Will the Fed's folly will come due in 2004? Bad news for us, and possible ammo for the Democrats

glenn1

Lifer
Sep 6, 2000
25,383
1,013
126
Article link

Led by the Federal Reserve, the world's central banks have spent five years pursuing some of the most reckless monetary policies ever seen in the developed world. Next year, though, their barmy bets will finally start to come undone.

The crackup won't start happening until the end of 2004 -- after George Bush, the market's favorite for president, has been safely re-elected -- but the coming deluge will usher in a period of global economic malaise and dire losses in financial markets. The fast-declining dollar we see today is an early indicator of the reckoning that Fed Chairman Greenspan has long tried to forestall, using unsustainable measures. America will be the epicenter of the bust, because it is here that debt totals, as well as trade and fiscal deficits, have risen to historically delinquent levels.

Granted, it almost always pays to ignore most apocalyptic-sounding warnings -- and much money has been made over the years betting against the end of the world. Moreover, shrugging off such a dark-sounding forecast would seem to make a lot of sense after most of this column's predictions for 2003 failed to materialize. For example, Detox confidently expected equity markets would end 2003 lower than they started. But they have of course risen sharply, showing a 22% gain on the S&P 500 index. Detox also said that stocks like General Electric (GE:NYSE - commentary - research) and Capital One (COF:NYSE - commentary - research) would crater, while Tyco (TYC:NYSE - commentary - research) would likely file for bankruptcy protection. None of those calls hit the mark, it is painful to report.

As foul as the freshly baked crow tastes right now, and as much damage as those predictions have done to this column's credibility, Detox is doubling up its bearish bet with its prediction of an economic and financial crunch starting toward the end of 2004. Why? Quite simple: America has no easy way out of the trap that the Fed has built for the country. No nation has splurged quite like this one without ultimately having to pay the piper. As exceptional as America is in so many ways, not even it can exempt itself from the laws of economics. And what's really scary for investors is that there is nowhere else in the developed world to flee.

Morgan Stanley's chief economist Stephen Roach sums up this dilemma. "Central banks have made the riskiest bets in modern history -- policy rates of 'zero' in Japan, 1% in America and 2% in Europe. At the same time, fiscal authorities have upped the ante as never before, with government budget deficits of 7% in Japan, 4% in America and 3% in Europe. And the authorities have colluded in currency management in a period of unprecedented external imbalances."

But America is where things are at their worst. Resurgent equity markets in the U.S. say otherwise. But when governments are printing money like never before, a rise in stocks does not mean that a healthy economic recovery is under way. It just means that people, and their government, have more money to spend -- which is a very different thing.

Higher government and personal spending is what has kept the economy afloat over the past three years. But the logical question to ask is: How did these spenders get the extra dollars to blow? Well, they borrowed them, something that would've been impossible without the low interest rates engineered by the Fed. Debt may feel like wealth when it is being spent. And through the gunning of bank reserves, the Fed can inflate an economy by underwriting higher levels of debt.

But at some point the explosion in credit has to be paid back. The Fed's crazy bet is that the spending will lead to a recovery that will in turn increase personal incomes and taxes to the point where the extra debt taken on over the past five years becomes manageable. But the debt is too high to make this work. In the second quarter, nonfinancial domestic debt was $21.6 trillion, or 199% of GDP. That's up $3.1 trillion from three years earlier, when the ratio was 181%. There has never been such a rapid rise in that ratio since the mid-80s, and we know what happened at the end of that decade. Some two-thirds of that increase -- over $2 trillion -- occurred among households or individuals. As a result, debt service ratios have climbed to historic highs for individuals, even with extremely low interest rates. It would take only small increases in rates to tip many people into real hardship or default.

The Fed believes it can win this gamble because it thinks it doesn't have to raise interest rates because inflation seems muted. There are two problems with that tack. First off, "real world" inflation does not show up in government statistics followed by the Fed and the markets. For example, the Bureau of Labor Statistics' most recent consumer price index data showed that growth in medical costs was slowing. There is absolutely no indication of that outside of the government numbers. "There is something very wrong with these inflation numbers," says John Vail, a strategist for Mizuho Securities in New York.

