Economic Themes for 2009

2009 has certainly started off with a bang. While the financial markets have been rather quiet, underlying economic fundamentals continue to deteriorate. Unfortunately, the rubber-stamped response to this deterioration has been nothing but more of the same. More debt, more deficit spending, and more subterfuge to insist that it just isn’t so. The monetary stops have been pulled as the Federal government has gone public with its intentions. The biggest problem with this is that what we’re hearing now is what was going on six months ago. The idea of persistent trillion dollar deficits has been firmly planted with absolutely no mention of an exit strategy or of how the Congress is planning on paying back these exorbitant amounts of borrowing.

What is going on right now is downright frightening to non-Keynesians as we are desperately looking at these initiatives for something – anything that will cause real capital formation or foster genuine economic growth. Unfortunately, the ultimate plan appears to be something along the lines of taking a pebble and putting a rock on top of it, followed by a cement block, followed by a boulder. And the American taxpayer is the pebble; about to be crushed by ten generations worth of debt accumulated before we even reach the next decade.

In a classic journalistic transgression, the Congressional Budget Office stole most of the thunder of our first theme for 2009 – a blowout in the Federal deficit as the government, almost out of options, pulls out all the stops and piles it on taking the national debt curve parabolic. Here are some of the related issues as we see them for 2009:

States circle the wagons for bailouts

California, New York, and as many as 29 other states are already in fiscal extremis as revenues plunge due to unemployment and decreasing tax receipts. States are faced with difficult choices in 2009. They can raise taxes, cut services, beg for a bailout, or in all likelihood all of the above. And in a typical ironic twist of fate, the market for municipal bonds is drying up just when the states are going to need the money most. To make matters worse, yields on municipal bonds blew out to nearly 2.2 times the yields on corresponding Treasury issues. This is more than twice the .96 historic level normally observed. Obviously, the message here is that the perception of security is gone.

We pointed out this likely eventuality when MBIA (MBI) and AMBAC (ABK) came under duress and saw their credit ratings cut back in June. Not only are the bonds questionable, but their insurance is as well. The bottom line here is that if bond issues can be sold, investors will command much higher yields resulting in greater debt servicing costs. Initial forecasts for 2009 indicate that there will be a 6% decrease in new bond issues sold, taking the total down to around $364 Billion.

The Goverbank buys Municipal Bonds

Goverbank: noun – The combination of the debt-issuing Federal Reserve and the debt-assigning US Treasury.

Because of the realities above, and a worsening cash crunch at the state and local level, the Goverbank will begin buying bond issues in 2009. Obviously, this is a common sense conclusion given the actions already observed as the Goverbank has inserted itself as the buyer of last resort in numerous other markets already. However, it serves to drive home one of the important themes moving forward: there will be no market or bailout too large for the monetary authorities to undertake. $700 Billion was only the beginning. The buying of Muni bond issues will also lessen the funds required to service the debt by creating artificially low rates. This will prevent the need for even further taxpayer-funded municipal bailouts – but only on the surface. Think of the classic shell game; either way you’re paying for it.

Private sector businesses and industries beg for bailouts

Already the steel and newspaper industries have stated their intention to vie for government bailout money. The TARP (already overspent) is going to have to be stretched much further. While some in the media will point out the semantical issue that the second half of the money hasn’t yet been released, it would be foolish to conclude that this will not happen. Sure, there may be some pandering and political posturing, but in the end the second $350 Billion will be released and distributed. In reality, the number is much higher than that already. It is very likely that we will see retail chains, more financial intermediaries, and scads of other businesses that rely on discretionary consumer spending in front of Congress as well in 2009. It is no accident that consumer staples companies did the best in 2008. The rest will soon be on Capitol Hill with hat in hand. The die has been cast – any industry that experiences malaise will want TARP money. A rather humorous story emerged last night, as apparently Larry Flynt is now demanding a bailout for the ‘entertainment’ industry. Incredible, but should come as no surprise. Expect more of this in 2009.

Creative financing will re-emerge to induce more borrowing

In an economy that is almost totally reliant on debt and spending, a cessation or curtailing of either of these activities will cause immediate problems. At this point, with negative savings rates having persisted since at least 2005, it is more imperative than ever that consumers continue to borrow and spend. The problem is how to induce this? The easy solution in 2001 was to put the pedal to the metal, drive interest rates down and create phony home ‘equity’ that could be easily tapped for almost any purpose.

