America's Economic Collapse
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|James Quinn||October 20th 2008|
Cutting Edge Economic Crisis Analyst
It has been excruciating watching your retirement portfolio disappear day by day. The S&P 500 has declined by 26% in the last three weeks and 43% in the last year. Everyone has been waiting for the bounce that always comes. The brilliant financial gurus on Wall Street have convinced us that we are supposed to buy the dips. The market always goes up in the long run. These experts have been lying to you. Are you surprised?
There have been many long periods when stocks did not go up in real terms. Most disappointing was the 25 year period from 1929 through 1954, when investors would have secured an adjusted 0% return. From the mid 1960â€™s until 1980 the market did not go up in real terms. Indeed, if inflation is taken into account, the market didnâ€™t really recover until 1990, 24 years after the 1966 high. The 2000 high was reached for a brief time in late 2007, but has fallen 43% since then. We have entered a period of time when the economy will go into a deep recession for at least two years. It is likely that our economy will not be strong for 5 to 10 years based on a continuing decline in the housing market and crumbling banking system that will not lend. The PE ratio of the market is still high and corporate earnings will collapse in 2009. Based on this bleak environment the market will likely decline by an additional 20%, before reaching its ultimate low. The S&P 500 Index will not reach its 2007 high until, at the earliest, 2015. That would be a 15 year period with no return. Evidently, stocks donâ€™t always go up in the long run.
Trying to gauge how bad the situation could become is difficult. People keep looking for some positive developments, but the situation appears to be getting worse. When confused, always turn to the wisdom of people who have proven trustworthy in the past.
Paul Volcker, former Federal Reserve Chairman, said, â€œToday, the financial crisis has reached a critical point. The sharp decline in the stock market and its volatility dramatically make the point. More important if less visible, the flow of credit through the banking system and the financial markets is seriously impaired -- even in part frozen. For months, the real economy, apart from housing, had not been much affected by the developing crisis. Now, a full-scale recession appears unavoidable. Important state and local governments face deficits they may be unable to finance. Recessionary forces are apparent in other important countries and exchange rates are unstable.â€
Nouriel Roubini, famed economist from NYU, revealed his pessimistic outlook in his recent blog entry. â€œAt this point the risk of an imminent stock market crash â€“ like the one-day collapse of 20% plus in US stock prices in 1987 â€“ cannot be ruled out as the financial system is breaking down, panic and lack of confidence in any counterparty is sharply rising and the investors have totally lost faith in the ability of policy authorities to control this meltdown. When in markets that are clearly way oversold even the most radical policy actions donâ€™t provide rallies or relief to market participants you know that you are one step away from a market crack and a systemic financial sector and corporate sector collapse. A vicious circle of deleveraging, asset collapses, margin calls, cascading falls in asset prices well below falling fundamentals and panic is now underway.â€
Dennis Gartman, well known commodities trader, wrote, â€œThus to begin, we say here this morning, mincing no words whatsoever, we are more frightened now for the future of the global capital markets than we have been at any time in our thirty+ years of watching, commenting upon and taking part in them. We are fearful... and we mean this fully... that we have passed the tipping point; that things are now spinning out of control; that forces have been unleashed that cannot be stopped without some truly massive, truly strong-handed, governmental action including the closure of markets and limits upon bank withdrawals, et al. These are troubling times, and our fear is palpable and growing. Worse, these concerns are giving rise to the likelihood that the Left shall be in ascension, and that manifestly left-of-centre, interventionist government lies ahead here in the US and in Europe. Higher, rather than lower taxes will be the end result. Greater... indeed very much greater... intervention in the capital markets lies ahead.â€
Famed investor Jeremy Grantham, was quoted in Barronâ€™s magazine last week saying, â€œI want to emphasize how little I understand all of the intricate workings of the global financial system. I hope that someone else gets it, because I donâ€™t. And I have no idea, really, how this will work out. I certainly wish it hadnâ€™t happened. It is just so intricate that all I can conclude, by instinct and by reading the history books, is that it will be longer, harder and more complicated than we expect.â€
Based on the views of these wise men, you should probably ignore the usual spin that you will hear from investment gurus on CNBC about this being a great â€œbuying opportunityâ€. The market is likely to have a strong bounce back rally in the near future. Any rallies should be seen as an opportunity to sell. The stock market will be dead money for years. The mainstream media is not reporting what is really happening behind the scenes. Starting in July of this year, before the current crisis, a shortage in gold and silver coins began to develop. The U.S. Mint issued the following statement this week:
"Due to the extreme fluctuating market conditions for 2008, as well as current market conditions, gold and silver demand is unprecedented and the demand for platinum is unusually high. The U.S. Mint has worked diligently to attempt to meet demand, however, blank supplies are very limited and it is necessary for the U.S. Mint to focus remaining bullion production primarily on American Eagle Gold One Ounce and Silver One Ounce Coins.â€
Kitco, a major precious metals retailer, has no American Eagle coins to sell. The one ounce Gold Maple Leaf coin that is available is selling for $910 an ounce, $60 above the current spot price. The logical conclusion to be reached is the â€œSmart Moneyâ€ saw this financial market collapse coming and has been moving into precious metals for months. The average American, who has been misled by Wall Street and government leaders regarding the depth of this crisis, has not been a buyer of these coins. As this crisis worsens and trust in our economic system declines further, an avalanche of demand for precious metals will likely develop. There have also been recent news reports regarding shortages in home safes and strong demand for guns.
