I wanted to summarize some major themes we have been addressing on the Daily Capitalist.
First and foremost, my view is that the markets and the mainstream media have been giving insufficient attention (if any at all) to the core problem that was revealed by the meltdown in 2008. Massive amounts of capital was misspent ("malinvested") during the boom. In order to finance the boom to its excess, financial companies ranging from small mortgage brokers in Orange County, California to titans of Wall Street burned through and pledged and hypothecated unbelievable amounts of capital. Recall that at the time, the total amount of base money in the U.S. was around $1 T. But the actual amount of bad loans and writedowns- not market value, which is a price that is evanescent- was gigantic. So it is my contention that what happened in 2008 was bankruptcy on an incomprehensible scale.
In other words, much of the "money" that "cash-rich" individuals or companies had "in" the bank or on loan in a money market mutual fund may have been worthless, or nearly so, due to poor lending practices. It is hard for me to see how Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, Bear Stearns, Lehman Brothers, Countrywide and Merrill if not acquired by BofA, various mortgage insurers, CIT, General Motors (a financial company with an automotive subsidiary, as it were), Chrysler, etc. could simply have imploded under any scenario other than gross near-insolvency of the financial system and mismarking of their assets and liabilities along with absence of prudent balance sheet management.
This quantity of huge bankruptcies (and all the averted ones due to massive government intervention) is extraordinary and may be without precedent for any leading financial power in modern history. But how often on CNBC or out of Washington have you heard matters framed this way?
If you believe the above, then an additional great tragedy is the failure to examine publicly at the highest levels what went wrong for so many years to lead to this catastrophe. Instead, the official explanation is that something unexplainable such as a Hurricane Katrina hitting New Orleans with a defective protective structure that was breached.
The deflationary events of the early 1930s saw almost none of this level disaster amongst the giant banks, even though objectively economic matters were much worse by 1932-3 than in 2008-9, in real terms which were amplified by the massive price deflation that assets suffered then. For example, the Bank of United States was based in New York City. James Grant recounts it as not being especially well-run, but there was no embezzlement or fraud. It went bust in 1930; it was not a giant. There were no level 3 assets or CDOs, much less CDO squareds. When the economic downturn came, the bank simply had a duration mismatch/illiquidity problem. It had financed good properties, but it had to go through bankruptcy. Several years later and many deflationary price percentage levels lower, depositors recovered 83% of their money. Given what happened to the stock market in the interim, these depositors did fine. They may even have gained purchasing power. Now, compare that to what you think you would have received if you were a depositor in Citibank if it was left to fail (let us talk about funds above the FDIC limit) amid a massive deflationary (price and credit, both of them) liquidation spasm that could have occurred in 2008-9 (and beyond) similar to the one that occurred in the early 1930s. Remember that every big money-center bank paid 100 cents on the dollar back then to both depositors and bond-holders (if there were any bond-holders): there were no insolvencies, and I have read that "only" about 2% of money deposited in banks was lost during this time period. Does anyone think that things were anywhere near so robust compared to the 1930s amongst the banking companies that did not go bust in 2008-9? There is no way to really know, of course, but remember that the big guys all did well enough then to survive in vastly more challenging situations than they were recently faced with.
Thus I contend that matters were in many ways worse in 2008 than after 1929 even though the economic downturn was much less severe, and that we are paying the price for that but in a different way. The result could be ZIRP on and on and on as the authorities continue to create enough new money to replace the immense balance sheet holes that the public is not allowed to see. There's no way for me to know, but secrecy and complexity in financial matters speaks for itself, at least in the DoctoRx mindset.
I contend that the current systemic instability is an (the?) absolutely fundamental reason that the Fed keeps "printing" money but there is no hyperinflation and that residential and commercial real estate prices have been falling again: the newly printed money is partly overwhelmed (though only temporarily) by the ongoing depressionary forces. The evidence of the ongoing depression is all around us. Just look at the Bloomberg Consumer Comfort Survey, the NFIB survey, the Discover/Rasmussen Small Business and Consumer surveys. Look at the Gallup survey that is posted daily. Unfortunately I cannot post their daily charts, but if you go to Gallup.com and look at the trends in hiring/not hiring; daily spending; and living standards, the highest any of these got in the "recovery" was to early 2008 levels: recessionary levels. They may already be declining again. Ignoring all the machinations in Europe, the U.S. has its own cyclical problems.
Is it too soon for another recession?
No, no, a thousand times no. Since 1940, there have been 12 recognized recessions in 71 years: one has begun less than every six years. The last one began nearly 4 years ago. According to NBER, the Great Recession ended in June 2009. Thus it officially was a 19 month official recession. The prior recession, as mild as the 2007-9 one was severe, ended exactly 10 years ago. That means that in the past 10 years, the U.S. has officially been in recession only 19 months: about average for the past 71 years.
