Scorched Earth Economy
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Here at Casey Research we have been on the record as bearish on the outlook for the economy for some years now. Lest you think that is loose boasting, I can offer proof in Doug Casey’s August 2005 article, the dramatically titled “Profiting from the End of Western Civilization”.
In that article, he looked ahead and saw the inflation that the government’s loose money policies made inevitable. A quote…
“Of particular importance is that the U.S. dollar has been used as a gold substitute for decades by other countries. This has been very convenient for the U.S.-we can create almost infinite numbers of greenbacks and give them to people in other countries in exchange for real wealth. Idiotically, central banks abroad have been holding those dollars as backing for their own currencies.
The amounts involved have grown so immense, and the eventual grim fate of the dollar has grown so obvious, that foreign central bankers are now looking at each other, trying to figure out who will head for the exits first. Many are “diversifying” from dollars into other currencies-which are themselves backed mainly by other paper money, mostly dollars. At some point there’s going to be a panic out of U.S. dollars that’s going to dwarf any financial event in history.”
And in that same article he also predicted the current collapse in the housing bubble that the loose money had made possible. Another quote…
“What’s going on now in the residential real estate market is much like the tech bubble, but potentially much, much more serious than what went on in stocks a few years ago.”
Jumping ahead 3 years, to today, the unhappy scenario Doug then foresaw is now unfolding. Right on schedule the economy and markets are heading inexorably toward what might be termed the Scorched Earth Phase.
Even a casual glance at devastation now being wrought on the very building blocks of the economy confirms he appropriateness of that term.
For instance, consider the U.S. financial firms, the single largest component sector of the S&P 500. So far, the losses to those firms are approaching half a trillion dollars. And the odds are high that there’s much more to come. With the exception of Bear Sterns, the big name financials have been able to cobble together the billions of dollars in additional capital needed to shore up their balance sheets… but they are quickly running out of rope.
That becomes apparent when you consider that many of their major revenue centers are now either severely wounded or in the morgue. Last quarter alone Morgan Stanley saw its investment banking fees fall by half and toxic paper sales (ah err, I mean “fixed income”) sales and trading revenue collapse by over 85%. And this at a time when these same firms are being forced by regulators to repatriate their off-balance sheet assets… to wit, the aforementioned toxic paper.
Sovereign Wealth Funds (SWF) to the rescue? Not anymore. Those that initially rushed in were seriously burned and many are now on record as staying on the sidelines. But any that might wish to take a second roll of the dice, will only do so if they get much better terms, which is dilutive to existing shareholders.
Meanwhile, the housing meltdown persists and will continue for at least another year or two. Unless, if course, the government gets serious about “doing something”… in which case the downturn could last 5 or 10 years.
Why do I say that? What the market needs most of all right now is for house prices to fall, as quickly as possible, to a market clearing price. The problem, of course, is that thanks to the self-serving exuberance shown by many appraisers during the real estate bubble-mania, at this point nobody actually knows where the bottom is. Another 10%? 20%? 30%?
There really is only one way to find out… let the brush fire burn, as painful as that will be. But as I don’t need to tell you, “doing nothing” is not a concept that politicians in an election year are very comfortable with. And so, like trained seals leaping after vote-fish, the politicians will jump though any number of hoops to keep people in their homes even though many can’t afford the carrying costs, let alone the mortgages. That only prolongs the pain and increases the government deficits that are at the core of the current crisis.
So, we have a tumbling collapse in the largest component of the stock market, coinciding with a tumbling collapse in the largest component of people’s net worth, their homes.
And we aren’t even warming up yet.
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