It is painful to admit but so far China and countries in Europe such as Germany are doing a better job than the U.S. of managing the worldwide recession that began more than four years ago.
China responded to its slowdown by loosening credit and keeping its exchange rate pegged to the dollar at rates that encouraged both exports and capital inflows.
The U.S. is China's biggest export market. Pegging its exchange rate low is the classic "beggar thy neighbor" policy straight out of the U.S. and UK's 1930s playbook. It did not work in the 1930s because the other countries retaliated in kind. But it has worked for China so far because the White House and Federal Reserve have not responded.
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 suffered as its large banks faced a double crisis: they had many billions invested in U.S. mortgage derivatives and more billions in the soveriegn debt of nations such as Greece.
Amazingly enough, the United States used some of the money Congress dedicated to helping the U.S. economy to help bail out a handful of big European banks caught by the U.S. mortgage debacle. Deutche Bank (DB) and Credit Suisse (CS) received billions congress appropriated to help Americans.
The European governments provided the rest.
The Europeans also bailed out the handful of big European banks, which had gambled by making foolish loans to Greece and Ireland. When the loans went bad the banks booked the losses and sold them off to naive hedge funds and speculators such as MF Global. Europe also funded a huge "bailout fund" for future bank rescues. Today the fund is about 500 billion euros and about to be increased to one trillion.
Europe also required countries with excess sovereign debt to cut their spending and raise their taxes as a condition of getting assistance to cover their budget deficits and payoff their sovereign loans. This thrust countries such as Greece and Ireland deeper into recessions and worsened their abilities to pay their sovereign debts.
Of late, Europe has somewhat changed its tune as its leaders realized that spending cuts and tax increases were not working. Now they realize countries with deficits and sovereign debt problems also need to grow their way out of them. And after four years of recession the ECB (European Central Bank) recently provided the commercial banks of its member nations with access to large amounts of liquidity. They provided it so the banks could continue to make business and consumer loans despite their losses on mortgages and sovereign debt.
The U.S. responded worst of all
The U.S. response to the collapse of U.S. mortgage and housing markets four years ago was led by the Bush-Obama White House (Obama kept most of Bush's economic team Geithner, Bernanke, and Bair) and its central bank, the Federal Reserve System.
Their initial response was to bail out, and make even bigger and more profitable, the handful of financial giants whose wheeling, dealing, and fraud caused the collapse: Goldman (GS), AIG, Deutsche Bank, and Fannie Mae (FNMA.OB).
The White House and Congress also bailed out a handful of inefficient car makers to save the jobs of the President's auto union political supporters. They also funded "shovel ready" make-work projects - only to discover such projects did not exist and would take years to get started due to the innumerable regulatory impediments and appeals processes.
Simultaneously, the Federal Reserve began causing millions of additional bankruptcies, foreclosures, and business and bank failures - which are continuing to this day - by failing to provide the commercial banking system with adequate liquidity.
It is true the Federal Reserve dramatically expanded liquidity (QE1, QE2) to encourage employers to stop laying off workers and to start hiring again. That's the traditional policy a central bank pursues when an economy sinks into a recession.
Unfortunately at the same time it was creating new money and expanding bank liquidity the Fed and FDIC subjected the banks to "stress tests," and then used the tests to justify raising the reserve and lending requirements of all commercial banks. This required the banks to hold as reserves the newly created 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.
To the contrary, the stress tests for all banks combined with directing assistance only to a handful of banks too-big-to-fail resulted in smaller banks being closed and their assets transferred to their bigger competitors. In effect, the way the help was spent rewarded the big banks for the problems they caused by 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. So tens of millions of American consumers and businesses suddenly lost their access to credit
As a result of the failure to end the recession millions of loans and mortgages were defaulted on by financially distressed families and businesses, bankruptcies and business failures skyrocketed, and hundreds of smaller banks were closed.
Worse, the initial loan losses in combination with the banks' higher reserve requirements resulted in even more bank failures. And this further reduced the ability of consumers and businesses to get normal loans and credit - which further depressed the economy and resulted in even more unemployment, foreclosures, bankruptcies and bank failures.
So where are things today?
Things are worse than investors and voters have been led to believe. The U.S. continues to be mired in a "Great Recession" - and it's much worse than the government admits. (see the January 6 Seeking Alpha article "Jobs Data Are Not as Cheery As They Would Have You Think.")
More specifically, today the U.S. economy is operating at only about 80% of capacity - producing about $16 trillion of goods and services instead of the $20 trillion or so it could be producing. So employment, profits, stock prices, and tax collections are far below the levels they would be if the U.S. economy was at full employment. In essence, it has deficits and unemployed people instead of jobs and budgetary surpluses.
China seems to be responding the best. It continues to hold its exchange rates down to attract foreign buyers and investors. It has also been creating new money and pouring it into its economy to keep its customer spending up and its economy growing. So China's factories are operating and its people employed. This will continue until the inevitable collapse of China's economy. (see the December 26 Seeking Alpha article "Investments in China Will Eventually Be Worthless.")
Europe is a mixed bag. Germany and its immediate neighbors are doing well. But there is massive unemployment and unrest in a number of countries such as Greece and Spain. Up to now they have been pressured by Germany to cut spending and raise taxes as the way out of their sovereign debt problems. They are just beginning to be pressured to remove their regulatory impediments so their tax bases can grow. For some, the reforms will come too late.
