Skip to comments.The Great Correction…Still Pending
Posted on 04/07/2010 6:05:55 AM PDT by blam
The Great Correction Still Pending
By Bill Bonner
04/06/10 Baltimore, Maryland For more than a year, the recovery bounce in the stock market has refused to give up. The indexes have recovered more than 50% of what was lost. Technically, they look pretty good. Whats more, the S&P sells at more than 21 times normalized earnings, according to Robert Shillers latest tally. It seems like nothing can stop stocks now.
Then theres the Treasury market. Overall, yields remain remarkably low. It is almost as if Treasury buyers are unaware that they are being asked to finance the biggest increase in sovereign debt ever. It doesnt seem to matter either that many of the applicants for money will be incapable of repaying it. Several sovereign debtors, including the US, have already reached the point of no return, according to professors Rogoff and Reinhard.
Still, the financial press is optimistic. Economists are irrationally confident. Investors and advisors are overwhelmingly bullish. And the American public seems willing to add a trillion-dollar health-care program to its burdens a sign of remarkable faith in the nations prospects.
So, lets go back and reexamine our basic position. Is this really the Great Correction that we think it is?
If there is one lesson weve learned over the years, it is that we need to be patient. Things that have to happen generally do, sooner or later. You just have to wait. And when they happen, they generally happen much faster than you expected. Even when youve been expecting something for years, it can come and go before you realize what is going on.
You get used to being wrong or at least premature. You wait. You watch. You think the time has come and then: whoops not yet. Pretty soon, you are overcome by anticipation fatigue. Then when the real thing finally does start to happen you dont believe it. You wait to be sure you hesitate and then its over!
Just what am I waiting for? Im anticipating more evidence of this Great Correction, including another big swing down in the real price of stocks, bonds and commodities further deterioration in the real estate market a falloff in consumer spending and a higher savings rate.
Im also expecting higher yields from government debt and a dangerous intensification of financial problems in both the private and public sectors. If Im right, those things must happen eventually. So far, were still waiting.
But this week the long-awaited turnaround in the bond market may have begun. Rates are rising along the entire yield curve, especially at the long end. The bond market is now very close to saying, Weve had enough, predicts the octogenarian stock market technician, Richard Russell. The 30-year T-bonds recent decisive move above 4.80% marks the end of a 25-year bull market in bonds, says Russell. Rates will be moving higher from here.
Investors are starting to tune into how sovereign debt works. And theyre starting to realize that even governments can default. In fact, almost all of them do default eventually. Yes, even governments whose debts are denominated in their own currencies default. And even when they have the power to print the currency themselves.
How could that be? Well, it is very simple and worth spending a little time on. I want to make two points:
First, governments will usually choose to default on their debt rather than risk hyperinflation of their currencies. Second, when they reach a point of no return they have no choice. They cannot cut back spending. Because even the most drastic cutbacks will not do the job. That would simply result in lower tax receipts and an even bigger deficit. At a certain point, the multiplier effect becomes the divider effect.
Ive made the point many times that democracy seems hell-bent on self-destruction. Americas founding fathers noticed many years ago that when people realized that they could vote themselves money from the public treasury, democracy would be doomed.
Most people presume that if a politician offers benefits, someone else will pay for it somehow, someday. In practice, the money doesnt come from additional taxes. Taxes are already, at least theoretically, at their optimal level. Higher tax rates produce lower economic activity, which lowers tax receipts. So instead of raising taxes, governments borrow the money. Then sovereign debt loads become larger and larger until, as Greece has recently discovered, they are impossible to carry.
America also has public sector debt problems of about equal measure to Europe and she has huge private sector debt problems as well. For the moment, the skies over the American financial markets are clear. But out at sea a hurricane is spinning faster and faster. There is a huge wave of debt defaults/foreclosures in the private sector that will hit the markets soon. This wave, combined with record borrowing from the US government, is bound to push up bond yields making it harder than ever to get needed funding.
The situation with the US government is more complicated than it is with private borrowers or even with Greece or California. The federal government can print money. But it, too, is ultimately at the mercy of the bond market. Last year Uncle Sam borrowed $2.1 trillion. This year it will borrow $2.4 trillion. Without this money, US government spending would have to come to a halt. The US counts on lenders. It needs lenders. Without them it would be forced to make cuts equal to about 10% of GDP. Think youve got de-leveraging now? Just imagine what that would do.
