good article...depressing though.
The Economy is Not Improving
By Robert Mchugh, Ph.D | march 2, 2010
For those who like to trade stocks based upon fundamentals instead of technical analysis, last week was a very bad week. We learned last week that the housing market is down the john. It is a royal mess. Commerce reported that New Home Sales crashed in January, down 11.2 percent to a record low, an annual sales pace of 309,000, the lowest level since records started a half century ago. This was the third straight monthly drop in spite of targeted Central Planner tax incentives for first time homebuyers and relocating home buyers. Confirming this disaster was the release Friday of January Existing Home Sales which also plunged, down 7.2 percent. Why? What is going on here? Fear of losing jobs, inability to sell current homes (illiquidity) and tight lending standards. In short, a lack of consumer confidence.
Consumer spending is 70 percent of GDP in a capitalist economy. That is a good thing. If consumers are spending, they are doing well, businesses are doing well, and government tax revenues are doing well. If government spending moves to 70 percent of GDP, that is bad. It means households are not doing well. So how is consumer confidence doing? Well a Conference Board survey showed its measure plunging 10 points from 56.6 to 46 in February, the worst level in 10 months. Readings above 90 are necessary for a sense of well being from consumers for a strong economy. Confirming the problem, a Thompson-Reuters/University of Michigan Consumer Confidence survey showed sentiment fell to 73.6 in February. This means that unless the government increases its spending as a percent of a growing GDP or gets the consumer back on track, we can expect horrid GDP figures in the future, assuming they are calculated and presented truthfully.
But there is a problem with government spending increasing while non-government spending does not. It means tax revenues will shrink without increasing income tax rates sharply. Shrinking tax revenues coupled with increasing government spending to stimulate the economy is a formula for disaster if those spending programs fail to get households back on their feet. So how are the policies of the Central Planners doing? They are failing miserably. Disaster is occurring. Sovereign survival is at risk. Here are the figures: According to the Treasury Department, the U.S. has a Federal Deficit of $11.46 trillion as of year end September 2009. This deficit is calculated on an accrual accounting basis. In other words, the Federal Government is insolvent, is bankrupt. It owes $11.46 trillion more than it owns. Now, can it work its way out of this mess if it is not forced to mark to market, if it is allowed to continue as a going concern for a period of time in the future? Possibly. But in the business world, corporations and individuals are not normally given such a chance to fix themselves. This is alarming. It would be one thing if this deficit occurred because the $11.46 trillion was rebated to households in the form if income tax rebates and cuts. In that case, we would know that a massive amount of tax revenue at low tax rates would be returning to the Federal Treasury because households would be using the money to clean up their and their bank’s financial positions, that household spending would be increasing dramatically, that small and large business top line revenues would be increasing and ergo, jobs would be added to business payrolls to handle the increase in aggregate demand for their goods and services. We could look forward to a reversal of the government deficit and a return from bankruptcy and insolvency. But that is not what has occurred. This Central Planner group has sent this deficit spending down a black hole with no self-sustaining resultant growth. Cars for clunkers was a complete waste. Targeted home buyers tax credits have failed to turn around the housing market. Municipalities are not turning around, but are close to bankruptcy. Employment is not increasing. It is worsening. Yes, a few large Wall Street firms are prospering, like Goldman Sachs, but that is about it.
On a cash accounting basis, the Federal Deficit rose to $1.46 trillion the year ending September 2009, a tripling of the deficit from a year earlier, which came in at $454.8 billion fiscal year ended September 2008. 2009 is a new record, the worst position ever. The previous record was 2008’s deficit. The propaganda machine is on overdrive to try and make folks believe the economy is improving and we are better off in 2010 than we were in 2009 or 2008. Just not true.
If we look at current entitlement programs, Social Security and Medicare, the Federal Government has unfunded liabilities of $45.88 trillion as of fiscal year end September 2009. Where is that money going to come from? Taxes? Taxes on struggling households in a shrinking economy? Tax and spend. It does not work. Look, this is not about political party affiliation. It is about economics. John Kennedy was a democrat and he used massive income tax cuts to get our economy out of a royal mess in the early ‘60s. Ronald Reagan was a republican. He used massive income tax cuts to get us out of a royal mess in the early ‘80s. Targeted government spending coupled with tax increases on “their definition of” the “rich” is not a formula for economic prosperity. It is socialism, and that experiment failed miserable in Eastern Europe and the Soviet Union over the past century. Karl Marx was wrong. Adam Smith was right. As far as the Central Planner definition of rich, $250,000 today, $100,000 tomorrow as the deficit grows worse, and eventually $50,000 as the deficit grows even worse. Look at it like this: If you are over 40 years old, you can remember the days when $25,000 a year was a really good wage. It got you to middle class in the 1960s through the 1970s. But you were not rich, not even close. Well, since then, the Dollar’s inflation adjusted value has dropped by about 80 percent. The Federal Reserve has overprinted so much currency that today you need $250,000 to be middle class. Whatever you earn, drop the last zero. In inflation adjusted terms, your standard of living at $250,000 today is equal to what making $25,000 was back in the 60’s and 70’s. You need $250,000 just to be middle class, to afford a house, send your kids to college, pay for health insurance, own two cars, pay for repairs (which it seems comes now in thousands of dollars every time you make a phone call, not hundreds), etc… If you are making $50,000 a year, you are teetering on the edge of poor. Drop a zero. $50,000 today is like it was making $5,000 back in the 60’s and 70’s. You folks over 40 years old know what I am talking about. Gas was 30 cents a gallon back then, and now it is $3.00 a gallon. $50,000 today gets you by, barely.
