Is The Risk Gone?

Market Watch articles have been published the last few years bearing conclusions applicable to our economy today.

What’s changed in favor of stock values the last two years?

Nothing. We are worse off: Debt, debt, debt and more debt. The Fed continues to re-inflate the economy to avoid deflation. We have had forced upon us artificially low “negative interest rates” (short-term rates of 1% are less than inflation). Unemployment remains high. Most disturbing is the permanent loss of high paying manufacturing jobs, and we are now beginning to lose high paying, high tech service jobs. The deficit was said to be $367 billion, but in fact, in the federal government fiscal year just ended, indebtedness increased by $606 billion. The trade deficit continues to hover around $500 million.

Let’s look at some current statistics

Over the last two years gold has increased more than 50% in price. Gold increases in price when investors lose confidence in currencies, specifically the dollar. 2.1 million job seekers have been out of work for 27 weeks or more. Five million people are working part time because they cannot find full time positions.

In the last two years, telecommunications has lost 330,000 jobs, computer technology 329,000 jobs, transportation 307,000 jobs, industrial goods 297,000, automotive 275,000, retail 258,000 jobs, government and non-profit organizations 251,000 jobs, electronic 252,000 jobs, financial industry 239,000 jobs and consumer goods 221,000 jobs. That’s about 3 million high paying jobs – lost forever – and transferred to less expensive labor markets, or made obsolete by technology.

70% of the U.S. economy is dependant upon consumer spending and consumers are locked into ever increasing amounts of debt. Credit expansion is now running at an annual rate of $2 trillion or 20% of our $10 trillion GDP, an increase far in excess of the country’s increase in cash flow, inflation included. The U.S. now consumes (borrows) 72% of the world’s savings and has gone from a net creditor nation to a net debtor nation.

Our debt and obligations exceed our net worth. As a nation we are upside down. Government debt is approaching $7 trillion, private debt is around $35 trillion and future, unfunded obligations, are estimated to be in excess of $40 trillion. All of this is on top of estimated household net worth of $40 trillion.

Something has got to give; if consumer spending slows down, the whole world economy will be adversely affected. If the U.S. borrowing 72% of the world’s savings slows down, the whole world will be affected. If we are to continue to spend, indebt ourselves and absorb the world’s savings, when will the point of diminishing returns be reached so that the bubble bursts, big time? Wall Street, the Fed, and the Federal Government’s leaders know this. They are desperate to inflate our way out of this massive debt cycle without a disaster.

China’s steel industry is now larger than America’s. Manufacturing of steel has long been thought to be the backbone of the U.S. military/industrial complex. It’s disappearing quickly; the question is, what will be the aftermath? There’s no precedent in history for a country being the largest military force, and the world’s largest debtor, while at the same time the country’s manufacturing base is deteriorating rapidly.

What has changed in the last 12 months?

Iraq produces an estimated $2.5 billion a month in GDP, and it is costing us $4 billion a month to remain there. The world is continuously focused upon, and amazed by, what is happening in the Middle East. Israel’s government has shown remarkable restraint in dealing with one group of people trying to blow up another group of people. Now, in less than 12 months, the most powerful collection of military alliances ever before amassed in history is currently involved in exactly what Israel has been dealing with for over a generation.

The geopolitical situation?

	1.		The primary military might of the world is engaged in the Middle East.

	2.		Those alliances, and other alliances of the Coalition Forces involved, comprise all of the world’s free economic and political systems and most of the rest of the world’s military might. While these countries have differences, all agree they are fed up with the Middle East’s problems.

	3.		Those alliances have the power to keep peace in the rest of the world while the guns are aimed at the Middle East. It is obvious the free world is working hard to maintain a balance of power to support world trade. Governments are desperate to maintain and increase their own cash flow. This continued behavior in the “Cradle of Civilization” is, bottom line, bad for business!

That’s the existing picture as compared to ten months ago; it’s expensive, it’s irritating, and it has been going on for a long time with no solution.

How does this affect the market?

Bleak or not, the above is a valid outline of the world’s existing posture. We can’t cut back consumer spending without a disaster. We can’t cut back borrowing without a disaster. We can’t slow down government growth without a disaster. We can’t change the huge U.S. trade imbalance without a disaster. The Middle East is already a disaster.

Where does logic dictate resources will be spent in the next several years, and how will that affect the market? It’s obvious debt will increase. Huge resources will be devoted to the Middle East. There will continue to be great displacement of employment in this country.

Conclusion

The only way our economic problems can be solved is by a tremendous increase in the country’s cash flow. Use of debt must be stabilized and reduced over time. The size and economic impact of government must be reduced over time. Furthermore, and most importantly, cash flow increases must be profitable enough so that we are no longer a net borrower of money. That’s not going to happen for quite a while, which means the market should go nowhere because:

	1.		The market’s already at all time highs;

	2.		The market’s already in a risky and potentially perilous position;

	3.		There are more practical economic and mathematical reasons for the market to go way down rather than to go up at all.

Look at the market’s cycles over the last century. The market runs in approximately 18 year cycles: there was a bull market from 1910-1929 and a bear market from 1929-1948 to correct the credit excesses of that bull market; a bull market from 1948-1966 and a bear market from 1966-1982 to correct that bull market’s credit excesses. A huge bull market ensued from 1982-2000 and the bear market, which started in 2000, may take the full 18 years to work out our current massive indebtedness. In fact, the U.S. may not escape from this economic calamity without giving up huge amounts of power to other governments. The golden rule of currencies is this: “He who has the gold rules!”. As the dollar becomes a smaller percentage of the world’s currencies and a greater percentage of the world’s debt, power will be transferred to the owners of the debt.

The market remains dangerous. Beware of the media and brokerage firms touting a new bull market. The market has already discounted (priced into stocks) the good news about economic growth. What will a new bull market do? Take us from absurdly high values to absurdly higher values? Where is the opportunity to make money in the market under those circumstances?

The terminal stage of a protracted bubble is commenced when there is a major divergence between weak economic performance and growing credit excesses. We’re there. The credit excesses are increasing, not decreasing. We are pouring on additional risk to a market that is already overvalued, over indebted, and over risky!

Caveat Emptor!
George Rauch
November 10, 2003

....