Deep thoughts from Richard Russell:
Reacting to unprecedented liquidity and zero interest rates, Fed Chairman Ben Bernanke is levitating almost everything that is tradeable — stocks, bonds, commodities, food, Wall Street salaries and bonuses. It seems that the Bernanke-Geithner team will stop at nothing in their desperate battle to halt or turn the primary bear tide.
But, you have to ask, isn’t the surging stock market providing evidence that Bernanke is winning the battle? And the answer is in the economic statistics. As soon as the “Cash for Clunkers” ended, sales of cars collapsed. The great American consumer, now frightened, confused, and poorer, continues to cut back on his spending. The fantastic largesse that has poured into Wall Street has not rubbed off on the man on the street. The latest statistics show that there are six Americans looking for every job that’s available.
Meanwhile, as the US dollar heads down, pressure increases on Bernanke to raise rates and “save the dollar.” The cover of this week’s Barron’s screams, “It’s Time To Raise Rates, Ben.” The sub-title reads, “The economy can now handle an increase in short-term rates to 2% from near zero. It’s the only way to prevent the dollar from collapsing and inflation from getting out of control. Give savers a break.”
But Bennie isn’t convinced that all is well. How about unemployment, which now seems to be almost a chronic disease?
Then there is the “sister” problem, the fading retail trade. It seems we’ve moved into the age of thrift. Interestingly, I receive more e-mails regarding “what is was like during the Great Depression?” than on any other subject. Americans are remembering the stories told by their fathers and grandfathers (and by ol’ man Russell, I might add).
In the early 1930s a series of horror movies came out, which pretty closely dove-tailed with the public’s sentiment — King Kong, Dracula, Frankenstein, the Bad Whispers. Today, if you look over the film section of your local newspaper, you’ll see the current explosion of horror movies, including Saw VI, in which my daughter, Betsy, has a leading role. Today, as in the 1930s, people relate easily to fear and uncertainty and suspicion. Today’s favorite lover isn’t Clark Gable or Errol Flynn, it’s your neighborhood ghoul, the vampire.
Causing Americans to feel even more insecure is the Dragon — it’s obvious to anyone who can read, that China with its 1.2 billion population is rapidly taking over as the world leader. The US and China have a strange and tenuous relationship. The US is spending far over its head, consequently the US needs outside money to survive. China lends us the needed money by buying our bonds. In turn, we buy China’s merchandise by the carload. In so doing, we keep millions of Chinese workers employed.
But there’s a problem. China is up to its neck in US Treasury bonds, all denominated, of course, in US dollars. As the dollar sinks, the Chinese are increasingly worried about their holdings in US securities. Chinese authorities have been warning the US about our outrageous finances. The Chinese could be dumping US T-bonds on the market. But that would hurt their own huge hoard of T-bonds.
So the Chinese have developed another strategy. With their US dollars, they are buying up the assets of the world (assets in the ground, rare earths,whole factories, real estate) – see cover of this week’s Fortune magazine below. If it’s an asset, particularly a precious asset, the Chinese want it, and they’ll buy it. The Chinese aren’t picky, they don’t care what language you speak, they don’t care what color you are, they don’t care what religion you follow, they don’t give a damn about your political system — if you have the “goods” (particularly strategic goods), they want it, and they’ll pay cash for it.
The fact is that we’re seeing the greatest transfer of wealth from one nation to another in history. It’s also dawning on Americans that US leadership in the world is moving (along with money and gold) — to China. I’m asked, “How long will China continue to accept T-bonds from the US?” And my answer is, “As long as it suits their purposes.” China, unlike the US, thinks in terms of decades or even half-centuries. China’s leaders believe that time and history is on their side. As time passes, China will build up its already huge military, China will continue to accumulate valuable assets, and China will move forward in technology. China is rapidly building up a large, wealthy middle class. China’s leaders want to build China’s own internal economic structure. The goal of China’s leaders is to have everyone employed and to raise the population’s standard of living. Example — China is now one of the world’s leading markets for autos. This from a nation that was poverty-stricken only 50 years ago.
Turning to the US again, claims for unemployment insurance surged in 1981 and again in 1983. This led to back-to-back recessions. Now we see another massive surge in claims for unemployment insurance. The first surge is here in 2009 along with the current “great recession.” Now we wait to see whether we get a decline and then a second unemployment surge. You can almost say that surges in unemployment claims and recessions go together.
Could we have another “double-dip” recession? My friend, John Mauldin thinks we could. Here’s what John says on his latest always fascinating “Frontline” report —
“Given that the current Congress is hell bent on massively raising taxes in 2011, we are likely to dip back into recession by then, if not before. Remember, taxes have a multiplier effect of three. That means tax cuts increase GDP (over time) by three times their amount. But tax increases reduce GDP by three times the increase. That will make deficits worse, and unemployment will again start to rise from already high levels. Twenty states have already raised sales taxes, and more are raising other taxes. It is a vicious spiral.
As an aside, I am not expecting that we will see the crisis I am thinking of any time soon. We can move along with positive GDP for some time. I am thinking of the longer term, 1-3 years out. We will become complacent. I will get letters telling me I am too pessimistic. Just as I did in late 2006 when I said we would be in a recession by late 2007. But I firmly believe we will see a double-dip recession within another 18 months (at the most). Stock markets drop on average about 40% in a recession. Adjust your portfolios accordingly.”
Source: Dow Theory Letters
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.