Doug Hornig

It’s now been a year since the dark days of early March 2009, when, although no one knew it at the time, the stock market hit rock bottom. From there, all of the indexes went on a tear through the rest of the year, moving higher almost without interruption before easing slightly in the first two months of 2010. At this writing (March 5), the Dow is still up 60%, the S&P 500 68%, and the NASDAQ 83%.

Virtually no one was calling for this kind of rally a year ago. But it happened. So investors are either seeing the “green shoots” supposedly sprouting from the moribund economy or believe that they’re about to break ground any day now. That sentiment is continually reinforced by government officials and media talking heads who almost universally proclaim that “the worst is past,” “we’re back from the brink,” or other words to that effect.

It’s often said that stock market action is a leading indicator, reflecting what investors think the economy will be like six or nine months down the road.

Are they right? Will good times soon be here again? Or is this just a big dead-cat bounce?

Jobs: Now here, we’ve clearly turned the corner. Everyone says so. For evidence, all we need do is look at the declining rate of job loss in the country. Uh-huh.

Perhaps it’s rude of us to point this out, but a declining rate of job loss is still a job loss. It is not the same as job creation.

The hard reality behind February’s “encouraging” numbers is that 14.9 million people remained out of work. 8.4 million jobs now have been lost since the start of the recession. In addition, there is a net need for 100,000 new jobs a month, just to keep up with first-time entrants to the workforce.

Even if the economy were suddenly to start churning out new jobs at the robust rate of a half-million a month — and the chances of that range from zero to none — it would still take nearly two years to return just to pre-recession employment levels.

(Near-term employment figures may blip up, as the government hires one and a half million people — who knew we needed so many? — to help take the census. That could lead to a classic false dawn.)

Anyone looking to the housing market to lead the recovery, as it often does, had better find a magnifying glass. January marked the third consecutive monthly drop in new home sales, and it was a whopping 11.2% tumble. Mortgage applications fell to the lowest level in 13 years. There was even a decline of 6.1% from January of 2009, itself a very dark month. Congress’s extension of home buyers’ tax credits is proving to be of increasingly little consequence.

New home sales are very important, since they cause a cascade effect down through the entire supply chain, from architects to building contractors, to sawmills, to sheetrock manufacturers, to carpenters, plumbers, and electricians. But sales of existing homes are also relevant, and there, too, the figures are grim. After piggybacking on federal subsidies through the fall, sales absorbed the worst pummeling on record in December, down 16.2%. January was a little better, only off 7.2%.

One number that is unfortunately growing is this: distressed sales, such as foreclosures, accounted for 38% of sales in January, up from about 32% in December. People are losing their homes at an increasing rate, with few buyers stepping up to the plate.

But hey, maybe there is a huge pent-up housing demand out there. We doubt it, but if there is, it doesn’t matter. Because lenders are ignoring it. In 2009, U.S. banks posted their sharpest decline in lending since 1942. One reason is that many are too cash-strapped themselves to deal with borrowers. According to the FDIC, at year’s end its “problem” list of U.S. banks at risk of failing hit a 16-year high at 702 (or nearly one in eleven), rocketing up from 552 at the end of September and 416 at the end of June. And little wonder. More than 5% of all outstanding loans are now at least three months past due, the highest level recorded in the 26 years the data have been collected.

Then there are those that can’t lend because they’re no longer with us. 140 banks went belly-up in 2009, and 2010’s total will be worse than that if January’s 15 failures prove representative. The FDIC is bankrupt after reporting a $20.9 billion loss in the fourth quarter of 2009 in its Deposit Insurance Fund.

However, never let it be said that the government won’t try to squeeze some lemonade out of its bag of lemons. To wit, the FDIC’s own financial woes haven’t prevented it from opening a huge new satellite office in the Chicago area. The facility will be dedicated to managing receiverships and liquidating assets from failed Midwest banks, and will occupy seven floors of an 11-story building. The office space being leased is well over 100,000 square feet and will employ approximately 500 temporary employees and contractors.