Typically, of course, government bond buyers dont cut off a lender altogether. They merely demand a higher rate of interest to offset what they see as an increased level of risk. The higher interest rate adds to the borrowers cost increasing his deficit and forcing him to borrow more.
This is where it gets interesting. You might say that a government can print its way out it can just print the money it needs rather than borrowing it. But what would happen if the US chose to print $2 trillion this year? It would risk hyperinflation. Lenders would run for cover. Prices would shoot up. The damage to the economy would be severe so severe that only governments under extreme pressure think Weimar Germany or Mugabes Zimbabwe are willing to risk it. Instead, they try to muddle through, as Greece is doing now promising budget cuts, making special financing deals and pushing up the rate of inflation a bit, but not so high as to cause panic in the bond market.
See, as long as the bond market permits it, debt levels continue to grow. But at some point the point of no return a government can no longer save itself from disaster. How does that work? Well, when deficit/debt levels are too high, the cuts necessary to bring the budget back in balance are so great that they squeeze the economy hard, reducing output and decreasing governments tax revenues.
In this case, the government cannot escape. It has to print money. Or default. Most often, it will choose default, because it is the less painful solution. Either way, the government finds that it will be cut off from the bond market. Hyperinflation is merely an additional and unnecessary aggravation. (That said, I agree with Nassim Taleb, that hyperinflation remains an underestimated black swan risk.)
The underlying story of the economy has not changed. We are in a Great Correction. We dont know exactly what it is correcting but it looks as though it will at least reduce some of the leverage that has been added to American and British households over the last 60 years.
So far, the process is tentative and unsure of itself. From a peak of 96% of household income in 2007 debt has fallen to 94%! The drop is so small that it makes you wonder if it is a trend at all. But if it is, it has a long way to go. Ten years ago at the peak of the dot-com bubble household leverage was only 70% of income. At the present rate it will take another 24 years to get back to 1999 levels.
Albert Edwards of Societe General has examined the non-financial leverage in the system. There is excess leverage of about 60% of GDP, he says. He calculates it will take a decade of Japan-like pain to eliminate it.
Either way, youre talking about a long process of getting back to normal.
The Great Correction is also what is keeping housing and unemployment down. When the banks arent adding to the nations credit, you just cant expect many new jobs or many new house sales.
Nothing has changed in the last week except we have moved one week closer to whatever crisis lies ahead.
By Bill Bonner
04/06/10 Baltimore, Maryland No matter how absurd things get, they can always become more absurd.
Summers: US nears escape velocity
Thats the headline on the weekend Financial Times.
Summers is jubilant. He got the latest employment figures on Friday. They tell the story of an economy that he thinks is headed into outer space, with 162,000 new jobs created in March. Hallelujah all this intervention by the feds is paying off! Thank God Summers was on the job. If he hadnt been well, the economy would have had to get along on its own right here on planet earth just like it did for all those centuries up until the feds got control of it during the Great Depression (or shortly after).
Heck, you know how terrible it was back then. People would go broke Speculators. Bankers. Promoters. They would be wiped out. Jobs would be lost. Businesses would go bankrupt. And then, a few months later, theyd have to get back on their feet begging, borrowing, or stealing enough capital to make a fresh start.
But now things are different. Now, we have a better world, designed in part, by Mr. Summers himself. Now, people dont go broke. Well, at least, major campaign contributors dont go broke. They get bailed out. They stay in business. The feds give them money so they can keep doing what they did before. And then, the feds put a booster rocket under the whole economy
its all on purpose
Just picture the stock market as a slot machine with a progressive jackpot. The jackpot keeps going up and up and will hit over 11000 pts. But, eventually some lucky player is going to pull the lever and cash out. All the other sorry suckers are going to be left feeding the machine.
Thanks for the ping!
I wonder how many of the non-census jobs (apprx. 110K) were due to govt construction projects starting up, road repair etc.?
Now, people dont go broke. Well, at least, major campaign contributors dont go broke. They get bailed out. They stay in business.
Failure was always the greatest regulator. The businesses that were "too big to fail" should have been broken up.
“I wonder how many of the non-census jobs (apprx. 110K) were due to govt construction projects starting up, road repair etc.?”
39,000 others were state & federal government jobs. NOT stimulus jobs. You need to factor those in as well.
What's wrong with this picture?
Don’t blame that on the American Public!!!
Do you see a bubble too?
Chris Matthews says you shouldnt use the regime word, only he can do that.
