The recent stock market rally signals a decoupling between the stock market and the economy. The economy, given its current state, would have a L-shaped recovery at best. As the consumers facing terrible job market, and high debt levels for households and government remains if not worsen, the economy powered by consumption is not likely to have a robust recovery.
On the other hand, aggressive cost cutting has fueled a recovery in corporate profit. However, sales trend still remains weak. With the decline of the dollar, I expect U.S. exports to recover as foreign countries start buying up electronics, IT and capital-goods. Foreign consumption would be the fuel for sales recovery for American companies. Therefore, companies that sells to foreign markets would see a healthy recovery while others would continue to face a tough market. The sales boost from foreign consumption would further increase profitability, and cause positive earning surprises which drives up market.
Another source of divergence between stock market and the real economy is inflation scare. With the government printing so much money, and skyrocketing budget and trade deficit over the years, it is hard to be bullish in the currency. The prospect of currency devaluation is enough to drive a lot of investors out of bonds and cash and into equity markets.
Therefore, while the real economy is struggling, the stock market might perform surprisingly well.
Buy a house on mortgage. This is the only way you can load up a lot of debt. We are marching closer to the inflection point beyond which deflation turns into inflation. Interest rates are still low - although they are feeling the pressure to go up. By loading up on debt, you are taking advantage of the coming high inflation, which would wipe out the your debt.
Of course, heed your cash flow, you don’t want to be forced into foreclosure before reeping the benefits of inflation. If you have extra money, put them into foreign assets and commodities.
The mainstream of economic teachings in highschools and universities is Keynesian economics. Unfortunately, the Keynesian school of economics has gotten everything wrong and has driven our economy towards total collapse. When a economic bubble burst, the excesses from the boom period must be allowed to be liquidated so the profitable and efficient businesses can absorb the resources tied up by unprofitable and inefficient businesses.
Government bailouts, stimulus spending, injection to money supply would only increase the inefficiencies in the economy by taking money away from the efficient and give it to the inefficient through current or future taxation.
Since the current government is having trouble financing all the spending, it is monatizing it by printing money. This will dilute the value of the currency and will inevitably cause high inflation or hyper-inflation down the road. Inflation is a form of theft which takes wealth away from people who save and give it to those who are deep in debt. The market has a corrective mechanism against run-away inflation, which is when everyone is incentivized to get deeper into debt, the interest rate must rise, cooling down the growth. Thus, to sustain the illusion of growth and prevent a total collapse, the central bank must print more money to drive down interest rates. Such action would drive more people to abandon their cash positions and the vicious cycle goes on and on until the economy is totally destroyed.
Thus, to protect your wealth, you need to take control of your own finances and investments. Carelessness in such matter would cause your wealth to be totally wiped out.
I’ve been following Peter Schiff, Jim Rogers, George Soros, Warren Buffett and Marc Faber lately. I’ve also been watching Obama and Bernanke’s speeches. And here are some thoughts about current state of the economy and where it is going:
The recession is deflationary because the current price levels are the results of the excesses of the consumption and credit bubble. After the bubble busted, there are an over-supply and over-capacity of everything: oil, houses, cars, cloths, over-paid employees. Deflation is market’s way of getting rid of the excesses, punishing the debtors, rewarding the savers, making resources affordable for entrepreneurs who would re-allocate resources more efficiently.
Unfortunately, the government is the biggest debtor of us all. Therefore, deflation would mean the debts the government owe would become more valuable in the future. Considering that a large portion of the debt are owned by foreign countries and investors, it is in the best interest of the U.S. government to engineer inflation rather than deflation into the economy. That’s why Bernanke and Obama keep telling us deflation is evil.
I can understand the government’s rationale that a deflationary spiral would be awful. But if the government acts as the lender of last resort, new entrepreneurs would jump into the scene and snatch up these resources when they are cheap enough to justify a profible business. I think here is where the government got it wrong. Instead of allowing the market to spur new businesses, the government is trying to do it artificially by spending on energy reform, health care reform, education reform, etc, etc. What the government fails to understand is that these investments would not be profitable because:
1. If they would be profitable, the entrepreneurs would see the opportunities way before the government sees them.
2. The government has not run anything efficiently in the history of mankind. It’s not the government’s job to run profitable businesses, and it does not know how to do it. Government spending is more likely to be wasteful at best.
3. The government does not know where to invest and how to invest. Central planning has never worked and never will. Capital allocation are best done at the private sector. One reason for this is that the government employee that makes decisions bears no personal financial risk should the investment go wrong. On the other hand, an
entrepreneur risks financial losses should he makes a bad decision.
It is true that this country needs to produce more scientists and engineers. Under market economy the shortage of scientists and engineers would reflect on their higher salaries, and therefore attract more students into these fields. Obama’s education reform totally ignores this fact. Students do not want to become scientists and engineers because the benefit does not justify the hard work one needs to put in. In the past two decades the brightest minds have gone into the finance industry because that’s where the money is. Since Obama is not letting the banks fail and bankers are still getting crazy salaries and bonuses, more bright students will get into the field and make crazy financial engineering feats that provides no value to society. The whole financial industry is over-bloated and must be allowed to shrink. The re-structure of the economy would depend on bright students going into industries that provide exportable goods and services.
From Obama and Bernanke’s speech it seems that their intention for the bank bail-outs are to prevent a financial meltdown. The financial system is saved at the cost of tax payers absorbing the losses from bank’s bad bets. Eventually these losses would have to materialize. Obama’s only hope is that the economy would turn healthy enough (produce more) to pay off these losses over time. It might work out if his plan actually will do what he promised. But I am skeptical on that because government and bureaucrats are never good at allocating resources efficiently. And Obama’s reforms and stimulus would not turn a profit, and would need subsidies by taxing profitable businesses in the economy, or borrowing more from other countries.
Many people are talking about a currency crisis for the dollar. The dollar has not devalued in the past decades because foreign countries are buying U.S. treasuries. Since the government would not allow deflation and encourages inflation, foreign countries are more worried about the value of these debts and the dollar reserves. That would pressure the dollar to devaluate. As a result, imported goods becomes more expensive and causes more inflation. At this point the Fed would have to raise interest rate to slow down inflation, which will hurt the recovery, and drive the economy into stagflation.
So there are three scenarios:
1. Government allows deflation, which would make our exports more appealing and make our currency stable. But deflation is devastating to all debtors, which includes most U.S. tax payers and the government. So this happening is unlikely as it might result in revolts and social unrest.
2. Government does not allow deflation, hoping foreign countries will keep lending us money. If this happens the economy will start to recover due to the injections of liquidity. But the recovery would be a very slow process as the Fed will pull out money supply at any sign of increasing inflation.
3. Government does not allow deflation, and foreign countries stops lending to us. The government then would have to increase tax, or print more money to fund its projects. At the same time the dollar devalues and consumer prices rise. The government might be force to choose war against other countries, social revolt, or hyper-inflation.
Total Job Openings is very sensitive to a corporation’s outlook for the future. A sharp decrease in job openings usually precedes a sharp increase in unemployment rate.
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