there is no national emergency that makes it necessary. In World War II borrowing was an emergency. Today, it is an imbecility.
We could add an additional question: What is the worst possible way for a government to borrow money? It is to borrow it from the central bank, which merely prints up the cash on request.
That is what the US government will do. More or less like the Japanese. That is what we expect. It is also what Richard Duncan expects. But he thinks it is something the feds must do… to avoid the collapse of civilization.
After all, the Japanese government has about twice as much debt to GDP as the US federal government. That gives the US lots of room to add debt. And that is where we part company with Duncan…
A financial system that makes bankers, speculators and Washington insiders rich… while everyone else gets poorer and more heavily laden with debt… is not worth saving.
The sooner we have shucked it off, the better off we will be.
More on Monday…
Deep Down the Rabbit Hole
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners
You know you’re deep down the rabbit hole when you read a headline like the one inWednesday’s Financial Times: “China bulls urged on by stimulus hopes.”
It was about the new $59-billion stimulus package out of Beijing, which focuses on railroad infrastructure and low-cost housing.
The spending is supposed to keep the Chinese economy on track to grow at the preordained rate of 7.5% this year.
According to the Chinese leadership, it’s intended to “spur businesses’ vitality, effectively increase demand and boost jobs.” According to the Financial Times, fund managers are banking on it working.
This tells us three things…
First, investors in China, as well as in the US, Europe and Japan, are still focused on the doctor (economic policy), rather than the patient (the economy).
Second, it’s not just the US… and other developed countries… that have a growth problem. The Chinese economy, which was once touted widely as the “engine of growth” of the global economy, is now coughing and spluttering.
Third, the bubble in faith in the ability of policy makers to ‘fix’ sluggish economies is alive and well. (It’s our view that this bubble will also, one day, go pop.)
The Chinese stock market is a deeply distorted one. And distorted markets are dangerous markets.
But the Chinese stock market is also a deeply discounted one – currently trading on a trailing P/E of 6.6 and a dividend yield of 5% (versus a trailing P/E 18.1 and a dividend yield of 2.3% for the S&P 500).
At least in China investors are being offered “bargain counter” valuations for the risks of holding stocks. That’s not the case in the US – where policy distortion is also the name of the game.