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.