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Posted on 12/20/2008 10:31:53 AM PST by SeekAndFind
I've been complaining for years about how excessively pessimistic everyone has been about the economy and the stock market. But I have to admit, now that the economy is in recession and the stock market has taken a serious hit, all the pessimism is serving some useful purposes.
First, pessimism has driven stock prices down to levels that make them terrific bargains. If you've been a long-suffering value investor, frustrated by decades of high prices, then your day has come. Stocks are cheap -- at last. Second, pessimism has given everybody a healthy respect for the risks that our economy faces now. Sure, it's annoying when people falsely compare today's economy to the Great Depression. But because we're talking about it, that means that we're unlikely to repeat the mistakes that created the Great Depression in the first place.
Now put those two ideas together. Stocks are so cheap they're priced as though the economy was going into a depression. But it's not, because we've learned how to avoid that kind of horrible economic catastrophe. That means stocks really are a buy.
Imagine you were living in 1930. It looked a lot like today. The booming economy suddenly stopped cold. The stock market had just crashed. Everyone was up to his eyeballs in debt and struggling to get out of it. But at that point it was still just a recession. You wouldn't have known then you were headed for a depression and certainly not the Great Depression.
What went wrong? What turned a recession into a depression. And what made that depression great?
For one thing, Herbert Hoover raised taxes. Then Franklin Roosevelt raised them again. The theory was that falling tax revenues were putting the government into debt, and all that debt would hurt the economy. No one seemed to realize that you hurt the economy even more when you raise taxes.
Fortunately, our president-elect seems to realize that. Barack Obama campaigned on the promise to repeal the 2003 tax cuts rather than just let them expire naturally in 2011. Now he's let it be known that he won't be repealing them, so taxes are going to stay low -- on incomes, dividends and capital gains. I never thought I'd be so glad to see a politician break a campaign promise.
In 1930, America enacted the Smoot-Hawley Tariff Act, which raised taxes on international trade. The idea was that protectionism would be good for American jobs and American tax revenues. But other nations retaliated, and the volume of global trade collapsed. It took more than 50 years for the percentage of world GDP contributed by global trade to recover to 1929 levels.
There's been a lot of talk about protectionism over the last several years, thanks to the rise of China and India as manufacturing superpowers, and the trend toward outsourcing low-end U.S. labor to them. But as the recession has set in for real this year, for some reason we're suddenly not hearing very much about it anymore.
In fact, when the G-20 group of nations met in Washington to discuss the global recession last month, the members pledged not to use protectionism as a tool for creating local recovery at the expense of the global economy. That's great news because protectionism is a lose-lose proposition. By destroying the efficiencies of cross-border trading, it hurts everyone everywhere.
Worst of all, in the early 1930s the Federal Reserve just sat there doing nothing while thousands of banks failed. And once that happened, the Fed tightened the money supply. From the peak in 1929, the Fed reduced the money supply by 28% over four years. You really couldn't come up with a more effective way to strangle an economy.
Today's Fed is doing precisely the opposite. After a series of bungled interventions earlier this year in which several banks and brokers not only failed, but in my opinion were forced into failure by speculation and regulatory mismanagement, the Fed and the Treasury are now dedicated to propping up the banking system at any cost.
When Citigroup (C: 7.02, -0.41, -5.51%) got into trouble last month, the Treasury invested $20 billion in new capital on top of the $25 billion they'd invested a month earlier. And the Fed put a guarantee on $262 billion of Citi's "toxic" assets to assure that the bank's balance sheet would stay strong.
And money supply? Don't get me started. The "monetary base" -- the best measure of pure money creation by the Fed -- grew at a 740% annualized rate over the last three months. The Fed's balance sheet has tripled. It's now equal to 20% of the balance sheet of the entire commercial banking system.
The Fed's move to lower interest rates to near-zero this week is part of that, but it's not itself especially relevant. The important thing this week was when the Fed announced that it intended to keep its balance sheet huge and even grow it from here by buying mortgages, Treasurys and who knows what else.
Put it all together, and it means that the four worst mistakes that caused the Great Depression -- tax hikes, protectionism, bank failures and tight money -- are most assuredly not being repeated today.
So I'm quite confident we're not moving from recession to depression. That makes me think that a lot of the massive "stimulus" that Washington is talking about will end up being a big waste of money. By the time we do it, it won't be necessary. And even if it were, I worry that a lot of it is really just an excuse to implement politically popular spending programs using an economic emergency as the excuse.