Does the FDIC know something we don’t? We can’t say for sure, but the fact is that the agency has already opened similar offices in Irvine, California, and Jacksonville, Florida.  Each time, the number of bank failures in those states spiked dramatically after the FDIC set up shop.

Elsewhere, consumer confidence is flagging and, since the economy is 75% consumer-driven, that doesn’t bode well. The Conference Board’s index took a swan dive in February, to its lowest point since last April. The index plunged to 46 from January’s reading of 56.5, stifling the previous three months’ uptrend. As a measure of how bleak the public mood is, the economy is considered stable only when the consumer confidence reading exceeds 90. We’re barely halfway there.

And finally, we don’t want to lose sight of the 800-pound gorilla in the room, the federal debt. How bad is it? Well, the Bank for International Settlements recently released a very frightening figure. In order just to stabilize debt at pre-crisis levels, the BIS says the U.S. government must run a budget surplus of 4.3% of GDP. Every year. For ten years.

For an in-depth look, try Harvard economist Kenneth Rogoff’s new book, This Time is Different: Eight Centuries of Financial Folly (co-authored with Carmen Reinhart of the University of Maryland), the first comprehensive survey of past financial crises around the world.

Dr. Rogoff, who may be the country’s leading expert on the historical record, concludes that a banking crisis often leads a country into default, because government’s response is usually to try to prop up the financial system with yet more debt.

If that sounds familiar and disconcerting, it should. Even more so because Rogoff has identified a clear tipping point, beyond which there is little hope of recovery. When a government’s debt grows to equal annual GDP, the game is essentially over.

Where we are now: We have $12.5 trillion in gross debt, growing at $2 trillion per year, on a GDP of $14.3 trillion. Next year, it will be $12.5T + $2T = $14.5 trillion on a projected $14.5T of GDP. Or 100%. A level we cannot survive for long.

That means it’s likely, in the not-too-distant-future, that the government will be confronted with a very stark choice between defaulting on the debt or trying to inflate its way out. The former would kill off economic growth and likely launch a worldwide depression of epic proportions.

Disastrous as that would be, if the alternative is chosen and Washington’s printing presses beget hyperinflation, that would probably be worse. In a serious deflation, those who have saved for a rainy day can make it through okay. In hyperinflation, which unconstrained further spending could easily bring on, everyone loses.

The truly prudent prepare, as best they can, for either eventuality.

Regards,
Doug Hornig, Casey Research
for Whiskey & Gunpowder

March 17, 2010

Doug Hornig
  • http://www.twitter.com/letsgetfiscal JKR

    Look, even if the market tanks again, there will be a solid floor because people have already been shocked into risk tolerance… the second time they will stick it out because at the end of the day they really have no other place to put their money. The folks who cannot bear another drop have been sitting this rally out and will continue to do so – therefore there will not be a major run for the exits the next time things turn down.

  • Scott

    Interesting reading. It appears that Rogoff’s analysis neglects to take into account the mountains of state and city debt, which would probably push us closer to the magic number even now..

  • http://www.thetexasring.com Linda Brady Traynham

    Another fantastic article, Doug. I was thinking again, today, how very lucky we W&G readers are in the selection of materials we get here. I spend many hours a day researching to keep up with what is going on; at any given time I have additional statistics, probably, but one of Agora’s editors has covered the basic theme. Anyone who reads W&G, the Daily Reckoning, and Taipan Daily–all out of the Agora stable–is well-informed on financial affairs. Laughter…this is an unpaid testimonial, reflecting my admiration of the company for which I write, and I don’t get paid for that, either.

  • http://onpoliticaleconomy.blogspot.com/ LS

    Somehow I just found this site, and after reading this article, I immediately added it to my RSS feeds. The preference for deflation over inflation makes sense to us who have saved for a rainy day. I only fear that that will not be the option chosen by the powers that be.

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