Solving the US Debt Crisis with More Liquidity

It is not for nothing that seasoned stock market participants advise, “Sell in May and go away.” During the last 60 years, the month of May has delivered the fourth worst average monthly return on the calendar. But that’s only the beginning of the story. The three worst months are June, August and September.

July isn’t too shabby, but it has the misfortune of sitting between the only two months – June and September – that have produced losses, on average, since 1950. August has delivered a gain, but just barely. So when you add it all up, you can see that the stock market has not provided a very hospitable home for capital during the summer months.

Dow Average Monthly Returns

Enter May, 2010, the worst May for the Dow Jones Industrial Average since the Andrews Sisters recorded “Boogie Woogie Bugle Boy.” The Dow stumbled 7.9% last month – dropping its year-to-date return to minus 3.9%. These numbers aren’t disastrous, but they aren’t very helpful either. Better to have sold in May and gone away.

Commodities didn’t fare any better in May, as the Reuters/Jefferies CRB Index dropped more than 8%. Only gold managed to keep its bow above the waterline by gaining 3% on the month.

What do all these numbers tell us? Only that it’s a jungle out there. But didn’t we know that already…at least deep down? Even when the stock markets were soaring between March 2009 and March of this year, it never felt quite right. The effervescence on Wall Street always seemed out of place alongside an economy that was obviously “sin gas.”

The Dow’s 12% slide during the last five weeks may have narrowed the gap somewhat between Wall Street fantasy and Main Street reality. But stock market valuations are chasing a moving target…or rather, a tumbling target. Many important economic realities on Main Street continue to deteriorate, as do many important economic realities on the “Rue Principales” and “Hauptstrasses” of Europe.

Stock prices are falling, but economic prospects may be falling faster. Leverage – in all of its many shapes, forms and derivative contracts – remains the root cause of the Developed World’s unshakable economic malaise.

Throughout Europe and the United States, large lending institutions and government entities are still carrying fatal quantities of debt. And there is no viable solution in sight. Politicians in both the Old World and the New have been convening lots of meetings to discuss bailouts, “austerity measures,” and various other non-solutions. But day-by-day the Developed World’s unmanageable quantities of debt continue to grow.

Here in the US, the stock market’s robust rally off the March 2009 lows provided a perfect opportunity for the market-fixers/manipulators at the Treasury Department and the Federal Reserve to congratulate themselves on a scam well done. “By providing ample liquidity,” the fixers explained, “we restored ‘normal’ price-discovery processes in the financial markets, which enabled the credit markets to resume operating ‘normally.’”

Left unsaid by the fixers is the fact that their “fixes” have raised America’s “normal” annual budget deficits from $300 billion to $1.8 trillion. Also left unsaid by the fixers is the fact that establishing and maintaining the new “normal” requires a wide variety of abnormal financial practices. A short list of these abnormalities would include nationalizing 90% of the nation’s mortgage industry, whimsically dispensing multibillion dollar bailout checks to selective private corporations, printing dollars to buy back government debt, preventing banks from foreclosing on delinquent borrowers and – our personal favorite – encouraging banks to value balance sheet assets at unrealistically high prices.

Taken together, these various measures did not produce a return to normalcy; they produced a moon shot into fantasy. But most fantasies fizzle eventually, and coming back down to reality is usually a difficult transition. Some parts of the economy are attempting to make this transition. Few are succeeding.

America’s residential real estate market provides some of the most poignant – and troubling – images of the economy’s continuing distress. “Bottom line,” says Mark Hanson, Managing Director of the real estate advisory firm that bears his name, “[at the current rate of foreclosures], it would take 101 months to clear the pool of 6.4 million loans headed for liquidation. At a pace of 180,000 foreclosures per month – which would be twice April’s record high – it would take 42 months to clear the existing distressed inventory.”

If Hanson’s very detailed and compelling analysis is on target, the residential housing market should clear its inventory of foreclosed homes sometime between Thanksgiving Day of 2014 and Halloween of 2018. But even 2018 wouldn’t be too bad, at least compared to the US government, which is on track to retire its indebtedness by Thanksgiving Day…of never.

Debt is a problem in the Developed World…a great, big problem.

Eric Fry
for The Daily Reckoning