This is the damage, this is the danger of spend and tax. It robs folks of their income. It robs folks of a chance to get ahead. Income taxes should be at most 10 percent flat across the board. At most. In a growing economy, that should provide plenty of revenue to run this nation. Government spending needs to be controlled so that a 10 percent income tax is sufficient. Period.
The U.S. finds itself in the unenviable position that it is dependent upon foreign nations to support our deficits and our debt. When you run a $1.5 trillion cash accounting deficit, the difference has to be made up by borrowing money. China now holds $894.8 billion of our U.S. Treasury debt, that we know about. Japan holds $768.8 billion. If they were to dump our Treasury securities, and there is some evidence that China is lightening up now, this will put enormous pressure on long-term interest rates, which would destroy whatever chance is left for the housing market. The only solution to that problem would be for the Federal Reserve to be the buyer of last resort for Treasuries in order to keep interest rates low. But that is called monetization of our debt, meaning the government has financed itself with printed dollars rather than interest bearing securities. Think of it this way. The Federal Reserve is not part of the economy. Their activities are outside the real economy. Transactions with the Fed are artificial. If the Fed were to buy Treasuries in exchange for printed dollars, it would eventually drive the value of the dollar to the floor in terms of gold, and in terms of foreign currencies with either gold backing or a slow expansion of their money supply. Our long term charts of the Dollar suggest this is going to happen.
Even if the Central Planners were to decide to sell the 8,000 tons of gold the U.S. holds, at a market price of $1,100 an ounce, it would not be enough to pay off the Federal Deficit. In fact it wouldn't even put a dent in it. The point to all of this is, we are in trouble. You can add the U.S. to the growing list of nations that have sovereign debt issues. What the U.S has going for it is the dollar remains the world’s reserve currency, which means it can print all the money it wants to finance its spending.
That status is going to change if we continue to run out of control budget deficits. “We are doing poorly but others are doing worse,” is not going to be a reliable argument to hold onto dollars.
We learned this past week that the FDIC was insolvent as of December 31st, 2009. It had a $20.9 billion deficit. This means it will either have to assess special fees against already stressed banking financial institutions, or will have to borrow or receive grants from the Central Planners to refund its reserves. We learned that the FDIC’s problem list of banks grew to 702 at 12/31/09 and if we include the 140 banks it shut down in 2009, one out of every ten federally insured banks were in trouble in 2009.
AIG, a black hole which took $182.5 billion of U.S. taxpayer aid in September 2008, and is owned 80 percent by the government, comrades, just reported an $8.87 billion loss in the fourth quarter of 2009.
Municipalities are the next contagion domestically, and sovereign debt such as Greece, Dubai, and other “to be announced” nations are the next international contagion. If I was running a bond portfolio today, I would be very careful about holding the municipal bond old maid card. I would be quietly, systematically dumping my previously AAA rated G.O.’s. (General Obligation).
Listen, we are in a ton of trouble, and this Central Planner group is spending our limited arsenal of bullets on failing targeted stimulus programs. Only massive, across the board, tax rebates and tax cuts can fix this mess, but it has to happen soon, before the household sector spirals into economic depression, and before the Central Planners spend our deficit so high that tax cuts become an impossible option.
And that is the picture fundamentally, folks. Now the technical picture:
We remain deep inside a Grand Supercycle degree Bear Market, one that either started back in January 2000, or in October 2007. In either case, a massive catastrophic leg lower has now started here in 2010. If for some bizarre reason stocks rise back above their January 19th top, then it means the start of this catastrophic downleg has been postponed for a few months, but regardless, it is coming. If it has started in January, 2010, it is normal for a slow quiet start to occur. This is what we have seen so far since the January 19th top, and is also how the devastating drop from October 2007’s all-time nominal high in the Industrials started, slow, relatively benign, hard to recognize for many. But the downside will accelerate at some point over the next several years as Supercycle degree wave (C) down gets legs. The fundamentals picture really fits this technical analysis picture quite well.
Robert McHugh
