An Ordinary End to a Post-Crash Bounce

David Rosenberg:

“The incoming economic data in both the US and Canada have improved and for the most part [are] bettering expectations. The dilemma is that market pricing has moved far beyond the fundamentals. Despite the temptation to jump into a ‘liquidity-induced’ rally…they cannot be sustained without a durable organic economic expansion. The problem is that the global economy in general, and the US economy in particular, is operating on so much medication that it is difficult to conduct an appropriate examination of the patient at the current time. All we know is that the markets seem to have very rapidly now priced in three years worth of recovery.

“The S&P 500 is now up more than 60% from the lows, which is truly amazing and kudos to those who called it. But the question is whether the fundamentals will ever catch up to this level of valuation – usually after a 60% rally, we are fully entrenched in the next business cycle. Never before have we seen the stock market rise so much off a low over such a short time period, and usually at this state, the economy has already created over one million new jobs – during this extremely flashy move, the US has shed 2.5 million jobs (as many as were lost in the entire 2001 recession).”

The markets rise. The economy sinks. It is not sinking as fast as it was. But it is still going down. Month after month, the number of people without jobs increases. Even Paul Krugman says that unemployment won’t reach its peak until 2011.

And house prices? Hard to tell what is going on. As Rosenberg puts it, this patient is so hyped up on drugs it’s not possible to make a diagnosis. Still, he doesn’t look good. There are millions of mortgages that still haven’t been tested. Interest only…Alt A…commercial…even prime mortgages. They are facing reset…and refinancing…with collateral prices down 20-30-40%. How can you refinance when you are underwater?

Let’s look at the basics. We had a nice thing going. From 1945-2007, consumer spending and credit increased. As long as lenders were willing to lend…and consumers were willing to go further into debt…the economy expanded.

Towards the end, it got a little crazy. And then it blew up.

As predicted, the feds rushed in to save the situation. But they only have one trick – adding more cash and credit. That works every time…until it stops working. And it stopped working in 2008.

Banks don’t want to lend against falling house prices. And consumers don’t want to borrow when their incomes are going down.

Ergo…the end of consumer credit expansion. Get over it.

But the feds keep at it. And with their help, the markets have bounced up. Of course, a bounce is one of the most reliable features of a market economy. A 50% bounce in the Dow – roughly equal to the bounce after ’29 – would take the index to 10,300. We’re not there yet.

So, there’s nothing unusual or unexpected about this situation. The markets have done what they were supposed to do. The feds have done what they’re supposed to do.

So what next?

Ah…dear reader…if only we knew the answer to that question…

Here we are in uncharted territory…terra incognito…

Never before has there been an international monetary system based purely on paper. And never before has it been run by people who believe they can force the market to do their bidding. They are convinced that they can avoid the Japan situation – where the economy dragged along for twenty years – by adding more cash and credit. Bernanke said he would drop it from helicopters if necessary.

Just one problem…. Bernanke can inflate…but only until the Chinese tell him to stop. When China pulls the plug on the bond market, the party comes to an end. That’s why the helicopters are still on the ground. And it’s why they will only take off when the situation becomes desperate.

In the meantime, we await the ordinary…that is, an ordinary end to a post-crash bounce. That will come with another crash. And another. And another. Until stocks finally hit bottom…and bubble-era delusions are finally all crushed out.

Taxes are going up. Governments have gotten themselves in a new trap. Well…several traps.

When you intervene in a place like Iraq, it is like a bad marriage. The first few nights are fun. But soon you’re looking for a graceful way to get out. Trouble is, there isn’t any easy way out. So you stick with it. Time goes by. And the costs mount up. Before you know it, the cost for the Iraqi adventure is more than $1 trillion…and then it goes to $2 trillion.

Now, the feds have intervened in the economy too. And, likewise, they are trapped. By pumping in trillions of dollars – not just in America, but also in Britain and China (which have both intervened even more forcefully) – they have made it look like things are okay. They have kept zombie companies alive. The big banks haven’t had to own up to their own mistakes. Companies haven’t had to cut back quite as much as they would have.

As our friend Nassim Taleb puts it, the financial system “still has the same disease.”

But it’s being kept alive with massive doses of very expensive medicine – provided by the feds.

So what are they going to do now? They claim to have prevented catastrophe. They say they’ve engineered a recovery. And yet, if they let up on the drugs…the patient dies.

They’re trapped…they’ll have to keep pumping in money for years…until the money runs out.

Naturally, the feds want to raise as much money as they can. So, like bank robbers, they go where the money is – to the “rich.”

Steve Sjuggerud tells us what has happened back at home…in Maryland.

“The state of Maryland couldn’t balance its budget last year. So the state decided the right way to raise tax dollars was to fleece the millionaires… Maryland state politicians created a ‘millionaire’ tax bracket.

“Maryland Governor Martin O’Malley of course expected tax receipts to go up. He said Maryland’s 3,000 millionaires were ‘willing to pay their fair share.’ The Baltimore Sun said the rich would ‘grin and bear it.’

“But the opposite happened…

“Instead of 3,000 Maryland millionaires filing taxes in April 2009, only 2,000 did. According to The Wall Street Journal: ‘Instead of the state coffers gaining the extra $106 million the politicians predicted, millionaires paid $100 million less in taxes than they did last year – even at higher rates.’

“A friend of mine lives here in Florida. He is not an American citizen. He pays US taxes while he lives here. But under the threat of higher national income taxes, he is contemplating giving up his green card and moving elsewhere.

“When Maryland’s governor raises taxes, Maryland residents leave and government income goes down.
“When the nation’s President raises income taxes, foreigners like my friend leave and government income goes down.

“Unfortunately, YOU CAN’T LEAVE.

“Wait a minute. This is America, land of the free, right?

“Not so fast… The US government will track US citizens everywhere to get tax money. If you leave to work in another country, you still pay US income taxes. America and North Korea are the only countries that tax you on your worldwide income.

“If it gets bad enough, you can just give up your citizenship, right? Nope, you can’t do that either. At least, you can’t do it without paying a potentially massive ‘exit tax.’

“The exit tax acts like an estate tax. If you want to give up your citizenship, you have to give up nearly half your wealth above a certain level. The Economist magazine calls it ‘America’s Berlin Wall.’ Nice, eh?

“Want some more nice? Once you’re gone, you’re not legally allowed to come back and visit family and friends. Yes, if the government decides you have renounced citizenship for tax purposes, a federal law prohibits you from entering the country ever again. (You can look up the rule under 8 USC 1182(a)(10)(E).)

“You can escape states with oppressive taxes. But ‘escaping’ the US – the land of the free – is much more difficult. And you can bet it won’t get any easier as the government needs more and more of your income to pay its bills.”