Second, and much more important, anyone who thinks a central bank can splurge and underwrite towering levels of debt just because inflation is low has no understanding of how economies work over time. Excessive borrowing leads to the extensive distortion of prices and productive capacity.

Without the growth in debt and consumption fueled by Greenspan over the past three years, we would have had deflation. Why? The monetary excesses of the '90s had pushed up prices to excessive levels and the economy tried to adjust to bring prices down to affordable levels. The Fed did everything to prevent that, because deflation would've caused debt totals to grow in inflation-adjusted terms, creating a big credit crunch. Greenspan's solution? Create more debt in the hope it will cause another boom that will bail us all out. "The Fed has tried to paper over the imbalances in the economy," says Paul Kasriel, economist at Northern Trust. "It has encouraged households to go deeper into debt."

Notably, central banks sitting outside of the Bank of Japan/European Central Bank/Fed axis have seen the danger of this approach. In press releases explaining why they have recently hiked rates, the Bank of England and the Reserve Bank of Australia both have alluded to credit growth. Because of America's higher debt levels, the Fed doesn't have the luxury of practicing orthodox, sound central banking, and that is why Greenspan can say in the Fed's most recent communication on interest rates that "policy accommodation can be maintained for a considerable period."

So how does the unraveling actually happen in 2004? The illusion of health will continue through most of the year. Bush will get his second term, elating markets for a short spell. Then the full size of the bills that must be paid will begin to really scare people.

But it's a job to know what will go wrong first when a patient is unhealthy in so many ways. It's clear that the breakdown will happen when interest rates go up. That will worsen debt burdens, causing forced sales in the housing market and a crash in that sector. Consumer spending will also get hit. Companies will not pick up the slack.

So what could cause a rise in rates? Perhaps a plunging dollar -- Detox expects $1.45 to the euro by year-end 2004 -- could force interest rates up. The government budget deficit could come in way worse than expected, and the bond market could play a big role in pushing up market rates with such force that the Fed has to follow. There could be an unexpected rise in inflation, due to the amount of money pumped into the economy. It may even be a corporate scandal.

In 2004, the problems at Fannie Mae (FNM:NYSE - commentary - research), the government-sponsored company that is the backbone of the U.S. housing sector, finally could come to the fore.

It may be another terrorist strike within American borders. Indeed, through its monetary madness, the Fed has made the American economy all the more vulnerable, in the event of an attack.

So where will the indexes end up at the end of 2004? Well, equity markets will be very buoyant for most the year, and then dip only slightly. The S&P 500 will end the year up 15%, around 1,250. The Nasdaq will jump over 20% to around 2350. But enjoy the increases while you can, because those levels won't be seen again for several years.

And the probability that Greenspan gets us out of this mess unscathed? About 5%. The argument from the bulls is that America had similar economic imbalances in the 1980s and emerged healthier. Sorry, bad history. First, Bush isn't cutting taxes to the degree that Reagan did, nor is he pruning back nondefense public spending, as Reagan did.

The Cato Institute recently pointed out that discretionary nondefense spending slumped 13.5% in Reagan's first three years vs. a stunning 20.8% increase under the current president. The current account deficit was never this large in the '80s, so there could be a steeper decline in the dollar.

Detox, gloomy from the start, has never been gloomier.




 

zephyrprime

Diamond Member
Feb 18, 2001
7,510
2
81
This guy says the economy will crater *after* Bush gets re-elected so I don't see how you could say it would be trouble for Bush.
 

SuperTool

Lifer
Jan 25, 2000
14,000
2
0
Did anyone believe that these borrow and spend economics coming both from the consumers and GOP government are sustainable long term?
 

CADsortaGUY

Lifer
Oct 19, 2001
25,162
1
76
www.ShawCAD.com
Originally posted by: dmcowen674
Originally posted by: SuperTool
Did anyone believe that these borrow and spend economics coming both from the consumers and GOP government are sustainable long term?
CAD, Charrison, Miquel, Rush & Hannity for starters.
Nope. Thanks for playing though.

