* By Polar Bear
The start of a new year lures many a so-called expert into forecasts which mostly turn out wrong. I am no forecaster, but I see some underlying realities which can serve as markers for the year ahead.
Let us start with a bold assertion.
All the current fiscal and monetary stimulus packages will fail.
Are you quite well, you may ask? The fundamental point is that governments cannot inject any fresh capital. They only redirect / misdirect existing resources. They may print money which goes into all those multitudinous rescues of banks, car companies, Fannie Mae, Freddie Mac, etc etc. But all this money creates a giant debit, which has to be paid for by savers now and in the future.
But Obama's trillion dollar stimulus package, combined with other packages, particularly that of China, must have a positive impact on the GDP numbers, you may well object. However, we must be clear what GDP is really measuring.
Think of it this way. Repairs and rebuilding after a natural disaster will increase activity for builders, carpenters, glaziers, brick makers, timber merchants, etc etc. On a small scale, the vandal, who throws a brick through a window, creates work for the glazier and demand for glass. The natural disaster and the vandal could be depicted as public benefactors.
What is not measured are the losses of materials and economic activities foregone, and, as a result, the jobs not created. These are the hidden losses.
GDP measures money flows, not aggregate capital investment. Saving is the essential fuel for capital investment. That is why, in aggregate, savings equal investment. To hear panicked politicians talking, you would imagine that the saver had unpatriotically withdrawn from the economy. To state the bleeding obvious, saving is not hoarding. The saver has chosen to spend on future goods rather than current consumption. For that, he or she will receive interest, earn capital appreciation, and or dividends.
The underlying assumption is that consumption drives the economy rather than savings cum investment. This is the great divide between the dominant "Keynesian" economic view and the "Austrian" school. I will leave the reader to debate the relative merits of the economic arguments. But we may observe the obvious absurdity of overborrowed, overleveraged consumers being called on to consume and borrow even more in order to "save" the economy.
I am not arguing that a "Keynesian" fiscal cum monetary stimulus will always be seen to fail. Paradoxically, Keynesianism will seem plausible after a period of liquidation, when cash balances are rebuilt. The problem is that resources will be directed\misdirected from activities favoured by savers to activities which appear to promise quick, short term benefits. For now, the Keynesians are bereft of those "idle savings", so essential for any successful fiscal stimulus.
We face deflation not hyperinflation.
But what all that monetary easing by Bernanke, the open ended bailouts, the purchase of long dated Government treasuries by the Federal Reserve and the purchase of mortgages and other liabilities in pursuit of a radical policy of quantitative easing, and the never ending fiscal stimulus packages? Yes, the money base has shot up, as I pointed out earlier. US commercial banks are stuffed to the gills with reserves, borrowed from the Federal Reserve. Federal Reserve credit has soared. Moreover, the adjusted monetary base has skyrocked. Interestingly, the monetary base rose during the Great Depression, hardly a period of inflation. Those screaming inflation, would do well to examine a chart of the M1 Money Multiplier, which is the ratio of M1 to the St Louis Adjusted Monetary Base. The plunging ratio indicates that little of that base money growth is making its way into M1 credit growth. Central banks and governments have no control over broader credit growth. Banks cannot lend when there is no capacity to borrow and service debt. Credit contraction is the order of the day until corporate and personal balance sheets are brought back into balance.
The US Dollar will continue to strengthen over time.
The inflationist crowd continues to rave on about the imminent collapse of the US dollar. But crowds typically look through the rear vision mirror. The US dollar has already crashed. Back in July, 2001, the US dollar index stood at 121.02. The "crash" occurred during the economic expansion, culminating in a low of 70.7 on March 17, 2008. At least, we should note that the US dollar weakness accompanied the growth of debt and leverage in the US. Thus far, the contraction has favoured a stronger US dollar. Moreover the panic low in the Dow coincided with a US dollar index peak. It seems that too many so-called experts, who have been calling for the collapse of the US dollar, have lost economic objectivity. They totally ignore the more serious structural problems in Europe, Russia and China and elsewhere. One so-called expert was screaming at all and sundry to get out of the US dollar and invest in China. He even advised that he was remaining long on the Shanghai Composite Index. If he was truly talking his book, he has taken a bath. No mea culpa so far.
Industrial commodities will continue to weaken, and Gold will strengthen in real terms.
The current credit contraction will likely impose further downward pressure on oil and industrial commodities, once the current rally comes to an end. We have seen the catastrophic collapse of the Baltic Dry Index, a precursor to a world decline in manufacturing. The much touted commodity boom is now a busted flush. The effect on the likes of BHP and the overleveraged RIO will be evident in the next six months. An enormous profit shrinkage will be a nasty surprise to many shareholders. On the other hand, Gold has strengthened not simply in nominal price terms but far more significantly, in real terms. This trend is set to continue. The big surprise is likely be the performance of the quality gold producers. During the recent boom, gold rose in nominal price terms but fell relative to industrial commodities. Accordingly, the gold producers were beset by rising fuel, steel and other material costs during the boom and their profitability and share prices tended to suffer. The coming out-performance by the quality golds would be a repeat of their performance during the last great depression.
For the next couple of months, the belief will be sustained that fiscal stimulus, monetary easing and bailouts will "work". Sharemarkets around the world will reflect this hope. But a recovery cannot start until savings rise in relation to consumption. Unfortunately, governments worldwide, seem set to pursue policies which attack saving and seek to perpetuate the imbalances created by the boom, thereby prolonging the downturn.