Where is the Economy Headed?

Two of my favorite financial commentators are Jim Rogers, currency trader extraordinaire, hedge fund pioneer and former partner with George Soros, and Dr. Mark Faber – creator of the GloomBoomDoom report, a former managing director of Drexel Burnham Lambert and an international investor with the uncanny ability to predict market direction. I thought it would be interesting to take a look at what their current thinking is about the economy and the markets.

Mr. Rogers cautioned that when another downturn takes hold "the world is going to be in worse shape because the world has shot all its bullets"; meaning that due to the extraordinary measures already adopted by central banks and governments around the world, the arsenal of available tools to combat the next recession is somewhat lacking. Speaking in an interview with business television channel CNBC, the septuagenarian investor said that "since the beginning of time" there has been a recession every four-to-six years, and that means another one is due around 2012.

Rogers has long been a proponent of abolishing the Fed. His point is that America survived and prospered without a central bank for long periods and can do so again. "We don't need the Fed. The Fed is making our lives miserable," the famed financier says. "The Fed is printing huge amounts of money, which we'll have to pay for sometime. The Fed has borrowed gigantic amounts of money on their balance sheet...the numbers are so staggering that this is going to have ramifications before too much longer." "Is Mr. Bernanke going to print more money than he already has? No, the world would run out of trees" Rogers says.

Mr. Faber comments “The Fed doesn't pay any attention to asset bubbles when they grow. That's their official policy. But they flood the system with cash when bubbles burst. They only care about bubbles when they crash. It's a very asymmetric response and it has many unintended consequences. In a credit-addicted economy, you don't need credit to actually fall for there to be problems. All you need is a slowdown in the growth rate, and you get big problems. Now, the government and the Fed are aware of this, so they are creating debt through fiscal deficits and monetization. That creates a hugely volatile environment. “

In 2008, government credit creation was inferior to private credit contraction, and asset markets tanked. In 2009, government credit creation was higher than private contraction, and asset markets went ballistic. Lately, government credit creation has slowed, and asset markets have gone down. Now, the Fed is aware of this, and it's only a matter of time before it throws more money into the system. I guarantee this.
I'm a believer that the stock market lows of March 2009 will not be revisited. You have people like Robert Prechter who think the Dow will collapse to 700 because of debt deleveraging. Debt deleveraging could happen, but the Dow will not fall because of monetary policy. The Fed will keep everything inflated in nominal terms. And if the Dow does go to 700, you'll have more to worry about than your investments. All the banks will be bust. The government will be bust. You don't want cash if massive deflation happens. On the contrary: It will be worthless. You have to think very carefully about hardcore deflation.”
Both Mr. Rogers and Dr. Faber share a good degree of the same pessimism. Both sound the alarm for the real threat of a deflationary spiral, due to the zero rates and the printing press actions of the Fed. Deflation is correlated with recessions including the Great Depression, as banks defaulted on depositors. Additionally, deflation may cause the economy to enter the liquidity trap, a situation where monetary policy is unable to stimulate an economy, either through lowering interest rates or increasing the money supply. Deflation discourages investment and spending, because there is no reason to risk on future profits when the expectation of profits may be negative and the expectation of future prices is lower. Consequently deflation generally leads to, or is associated with a collapse in demand. Without the "hidden risk of inflation", it may become more prudent just to hold on to money, and not to spend or invest it.

Sobering thoughts on a hot summer July afternoon, as the market sputters back and forth from gains and losses trying to figure out what will happen next.

C. Cohn
Cohn-Reilly Report

______________Comments

Erin Thak said...
This is very scary stuff. I can't imagine what was going through the minds of the the general public during the great depression, but I can certainly say that I know this past three years on the economic and financial market front will be a significant part of our history. One that will be analyzed for decades.

August 20, 2010 7:54 AM

Katherine said...

I will have to agree with you on that Erin. I feel I am living in fascinating times. Don't get me wrong, it is definitely extremely difficult times for the majority of the the population, including myself, but I can't help but recognize the importance of what is taking shape.....for better or worse.

Reform Bill Signed ..and the Sky is Not Falling

The Bill was finally signed by President Obama on Wednesday July 21st, marking the most extensive financial reform legislation since the great depression. In addition to tougher regulations and fees for large banks, the bill outlines new processes and steps to be taken to address troubled companies, which would break down the business units and sell them off, rather than bail them out. The bill is being heavily criticized for what appears to be the government’s increased role of power and control. Further, despite what we’ve heard from the President and democrats on Capital Hill, the bill does contain language that suggests that the Federal Government still retains the authority to bailout troubled companies. Bloggers are going bonkers over this issue. I, on the other hand, feel otherwise. In all likelihood, the government’s authority is restricted to last resort options, or special circumstances. Let’s face it, no one could have predicted the turn of events in ’08 and ’09. Therefore, to close the door to any alternate options that may save the country from another “never before seen” economic turn of events, would not be wise.