In essence, the initial European solution did not work for Greece. To the surprise of the EEC and IMF elites, and no one else, unemployed workers and businesses without customers do not pay taxes. So the deficits of countries such as Greece and Spain, and thus their ability to pay their sovereign debts, are getting worse. The result will be sovereign defaults and countries going off the euro. (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 new laws and regulations - all of which discourage lenders, employers, and business investments. (Bush and Obama are lumped together because President Obama kept most of the Bush economic appointees whose policy failures and cronyism got us into this mess and are keeping us there - 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.
The majority of congressmen still don't understand that in the real world the U.S. can only grow its way out of its deficits - that higher taxes and less spending won't be enough. Today the U.S. would have a budget surplus if its economy had full employment. But it has no surplus because today the United States is stuck in a "great recession." It's all very unnecessary. (see the January 24th Seeking Alpha article "A Letter From Adam Smith To Investors)
What is most surprising is that the governors of the Federal Reserve, appointed by the president and approved by the senate, are allowing the recession to continue. They still think that keeping the overnight rate of interest low will somehow cause banks to have more money to loan - even though the money the banks borrow has to be repaid within 24 hours. And even if they had enough money to loan there are now fewer qualified borrowers due to all the bankruptcies 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 and stock markets of Europe and the U.S. would quickly recover if they copied China's policy of getting more purchasing power into the hands of their people and businesses. Then more people would have jobs as employers increase their production. And with more customers businesses would make more profits and their stock prices will tend to rise. Also as business picks up tax collections will rise and the deficits will tend to disappear.
In the real world the United States fiscal policies and monetary policies based on the overnight interest rate do not and cannot work. That leaves monetary policies based on quantitative easing as the only viable way for the United States to get out of its current economic malaise. It needs to begin so that more customer revenues flow to our employers. Only then will they begin hiring workers, making bigger profits, and generating higher stock prices. (see the January 1st Seeking Alpha article "Keynes, Krugman and the Economy)
That's where we are today - waiting for the Federal Reserve to begin 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 leave unemployment from inadequate spending.
Similarly, Europe and the U.S. need to reverse course on the regulatory impediments they have imposed. They have gone way too far in letting anything and everything stand in the way of increases 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 environmental lawsuits could be accelerated with regulatory courts at the appeals court level and "loser pays" court rules.
Is a solution even possible?
So far the governments of the United States and Europe have proved yet again that a modern monetary economy based on profits, incentives, and wages cannot cut or regulate its way to prosperity and budget surpluses. The only alternative is to grow its tax base. And that requires enough money in circulation so that enough customer spending flows to employers. It also requires not holding employers back from hiring workers and increasing output with useless regulations, restrictions, and regulatory delays.
A solution is possible. The Federal Reserve could abandon its unworldly policy of focusing on the overnight rate of interest and actually put sufficient amounts of loanable funds into our economy so that its current capacity is fully utilized. It could do this 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, nothing is going to happen until there is some form of actual "quantitative easing." It would be the first one because QE1 and QE2 never provided the banks with loanable funds. In essence, QE1 and QE2 were as fraudulent as the supposedly 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 who might provide them with employment when their current terms are finished, investors will not see a major bull market. It is, after all, 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 rapidly as an economy comes out a recession. The stocks of companies that can rapidly ramp up production will be the biggest winners. When the Fed acts is the time to buy a broad portfolio of stocks. That time is not now.
Investing In Other Economies
Countries engaging in economic or political reforms that let them grow out of their debt crises or, in the case of China and India, grow out of their poverty, are interesting opportunities. The stocks and bonds of companies that will benefit from such reforms if and when they ever happen will be the biggest winners.
The time to buy such an economy's stocks and bonds would be when the reforms are actually implemented and significant. That time is not now for Europe, China and India. One possible exception is Greece - because the collapse of its property prices and coming move off the euro means lower dollar prices for Greek properties and businesses.
The prosperous European countries such as Germany also have big question marks hanging over them. It is uncertain which of their stocks and bonds will prosper when Greece and other countries with too-large-to-sustain sovereign debts go off the euro. For example, Germany's prosperity is heavily dependent on exports, which will be reduced when Greece goes off the euro and the euro exchange rate rises.
Accordingly, until another economy makes a significant move the best investments today are still in the U.S. or U.S.-related despite the continuing malaise of the United States economy.
The current "Great Recession" will not be ended soon
The Federal Reserve, Congress, and the White House do not appear to be close to doing something that would get enough purchasing power into the hands of consumers and businesses. To the contrary, if the recent Federal Reserve governor appointees are any guide, the Fed will continue to have no macro economists with real world business or commercial 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 who got us into this mess in the first place.
In other words, investors need to be skeptical that the United States 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 Still The Best Investments
The Federal Reserve and politicians' continuing failure to use rational monetary and fiscal policies strongly suggests the economy and its markets will continue to stagnate. Until the White House finds competent appointees and the Fed begins to carry out its statutory duty to maintain full employment, investors would be well-advised to stick with the White House and Fed's favored few: Goldman Sachs, Bank of America (BAC), Deutsche Bank, JPMorgan Chase (JPM), and CitiBank (C).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
