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This was written on 1/12/2011

The market can keep going higher even if it is large a bear market bounce (i.e., somewhat higher even if it has flattened out already).  That happens when the traders are struggling to digest what is going on at a given time (like they did yesterday), but then news comes along that they perceive as positive and so they bid up the stock market more again. 

The problem is that most news that they perceive as positive these days and in recent times actually isn't good news at all in the big picture - and that is going to come back to haunt all conventional thinkers eventually. 

The reason why is simple (but will take some words to describe). 

Today is a perfect example.  Portugal is in dire shape financially - and so everyone in the financial system was worried that Portugal might not be able to sell a large tranch of bonds that they had to sell this week to stay solvent.  If it had not worked, all hell would have broken loose - but the reality is that the system has been relying on borrowed money for a long time already and so every aspect of the system is set up to make additional debt auctions as successful as possible.  And so the cheerleading went on as usual, especially in the current environment, ahead of the bond auction to make sure everyone would know that Portugal could handle it this time.  And Portugal did (not exactly a surprise to me for this time around) - the auction was successful and so everyone is celebrating now. 

The problem is that it can't hold up in the long run - but just about no one has the foresight to (want to) see that. 

The situation is simple.  In times long-past past (and in unsophisticated economies now yet, too - such as in Zimbabwe), if a government wanted to keep their system going beyond where it would do so on its own, they would pump cash into the system so people would have more money to spend and that would go on for a while until a large inflation (prices up dozens of percent a year) or even a hyperinflation would result.  Then the society would have a situation that was worse than they would have had if the government has just left well-enough alone. 

But that is not how it works these days, at least not in the modern societies - in all modern societies, i.e., ones that are even remotely advanced, the new money goes through the banks.  It is borrowed money.  The central bank puts money into the backs of the banks and the banks are expected to lend it out.  The reason why everyone thinks this will work is because Keynesianism does not address the issue at all of the fact that economies lose momentum, they lose steam, over time.  So, since most Western economists are Keynesians, they are completely unaware of that fact.  And so they think that they can just keep pumping debt into the system (this is actually a much more efficient way, at a practical level, in modern times, of getting money into the system to provide people with cash if the society has a well-developed banking system) and everything will be fine.  And that is why, even if it looks like a place is teetering on the brink, people celebrate even when a new big debt issue from a government, especially one from a government that is clearly in trouble financially, goes out successfully. 

But in the long run (the very long run if there is a law against recessions on the books, but that is now, for us, in the big picture), it does not work - because economies keep losing more momentum as time goes on and eventually, there is simply not enough momentum anymore to keep the debt payments going.  But, with reference to current times, most people like the result of the debt-fueled binge in recent decades so much - and definitely don't want to see it end, and expect it to be able to continue because it has done so for so long already - that even if some people come along who say "this can't go on like this," they just say "but it has so far!" and then just celebrate when there is any sign that it actually is going on yet. 

This even applies to central bankers.  Several years ago, during the downturn of the early 2000's, some one in Congress asked then-Fed-Chairman Greenspan during testimony how things should go on and Greenspan simply said something along the lines of, "As long as most people can still pay their bills, we are fine - and I see no sign that that will change anytime soon."  It was, in fact, only a matter of time (some years) before the point would be reached where that would no longer be true - and we have reached that point.  But there is no way a Keynesian - like Greenspan - would ever see that coming. 

And so the situation just keeps building - with the economy losing more and more momentum (it is now taking federal deficits of over $1 trillion/year to keep things going) and the debt binge continuing, as well, but with fewer loans going out in America, overall, because of the credit crunch, and more and more people not being able to pay their bills as time goes on. 

The economy is now so weak that even Fed Chairman Bernanke has had to say several times in recent months that he is disappointed (he means very disappointed - central bankers are always careful with their language) with how well the economy is doing in response to the stimulus measures from the Fed (I am not surprised the economy is not doing well, see the rest of this website - I was just not sure if the Fed would admit to it, but even that has happened in the meantime) and the weak economy will essentially remain that way until the system is simply overwhelmed (for starters, the national debt is now going up at a rate of close to $1 trillion every 6 months, it hit $13 trillion at the beginning of June 2010 and hit $14 trillion on about January 1, 2011 - and it took only about the same amount of time to go from $12 trillion to $13 trillion before this latest trillion). 

And that is why we are headed for a MASSIVE TRAGEDY - when people finally realize just how over-optimistic they have been in recent years, really already since the late 1990's, and realize what they are really up against.  I expect that when that time comes - and I do not think it is far off anymore, even with the law against recessions - people are suddenly going to decide that the downturn that started (for most of them) in the fall of 2008 is real after all and then they are going to stop all but essential spending to preserve cash (in part because most of them don't have much cash to begin with if only because they have been so overoptimistic for so many years and have been spending their money as a result).  When they stop spending, an economy like America's that is 2/3 dependent on consumer spending is going to be in a world of hurt - and I think the American economy is going to simply more-or-less stop at that point, with the result that prices are going to crash (because people are not spending anymore) and unemployment is going to go way up (I think the velocity of money through the economy will go to essentially zero). 

By the way, as noted above, a hyperinflation, which is what so many people are worried about for the United States because of all the "money-pumping" by the Fed, is impossible if the money is borrowed (what happens instead is debt defaults leading to deflation).  A hyperinflation can only happen if the money that is pumped into the system is at least primarily cash that does not have to be paid back (such as what happened in 1920's Germany and in modern Zimbabwe - the two examples that are most frequently trotted out by people who are worried about a hyperinflation in the United States). 

There is also a note this morning in the financial news that the Spanish and Italian stock markets are up sharply today in response to the successful sale of the large bond issue by Portugal.  This is because Spain and Italy are two of the other countries in Europe that are regarded as being in deep trouble - and so people are probably thinking that if Portugal can still sell a large tranch of bonds, then things might not be so bad after all.  The problem is that this is simply group-think - the idea being that if other people still have confidence in Portugal, then it must not be so bad in Spain and Italy, either (Ireland and Greece, the other two major European countries in trouble already, are not being treated as kindly because everyone already KNOWS, conclusively, that those two places are in deep trouble).  But this is basically just people saying that if other people think it is OK, it must be - rather than doing their own analysis to come to their own conclusions.  And it is also a case of people wanting to think hopefully and optimistically where ever and when ever they can and looking for any excuse that they can to do so.  But the reality is that Spain and Italy ARE in deep trouble (Spain for the same reason that America is - a housing bubble gone bust) and no amount of optimism and hope is going to change that. 

There is also now a flash headline that the U.S. government is mulling corporate tax cuts - and initial news of that (before it hit the public headlines) may also be helping to drive the stock market higher.  I am sure the idea of the corporate tax cuts is to reduce the burden on business in order to help the economy along.  The problem with that is that even if the politicians do get it through the legislative process (Democrats probably won't be very cooperative), it will probably take so long to do that as to not have much, if any, effect.  The problems that the United States will soon be dealing with are far more immediate than that. 

Oil closed at a two-year high today, nearly $92/barrel.  I have said from the beginning of this crisis that as the economy recovered, oil prices would go back up, thus undermining the economic recovery.  Oil prices have only been nearly this high for a few weeks - not long enough for the effect to propagate thoroughly through the system yet - and if the economy keeps improving for the time being, oil prices will probably go even higher.  I do not think such high oil prices will be good for the economy.