The Best Investments If There Are 'Low Rates' Until 2014

by: John Lindauer

It is painful to admit but so far China appears to be doing a better job than Europe and the U.S. of managing its recession.

China responded to the downturn in the exports that have been driving its economy by loosening credit and keeping its exchange rate pegged to the dollar at a rate that encourages exports and capital inflows to buy into Chinese companies and help set up new ones.

Pegging an exchange rate low is the classic "beggar thy neighbor" policy straight out of the U.S.' 1930s playbook. It did not work in the 30s because the other countries retaliated in kind. It only works when the neighbors' leaders and central banks are so misguided and weak they leave their people unemployed, and their employers with excess capacity, rather than respond (the White House today?)

China's overall policy solution could be summed up as "do whatever it takes to get enough customers for China's employers so they can keep hiring workers and the Chinese economy keeps growing."

Europe, in contast, has responded to the sovereign debt problems and the employment strangling laws and regulations of Greece and other eurozone countries by bailing out the handful of large banks that gambled by making foolish loans that could not be repaid and by requiring countries with excess sovereign debt to cut their spending and raise their taxes - and thus thrusting them deeper into recessions and worsening their ability to pay their sovereign debts.

The U.S. is responding worst of all

In response to the collapse of U.S. mortgage and housing markets and the resulting "Great recession," the Bush/Obama government (Obama kept Bush's entire economic team Geithner, Bernanke and Baer) and its central bank, the Federal Reserve System, bailed out and made even bigger and more profitable the handful of financial giants whose wheeling, dealing, and fraud caused the collapse: Goldman (NYSE:GS), AIG, Deutsche Bank (NYSE:DB), and Fannie Mae (OTCQB:FNMA) - apparently naively thinking their resulting larger sizes and continuing ability to generate big profits and huge employee bonuses would result in benefits that would somehow trickle down to the real world and somehow benefit U.S. workers, employers and commercial banks. It didn't work and never will.

Then, while continuing to help the too-big-to-fail financial giants that made bad bets and continuing to ignore the millions of foreclosures, bankruptcies, unemployed workers, and government deficits, the White House and Congress bailed out a handful of inefficient carmakers to save the "jobs" of its auto union political supporters, many of whom had been literally sitting around idle for years. It also funded "shovel ready" make-work projects - only to discover they did not exist and would take years to get started, if ever, due to the innumerable regulatory impediments and appeals processes imposed on job-creating construction.

Simultaneously with the failure of the Bush/Obama White Houses and Congress, the Federal Reserve and the FDIC caused millions of additional bankruptcies, foreclosures, and business and bank failures by failing to provide the commercial banking system with adequate liquidity. To the contrary, the Fed expanded liquidity (QE1, QE2) while both simultaneously conducting "stress tests" and using them to justify raising the reserve and lending requirements of all commercial banks - thus requiring the banks to hold as reserves the QE1 and QE2 money they would have normally loaned to consumers, home owners, and businesses. In other words, contrary to "common knowledge" as reported in the media, The Fed has not yet acted in a meaningful way to increase the supply of loanable funds in our commercial banks.

The higher stress tests for all banks combined with directing the special assistance only to those too-big-to-fail resulted in the smaller financial institutions being closed and their assets transferred to their bigger too-big-to-fail competitors - in effect, rewarding the too-big-to-fails for the problems they caused and giving them even more market share and profits.

Simultaneously, the Fed and FDIC bank examiners took steps to make even fewer consumers and businesses eligible for the few loans that the banks had money to fund.

As a result, during the first years of the current "Great Recession," and continuing to this day, loans and mortgages issued by commercial banks and other lenders were defaulted on by financially distressed families and businesses. The resulting loan losses in combination with the banks' higher reserve requirements, of course, resulted in even more bank failures and a further inability of consumers and businesses to get normal loans and credit - further depressing the economy and resulting in even more unemployment, foreclosures, bankruptcies and bank failures.

So where is the U.S. and the world today after four years of mortgage fraud, central bank incompetency, and fiscal excesses in some of the eurozone countries?

Things are worse than investors have been led to believe. The U.S., for example, continues to be mired in a "Great Recession" - and it's much worse than the government admits. (See this January 6 Seeking Alpha article).

China seems to be responding the best. It continues to hold its exchange rates down to attract foreign buyers and investors, and it is creating new money and pouring it into its economy to keep its customer spending up and its economy growing. So its factories are operating and its people are employed. This will continue until the inevitable collapse of China's economy. (China won't last - see the December 26 Seeking Alpha article "Why Investments in China Will Eventually Be Worthless.")

In contrast, the eurozone still has massive unemployment and unrest in a number of countries in its southern tier. Each has been successfully pressured to cut spending as its way out of its sovereign debt problem in exchange for financial aid - instead of being pressured to remove the regulatory impediments so its tax base can grow.

The european solution is not working. To the surprise of the European Community and IMF elites, and no one else, unemployed workers and businesses without customers do not pay taxes. But they are sufficiently distressed to be eligible for welfare and assistance. So in most cases the deficits of the euro countries such as Greece and Portugal, and thus their ability to pay their sovereign debts as they come due, are getting worse, not better. It's the IMF solution and it has never worked. The result will be sovereign defaults (see the January 22 Seeking Alpha article "Greece Will Default: This Means Big Investor Opportunities.")