Very good from Bill Bonner
I feel vindicated just reading this excellent analysis.
He is so right in his statement that what comes will come, but we just don’t know when. This is the process that makes the uninformed say “he is a permabear, of course he will eventually be right after warning of doom and gloom forever”. I see this time and again here, with people discounting correct predictions that simply can’t be timed.
As far as his analysis, it sounds right on to me. I am not bying this “recovery”. Not at all. The fundamentals are still terrible. I don’t see any fundamental reason for renewed. We are still buried in public and private debt. All that has happened is that a huge piece of private debt was absorbed by the US Central Government, making it public debt. It didn’t go away - it was just transfered. That, and the Obama administration is aggressively adding to the debt above and beyond this transfer from private to public debt.
It is hard not to feel we are doomed. I am not convinced Bernanke will allow a default of debt rather than risk hyperinflation. I’m sure he will risk hyperinflation, thinking he can cut the liquidity in time to prevent it.
I have no clue where we are going from here, but we are not in a recovery. Not even close. It remains to be seen if the government can inflate a new bubble with green jobs or alternate fuels or something. I don’t think so. I think the Japanese style lost decade or two is much more likely than a recovery or a new bubble.
I guess we’ll see. This is not going to be pretty.
The original article for this thread and the link you posted come to 2 different conclusions.
The original post claims that governments choose to default on debt rather than risk hyperinflation, so too with the USA.
The article at the link claimst that governments choose to weaken the currency to inflate out of debt, so too with the USA.
This is the $64,000 question that points to whether we ultimately inflate or deflate. Maybe gold is useful in both instances, but otherwise there is no way to prepare for both and the investment strategy for one will kill you if you get the other. If you buy 3 investment properties and get default/deflation and a lost 2 decades, you have depreciating properties that rent for less and less. If you avoid a penny of debt and put all of your money in the bank and get high inflation, you have worthless cash that now buys a fraction of the hard assets you could previously have owned.
I am still a confusionista with no clue how this pans out, and anybody who feels they know the unknowable is kidding themselves. I am still leaning toward currency devaluation and high inflation and possible hyperinflation. That is what I see the government doing. Their current policies are certainly not indicative of a stronger currency.
Who knows? This is going to hurt either way.
We live in interesting times. A lot of people are getting a 1st class education in the dangers of debt.
I'm preparing for inflation. It will come at some point.
Stocks are flying high out of false hope, ignorance, manipulation, and soon — the greater fool theory. It is funny money. When the government stops quantitative easing, the market plunges. Maybe before.
I agree. I just don’t know if it will be an deflationary depression or an inflationary depression.
The price of gasoline/energy will drive the economy off a cliff by itself if the below forecast is correct.
Methinks inflation also (used to think The Big D). My basis is the "poor man's silver" indicator - the lowly 5c piece. It's intrinsic value has gone from 4.4c to 6c in three months - the confirmation will come when the Treasury touts the "New Steel Nickel". The 97% zinc cent is already worth 6/10s of face value. Can you spell "Fractional Currency" children?
Wow, so about 39K for govt, about 50K for census leaves only 73K for the private sector and you can bet a lot of that is roads & bridges.
Been doing that for the last six months - $20-$40 at a time - at different banks so they can't rat me out later on. :-)
Just for grins, I started filling up an old 1938-61 Whitman Blue Book I got at a swap meet. Would you believe, I've almost half of it filled, including a nice 1943 P silver war nickel. I won't get 'em all of course, but it's a nice little sideline. I'm also separating the Lewis & Clark ones - humongous mintages, but if the nickels start getting melted down (clandestinely of course), just like with the "common" silver coins, mintage figures will go out the window.
Melting, to me, silver or otherwise, was always a dumb move. To paraphrase the old Dutch traders' maxim - "they aren't melting nickels, they're trading nickels". I give it another year at the current rate and then we'll start seeing ads buying them at "x times face value" like the silver coins did in the late '70s.
That makes it impossible to guess the winner. I understand why immediate needs would inflate while luxuries and secondary (optional) needs would deflate. Which wins in the end? This pattern of needs inflating while luxuries deflate doesn’t tell us anything about Bernanke’s willingness or ability to debase the currency.
I REALLY wanted to buy oil stocks under $40 but I couldn’t get liquid to do it. Now I’m kicking myself. Maybe I should have gotten a loan to invest, but I don’t like to leverage myself that way.
