Today the Dow Jones Industrial Average reached its highest point of the year. It is also at the highest point since its complete collapse in late 2009 when it bottomed near 6600. As I post this the Dow is up to 11,525 and it may very well close higher by the end of the day’s trading.
For the last week the television has been abuzz with “good news” for our economic future.
Some of the reasons given I have heard are…
- The republican gains in the recent election
- The compromise on the “tax cuts”
- Consumer spending is up
- The banks are making deals and opening up capital
- People who didn’t lose jobs are no longer afraid to spend and borrow
The reality is there are tiny flecks of truth in all of this. The big problem with our current recovery is that it is nothing but an illusion driven by a public relations campaign! None of the items above actually can correct the real reasons behind our economic turmoil, some of the major issues are…
- The collapse of the housing market is still in full swing
- High unemployment that isn’t getting better
- The majority of US States are near bankruptcy
- Many cities and municipalities are near bankruptcy
- The US is 13 Trillion dollars in debt and climbing
- The deficit in 2010 was over 1.4 trillion dollars and it will be as bad in 2011
- Many US banks are really bankrupt and only still in business via bookkeeping voodoo based on a rule change to FAS 157
There are more reasons of course but the above 7 are the seven deadly cracks in the current economic outlook. Now despite a massive PR campaign by Washington and Wall Street there has been zero improvement in any of the core issues that created the collapse in the first place. On top of this the Federal Reserve is printing money hand over fist in the form of quantitative easing and doing all it can to attempt to jump start inflation. The reality is inflation is already hitting us on many of our daily needs like gas, food and electricity. Much of which the government is leaving out of the official inflation numbers.
Inflation is coming though and in my view it will make things better. What! Did I just say inflation will make things better, I did, but the next part is critical, it will only get “better” for a time and the result will be a larger deeper collapse.
To understand the pending collapse we must first understand how inflation can create the illusion of recovery. Sine we naturally view inflation negatively this can be difficult for many of us to see but the theory is quite simple. During a down turn companies lay off any non critical employees (dead weight) and stock pile cash. They also rake suppliers to cut their costs on production, importation, outsourcing, etc. Since times are tough the supply chains capitulate feeling fortunate to have any business at all.
Companies that survive the first 1-2 years of a downturn become very strong, weaken competitors and emerge as truly solid companies. This is a great case for true capitalism, unfortunately we don’t have true capitalism so this is only the first part of the equation. While this is all occurring the Fed is continually pumping money into the economy as is the government with “stimulus spending” to try to “jump start things”. This is classic Keynesianism. In the Keynesian system all spending is good and all growth is good and despite many weaknesses on some levels it works. Well it works just like giving a skid row bum a credit card works, a week later he looks great but a year later he is worse off then ever.
This is what is occurring now, the inflation is finally kicking in, prices are really rising and the strong companies have leaned out costs and are now more profitable then ever. The talking heads are also correct in stating that American’s that have not lost jobs are now spending more then anytime since the down turn started, many of them are also flush with cash and low on debt. When the downturn started many people “woke up”, paid debts and cut spending but those who have skated through are now switching over to the “can’t happen to me camp”. This has all happened before in many cycles of boom and bust in our past.
So why is this time different, well, because the seven deadly cracks will not be repaired by any of these things. Unemployment may drop a point or two but the banks can’t fix their true insolvency. There is no way that more than half of our states can avoid what can only be called a bankruptcy, of course it won’t be called that by the press. Over 1.2 million more foreclosures are expected in the next year on top of more than 2 million that have already occurred. That is 3 plus million homes on the market and 3 plus million families that won’t be “qualified” to get a mortgage for a very long time. I don’t think most people get that you really need to double the foreclosure number to understand its real effect. It isn’t just another home on the market, it also another buyer out of the market.
The rest of the deadly cracks are just as real and just as deadly. So what this means is government spending and the Fed’s policy of inflation at all costs will work for a time, it also means the better they work, the worse the eventual crash. It will go something like this, the Dow will in early 2011 cross the 12,000 threshold a meaningless but very psychological number. Boosted by growth in revenue and unwillingness to pay excessive taxes on it many of the surviving companies will look to expand and begin hiring, not a ton but some. This will drop the unemployment number by say a point perhaps at best two points. People will become abuzz with confidence even more than right now and spending will get stupid again.
All of this will create true inflation and the Fed won’t be able to contract things as fast as it expanded them, we will see published inflation in the neighborhood of 2-3% with actual inflation near or over double digits. No one except the poor and retired (fixed income) will care. Most of the general population (sheep) will think good times are on the way back and begin to spend and borrow even more. Again this cycle has created boom in bust ever since the days of the first U.S. Central Bank. Only this time the nation, its people, its states and its banks are all essentially bankrupt.
Don’t ask me to put a date on this but somewhere in the utopia of a recovery one of the seven cracks will begin to fully crumble. My guess is it will be a state or two at first that cuts retirement for state workers and ushers in a form of austerity. If you think Ireland having issues drops our stock market wait until it is California and New York. Once the damn springs a few leaks momentum builds. Our creditors (The U.K., Japan, China, etc.) will slow down buying our bonds and require higher interest to buy any at all, a few banks will begin to fail and in the end the crash of 2008-2009 will look like the “good old days”.
Unlike many people I won’t sit here and tell you it will happen by x month of x year, the truth is I don’t know how long this illusion and PR campaign can be maintained. I am not sure how dim the American people have become and how long they will let their bets ride the second time around. What I will tell you is this, when everyone says the recession is over, protect everything you have for at that point the beginning of the spiral will have just begun.
So why should you trust my analysis on this? Well because I was stating that this would be exactly what would occur in July and August of 2008 before the initial downturn even occurred. This is one of those things I certainly do not want to be right about, unfortunately I believe that my analysis is absolutely correct. It has flown in the face of every professional on both sides of the issue. The conventional wisdom was that no crash was coming and when it did come that there was nothing to really worry about, it would all get better and life would go on as normal. On the other side the likes of Schiff and Celente (both of whom I highly respect by the way) were sure this was the big one, an abyss from which would could not ever hope to recover.
We are now entering one of the most dangerous times in our history in my view. My suggestion is to cautiously use the false recovery we are entering to prepare for the day of reckoning that surely is coming. Just remember when that guy on T.V. says we are out of the woods, he was probably the same idiot that told you there was nothing to worry about right before the first collapse.