But let's not pick nits. The point is that we're not headed into a depression. All the rest is details.
If I'm right, and this view starts to gradually seep into public consciousness, then stocks are going to keep working higher, as they have for much of the last month. There will be scares. And there will be big downdrafts as investors who didn't sell on the way down use rallies as an opportunity to get out while the getting's good. But I really think the bottom is in and that stocks are headed for a very nice rally from here.
If nothing else, a rally is due just from sheer exhaustion of selling. Late November was surely a "selling climax," and even if we ultimately have to retest those levels, we can still have a nice rally in the meantime. When stocks have moved somewhat higher a month or two from now, we can stop and reappraise. But for now, the course of least resistance is higher.
Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. You may contact him at don@trendmacro.com.
Remember that scene in the sci-fi movie “TimeCop”?
When the villain (played by Ron Silver) sends one of his minions back to 1929 to buy up stock in companies dirt cheap that will be worth zillions in the future?
Nope, I think this is a coming depression. A deflationary credit contraction followed in about eight months by hyperinflation. The problem is that the Fed is pumping enormous amounts of money out there, plus Obama’s bailout and No-Energy policies will also monkey wrench the system. M2 is apparently growing at 12% right now. I just see no silver lining for five years.
I wouldn’t call it excessive pessimism, but the end of excessive optimism.
When others lose their jobs, it’s a recession. When you lose your job, it’s a depression.
My financial investor thinks this talk of depression is overstated and 4Q09 we’re growing again if not sooner. This is like the Dotcom bust and will just take some time to recover.
Fortunately, our president-elect seems to realize that. Barack Obama campaigned on the promise to repeal the 2003 tax cuts rather than just let them expire naturally in 2011. Now he's let it be known that he won't be repealing them, so taxes are going to stay low -- on incomes, dividends and capital gains. I never thought I'd be so glad to see a politician break a campaign promise.
America 1930 is the wrong analogy. See Germany in the 1920's.
“My financial investor thinks this talk of depression is overstated and 4Q09 we’re growing again if not sooner.”
Is his on commission? LOL!!
yeah, sure.
And this from the people who gave me all that great financial advice that has my retirement tanking. LOL!
Buy a little gold as an inflation hedge, both paper and physical. Worse case scenario is you lose a little money down the road. Otherwise, buy lots of canned goods.
8+ trillion in bailout promises, just to keep this economy afloat? This is far more serious then a recession.
Right now, we are in a deflationary cycle — the first since The Great Depression.
Just wait till February, this downturn is far from over...
Yep, the Germans inflated to get out of war reparations. The US will inflate to get out of the enormous treasury debt.
Of course your investment advisor has nothing to gain by making you believe this??
This, from the guy who claimed that the “bottom was in” on the stock market on (ready for this) November 30th, 2007.
This, from the guy who said in July of 2007, that the “bears are in for a disappointment.”
This, from the guy who said in August of 2007 that Bernanke “hasn’t cut the Fed funds rate and why he isn’t going to...”
Luskin is a fool and an idiot. He is one of the two types of people on Wall Street who can and will cost you EVERYTHING: The “perma-bull.” The other type who can and will cost you everything is the “perma-bear.”
Both of these types of idiots just refuse to observe facts. They cannot accept that there a) is a business cycle, b) there is a real estate cycle, c) there is a commodity cycle, and that there is a time to be bullish and a time to be bearish.
Right now is a really good time to be bearish.
And yes, we’re increasingly looking at the possibility of a depression, where “depression” is variously defined in a number of ways, but one of the ways is that unemployment goes over 10% for four quarters. I think that is increasingly probable - the world simply has too much production capacity and much of it has been financed by the US consumer going ever deeper into debt.
Well, the US consumer has finally broken his back, carrying the weight of the US and Chinese economies.
America 1873 is a better analogy yet.
What will you IA lose if he is wrong? As much as you will?
No. We’ll see what happens. With all the hedge fund slugs pouring gasoline on the fire these downturns become more and exaggerated. How one views this depends on their investment horizon. Those people starting out and getting their first home now and starting to invest have a great buying opportunity over the next year. On the other hand those getting ready to retire and still fully invested are in a difficult pinch.
No. I should have made that more clear - its an investment newsletter and use him as an advisor. I manage my own money.
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