The United States' current response is the least adequate

The Bush/Obama White House and its appointees continue to generate costly and time consuming policies and regulations - all of which discourage lenders, employers, and business investments. (Bush and Obama are lumped together here because as noted, Obama kept all the unqualified Bush economic appointees who got us into this mess - Bernanke, Geithner, and Bair at the FDIC)

And Congress is doing its part to keep the recession going - trying to cut spending to reduce the deficit even though less spending will cause even less production and more job cuts and, thus, more foreclosures and business failures and result in even bigger deficits. They still don't understand that in the real world the U.S. can only grow its way out of its deficits and that today the U.S. would have a budget surplus if its economy had full employment instead of today's unemployment of approximately 20%. (See the January 24th Seeking Alpha article "A Letter From Adam Smith To Investors.)

And the presidentially appointed governors of the Federal Reserve are doing their part to keep the recession going. They still naively think that reducing the overnight rate of interest and keeping it low will somehow cause banks to have more money to loan and that they will do so - even though the money they borrow has to be repaid within 24 hours and there are now fewer qualified borrowers due to all the bankruptcies, foreclosures, and business failures, to say nothing of the higher loan standards that the banks are now required to impose.

Recovery remains right around the corner. And will stay there

The economies of Europe and the U.S. would quickly recover if they copied China's use of modern macroeconomic policies to get enough purchasing power into the hands of their people and businesses - so more people go to work as businesses increase their outputs and make more profits and their stock prices rise. Then tax collections rise and the deficits, which so wrongly worry Congress and rightly worry the states and local governments, would tend to disappear.

Fiscal policy and monetary policies using overnight interest rate changes do not and cannot work in the United States (see the January 1 Seeking Alpha article "Krugman, Keynes And The Economy") That leaves monetary policies based on quantitative easing as the only viable way for the United States to get enough additional purchasing to end the current Great Recession. Today that means creating "enough" new money and actually getting it into circulation - not too much additional money so as to cause inflation from excessive spending nor too little so as to cause unemployment from inadequate spending.

Similarly, Europe and the US need to reverse course on the regulatory impediments they have imposed. They have gone too far in letting anything and everything stand in the way of an increase in their tax bases. They would do well to revisit both their excessive regulations and the regulations' delay-intending appeals processes. At the very least the progress of employment-delaying lawsuits could be accelerated with regulatory courts at the appeals court level and "loser pays the costs" rules could be adopted.

Is a solution possible?

So far the governments of the United States and Europe have proved once again that a modern monetary economy based on profits, incentives, and wages cannot cut or regulate its way to prosperity. The only alternative is to grow its tax base - and that requires seeing that enough revenue flows into its profit and nonprofit employers and that they are not held back by useless regulations, restrictions and regulatory delays.

A solution is possible. The Federal Reserve could abandon its naive policy of changing the overnight rate of interest and actually put sufficient amounts of spendable funds into our economy - either indirectly via adding loanable funds to our commercial banks or directly via funding high propensity to consume spenders such as social security recipients. In other words we need some form of a real "quantitative easing." It would be the first one - because they never provided the banks with loanable funds QE1 and QE2 were political frauds comparable to the AAA mortgage-backed securities sold by Goldman Sachs and Lehman Brothers.

Until the White House and its central bank appointees act on behalf of the entire economy, instead of just the favored few, investors will not see a major bull market. - and its especially silly of the President to think the same old people doing the same old things will generate anything other than the same old results.

But when the Fed finally acts, and sooner or later it will, investors will be greatly rewarded as profits and stock prices tend to increase faster than production increases when an economy comes out a recession and moves to full employment. The stocks of companies that can rapidly ramp up production will be the biggest winners. That would be the time to buy a broad portfolio of stocks. That time is not now.

The current "Great Recession" will not be ended soon

The Federal Reserve, Congress, and the White House do not appear to be in any way close to a solution to rescue the U.S. economy by getting enough purchasing power into the hands of consumers and businesses as the Chinese are doing. To the contrary, if the recent Federal Reserve governor appointees are any guide, the Fed will continue to have no macroeconomists with real world business or banking experience involved in its decisions. Thus it is likely to continue to concentrate its efforts on changing the overnight rate of interest and helping the handful of too-big financial firms that got us into this mess in the first place.

In other words, investors need to be skeptical that the economy and the stocks associated with it will recover so long as the same old people at the Fed do the same old thing in the same old way over and over again.

So Today These Are The Best Investments

For investors the Fed's and White House's continuing insensitivity to the state of the businesses, commercial banks, and workers in our economy means the favored few will continue to prosper while the rest of the economy stagnates. Until the White House makes competent appointments and the Fed begins to carry out its statuatory duty to maintain full employment investors would be well-advised to stick with the favored few: Goldman Sachs, Deutsche Bank, Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM), CitiBank (NYSE:C), Credit Suisse , and Morgan Stanley (NYSE:BJI).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.