Stocks were up yesterday…the Dow rose 196 points.
What were investors thinking?
“Home prices fell more than forecast,” reports Bloomberg. They’re still going down at a 19% rate. Unemployment is still rising too.
The state with the biggest economy in the nation is going broke. So is the nation’s biggest manufacturer. Profits are falling. And the government is racing to put in place a form of state-sponsored socio- capitalism much like Mussolini’s Italy…or Peron’s Argentina.
These do not sound to us like ideal conditions for a bull market.
Did we say thinking? There’s not much thinking going on. People don’t often think…not if they can avoid it. And it’s probably better that they don’t. Who knows what opinions they might come to if they put their minds to it?
Instead of thinking, they react. And after a big drop in stock prices, they bounce. We’re now in an extended bounce…which could last until mid-summer…and could take the Dow back to 10,000.
That is to say, there is nothing unusual about this kind of stock market action. Au contraire…it’s classic.
Investors are also reacting in the bond market. They’re buying Treasury bonds in reaction to bankruptcies, defaults and falling asset prices. Investors feel they can put their money into Treasuries and not worry.
But maybe they should spare a thought or two about what is really going on. Lending money to the US government is no sure thing. Far from it. In fact, under the present circumstances, lending money to the feds is asking for trouble. Recently, you could put your money in T-bills and get zero yield. “An extraordinary thing…” said Warren Buffett – so extraordinary that he was “not sure [you’d] see that again in your lifetime.”
On the numbers, the US government is the worst credit risk in the world. You determine a man’s creditworthiness by looking at his balance sheet. Add up his assets and subtract his liabilities. Do that to the federal government and you get a very big number with a minus sign in front of it. Even if they were to sell off the Capitol building and all the federal lands west of the Mississippi, the feds would still have a hole in their finances larger than any other in the entire world.
While the balance sheet looks awful, the cash flow is worse. In the current year, the feds will take in about $1.9 trillion in taxes and spend $3.6 trillion. In other words, the feds aren’t just living beyond their means…they’re not even on the same planet. Who in his right mind would lend to a spendthrift whose outgo exceeded his income by nearly 100%?
The only way any loan can reasonably be repaid is from income. Income must exceed expenses or there will never be money for debt repayment. Lending to a corporation or an individual, the lender expects the borrower to earn his way out of debt. Otherwise, it’s a fool’s game. The debtor is soon kiting checks and going deeper in the hole. He borrows from one lender in order to pay off the first lender… In effect, he operates a pyramid scheme – depending on fresh suckers to keep giving him new money – until the whole thing comes crashing down.
The federal government doesn’t even pretend that it is going to earn its way out of debt. It presumes that there’s an endless supply of money it can borrow…and new suckers born twice a minute who are willing to lend. But this is exactly where all Ponzi schemes crack up. The fed’s pyramid will fall in the same spot; where it runs out of new money.
Mr. Obama says he plans on cutting the budget deficit in half by the end of his term. Let’s see…that’s four years out. If he’s true to his word, that will mean deficits averaging about $1.5 trillion a year…or about $6 trillion total. Where will that money come from? What sucker has that kind of cash?
America’s savers are putting their backs into it. They’re saving about 4% of GDP currently, which could rise to 5%. They typically only put less than one percent of their wealth into Treasury paper; but let us imagine that they use every penny to buy it. Over Obama’s term that could be as much as $2.4 trillion. The other big buyer is the Chinese. If they were somehow able to continue buying at the same rate that they have for the last 6 months, that would add $2.8 trillion more. So even if both these Hollywood endings should come to pass, the show would still be a horror. There would still be $800 billion worth of Treasuries left unsold.
More likely, Americans might multiply their purchases of Treasuries by 10 times…not 100 times. And more likely, the Chinese might buy another $1 trillion or so. But sooner…not too much later…buyers are going to begin to notice that there aren’t enough of them to keep this Ponzi scheme going. The smart ones will head for the exits early…the slow and the dull will be crushed at the doorways.
for The Daily Reckoning Australia