by David Galland Managing Director,
Originally posted April 13, 2010
THIS MORNING, LISTENING TO THE BBC NEWS AS I DROVE home from my Tuesday torture class down at the gym, I was treated to a discussion of the political manifestos published by the ruling Labor party and the opposition Conservatives ahead of the upcoming British elections, to be held in early May. (Remarkably, the entire British election cycle lasts just four weeks – I’ll have to add that to my Christmas wish list.)
According to the BBC analysis, the Labor party of Gordon Brown wants the government to do even more to smooth the daily travails of the citizenry, while the Conservatives under David Cameron want all of the citizenry to “join the government.” Whatever that means. But neither manifesto provides even a scintilla of a plan as to how that country’s future government might wiggle out of its cripplingly expensive social contract, or more specifically, the spending that contract calls for – spending that has left the British in the worst financial shape of any of the G-20 nations.
The lack of detail is not an accident but rather a reflection of reality. The UK is broke and much of the populace hanging on by tender hooks. Should the government cancel the social contract – a contract that calls for the steady provision of free or low-cost council housing, food, education, hard cash and healthcare – the natives will almost certainly grow restless. Of course, the Brits are not the only ones in the soup. Bobbing alongside of them are most of the world’s nations – and I’m not just talking about the second-raters. An article from businessinsider.com yesterday provides a good overview of the hot miso broth that Japan, the world’s second largest economy, now finds itself in.
How long will it be before investors begin demanding higher yields on Japanese debt? And what will higher rates do to their debt problems?
I’ll have just a bit more on Japan in a moment, but the key point that every investor needs to understand at this point is that the problems of excessive sovereign debt will be a driving force – and maybe the driving force – for the global economy for the next decade. And because the global economy has become incredibly politicized, sovereign debt will drive politics as well. On a personal level, the political calculations and machinations that will be undertaken in an attempt to deal with the debt – and to do so without angering a majority of the voting public – means higher taxes for the productive and, through increased business taxes, on the unsuspecting masses as well.
We expect to see a VAT imposed here in the U.S., and we expect to see the imposition of carbon taxes – not because it’s the right thing to do (it’s not), but because it’s anticipated as an important revenue source in the administration’s forward-looking budget. Tax enforcement, which in the U.S. is already the most systematic and stringent in the world, will only get tougher. With a special focus on the wealthy or those who look to move assets overseas– the same people who already pay the vast majority of the nation’s tax revenue. Fair share be damned. From here on out, if you’ve got any fleece left, it’s getting sheared.
My dear partner and friend Doug Casey has warned of a government takeover of retirement accounts (the most likely path being a requirement that some large percentage be invested in government paper, or withdrawn and taxes paid)… of exchange controls and… of course, a serious inflation that will allow the sovereignty to pay off today’s debt with a currency worth considerably less tomorrow. In the new world of sovereign survivalism, those actions – and others as desperate – are a certainty. Is there anything you can do to protect yourself from becoming a victim of the survivalist state?
The answer rests with your individual circumstances. If you have the funds – and it can cost a lot less to live elsewhere – then consider diversifying your life internationally. At the least, keep one foot in your home country while settling the other firmly elsewhere. Then, if things go as now seems inevitable, you’ll be ready to pick the one foot up. As an American, that won’t protect you from the confiscatory taxation – but there’s much to be said about being one step removed from a government that looks upon you as a tax slave. (More on our own version of Galt’s Gulch can be found here.)
If you don’t have the ability to move, then consider working on skills that you can use in barter. And consider not living in a city, if you do. While I don’t think that we’re headed toward a nation of Detroits – which is to say, the world of Mad Max – in hard times, the fewer of your fellow citizens you need to rub up against, the better.
Could the struggling sovereigns decide to follow Roosevelt’s lead and confiscate gold? Of course. But we should see straws in the wind before that happens and so have time to react (a linking of gold with international terrorists would be a big red flag). How we got to this spot between a rock and a hard place is a topic we have covered in great depth over the years, and so I won’t rehash the story in detail here and now.
But I will say, in the simplest of terms, that we are here because of political incrementalism – decades of politically motivated decisions of mostly small and medium impact, but periodically of major consequence (Medicare, Social Security, etc.) – that has drained the public coffers while simultaneously ratcheting up “non-discretionary” spending.
A popular tune by the Rolling Stones includes the memorable line, “You can’t always get what you want. But if you try sometimes, well, you might find you’ll get what you need.” At this point, what the masses want and what they need have become conflated, with the only certainty being that if you as an individual have assets, the politicians want them. So how it is that the stock market, that useful albeit unsteady barometer of economic health, is not viewing the intractable debt problem and running for the exits? To help answer that, I will dip into the archives of The Casey Report…
Does QE Lead to a Dead-Cat Bounce?
While no two economic situations are identical, one likes to think that, all things being somewhat equal, if the monetary authorities do “A,” then “B” should result. For example, if you massively inflate the money supply, then history has shown time and time again that a serious price inflation is almost certain to follow.
Likewise, if the politicians decide to turn on the monetary taps to help soften the blow of a crash, one should not be surprised if the stock market begins to recover. Especially, as has been the case in the current crisis in the U.S., when much of the money has flowed into the financial sector. As discussed yesterday, that sector has shown the biggest bounce in profits. Looking for answers, we might restate the question thus: “Does quantitative easing result in a stock market bounce?”
With that, I would like to enter into evidence the following chart from the January 2009 edition of The Casey Report. As you can see, with their first experiment in quantitative easing, the Japanese were able to buy a bounce that helped the Nikkei crawl about halfway back toward its pre-crash high. But what happens once the monetary props are removed? As you can also see in the chart, when the QE ended – and it ended because, like the America of today, the piling of debt on top of debt was speeding the country toward bankruptcy the stock market ran out of steam and plummeted to its crash lows. So, where do things stand here and now in these United States?
I don’t have the time and the resources – our Mr. Wood is taking a much-needed holiday, and I am running late anyway – to duplicate that chart for the U.S., but a back-of-the-envelope calculation shows that from its 2007 peak, the S&P fell about 875 points, to a low of about 675. If, as was the case in Japan, “B” followed the “A” of QE, then we would expect the U.S. market to rebound by about 437 points, which would take it back up to the area of 1,112 before hitting a plateau. That is the general level of where it is now trading. And once the government pulled the plug on the quantitative easing – which it is making noise about doing – then we would expect the market to retest the low of 675.
Now, as you don’t need me to tell you, there is nothing scientific about that analysis (ergo the “back of the envelope” caveat). And there’s no question the situation in Japan then was different from that in the U.S. today. For one thing, the Japanese have run a trade surplus throughout the period, whereas the U.S. has run year after year of massive trade deficits. Even so, I think a certain amount of logic supports the basic premise.
If the premise is correct, then today’s stock market is running on vapors – the vapors emanating from the government’s burning of stimulus dollars. In time, for political reasons, if no others, the quantitative easing is going to have to moderate – at which point, watch out below. I would like to leave you with a final bit of homework, a press release just out of the International Monetary Fund regarding a ten-fold increase in its lending facilities. Why, if the world economy were on the mend, would the IMF look to increase its lending capabilities ten-fold?
The answer, I strongly suspect, is because they see what we see – and what anyone paying attention is now seeing: that the worst of the sovereign debt problems are still ahead.