Can a recession occur with a positive yield curve? Yes for at least two reasons.
One is Japan.
The other is that the Economic Cycle Research Institute says that it does use the yield curve to forecast recessions.
When the free market cannot match capital assets with what are perceived to be good investment opportunities, a somnolent future economic state is expected. When the profit motive doesn't stimulate borrowing at rock bottom interest rates, and when there is so much capital available, my conclusion is that there is simply enough of most things.
So the central government goes on "filling a demand void" when the problem instead is a lack of real savings. Borrowing/printing money to give $500 handouts to old people regardless of need simply because they "consume" is representative of all the wrong-headed but "nice" tendencies of American Keynesianism.
To summarize: the country ran out of a lot of its real capital during the boom/bubble 1996-2007 period. This was masked by financial shenanigans but the lack of real capital was revealed when a mild recession forced the financial emperors to be revealed as nearly naked.
The "Great Recession" did not cause the lack of capital. Instead, it revealed it, just as the little dog Toto revealed the fake wizard behind the curtain in the merry, merry land of Oz. Only after that revelation did the recession become a depression.
So once again, in case I have not been clear, the (neo-)Keynesians may have the best of motives, but from the standpoint of stimulating healthy future economic growth, they have matters backwards. What is needed for a true recovery is more useful savings, not more consumption paid for with borrowed or newly printed money. Until real savings (real capital) is rebuilt, it is difficult for me to see other than a continuation of the current pattern: limited economic growth and upward price pressures as the quantity theory of money gradually wins out.
From a timing standpoint for investors, however, which is more of a micro than macro concern, my sense is that we are so far from the onset of the Great Recession that another down-wave in the depression (or a new recession if you go by NBER) is either here or due soon. It may not be a severe downturn, as housing and autos would be falling from first- or second-floor windows in that case, but it would be occurring on the backdrop of a weakened structure, and thus the financial effects could be more severe than the economic effects (which could be severe or mild). Remember that the mild 2001 recession was associated with about as severe a stock market crash as was the 2007-9 monster downturn.
My suggestion is: watch the ten-year T-bond rate, lower meaning more economic weakness; watch the gold:platinum ratio, which is already signaling recession; do not trade off of European developments (you will be front-run by those in the know); do not use trend-following techniques that used to work and equally, do not use counter-trend trading techniques. For that last point, the algos will beat you most of the time in either direction. Some markets are untradeable except by true pros. So if one has a "good" investment, don't sell just because the price drops. Some robot might be getting you out at the bottom of the move.
As far as gold, I have recently suggested it would be quiescent for a while. I stick with that view, with a positive longer-term view, though there is significant downward price pressure possible from this level should a new recession be recognized and lead to a temporary asset liquidation to gain access to plain old fiat U.S. dollars.
Finally, I want to state the core paradigm that has worked reasonably well the past few years. It uses the recent Japanese ZIRP experience and combines it with the very prolonged period of very low interest rates in the U.S. following the 1929 crash, even though price inflation resumed after FDR took office in 1933 and deflation never really came back. In this scenario, real short- and intermediate-term Treasury yields can stay lower than one thinks for longer than one thinks and can be negative after accounting for inflation year after year. Right now I favor the Japanese trend of yet lower long-term rates because I consider that the destruction of real financial capital was greater in the bubble years now than perhaps ever before, and whereas America went back to saving as quickly as it could in the 1930s, that has not been the case ever since Mr. Greenspan ramped the presses while Mr. Bush told us to go shopping right after 9/11 and ever since the Fed began QE1 in late 2008.
In this hybrid Japan-U. S. post-Depression scenario, long-term bonds have their best use as trading vehicles to be sold near the end of recessions, but given much (much!) higher stock valuations now than in 1933 and its aftermath, stocks have more crash potential now than they did at most points in that era (until the 1960 time frame and beyond, when stocks finally began to get frothy again).
Financial matters are at best a confusing mix of matters, more so now, and central authorities will do what they will, when they will, without giving you a heads up. And the robots and trading costs will beat you as certainly as the slots in Vegas if you try to trade where you are not an expert.
People who think the Austrian way and go back to the first principles that the economic damage occurs because of malinvestments during the boom, and that the bust should be the healing phase, are way ahead of the game in contrast to Keynesians who misdiagnose a lack of real capital for some implausible anorexia consumptionosa of the public at large. So long as the authorities keep doing what they are doing, I would analogize this bust as a wound that is not allowed to heal because the doctor keeps damaging the scab.
Sometimes it just is best to get up each day, go to work (or a coffee house), and not think too much or do too much about the financial markets, all the while increasing one's knowledge about things one has real interests in. The world keeps turning, and one wants a coherent game plan for the period ahead when the times are not out of joint.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Please leave in the reference to the Daily Capitalist and note that it was written by DoctoRx who writes market commentary for us. Thanks, Jeff