By Bob Wood, MMNS
Investors paying close attention will notice that 2008 is getting off to a terrible start for anyone holiding traditionally allocated accounts. The current market is having its worst beginning in decades. Though short-term bear markets are a normal part of market cycles, our countryâ€™s leaders, for some reason, are determined to prevent one now. Whether they will succeed is highly doubtful, yet they continue to offer a false sense of comfort that will cost investors dearly as the year grinds along.
While our Government and Federal Reserve leaders have been continuously repeating in recent months that the U.S. economy is strong and the envy of the developed world, many stock market promoters are screaming for stimulus with the hope of boosting both the economy and stock market. Doesnâ€™t it seem strange that an economy which is portrayed as strong as ours is in such dire need of help in the form of interest rate cuts, record-setting money printing and credit availability? If the economy is truly strong, why do we need these extra measures?
Even stranger is that our so-called strong economy may need an emergency stimulus package, which the Bush administration is now discussing. The Government is determined to print money and give it to consumers in an effort to encourage spending; this speaks of an economy that is anything but healthy.
Chairman of the Federal Reserve, Ben Bernanke, may be remembered, in part, for saying that recessions and deflation can be averted by using the printing press to create dollars out of virtually nothing. He used the analogy that the Fed could simply drop money out of helicopters, allowing anyone to scoop them up and head to the nearest shopping mall.
This new economic stimulus package under discussion at the White House is alarmingly close to the Fed chairmanâ€™s proposition. Which sounds worse: letting the economy slipped into recession — or printing money with reckless abandon in an effort to prevent recession?
If any other country was having this discussion, how would we react? Would we call such a measure a sure sign that a banana republic was on the verge of failing? Would we see any probability for success in desperate measures such as dropping money out of helicopters or simply sending checks for hundreds of dollars to those willing to take them?
Maybe the most alarming aspect of such a plan is that, while considering that a stimulus package may be a good thing, we actually have no money available to dole out to consumers. We are broke! Bankrupt! And weâ€™ll need to print or borrow from foreigners any new money used to stimulate spending!
What do we gain by borrowing more money to spend on consumer goods, food, energy or anything else that keeps our economy moving? Of course, we could avoid borrowing anything from anyone by, as Bernanke has said in the past, by simply printing all the money we need.
If you are looking for a flaw in the plan, Iâ€™ve found a very big one. One reason that the economy has slipped into recession is that the average consumerâ€™s income has not risen as quickly as prices of what he buys daily. Inflation today, if measured as the Government did during the 1980s, is running close to 10%, calculates economist John Williams of shadowstats.com.
While Government leaders will certainly argue that number, a recent local newspaper article shows that, over the past year, the price of eggs has risen by 32%; gas, 30% and milk, 22%. Health care costs, college tuition and other expenses, which are purposely excluded from the so-called â€˜â€™ core rateâ€™â€™ of inflation, are also rising at a much faster rate than wages.
Making it even harder for consumers to catch up is that high-paying manufacturing jobs have all but disappeared. Companies such as General Motors are doing whatever they can to stave off bankruptcy, including aggressively cutting jobs and salaries. The company is also reducing its workforce by an additional 46,000 employees, on top of the 48,000 workers already cut since 2003.
An interesting detail in the latest General Motors plan is the anticipated replacement of newly fired workers with newly hired employees paid at a much lower rate. By classifying them as â€˜â€™non-coreâ€™â€™ workers, GM can offer the new-hires reduced compensation packages, with pay and benefits costs about a third of those for current workers.
As a result, new manufacturing workers at General Motors will find keeping pace with the rising costs of living more difficult. And the move will also put pressure on wages for workers at Ford, Chrysler and parts suppliers.
As you can clearly see, two disturbing trends are at play. Wages are, at best, going nowhere. Prices, on the other hand, are moving relentlessly higher.
So if the Government issues $1,000 checks to all eligible consumers with the hope that every dollar will be spent, how long will this effort stimulate the economy? What happens in three months when the money has been spent by consumers who return to their previous struggles? With the absence of new, high-paying jobs, consumers will continue to fall behind â€“ bit by bit.
If our Government decides to create money out of nothing but paper and pretty ink, what does that tell foreign holders of hundreds of billions of our dollars about our so-called â€˜â€™stronger dollar policyâ€™â€™? Consumers in Indonesia are complaining bitterly about the high price of soybeans. Consumers in Saudi Arabia are complaining bitterly about the high price of milk and other food items. Consumers in America are complaining bitterly about the high price of oil and gas. Since these commodities are all priced in dollars, a bigger supply of dollars will mean an even higher price for the commodities.
Isnâ€™t it obvious that we have been exporting inflation around the world? Remember, our financial instruments, such as mortgage bonds, have also caused huge losses among institutional investors in Asia, Europe and Australia. The economic pain that we are spreading around the world will surely come at high cost to us. Stimulating consumer spending by printing money and â€œdropping it from helicoptersâ€ might seem like a reasonable attempt at a short-term cure. But what is the longer-term cost of doing something so obviously flawed?
The problems in our economy are structural in nature. Too much money printing, too much easy credit and too little regulation of the financial services industry have caused problems that cannot be papered over with small checks dropped to American consumers. Using short-term solutions to solve long-term problems only delays the inevitable day of reckoning. The longer we avoid dealing with structural issues that have caused this financial mess, the bigger the ultimate price to pay.
Does anyone really think that our current leaders or any of the candidates now running for president, (with the possible exception of Ron Paul), has the courage to deal honestly with our financial mess? I think the answer, of course, is a resounding â€œNoâ€!
So they continue to seek cosmetic solutions to endemic problems solvable only with massive structural changes to our economy. Since such changes would come at the expense of the nationâ€™s wealthiest few and our largest corporations, do not count on the enactment of meaningful measures anytime soon.
For investors, the environment remains unchanged. We are locked in a secular bear market which now suffers from the weight of massive fiscal and monetary blunders. We are deeply in debt to each other and to foreign lenders around the world. That indebtedness continues to grow, especially now that our largest financial companies are traveling the world, tin cup in hand, looking for bailouts from foreign entities.
Are you, too, wondering why companies such as Citigroup, Merrill Lynch and others are courting foreign lenders? Are there no sources of funding available in America? Some suggest that without recent infusions of foreign cash, Citigroup might be on the verge of bankruptcy.
Does anybody really think that dropping money from helicopters or sending consumers checks for a few hundred dollars will keep spending high enough to offset the failure of one, or possibly several, of our leading financial institutions?
I see the new economic stimulus package as a last-ditch, desperate leadership attempt to avoid admitting the obvious. Our economy is now in recession and quite likely on a path to something even more severe.
For investors, the signs should be obviously clear. Allocate your savings as defensively as possible. Small allocations in gold, energy, basic commodities and, when acceptable, international bonds appear appropriate.
Investing in international stocks has become a dicey proposition, since troubles in our domestic markets are causing concern for investors everywhere. By staying defensive, you will, at least, be positioned to buy shares of the best companies around the world — after this situation settles out.
Have a great week.
Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., firstname.lastname@example.org.