Market Watch - April 29, 2016
Record Household and Business Cash Balances
It took four years after the end of WWII for the U.S. economy to regroup and convert to making consumer goods rather than war material. The Dow Jones Industrial Average hovered around 165 points during those transitional years. Sixty-five years later the Dow Jones is at 18,000 points, representing the greatest increase in wealth in history.
To accomplish this economic miracle, we loaded up the public balance sheet with debt. We also introduced socialism. The combination of the two has resulted in $20 trillion having been introduced into the spending stream that otherwise would not have been there. This huge wave of consumer spending since WWII has driven the growth of our wealth, and hence, the stock market, to new heights. Business fundamentals in America are very good, even though business around the world is lagging. Money continues to pour into America as a safe place to invest.
Question: America has pretty much practiced Keynesian Economics since the 1930s, especially from the 1960s forward. Is this economic success an indication that Keynesian Theory really does work?
Answer: In hindsight it looks as if Keynesian theories have worked. Keynesian Economics is based upon the concept of government borrowing heavily and providing money to employ people during difficult economic times. Then, during good times the government pays down debt with increasing tax revenues. But our government never pays down debt. While it appears these theories have worked, success has been because we have borrowed $20 trillion in the last 30 years to stimulate the economy. Not one dime of that money has been repaid. There is no U.S. budgetary item for repayment of debt. Problems will occur when the U.S., like other over-indebted countries, can no longer meet its debt payments.
Question: How much longer can the stock market boom last?
Answer: Nobody can answer that question. We know our debt is unsustainable. Our own government accounting office published a report a few weeks ago stating unequivocally that U.S. debt increases were unsustainable. Sometime in the next several years there will have to be a recapitalization of the world’s currencies. The U.S. is jockeying right now to ensure that whatever recapitalization occurs, the dollar will end up continuing to be the dominant world currency. Right now the dollar represents about 65% of the world’s money.
Question: Because of the economic problems of the rest of the world, it is frequently written that our economy will also soon be in trouble. How do we avoid that?
Answer: It is merely an assumption that we will have economic problems due to the rest of the world’s economic problems. The U.S. is in terrific position to weather economic storms. Households, banks and businesses have more cash than ever before in history. Consumer spending remains high. American’s are optimistic and the economy continues to grow. There is very little indication of a problem, or imminent problems, in the U.S. economy. Our large cash balances are the reason the economy is probably not facing a serious business downturn. Consumer spending should help carry the day. A good number of countries in the rest of the world, however, are low on cash, or broke.
Question: Loan demand is very low. Interest rates remain at record lows. Won’t banks have to start lending greater volumes of money if this economy is to grow?
Answer: Not necessarily. Businesses and individuals have saved so much money since 2008 that they are able to finance their growth without borrowing from the banks. They can use savings. It’s looking very much like the U.S. stock market could enjoy continued growth. Consumer spending, 2/3rds of our GNP, is at all time highs. Corporate quarterly earnings are coming in at records, again, after most analysts said earnings would be depressed.
Question: The U.S. is “re-involved” in the Middle East. Will continued, and renewed, war increase the probabilities of our economic success?
Answer: Not really. Defense spending is no longer a huge percentage of our GDP. War has not caused our borrowing to increase. Welfare payments have. Belligerent countries like Russia and China spend a far higher percentage of their GDP on the military. Both Russia and China have horrible economic problems of their own.
Question: Could Russian and Chinese economic problems harm our economy?
Answer: Short of war, probably not. Russia, in particular, is in dire straights. The 2014 average Russian wage was $850/month. In 2015, it dropped to $450/month. Imagine your income being reduced by 47% in one year. Countries around Russia that used to be their satellites are succeeding economically. The Russian population notices what is happening in Poland, Hungry, Latvia, Lithuania, Estonia, and Romania, all former members of the USSR. They are enjoying tremendous economic success as a result of the free enterprise system. Russian citizens want the same for themselves. Russia is on the verge of another revolution.
Speaking of potential internal revolutions, as far as China is concerned, sustaining their economy can only be accomplished with a continuing healthy business relationship with the U.S. China’s emergence as an economic power since the 1990s is solely a result of the growth of business with America. China’s situation is comparable to Japan’s in the 1970s and 1980s. During that time, Japan’s primary economic needs were continuing strong U.S. business orders.
Conclusion
There are some warning signs in our stock market.
Margin debt, or money borrowed to purchase stocks, has exceeded the record highs of margin debt in 1999 and 2007. Margin debt is the percent of money allowed by regulation that can be borrowed to purchase stocks. For example, a $100 stock can be purchased for as little as $25 of your money, and $75 borrowed dollars. Speculators are mostly margin (debt) purchasers of stocks. Poorly capitalized speculators can’t pay debts when significant market declines occur. After 2000 and 2007, stocks dropped 50% and 55% respectively. Most speculators were bankrupted. Historically, high volume margin purchasing (stocks purchased with debt) precedes big market sell-offs. This is a “warning sign” economists watch closely.
Bottom line: in spite of warnings, as long as individual and corporate cash flow continue to remain solid, the economy should remain solid. Shortages of cash cause recessions and market downturns. There is no shortage of cash. Record increases in cash continue to be accumulated.
Carpe Diem.
George Rauch
April 29, 2016