As anticipated, the large financial institutions will be subject to increased oversight. Unfortunately, my understanding is that the Securities and Exchange Commission is going to be the watchdog. Are you kidding me? Now this is a real concern! The SEC, in all due respect, is the very same group that ignored countless warnings about Madoff, slept as the high risk sub-prime were securitized with “A” ratings, while spending thousands of office hours porn surfing. I am not encouraged by this at all.

I'm sure you've heard the "sky is falling!" type reports surrounding the passing of this bill, where market journalists, analysts and self proclaimed finance geniuses speculate that the bill will have a harsh impact on banks, which will stall or reverse the economic recovery. Sure there will be some initial impact, but banks have always found ways and means of navigating around the Regs and pulling out their multi-billion dollar profits. Time will tell, my friend times well tell. In the meantime, I shall remain open minded until I get more information about this historic bill might impact the economic recovery.

K. Reilly
Cohn-Reilly Report

___________Comments

Charlie said......
I agree with you about the SEC. The problem is that companies are concerned about how the financial regulations will affect their businesses going forward, along with the impact of health care reforms. As a result, firms are sitting on trillions of dollars in cash, reluctant to commit to hiring the still 9.5% of the population that is unemployed.

I speak to recruiters frequently and they confirm that employees are still working long hours to make up for the lack of staff in their departments. Hiring managers have numerous open requirements for employee spots to be filled, but until senior management can get over this uncertainty, we still will have major hurdles in putting America back to work.
JULY 23, 2010 6:25 AM

Katherine said......
You're right, Charlie. We don't disagree. Except from my standpoint, the Reform Bill is a key contributor, but there are other factors that come into play with respect to companies sitting on cash, and still reluctant to hire. Overall, the concerns are valid: How stable is the market?, How tight will the banks be with distributing credit? , and Will there be liquidity?, These are significant issues where the corporations are concerned, particularly the small companies, who depend on credit to purchase inventory, and make payroll. I definitely get it. Nevertheless, reform was absolutely necessary. We all know the financial industry was out of control, and now we all have to suffer for it. My old boss used to say "This too shall pass". Corporate America will adjust, survive, and eventually thrive again. Yes the economy may stagnate, but it will prevail.

No doubt there will need to be some changes in the Reform Bill – a few nips and tucks before we can strike a balance between consumer protection and keeping the banks motivated.
JULY 23, 2010 7:35 PM


Anonymous said......
Hey....nothing like a healthy debate, right? You both make solid arguments, but I’m more of the wait and see type. These are scary times, but I hear they don’t compare to the great depression – we have it easy. Look. - it’s not going to be the same no matter what we do, so why whine about it. Let’s just man-up and wait it out. Banks are never going to satisfied, and the Wall Street high rollers are moaning because we're raining on their parade. Wall Street and Main Street will never see eye-to-eye. So how do you write legislature that reflects the concerns of both sides. You Don't!

Federal Tax Increases Could Affect Lower and Middle Income Families

Tax cuts that were put into place by the Bush Administration are scheduled to expire at the end of this year. There could be some significant changes that will take people by surprise. The public has been led to believe that only tax payers in the top two brackets will face higher federal income taxes when the Bush cuts are gone. This may not be the case if Congress and the President fail to act. There are currently six rate brackets - 10%, 15%, 25%, 28%, 33% and 35%. They will be replaced by five new ones: 15%, 28%, 31%, 36% and 39.6%. A few months back it was thought that Congress would keep the old brackets to protect lower and middle-income families. It is now uncertain if this will happen.

There will be higher capital gains and dividends taxes.Right now, the maximum federal rate on long-term capital gains and dividends is only 15%. Starting next year, the maximum rate on long-term gains will increase to 20%. The maximum rate on dividends will skyrocket to 39.6% unless action is taken to limit the rate to 20%, as the President has repeatedly promised. For people in the lowest two rate brackets of 10% and 15%, the current rate is 0% for long-term gains and dividends. Starting next year, those people will pay 10% on long-term gains and 15% and 28% on dividends (compared with 0% now) unless a change is made. Otherwise, taxes on long-term gains and dividends will go up for everyone.

Currently, the standard deduction for married joint-filing couples is double the amount for singles, easing the so-called marriage penalty (see this link for more information http://en.wikipedia.org/wiki/Marriage_penalty) that can force a married couple to pay more in taxes than when they were single. Starting next year, the joint-filer standard deduction will fall back to about 167% of the amount for singles unless Congress takes action and the President approves. If that doesn’t happen many lower and middle-income couples will face higher tax bills. In the current system, the bottom two tax brackets for married joint-filing couples are exactly twice as wide as those for singles. That ratio helps keep the marriage penalty from biting lower and middle-income couples. Starting next year, the joint-filer tax brackets will contract, causing higher tax bills, unless a change is made.

The tax cuts in place now offer tax relief to most Americans who pay federal income taxes. The scheduled demise next year will raise the tax bill of nearly every taxpayer, unless Congress makes changes and the President jumps on board.

