Friday, January 23, 2009


Now that Obama has formally taken office, hope springs eternal that he will be able to fix the damage wrought by 40 years of class warfare. If only he could somehow get back the millions of jobs lost to overseas outsourcing. And then maybe he could also put a floor under house prices and once again render solvent the middle class, most of whom are essentially bankrupt and are not even aware of it. As you guessed, I am more than a bit skeptical.

Many hold faith that Obama's pending $825B stimulus package will get the economy back on track with its promise to create 3-4 million jobs over the next two years. Unfortunately, last year alone the U.S. economy lost 2.6 million jobs and at the current accelerating rate, the economy is on track to lose a further several million jobs in the coming year. That means the pending stimulus package will only partially mitigate the economic effects wrought by relentless job losses. Consider that in December alone, the economy lost over 500,000 jobs and December is usually a light month for job losses, as employers are generally reluctant to cut before the holidays. The other issue is that many of the jobs being lost are high income jobs in such fields as Finance, Sales, Marketing and IT that won't be duplicated under the Obama stimulus plan. The Obama plan is expected to create jobs in the construction, renewable energy and infrastructure industries.

Further frustrating any attempts to stimulate the economy:

1) Increased savings rate: By all accounts, Americans are starting to reverse their decades long trend of over-spending by increasing their savings rate. This is largely due to growing job uncertainty and the reverse wealth effect caused by the destruction of trillions of dollars in stock market and credit market wealth. Were the savings rate to rise from recent negative levels and return to its historical average level of ~8%, that would have a massive impact on GDP, as consumer spending is roughly 70% of the economy i.e. each 1% increase in savings reduces GDP by roughly .7 %, so a return to an 8% savings level could lower GDP by over 5%.

2) Reduced access to credit: As one would fully expect during a deflationary credit collapse , (potential) borrowers can not/are not borrowing and lenders are not lending. Most borrowers have their hands full with the debts they already owe, while lenders are still reeling from the trillions in losses they took down last year. This lowered reliance on credit and debt to fuel consumption will have a substantial yet-to-be-quantified negative impact on GDP. As I wrote recently, in a cash-based economy, consumers will forgo purchasing big ticket consumer durable items as long as possible. The fact that policy-makers are still fiddling with the TARP program and other myriad schemes to induce bank lending, tells me "they" (the policy-makers) really don't get the fact that the borrowing induced debt Ponzi is over, once and for all.

3) Negative wealth effect: Over the past several years, the hyper inflation of every asset class from stocks, bonds, commodities, real estate led many people to rely on the growth in asset values to fund consumption. Whether through mortgage equity withdrawals or by cashing in on over-inflated stock/bond portfolios, this hyper-inflation of asset values has had significant impact on consumption. Now, in credit and asset deflation, that additional economic stimulus from asset values will be removed from the economy. What few people seem to realize (and what Prechter has pointed out), is that when asset values collapse, the majority of the lost value in collapsing asset class 'A' doesn't move to asset class 'B' or 'C', it simply disappears. This is because financial assets are valued by the marginal (last) sale of the asset. So for example, when Microsoft dropped from $19.50 to $17.00 per share on Thursday last week (due to its punk earnings report) that revaluation of the company eliminated $2.50 of value from ALL (9 billion) of the shares outstanding, not just the small subset of shares that traded that day. This phenomenon is especially hazardous in some of the more exotic (and illiquid) credit assets such as CDOs (Collateralized Debt Obligations) because of what I euphemistically call "discontinuous price discovery", which leads to very severe price downward price adjustments, due to the fact that these types of assets trade relatively infrequently. During 2008, just in terms of stock market losses alone, over $30 TRILLION dollars in wealth was lost, which is half of combined global GDP.


Fortunately, one of my dire economic predictions that has not come to pass so far is a nationwide bank run. This event has been forestalled by the proactive efforts by Bernanke's Fed to support the banks during the credit crisis. As indicated, the Fed has found some very creative ways of lending trillions of dollars to the banks to maintain the illusion that the banks are still solvent. Despite these efforts, Nouriel Roubini just this week indicated that the U.S. banking system is now "effectively insolvent". Beyond the roughly $1 trillion in writedowns taken by major banks to date, he indicates that further writedowns will eventually wipeout all remaining equity in the banks. Further to this point, Citigroup and Bank of America shares sank to decades lows of $3 and $5 respectively, and the combined market capitalization of the top 24 U.S. banks is now less than the market capitalization of Exxon Mobil ! Therefore, if you still have your cash sitting in bank deposits, I would highly suggest moving it to the higher ground of a brokerage account where you can invest it in short-term Federal Treasury bonds (either directly or through ETFs such as SHY and SHV). Any money you keep in local bank deposits could eventually be subjected to a bank run at which point you will need to wait in (a very long) line to get your money back from the FDIC, assuming it's still functioning and solvent. By the way, that's an ENORMOUS 'IF', considering that the FDIC only maintains reserves amounting to 1.15% of outstanding deposits! (you read that right).

As bad as things are for the U.S. it appears that the U.K. economy and financial system are in even worse shape. Adding to anxieties in the marketplace, the Pound Sterling has fallen off a cliff of late as foreign investors dump the Pound and all things U.K. denominated. Were it not for the fact that the U.S. dollar is considered a "reserve" currency, this would surely be the fate of the U.S. at this time, and no doubt portends badly for the future. For as I have written recently, the U.S. may well be able to "print" its way out of this mess (starting now with Treasury bonds, but eventually leading to printing currency), but once foreigners start to dump dollars in earnest and the dollar loses its status as a reserve currency, then the Post-Apocalyptic cash-only economy I have been writing about will become a full fledged reality.

So while I am tempted to drink the Kool Aid along with the rest of the Obamaniacs and believe that the man is some sort of magician who can make everything right again, the facts and reality tell me that the inexorable economic collapse to lower more sustainable levels is still very much on track and poised to accelerate in the not too distant future. Not to say that he isn't a breath of fresh air after 8 years with that other guy, but let's face it he is only one man in all this madness. Meanwhile, the hardcore right wing is already working overtime to slander and subvert the poor guy literally only hours since he took office. Sadly, I expect that despite the horrendous mess he has been handed, it won't be long before the honeymoon is over and he starts to accumulate blame for not fixing what in actual fact is an irreparable situation.