It should be noted that when home equity loans were first introduced the money had to be used for some type of noble purpose such as education or improving the property. No more. The big question now is how will consumers be cajoled into borrowing even more money? Look to the same folks who created adjustable rate and reverse amortization mortgages for the answer. Creative financing will be back in 2009. And I don’t just mean 0% interest loans. Any machination that allows payment to be put off until a later date will do. 12, 24, and 36 months interest-free. No payments for 12 months. Partial payments for 12 months. No down payment and we’ll make the first 3 monthly installments for you. We’ve already seen these before, but they’ll become commonplace in 2009. Look for new ones as well with longer payments terms, which ironically means you’ll end up paying even more for the items. However, the focus will be on the ‘low monthly payments’.

Stimulus checks may not be checks at all, but may rather have a requirement for consumption attached. All indications are that the framers of the last stimulus package were unhappy because not enough of the money was spent. Apparently some people actually paid bills and/or saved the money. Maybe Wal-Mart (WMT) and Home Depot (HD) gift cards will be the delivery method for the next economic stimulus. I’m only half joking about this.

2009 - The Bottom Line

In the end, the answer will be the same as it has always been – money printing. We have known this for a long time and the proof continues to come in each day in our news headlines. The government believes that only it can save us from certain financial destruction. And it will do so by employing the same policies that got us into this mess to begin with. Amazing. History has borne out this reality ever since the invention of fractional reserve banking and the printing press. The quantity of dollars in your bank account may be guaranteed. There will be enough dollars created to permit all the states, private firms, Bernie Madoff, and perhaps even Santa Claus to avoid insolvency. Bankruptcy, however, has been replaced by receivership. Firms will no longer go bankrupt; they will be absorbed in a giant asset consolidation. Bear Stearns (BSC), AIG, Fannie (FNM), Freddie (FRE), WaMu, Citigroup (C), and Lehman (LEHMQ.PK) are all examples of this new financial hierarchy. There will be plenty of dollars. The problem Main Street will face in 2009 and beyond is twofold.

Monitoring and maintaining the VALUE of the currency will be the challenge. When and if the spigots are opened and these new dollars cascade into the real economy, the value of existing dollars will be destroyed in a very short period of time. Consequently, prices will skyrocket. Secondly, as has been pointed out before in previous articles, recognizing the transition will be key. It may happen slowly or it may happen quickly. Much of the effort of the Treasury so far has been aimed at controlling the flow of the fresh money to avoid touching off a hyperinflationary spiral. These developments will require constant analysis as 2009 unfolds.

Ultimately, the quantity of a fiat currency is easily manipulated. However, it is the value that is much harder to maintain. Preserving value will be your challenge in 2009 – and ours along with you.

Disclosures: Long MCD, XLP

Comments

[Gtarras:]

what is your definition of "skyrocket"? while I agree with thesis that elevated inflation is a given, once we deal with the current mess, let me remind you that $1 trillion dollars is only 7% of US GDP.

Oh, and the current US debt to GDP ratio of 65%-70% is not even close to, for instance, Japans, which is north of 300%...

Jan 12 06:29 AM

[patio:]

In every one of these discussions ( on SA, not just this author ), you cannot just talk about money printing in isolation, you must add velocity, and the supposed mechanisms of how all this money gets into circulation. We know banks currently aren't lendng, except to those few who qualify under the new guidelines ( guidelines back to sanity ). we know companies aren't expanding, consumers aren't spending, so who is at the till asking for new credit?
Then, you must discuss our printing relative to other countries and their printing, to discuss whose currency will devalue relative to the others.
That sounds bossy, you "must" do these things- sorry, poorly worded.
I mean it seems to me you can't look at one aspect in isolation.

Jan 12 09:55 AM

[OldLimey:]

Gtarras: I assume the author is thinking of a figure well in excess of the $1 trillion you mention. Not only are there the bailouts and the Obama stimulus to consider, but also whatever the Fed pumps out into the economy via asset purchases.