C. Cohn
Cohn-Reilly Report

___________Comments

Erin Thak said.....
In the short-term some of the Obama Administration‘s policies and regulations may appear to be more toxic than they really are. Like anything else, time may prove otherwise. I remember thinking that NAFTA was a good, progressive idea, which after 15 years, has proven to have a horrific impact the US. NAFTA commenced an huge increase in outsourcing resulting in the loss of 1.7 million jobs, as well as suppressed wages, due to the extremely low cost of doing business in Mexico. As brilliant as Bill Clinton is, he was unable to see the long-term ramifications of NAFTA, nor was any of the geniuses in his administration. So I remain guarded but hopeful that in the long run, the best interest of the country is being protected. This administration can’t do any worse than the previous one.
JULY 15, 2010 11:27 PM


Charlie said.....
I agree about NAFTA and the prior administration. However, I hope the new regulation laws do not have adverse affects on the many good companies that are not guilty of unethical practices and actually employ most of us. Also, as I mentioned above, I hope the President and Congress are aware of the impact that the reversal of the current tax cuts will have; not only on the wealthier citizens, but on the lower and middle-income tax payers as well.
JULY 16, 2010 10:55 AM

Katherine said.....
I agree 100% with Erin, as you well know Charlie, given our recent debate. However, Your point is well taken regarding the reversal of Bush's tax cuts. I cannot imagine that (with the dozens of economic and financial advisors on the Obama Administration's advisory board) no one is emphasizing this critical issue to the President. Although the Republicans are normally not cheerleaders for the middle class, this is one time that I hope the Republicans make this point loud and clear.
JULY 17, 2010 7:10 AM

Charlie said.....
I agree that the Administration has an ample supply of advisory personnel. However, the year is slipping away and with all the current distractions including a war, regulation, health care, etc., will there be enough time to mount sufficient effort to tackle this issue? Also, it is not just The Administration that must act - Congress has to move too. We all know that nothing gets done overnight in Washington and December 31 is closer than you think.
July 19, 2010 6:03 AM

Independence Day for the Feds: Lawmakers to Let the Federal Reserve Retain Their Independence

Wall Street reform, begins to take shape as the House of Representatives and the Senate attempt to hammer out the details of the much anticipated plan.
The Federal Reserve has been the subject of much sustained criticism for its role in the financial crisis. Eventually the Feds admitted to being complacent and not responding to mitigate mounting housing troubles due to risky lending practices back in ‘2007. Accordingly, there was a not-so-subtle push to make the head of the Federal Reserve Bank a political appointment. This idea was, thankfully, abandoned according to a Reuters report. Nevertheless, the Federal Reserve did not get off completely, as Lawmakers allegedly signed off on a one-time review of its emergency lending during the Crisis, and has ordered them to disclose the Discount Window and Open Market operations on an on-going basis. Even though the information requested is at a 3-year lag, this may come as huge adjustment for the Feds. Hey Feds...you win some, you loose some.
I am guarded but excited about the prospect of Wall Street reform, but I anticipate a difficult road ahead for the lawmakers as they chisel out the historical bill. It will certainly be interesting to see how they revise and attempt to blend the separate(and very different) bills that previously emerged from the House and the Senate. This July 4th weekend, which was the White House dead line, should quickly reveal just how bumpy the road might have been. As of week before last, the key issues were as follows:
1. "Yes" or "No" to a provision that would open the Fed’s interest-rate policy to congressional audits. If not perhaps they would look at examining other less sensitive areas.
2. Establish tighter regulations that would essentially crimp financial firms' profits, but serve to avert a repeat of the financial crisis of 2009.
3. Establish improved consumer protections. This would protect consumers from predatory and unsavory loan rates and fees.
4. Set up a process for dismantling troubled firms, in lieu of costly bail outs
5. Limit the range of high-risk, but profitable trading activities, which played a key role in the financial collapse of banking firms.

Although the Lawmakers differ in the details, both the Senate and the House would like to see funds set aside for dismantling troubled companies, rather than save them because they're “too big to fail. Regulators have also been directed to find ways to eliminate the conflict of interest that may have lead to credit-rating agencies. I wonder why they're ignoring the conflict of interest concerning research analysts who issued “strong buy” reports to stocks and companies that were troubled? Will they be included? You may or may not recall that one of the research analysts of a major investment bank was fired after pressure from Enron, because he did not give them a "strong buy" rating. Once the analyst was fired, Enron rewarded the Investment bank with a $50 million transaction. I can only imagine the numerous stories that have not been made public? At some point this week the details will be made public on this widely anticipated bill.


K Reilly
Cohn-Reilly Report

Post Script

Geithner and Michelle Obama at The U.S. Treasury

The two talk about the hard work of the treadury department employees, and the finance reform programs that are designed to mitigate another financial crisis from happenign again. Mrs. Obama talks about her child obesity initialtive.