Saturday, September 12, 2009

Funhouse Economics

Chris Mayer asks the question that has been bothering me for some time:
But with all the artificial stimulus money floating around, you can never be sure of what you see. Is this a real recovery or is it an artificially ripened tomato, and hence an imposter? When the stimulus money stops flowing will the recession get worse?
He goes on to describe these distortions as having the effect of a funhouse mirror as one tries to look at the numbers and figure out what is going on with the economy. It is an apt description. I am bearish on the economy, flat-out, for at least 5 years and possibly more, no question. I don't plan on changing my opinion until I see some very big changes, and frankly, I don't see anything in the pipeline that even comes close. Personally, my bets are on a near systemic collapse, and any coming recovery will have to be in its aftermath. So it becomes difficult for someone like me to explain a stock market rally going on six months now since the March lows. In fact, the phenomenon appears to be global, with stock markets around the globe caught up in the euphoria. What to make of this? There are two main answers, in my opinion, and Mayer supplies one of them. China, like virtually every other nation around the globe, has been dabbling in "stimulus," even to such a degree that it would make an American central banker blush:
China supposedly grew in the first quarter at an annualized rate of 15%. Yet, the government also spent a lot of stimulus money. As Eric Sprott writes in his latest letter to shareholders:

“The Chinese have injected a stimulus equivalent to 64% of their first half 2008 GDP in the first half of 2009…The Chinese government has effectively spent and lent enough in six months to buy 122 Ford Class aircraft carriers at US$8.1 billion a piece. It is akin to the US government injecting (and US banks lending) almost $4.5 trillion USD to its citizens and businesses before July 2009…an ungodly sum that would impact every asset class under the sun. Is it any wonder then that the Shanghai stock exchange has more than doubled from trough to peak since its November lows?”

Time for some critical thinking. You do the math: had the government of China not provided a monetary black hole equivalent to 64% of GDP to shovel all those wasted resources into, growth would have been... that's right, a wee-bit negative, to make a generous approximation. Do you suppose these artificial sales might have had some impact on stated earnings, you know, the ones investors use to price shares in said companies? Do you think the Chinese government can afford to continually supply the funds to purchase 64% of GDP, just to keep the wheels turning and the stock market burning? If the government does not, who will? Does it seem like a good idea to provide artificial markets by government fiat? Does this really count as actual growth, as the numbers would have you believe? Consumers have had their say; they didn't want the goods. Why is it productive for the market to continue to produce them? A market bull trying to justify the present rally in Chinese stocks is going to have to provide some pretty convincing answers to some very tough questions. Nothing I have seen would stand up to scrutiny. Similar efforts have been going on around the globe, not typically to the degree the Chinese have chosen to pursue them, but their effect is the same nonetheless. Investors and government will not accept the liquidation of malinvestment that is clearly needed to put the market on more sustainable footing, and they are pumping the economy full of freshly printed dollars in order to keep the game of pretend going a little longer, supplying phony consumption and cooking the books in the process. The numbers do not reflect what is really going on, which is waste of resources and capital consumption. But the numbers are what stock prices and business decisions are based on. The second answer is slightly more subtle. Cost cutting measures, such as layoffs and shuttering of once productive capital, are increasing earnings by reducing company spending. This is actually healthy, painful as it may be for those experiencing it, as it is part of the process of reallocating capital towards satisfying consumer demand (or possibly phony demand provided by wresting purchasing power away from consumers, a.k.a. stimulus, as the case may be. But that is not healthy.) But the point is this: unemployed capital and labor do not make for a growing economy. We will not have "recovery" until this trend reverses, and companies cannot expect to continue to improve earnings by tossing workers out the door and idling capital. Continue to do this, and you have no economy. They are going to have to show improved earnings by making money the old fashioned way -- engaging in productive economic activity that satisfies consumer demand -- before we can say we are coming out of the woods. Don't be fooled by the hype. Remember two things: the stock market is not the economy, and the economy, governed as it is by the unbending physical laws of the universe, cannot be fooled by phony accounting. At its most basic level, economic growth is something that anyone can understand: real capital accumulation, leading to higher productivity aimed at satisfying consumer demand, and increasing real wealth. Not number jiggling. Not phony accounting. Not pushing money around in circles. If you do not see this occurring, things are not getting better. Things may feel nice now, but there are dark days ahead. I am sure that we will see asset prices rise and fall along the way thanks to all the confusion and deception, possibly quite dramatically. But until you see this simple model being satisfied, you can be certain that there is no wealth creation going on, and the economy is not getting better. Right now, it is devouring itself, but the numbing effect of printed money prevents us from feeling it. We are getting poorer, but we just can't tell. Looking at cooked books doesn't help us figure it out. I do not know when the next downturn will be, but I expect a "double dip" type recession, possibly followed by something like a long flatline, if we are lucky. At a minimum, the dollar is on death row, we just don't know when the sentence will be carried out. Fiat currencies across the globe are not doing much better, but that is another post for another time. If we are not lucky, it will be a catastrophic breakdown. And I'm not feeling all that lucky.

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