In addition to the size of the numbers, an important and now widely discussed issue is how soon and to what extent the velocity of circulation will take off. I assume this is what the author is referring to when he says "When and if the spigots are opened and these new dollars cascade into the real economy...." To extend the analogy, I personally reckon the spiggots are already open but flow is being held back by an 'air lock'; once that is cleared, assuming that it can be, it will be up to the central banks to edge the spiggots closed. Unfortunately, I'm not convinced that machine analogies truly reflect the complications involved in attempting to fine-tune an economy. I think the author's warning in his last two paragraphs is on the mark.

Jan 12 10:54 AM

[patio:]

Same question: OK, let's say the spigots open. Who is on the receiving end of those spigots, how does the money get into circulation?


On Jan 12 10:54 AM OldLimey wrote:

> Gtarras: I assume the author is thinking of a figure well in excess
> of the $1 trillion you mention. Not only are there the bailouts and
> the Obama stimulus to consider, but also whatever the Fed pumps out
> into the economy via asset purchases.
>
> In addition to the size of the numbers, an important and now widely
> discussed issue is how soon and to what extent the velocity of circulation
> will take off. I assume this is what the author is referring to when
> he says "When and if the spigots are opened and these new dollars
> cascade into the real economy...." To extend the analogy, I personally
> reckon the spiggots are already open but flow is being held back
> by an 'air lock'; once that is cleared, assuming that it can be,
> it will be up to the central banks to edge the spiggots closed. Unfortunately,
> I'm not convinced that machine analogies truly reflect the complications
> involved in attempting to fine-tune an economy. I think the author's
> warning in his last two paragraphs is on the mark.

Jan 12 11:44 AM

[secmaven:]

And Japan's currency is the strongest in the world and getting stronger by the day!

Jan 12 11:52 AM

[OldLimey:]

Patio: blame the width of the Atlantic, but when I load a comment on SA the preceding comment does not always show until afterwards. In other words, I didn't have access to your first comment until after I'd posted mine.

Regarding your second comment, the questions are absolutely on point. Answers come down to a matter of opinion. You'll notice that I hedged the velocity issue with the words 'assuming it can be' because I have no more idea than anybody else whether consumers and corporates can be forced to drink even once the Government has led them to the well. (Probably one metaphor too many!) I tend to the view that there are a lot of people - particularly amongst those under 40 - who are keen to believe that there's a quick fix, are susceptible to being convinced there is, and will open their wallets accordingly. I know the response to this is that houshold debt is so high in both the US and the UK that this won't happen, and that could of course be correct. However, there's another article on today's SA (Promod Radhakrishnan) painting a slightly less gloomy picture of consumers' resilience in one part of the US; here in the UK retailers are dropping like flies, but I still come across folks on a daily basis who reckon the whole thing's just being stirred by the media. For all the horrific rise in unemployment, there are still a lot of people who have their jobs and as soon as they feel it's safe to go out and spend they will probably be at it again. Final metaphor - the gun is cocked, but whether or not consumers have strength left to pull the trigger remains to be seen.

Regarding currency relativities, the true scale of our respective bailouts, asset purchases, nationalisations, and stimuli as a percentage of national economies generally and money supplies in particular are so murky (and will probably remain so murky) that I think initially it's going to be a matter of confidence as to which country is managing most responsibly. That then becomes a matter of personal and national perspective. Personally, I think authorities in both the US and the UK have been acting rashly whilst the ECB has tended to be more responsible. This is a minority view in the Anglo-American world, where 'aggressive' action seems to be prized over slower consideration of unfolding circumstances (aka being 'behind the curve'). Time will tell.

Jan 12 01:38 PM

[prudentinve...:]

I'll suggest the Yen is strong because Japan manufactures many products that the rest of the world wants to buy, while consuming less of the rest of the world's output than they produce and export.


On Jan 12 11:52 AM secmaven wrote:

> And Japan's currency is the strongest in the world and getting stronger
> by the day!

Jan 12 08:29 PM

[PeteK:]

The proposed stimulus package will benefit ABK, MBI, and GNW plus a few other insurers. That's why these companies went up pretty nice the last 2 trade days. Most people support stimulus help from the government so that things can get back to normal. For the good of this Nation, it must be done and quick. (1-25-2009)

Jan 25 05:48 PM