What Happens Next
The governments of the world will continue to pump hundreds of billions of currency they do not have into an insolvent banking system. The currency printing presses are running at full speed. These actions will have dramatic unintended consequences in the future (inflation). There are approximately $55 trillion of derivatives outstanding in the world. No one knows how much is at risk. There is no formal system for handling these instruments. If these derivatives continue to implode, no country in the world has enough money to prop up the system. Very smart people are extremely worried about this possibility. Protectionism and looking out for your own country will grow. World trade is based upon credit, trust, and minimal government intervention. The only part of the U.S. economy that has been strong has been exports. Companies are not confident that the buyer of goods will pay them. Therefore, world trade is grinding to a standstill.
The talk around the water cooler and on soccer fields throughout the country has changed from baseball and football to how much youâ€™ve lost in the market. Over $6 trillion of stock market value has been lost in the last year. Everything that Wall Street has brainwashed Americans to believe has proven to be false. The market is lower than it was in 1997, 11 years ago. For those who are retired or close to retirement, their future has been devastated. Unless the government artificially props up home prices, they will continue to fall to their natural level of equilibrium. The pundits want to stabilize home prices, but the sooner we let prices fall to a normal level of valuation the faster we can start the long road to recovery. The fear, panic and mistrust of government and banks have led Americans to rightfully cut back on all spending. For the first time in 11 years, Americans have actually reduced borrowing. This is a smart thing for individuals to do. The problem is that with every American cutting back simultaneously, an economy that is totally dependent upon Americans spending more than they earn, will implode.
The enormous cutback in spending by consumers will reverberate throughout the world. Thousands of retailers and restaurants that expanded based on debt-aided demand will be going out of business. Highly leveraged mall developers and commercial developers will go bankrupt as their tenants stop paying rent. These bankruptcies will lead to a dramatic jump in unemployment. The shoe that hasnâ€™t fallen yet is that small regional banks were the major lenders to developers. The bankruptcies of developers will lead to the bankruptcies of hundreds of small banks. Foreign countries, dependent upon U.S. consumers spending, have built factories based on these consumers spending at an increasing level. China and other Far East countries will see a huge drop in demand. This could cause social upheaval among their poor peasants. The negative feedback loop nature of this crisis will lead to an unemployment rate of 8% to 10% by the time we reach the bottom. This will lead to much anger and social unrest.
Federal, state, county, and local governments did what they always do. They extrapolated the tax revenue they were receiving during the housing boom years. Their current spending far outreaches the revenue that is coming from taxes. 32 states will have a combined budget deficit of $50 billion this year. It will get worse in 2010. California is already begging for $7 billion from the Treasury. New York State and City have been dependent on Wall Street tax revenues. They will get $0 from these firms going forward. Citizens will not be happy with tax increases during a recession. Barrick Obama will likely win the Presidency and Congress will be overwhelmingly controlled by the Democrats. There will be a witch hunt for those responsible for the financial crisis. The animosity between political parties will reach epic proportions.
The backlash from this crisis will be Democrats passing more government programs, instituting more government regulation, and more government control of our society. This is the wrong reaction to this situation. If the Federal Reserve and SEC had just enforced the existing rules, this crisis would have never occurred. Our country has $53 trillion of unfunded liabilities, a national debt of $10.1 trillion, and an annual deficit that will approach $1 trillion next year. We cannot afford more government. Government and big business caused this problem. Our politicians are corrupt and incompetent. Their votes are bought and sold by lobbyists. They are incapable of understanding the problem and should not be trusted to solve the problem. The CEOs of major corporations have also proven to lack competency, vision, or any semblance of risk management abilities. Their greed, short-term profit focus, and obscene pay packages will lead to major retribution from Congress.
Why anyone would want to be President of the United States at this point in history is beyond comprehension. The government is no longer trusted. Our country is undergoing a paradigm shift. No one is sure what type of country we will be when this crisis subsides. It appears that we are headed towards a socialist state with less personal liberty and control of our lives. Government will attempt to take Americans further under her ever expanding wing. Founding Father, John Adams was not optimistic when he wrote these words in 1814:
â€œRemember democracy never lasts long. It soon wastes, exhausts, and murders itself. There never was a democracy yet that did not commit suicide.â€
Are we in the midst of committing suicide as a nation? If we allow our government leaders to take more of our freedoms away and commit trillions of our grandchildrenâ€™s money to propping up insolvent companies, this could mark the beginning of the end for our great country. Representative Ron Paul cuts to the heart of the matter in a speech before Congress:
â€œI believe that our economy faces a bleak future. We risk committing the same errors that prolonged the misery of the Great Depression, namely keeping prices from falling. Instead of allowing overvalued financial assets to take a hit and trade on the market at a more realistic value, the government seeks to purchase overvalued or worthless assets and hold them in the unrealistic hope that at some point in the next few decades, someone might be willing to purchase them. As with many other government proposals, the opportunity cost of this bailout goes unmentioned. $700 billion tied up in illiquid assets is $700 billion that is not put to productive use. That amount of money in the private sector could be used to research new technologies, start small businesses that create thousands of jobs, or upgrade vital infrastructure. Instead, that money will be siphoned off into unproductive assets which may burden the government for years to come."
Paul and others have observed that esteeemed French economist FrÃ©dÃ©ric Bastiat may have been known best for explaining the pivotal difference between "what is seen" and "what is unseen." Clearly, the bailout's proponents see whatever benefits they think will accrue--that is what they see. Yet they fail to see the jobs, enterprises, and technologies that will not be created as a result of this titanic waste of money. It is unmistakeable to all that the housing bubble has burst, unemployment is on the rise, and despite occasional clips upward, the dollar weakens almost every day. Regrettably, American leadership has failed to learn from the mistakes of prior generations. Our leaders continue to steer us down the road of economic ruin.
Cutting Edge Economic Crisis Analyst James Quinn is a senior director of strategic planning for a major university. This article reflects the personal views of James Quinn. It does not necessarily represent the views of his employer, and is not sponsored or endorsed by them.