You could see this coming when oil fell under $40. I don’t see $150/Bbl but it is certainly possible and I know we will see $100. At $40, that would be a 150% return for doing almost nothing.
I hate missed opportunities.
I just looked that up after I saw you post it, and I think it describes what is going on exactly. The trading value of stocks is based largely on emotion, and that would explain why stocks go up in spite of unsustainable deficits and proposed taxes instead of cutting down government, and why many get stuck in each bubble. The memory of 2008 should make buyers more cautious but....
DJIA are all “big box” stocks.....stuff you buy no matter what the economy does.
Procter & Gamble
NASDAQ is doing $hit. It is still way below where it was 10 years ago. These are the growth stocks. There ain’t no growth.
On Wednesday April 7, 2010, 4:35 pm
By Leah Schnurr
NEW YORK (Reuters) - U.S. stocks fell in a broad late-day drop on Wednesday after a top Federal Reserve official said interest rates should not stay low for much longer, giving investors an excuse to take profits.
A speech by Kansas City Federal Reserve Bank President Thomas Hoenig drove afternoon selling after he said keeping interest rates too low for too long would encourage risky financial behavior.
Energy stocks led the declines, with the S&P energy index (SNP:^GSPE - News) falling 1 percent, and Dow component Exxon Mobil (NYSE:XOM - News) sliding 0.8 percent to $67.34. Crude oil futures fell 1.1 percent to $85.88 a barrel after data showed domestic inventories rose last week.
The Federal Reserve's near-zero interest-rate policy has underpinned a rally of almost 75 percent since the March 9, 2009, low, and the removal of easy money is one of the market's biggest fears. Hoenig, however, was the sole dissenter at the most recent Fed meeting, advocating higher rates.
"It looks like what the market is latching onto is Thomas Hoenig -- the lone dissenter of the idea of not raising rates -- had some very strong comments," said Scott Marcouiller, senior equity market strategist at Wells Fargo Advisors in St. Louis.
"The real reason is it's a short-term extended market that's vulnerable to short-term pullbacks and this is what it's using as the excuse."
The Dow Jones industrial average (DJI:^DJI - News) fell 72.47 points, or 0.66 percent, to 10,897.52. The Standard & Poor's 500 Index (^SPX - News) slipped 6.99 points, or 0.59 percent, to 1,182.45. The Nasdaq Composite Index (Nasdaq:^IXIC - News) lost 5.65 points, or 0.23 percent, to 2,431.16.
If interest rates shoot up, the stock market party will not be able to survive it. Even with all the manipulation. It will come down very fast. All that funny money will seek safe harbor in 10% treasury bills.
"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises
Apr. 7, 2010, 3:20 PM
Here it is, folks, the chart to break a million retailers' hearts.
It's the Fed's latest consumer credit reading, and after starting to come back, total outstanding consumer credit has fallen right back down, with a monster month-over-month decline.
Thanks for the reply. But I am not going to take it literally. The DIJA stocks got a good butt-kicking in 2008. Yes, if you held on to those stocks for a couple of years, you might be OK (although it's possible for the bottom to fall out when nobody expects it), but I did better by taking all my money out of stocks before that happened. I started putting money back into stocks, but a few days ago, I took out 90% of our money from stocks again. Sometimes I get a gut feeling that "something ain't right." I don't want to be "the greater fool," and mostly my paranoia about stocks has served me pretty well.
“a few days ago, I took out 90% of our money from stocks again. Sometimes I get a gut feeling that “something ain’t right.” I don’t want to be “the greater fool,” and mostly my paranoia about stocks has served me pretty well. “
That isn’t paranoia, that is well reasoned sense, based on your profits, and the likelihood that the market is over inflated. Good going!
By the way, I have not bought or sold any stock myself since GE went down to 6, right after the banking melt down I bought a lot of that, then flipped it a few weeks later at 12.25.
That was a looooong time ago.
I only look for shorts these days. Too many good real estate deals out here right now.
The stock market roars ahead on impulse because there is nowhere else to invest: housing prices continue to languish, bond yields are either too low or carry far too much credit risk. Additionally, after-market trades of index futures (from what sources remains an open question) continue to feed the Bulls' appetites for equities.
When the correction comes - and it will - the fall will be steep and prolonged.
There's more than one way to default. Cutting transfer payments to the "wealthy" is effectively a default. Then, once you establish the precedent, incrementally redefine "wealthy".
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