The Nonsense Recovery
Eventually, investors are going to realize that the discussion of a “recovery” is nonsense. The economy can never recover the pace and frenzy of the bubble years – and so much the better. It has to move on to something new. The big question is: What will this new economy look like?
One important detail: in this new economy US stocks are not likely to be as highly prized as they are now. That is not to say that companies won’t make money. They will – especially those that are taking advantage of strong rates of growth overseas. But investors are likely to appreciate them less regardless. That’s what happens in a bear market: the price-to-earnings ratio falls. Earnings do not necessarily go down; but the multiple investors are willing to pay for each dollar of earnings does.
When people are optimistic about the financial future they’re willing to pay 20 or 30 times for each dollar of earnings. But when they are gloomy and negative they’re unwilling to pay anything more than 10…or even 5…times for each dollar of earnings.
Americans, and to a lesser extent people living in other developed economies, are going to feel increasingly negative as the years go by. For one thing, their economies are likely to underperform their competitors in the emerging world. But I’m going to focus on another reason today: their government financing systems are fundamentally dishonest and bankrupt. To make a long story short, their economies have been living on borrowed money and borrowed time. The moment for settling up is approaching. It is going to be painful, gloomy and depressing. All asset classes – save maybe cash and gold – are likely to fall.
This message came out this week from two important sources. Professor Lawrence Kotlikoff of Boston University and former Reagan-era OMB chief David Stockman. Both make the same point: government finances are worse than we thought and headed for disaster.
Of course, we knew that. You can’t go deeper and deeper into the hole forever. But two things are new: (1) these arguments are reaching the mainstream media; and (2) they show that federal finances are already beyond the point of no return.
I’m going to briefly rehearse the numbers and basic ideas for you. Because it’s easy to forget what is going on. One day the Dow goes up; the next day, it goes down. One day, the economy seems to be recovering; the next, it seems to be slipping backwards. It is as though we were on a ship that has hit a submerged reef. This ship is still afloat. The bartender is still serving drinks. People stand around and argue about politics. The music is still playing. It’s easy to forget that the ship is sinking.
Kotlikoff and Stockman each put forward evidence that clearly shows the US to be effectively bankrupt. If you add municipal debt to the official national debt, says Stockman, the total is already at Greek levels: about 120% of GDP.
Stockman has an axe to grind. He blames the Republican Party for abandoning old-time fiscal rectitude for the allure of “vulgar Keynesianism” (in which “deficits don’t matter” because we will “grow our way out” of them. Tax cuts, for example, are supposed to be self-financing, because they boost GDP, which increases tax receipts even at lower rates.)
Win-win is an attractive goal in contract negotiations; it rarely works its magic in public finances. When you cut taxes the first time, you may get an offsetting boost in GDP. But rarely a second or third time.
The Reagan-era cuts seemed to pay off. The economy boomed.
Republicans believed they had the winning formula: promise voters the moon and count on supply-side growth to pay for it. But the boom of the ’80s and ’90s was really Paul Volcker’s victory…not a victory for Republican fiscal management. After Volcker got control of inflation, the economy was able to grow and prosper for the next 20 years as interest rates fell and stocks rose.
The “deficits don’t matter” creed backfired under the administration of George W Bush. Spending programs – projected into the future – created huge structural deficit gaps that cannot now be closed by any reasonable economic growth assumptions.
In addition to the government deficit there is the accumulated trade deficit of $8 trillion – money spent by the private sector on goods and services bought overseas and not offset by investment back into the US by means of higher exports.
Official federal debt and the accumulated trade shortfalls adds up to $26 trillion – not quite 200% of GDP, but getting there.
Stockman:
[N]ow there is no discipline, only global monetary chaos as foreign central banks run their own printing presses at ever faster speeds to sop up the tidal wave of dollars coming from the Federal Reserve.
Stockman also condemns the growth of the financial sector:
The combined assets of conventional banks and the so-called shadow banking system (including investment banks and finance companies) grew from a mere $500 billion in 1970 to $30 trillion by September 2008.
But the trillion-dollar conglomerates that inhabit this new financial world are not free enterprises. They are rather wards of the state, extracting billions from the economy with a lot of pointless speculation in stocks, bonds, commodities and derivatives. They could never have survived, much less thrived, if their deposits had not been government-guaranteed and if they hadn’t been able to obtain virtually free money from the Fed’s discount window to cover their bad bets.
Kotlikoff focuses more on the total of US debt, including unfunded “unofficial” debts and obligations. He puts the total at $202 trillion – an amount that clearly can’t be paid.
Let’s get real. The US is bankrupt. Neither spending more nor taxing less will help the country pay its bills.
David Stockman said it, not us.
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