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.
[FC, maybe you can answer this question for me. The Fed is pumping money into the system like crazy. Where is the money going? The banks don’t seem to be lending it. Are they sitting on it? Or, are they buying T-bills? Is the Fed shoveling it out one door and shoveling it in the back door? ]
I think it’s sitting in the banks, but they are all scared to lend, so they are sitting on the capital. We are in a huge credit contraction, thus deflation right now. But we still have a couple trillion about to be pump out there, so at some point the game of musical chairs begins.
Wrong, it's in the banks in china,there is just some people you cannot refuse to pay.
The lock against hiring for the year has only just begun. How long will it last—through February, March, April? The “depression” will be more apparent in the late spring and early summer. Some developers with rather large companies told me that there are no loans for their next projects.
I didn’t read the article, but I will as soon as someone can tell me that the author, Donald Luskin:
1) anticipated the collapse of the housing bubble
2) anticipated the collapse of the financial sector
3) predicted the scope and scale of the stock market crash
4) predicted that this mess would impact the real economy drastically
You see, any asshat can shoot his mouth off about what he thinks, but at this point, I’m only listening to those who have credibility, who saw all of this coming and screamed about it.
So, can anybody point me to some of his articles where he predicts the above, the way I did. If he didn’t, then he lacks even my limited, pathetic forsight and I have no reason to listen to him now.
That is not to say I disagree with his article. I don’t know. I won’t read it until somebody tells me he is credible and was out in front with his predictions of what has occured.
OK. You answered my question. Luskin has no credibility. Good thing I didn’t waste my time reading the article.
I didn’t bother to read it either. The depression is coming, the question is how bad? Luskin is an idiot, I could post 25 articles from people that KNOW what they are talking about, unlike that clown.
In the meantime, the entire financial chattering class will forecast that it ends in hyperinflation and dollar collapse, and they will all be spectacularly wrong, 180 degrees, and in every detail.
You heard it here first.
Politics is one thing, economics another, and finance a third. Ideologues are always trying to substitute their spin for the organic realities of the second and third, and they are always wrong. Always.
Um...the rather large company my husband works for just cut capital investments (projects) for 2009 by one-half.....and froze salaries.....we’ll see....
Your not the first I’ve seen say this. I’ve read a few articles that this crisis is VERY similar to the panic of 1873. IIRC, the best one was on iTulip.
Yes, here it is...
http://www.itulip.com/forums/showthread.php?p=52465
FWIW, Eric Janzen is NOT saying the outcome of this episode will mirror the lengthy depression following the panic of 1873. Eric is very firmly in the camp that the government will succeed in reflating. He remains convinced that the final outcome of the current crisis will be high inflation, NOT deflation.
I’m still struggling to decide if the government can prevent deflation. With trillions committed and with the Fed beginning to print and print hard, I am beginning to agree with Eric that the Fed will succeed, they will snap us from deflation into double-digit inflation. But seriously, my opinion matters little as I really have no clue how it goes. My point is, that Janzsen is still sticking to his guns that the gubmint will beat deflation with double-digit inflation and it will work.
You have it all wrong. Hedge funds aren’t pouring gasoline on the fire. They are flat liquidating. The hedge fund model is imploding before your very eyes. You imply that the hedge funds are temporarily dumping and will pick up later. Nope. They are finished. Done. The model has failed. Hedge funds are liquidating.
“This is like the Dotcom bust and will just take some time to recover.”
I’m trying to remember what some guy (”financial expert”) had said about these “busts”. Talking about booms and busts, and the economy recovering. Something like: After the Saving & Loans busted the economy recovered because the Dotcom Boom came along. The Dotcom Bust economy recovered when the housing market boomed. The housing market bust (and the banks, credit, etc.) will recover when the Dollar Boom arrives. But nothing will be along to pick up the pieces after the dollar bust.
I guess he was saying that these booms and bust were short and shallow but money found its way to other things. (Each one seeming even more shallow to me - no real worth or value). So we may be out of this recession by the end of next year or two, but when the next boom (the Dollar) fails - then it will be bad.
I have no idea if all of that makes sense or not. But, to a layman like myself it seems to. Throwing money at something to fix the problem seems REAL shallow to me.
And - if we think it is bad now - give Obama’s policies a couple of years time and see how it goes.
Can you please post what your advisor said in 2006 about the current recession and stock market crash? Did he see all this coming? Did he save you from any loss, the way I saved myself form any stock market loss by moving all of my investments from equities to cash in December of 2006? I saw all this coming. Did your advisor see this as well?
As far as T-bills goes, other nations are snatching those up as fast as they can, though the return is so low it is essentially a loss after administrative costs. Yep, other nations see nothing better to invest in in their own countries, so are buying T-bills at a loss. That is what they see as the safest bet.
Bush is like Hoover and Obammie the Commie is like FDR, who ridiculed Hoover's economic policies in order to get elected, then adopted those same policies and put them on steroids, thus causing the Depression.
The money they've been printing for the past year and a half (and the fact that the Dems in congress decided to stop publishing how much new money is being printed — the end result being we have no idea how much fiat currency has been pumped into the economy for the last year and a half), will bring the combination of 1920’s American socialism and the 1930’s Weimar Republic into a high-speed merge where neither gets out of the way of the other. Think massive, flaming wreckage cartwheeling down the highway at a hundred miles an hour.
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