If you would ever pay attention to my posts you'd know that I am for CUTTING gov't spending....but whatever dave - you are batting close to .000 today:)

CkG
 

dmcowen674

No Lifer
Oct 13, 1999
54,894
46
91
www.alienbabeltech.com
Originally posted by: CADkindaGUY
Originally posted by: dmcowen674
Originally posted by: SuperTool
Did anyone believe that these borrow and spend economics coming both from the consumers and GOP government are sustainable long term?
CAD, Charrison, Miquel, Rush & Hannity for starters.
Nope. Thanks for playing though.

If you would ever pay attention to my posts you'd know that I am for CUTTING gov't spending....but whatever dave - you are batting close to .000 today:)

CkG
But but but you would have to be against Bush then since he is spending like mad and you are certainly not against Bush so it looks like I've hit a Grand Slam as far as your concerned.


 

CADsortaGUY

Lifer
Oct 19, 2001
25,162
1
76
www.ShawCAD.com
Originally posted by: dmcowen674
Originally posted by: CADkindaGUY
Originally posted by: dmcowen674
Originally posted by: SuperTool
Did anyone believe that these borrow and spend economics coming both from the consumers and GOP government are sustainable long term?
CAD, Charrison, Miquel, Rush & Hannity for starters.
Nope. Thanks for playing though.

If you would ever pay attention to my posts you'd know that I am for CUTTING gov't spending....but whatever dave - you are batting close to .000 today:)

CkG
But but but you would have to be against Bush then since he is spending like mad and you are certainly not against Bush so it looks like I've hit a Grand Slam as far as your concerned.
Nope - not really. You seem to have fouled that one off.:D Seems as though NONE of the candidates are for less government spending. Care to take another swing?

CkG
 

alchemize

Lifer
Mar 24, 2000
11,489
0
0
CAD: Well Dean claims to be fiscally conservative, will have a balanced budget, etc.

Yet he also says he won't reduce the Defense Budget.

He also has a litany of programs he is proposing. That would far exceed

So either he is lying, or not only is he going to repeal the tax cut, but he'll raise taxes. Not my idea of fiscally conservative. That's good old fashioned "tax and spend", with a twist. "We'll only spend what we tax. Not enough money? More taxes! We don't need this new fangled federal debt thingy!"
 

glenn1

Lifer
Sep 6, 2000
25,383
1,013
126
So either he is lying, or not only is he going to repeal the tax cut, but he'll raise taxes.
Repealing tax cuts equals raising taxes by definition, but I think we get the point you're tying to get across :)
 

reitz

Elite Member
Oct 11, 1999
3,878
2
76
alchemize,
My thinking is that he's going to repeal the tax cuts, seek to eliminate waste and streamline things a bit, and then use the extra money to increase spending. I also don't exactly believe him when he says he won't cut the Defense budget (not that I think that's a bad thing).

I'm with CAD here re: cutting spending. My ideal candidate would scrap all federal subsidies and entitlement programs and cut taxes to fund the bare minimum: defense, emergency response, construction/maintenance of interstate infrastructure, government operations, and foreign aid. The money all of us taxpayers save would then be available for the states to tax at their leisure, funding whatever programs and institutions the individual states deem worthwhile.

It's a pipe dream, though, with the Democrats and Republikans in power.



zephyrprime,
See Hoover, Herbert; 1932.



Super Tool,
You're being a bit disingenuous here, don't you think? While the Bush admin often reminds me of a teenage girl with daddy's visa platinum, the fiscal problems this country is facing did not materialize on January 20, 2001. Criticize Bush where criticism is due ($1.7 trillion in tax cuts while running the largest deficit in two decades; 20+% increase in discretionary spending; a shameless new federal entitlement program), but don't forget how long these problems have been brewing.

When was the last time the United States had a trade surplus?



dmcowen674,
<<But but but you would have to be against Bush then since he is spending like mad and you are certainly not against Bush so it looks like I've hit a Grand Slam as far as your concerned.>>

If they taught classes in common sense, I'd pay your registration fee. I'll probably vote for Dean in 2004, even though I strongly disagree with his stances on labor and health care, and I despise that he's now going to be bringing "faith" into his campaign. Should I be "against" Dean because of those disagreements, just like CAD should be "against" Bush over fiscal policy?

PS: It's you're. Your is possessive; it expresses ownership, origin, or some possessive relation of one thing to another; as, your boat. You're is a contraction of you are.
 

ASK THE COMMUNITY