March 15, 2011
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This essay is excerpted from the most recent version of the HCM Market Letter. To subscribe directly to this publication, please go here.
“[T]he Commission majority’s report ignores hypotheses about the causes of the causes of the financial crisis that any objective investigation would have considered, while focusing solely on theories that have political currency but far less plausibility. This is not the way a serious and objective inquiry should have been carried out, but that is how the Commission used its resources and its mandate.”
Peter J. Wallison,
Financial Crisis Inquiry Commission Dissenting Statement1
Despite the increasing undercurrent of negative news creeping into the financial markets, the stock market remains strong. HCM expects equities to continue to perform well for the foreseeable future (i.e. through the end of June) although most of this letter will discuss the reasons why it shouldn’t. In some ways, this market is a lot like Charlie Sheen. It pretends to have tiger blood and the powers of a warlock, but deep inside it is suffering from an addiction to a substance (i.e. debt) that will ultimately kill it.
The list of burgeoning economic concerns includes the following:
- Rising energy costs.
- Lousy housing data, including rising foreclosures, weak pricing and sales.
- A high jobless rate that is being statistically manipulated to look lower than it really is.
- State government finances in a shambles.
- A federal budget that doesn’t qualify as a shambles.
- Europe deferring rather than solving its budget crisis.
- Rising Middle East instability.
On the positive side, many U.S. corporations are doing extremely well and certain measures such as consumer confidence are rising steadily. Our friend Doug Kass noted in a recent note (“Mea Culpa,” March 2, 2011) that the cyclical recovery in profits had been sufficiently strong to overcome his macroeconomic concerns Consumers also seem to be spending pretty freely, although where they are getting the money is a mystery to HCM in view of the high unemployment rate and generally tepid economy. Of course, every time HCM reads about the consumer confidence measure, we reminds ourselves that these are the same consumers that voted Congress into office (and made Two and a Half Men the most popular comedy on television), so placing too much stock in their wisdom is probably not the best course for preserving one’s wealth. Moreover, concepts such as value investing, contrarian thinking and variant thinking would have to be thrown out the window if investors allowed themselves to be guided by the madness of crowds. Still, as Keynes taught us, investors must choose the least ugly girl at the dance, so one cannot ignore such subjective data in determining how to invest.
The recent downward revision in 4Q10 GDP (from 3.2 percent to 2.8 percent) was not a surprise to HCM, nor we imagine to certain other observers who remain convinced that the U.S. economy is running on empty. We can only wonder what Federal Reserve Chairman Ben Bernanke really thinks when he turns out the lights and counts helicopters in his sleep, but we suspect he worries about the same thing. For if he were more confident that the U.S. economy could grow on his own, he would be hard pressed to explain why he is printing (thank you Kyle Bass) $2.5 million per minute and $3.5 billion per day of new money to keep the economy (and particularly the new object of his affection, the stock market) afloat. With second half 2010 growth coming in at well below 3.0 percent (2.6 percent in 3Q10 and 2.8 percent in Q410), it is apparent that the U.S. economy is being weighed down by the albatross of excessive debt in both the private and public sector.
While much of the private sector debt crisis has been shifted to the public sector both inside and outside the United States, the fact remains that private industry remains scarred by the 2008 financial crisis. Having seen their Christmas bonuses pass before their eyes, corporate executives have hastened to fill their stockings with coal rather than shower the economy with gifts in the form of new plants and equipment and new job offers. This prudence, as HCM has written in the past, makes eminent sense for these companies individually, but on an economy-wide basis has created a paradox of thrift that is retarding economic growth. This phenomenon is compounded by the excess capacity that plagues many industries such as residential and commercial real estate and retail (Blockbuster Entertainment and Borders Group being the latest casualties in the latter space). And this is the situation before state and local governments begin gutting their budgets, which will further starve the economy of fuel.
In order to appreciate the severity of the debt crisis that America is facing, it is important to place it in context. Nobody is better at doing this than our friend David Rosenberg. Mr. Rosenberg writes:
“The United States is a 236-year old country, and almost 40% of the entire public sector debt has been built up by the current Administration in barely more than two years. The United States has a monetary base of $2.06 trillion, and nearly 60% of that has been created since Helicopter Ben took over the cockpit in early 2006. A 236 year-old country, and well over half of the stock of money has been created in just the past half-decade. Remarkable. Maybe the real question we should be asking is why the stock market has only managed to double from the lows with all this massive stimulation.” 2
Reading these words should make all of us feel deeply embarrassed to have witnessed right before our eyes the damage inflicted on America’s economic hegemony in such a short period of time.
In this respect, recent testimony by Secretary of State Hilary Clinton before Congress is especially painful to hear. Mrs. Clinton warned Congress in some of the most explicit terms used by a public official that the United States is losing global influence to China (and presumably to others) due to its debt problem. “We are in competition with China. Let’s put aside the moral, humanitarian, do-good side of what we believe in, and let’s just talk straight realpolitik. We are in a competition with China.” She continued: “At the core of [America’s] strength is our economic strength, [which creates] the necessity for us to take action to rein in our debt, and particularly our indebtedness to foreign countries, the top of the list being China.” In particular, Mrs. Clinton pointed to China’s active engagement with regimes around the world in an attempt to secure future energy resources, which (these are now HCM’s words, not Mrs. Clinton’s) stands in sharp contrast to the failure of the United States to develop a serious and comprehensive energy policy. Broadening the context of this discussion, this is why the complex of tax and other policies that encourage debt financing and speculation are harming this country’s long-term strategic interests, and why a system that operates to enrich a small elite through such unproductive activities at the expense of productive investments that would benefit a wider swathe of society is so dangerous to the future health, prosperity and freedom of the United States.
This is why the federal government’s lack of serious effort to address the country’s ongoing debt crisis is not merely a political disappointment but a profound moral betrayal and potentially an existential failing. While the budget debate rages on, there can be little question that we are making little or no progress in solving our budget woes and are continuing to make them worse. President Barack Obama released a budget that promised a $1.6 trillion deficit this year and $1.1 trillion in 2012. The budget included $1.0 trillion of spending cuts and tax increases but avoided the only areas that can possibly bring the deficit under control: Social Security and Medicare. Instead, the President said that he wanted to save those tough decisions for discussions with the Republican opposition at a later date. This abdication of leadership was rightly criticized by observers of all political persuasions. The man who ran for president saying he would make the tough choices decided to duck one of the toughest choices of all.
Mr. Obama’s budget has been called highly political. In reality, it is the height of narcissism. By avoiding the entitlement issue, it is in no way intended to solve America’s debt problem (to which Mr. Obama’s policies have in many ways contributed); instead, it is primarily designed to pass the buck and promote the president’s re-election in 2012. In other words, Obama is telling the world that it is more important that he be re-elected than that the broken finances of the United States be fixed. With all due respect to Mr. Obama, no man’s political prospects justify such a choice, and certainly nothing that Mr. Obama has done during his first two years in office suggests that he is any exception.
1. The Financial Crisis Inquiry Report, Authorized Edition (New York: Public Affairs, 2011), p. 449.
2. David Rosenberg, Breakfast with Dave, Gluskin Sheff, February 22, 2011, p. 10.
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