W = Watchful and Wary Waiting

January 23, 2010 by barbara

barbara writes

leftymn and I were jawing as we sometimes do about the political landscape and the economic terrain. He said he wouldn’t burden me with his economic analysis. But you know what? He’s a whole lot savvier about that than I am, so I asked him to lay it out for me. Now I’m laying it out for you.

leftymn writes:

The TARP and the stimulus salvaged the base of our freely operating credit economy. Things could be much worse. In something of a rarity, world leaders actually worked together to effect stimulus in Europe, Asia and Latin America. Also Central bankers in most countries that matter most economically slashed rates to zero, basically to keep liquidity alive. This essentially restored us to status quo.

Most importantly, in 2008 after the crisis stopped its gradual exchange rate tightening, China simultaneously loosened bank lending and eased its interest rates. And they went on a public infrastructure spending program, with money flowing and public jobs still sanctified (although hundreds of thousands did lose jobs in some export industrial works). Within about six months, the Chinese were up and running and ginning their domestic economy.

As usually happens in China, speculative investment in real estate and hard assets began. Copper has escalated in world markets strictly as a result of Chinese buying. Commodities stabilized and turned around. The Chinese bought soybeans as though there were no tomorrow, soybean-wise. This in spite of the fact that they could not sell their own surplus soybeans in their domestic markets since the domestic prices were higher than imported soybeans. This all resulted in stimulating both the Chinese and the world economy. Read on.

Once the USA and other markets had somewhat stabilized and businesses that had cut inventories began to do some replacement, this also contributed to Chinese prosperity.

However, banks and large investment companies (once again with a low return on money) began to look at riskier investments in high-yielding bonds and emerging market debt, and in Chinese stocks. Chinese investors and middle and upper class people started buying real estate, on leverage.

Buildings in Shanghai and Beijing and other coastal cities started going up. Today many of them are only 20 to 40% full, but the condos are owned by outside investors....on leverage.

About three weeks ago, after many economists and journalists had been saying that a bubble is forming in China, they were trying to figure out why crude oil is at $80 per barrel when both industrial and consumer usage in most countries is down. And while the surplus amount of crude oil in rented empty tankers is at world time high, China announced a slight increase in its interest rates. It also announced a beginning crackdown on lax lending practices at banks. Now, real estate investors, except for first-time home buyers, must put up a 40% down-payment to buy real estate!

China is beginning the process of increasing the value of their currency, and recently announced that they passed Germany as the world’s largest exporter. Their foreign reserves of currencies hit new increased highs. Other Asian countries and the EU and USA and the rest of the developed world is criticizing China and asking them to tighten up, and now they are doing so.

At the same time, the UK, EU and USA are looking at either expanding deficits or starting the process of cutting stimulus and cutting spending. (Expect to hear about this in the SOTU speech next week). At the end of March, the Treasury is supposed (I say supposed for obvious reasons) to stop buying mortgage-backed securities issued by Fannie Mae and associated concerns. This is keeping the lid on mortgage rates from going up. And as we just learned, another stimulus and more spending in the light of 10%+ unemployment is unlikely. Forty-six (46) USA state governments are in deficit, and in order to balance, they will cut spending and jobs, and also cut aid to counties and cities, which will also have to cut jobs.

In financial markets, the Fibonacci analysis says that markets correct at 50 to 66% retracement from lows. Last week these retracements happened in the S+P. Commodities have fallen in the past week significantly, the US dollar is up, and crude oil is down.

Chinese New Year is in mid-February, so nothing will happen there for two weeks – right at a crucial time when markets need gas. So markets will lag. Companies that have kept profitable by cutting employees really have to start making profits other ways as they can hardly cut more.

The upshot is that we should see another downturn in financial markets. And if stimulus values in China and EU and USA start running colder – which they realistically have to – then the economy will sputter and in the USA unemployment will go up. Stock markets will adjust to levels commensurate with earnings ratios and now with the perception of growth ginned up by Chinese and USA stimulus, that is fading.

Nothing I see politically will accomplish anything positive. As you may recall, the Bush tax cuts expire in December 2010. But, lo and behold, it is an election year. And do you think that this is going to be an issue? Well, of course!

No one running for election in a recession will be in favor of raising taxes. But at the same time, not raising taxes with a situation of declining revenues due to recession means higher deficits. Higher deficits will lead to calls for cutting spending. Cutting spending (should this occur in earnest) will lead to job cuts in public and private areas. Not cutting spending will add to the deficit, place pressure on the Fed to raise interest rates and scuttle the bond market. None of these things is good for jobs or the economy.

So what I am seeing is a W-shaped recession. We are already at the mid-top, to be followed by a down leg from February to October at the very least. Unemployment probably going will rise to 11% or higher.

It’s important to note that I am a relentless pessimist. Ergo, I hope I am wrong. But I think all this is locked in motion and cannot be stopped.

W is also for "Wow." I hope you’re wrong, lefty. But you have a good track record re being right, darn it.

Posted in