Shell Game

“Now this is not the end. It is not even the beginning of
the end. But it is, perhaps, the end of the beginning.”

—Winston Churchill

Recovery?

Our regular readers know we’ve been skeptical of the of the so-called “recovery” – and we’ve been warning of a “Double-Dip Trip” as far back as a year ago. Recently unfolding economic news hints $trillions of government stimulus (via money created out of thin air) is not doing the trick. We never thought it would. It’s long been our opinion government spending never causes sustainable economic growth – especially if the consumer is not taking part.

Here are excerpts from an interesting August 14th Bloomberg article:

“Prospects for U.S. economic growth took a hit this week after reports showed the trade deficit swelled and consumers reined in spending… A record jump in the trade gap for June capped figures that indicated the world’s biggest economy grew at least a percentage point less than the 2.4 percent pace the government estimated last month. The Standard & Poor’s 500 Index slumped 3.8 percent in the five days ended yesterday, the biggest one-week loss in a month, and a surge in Treasuries pushed the yield on the benchmark 10-year note to the lowest level in 16 months on concern the economy will relapse into a recession.

Reports this week showing Chinese industrial output cooled and growth in Europe was uneven added to pessimism over the prospects for the global economy, just as the Federal Reserve said the U.S. recovery was weaker than anticipated… Purchases at U.S. retailers in July climbed 0.4 percent… Excluding auto dealers and gasoline stations, sales dropped 0.1 percent, the second decline in three months… Consumer spending, which makes up 70 percent of the economy, is being held back by an unemployment rate close to a 26-year high… more Americans than estimated filed applications for unemployment benefits last week… J.C. Penney Co., the third-biggest U.S. department-store chain, lowered its profit forecast for the year. The guidance reflects “a conservative approach to what continues to be an uncertain consumer climate, particularly for the moderate consumer,” Chief Executive Officer Myron Ullman said yesterday on a conference call…

“The pace of economic recovery is likely to be more modest in the near term than had been anticipated,” the Federal Open Market Committee said… The U.S. trade deficit widened by $7.9 billion in June, the most since record-keeping began in 1992, to $49.9 billion… Exports posted the biggest decline since April 2009… China’s industrial output rose the least in 11 months and retail sales growth eased, government reports showed, adding to signs the world’s No. 3 economy is cooling…”[1]

Not a pretty picture indeed.

Shell Game

What’s next? It’s been our continual belief the Fed would print more money (again, out of thin air) to buy more U.S. Government debt – to fund the overspending of an effectively broke country. And to attempt to stimulate a teetering recovery. Even though the Fed said they wouldn’t continue to do so, we never believed them. That’s because the alternative would be for the Fed to step out-of-the-way and let money, credit, and prices (across the board) contract to (we’re not kidding) possibly early 1980′s levels (not politically popular at all). And a shrinking money supply means a stronger/more valuable Dollar – the same Dollar the U.S. Government would have to pay its $trillions of obligations back with. Remember, debtors don’t like paying their debts back in a more valuable currency. Instead they like to pay them back in one that’s watered down/less valuable.

In what looks like quite a 180 degree policy change by a Fed which recently talked about winding down the massive amounts of stimulus created over the past 2-3 years – the Fed Open Market Committee announced on August 10th it would use principal payments it receives on maturing mortgage bonds it owns to purchase long-term Treasuries.[2] In other words, instead of using the principal payments it receives to reduce its balance sheet – the Fed will use the money to buy more government debt (keeping its balance sheet the same size). To us, doing that vs. printing money to buy Treasuries is 6 of one – half dozen of the other.

We are not surprised at all. It looks to us like nothing more than a “shell game.” And we think it may very well be just the “end of the beginning.”

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD
Vice President
Ernharth Group
www.ernharth.com

Go to www.ernharth.com/economic-commentaries to read past articles from our Economic Commentary series.

1.Bloomberg, “Economic Growth Prospects Dim in U.S. After Retail Sales, Trade Reports”, August 14, 2010
2.CNBC, “Instant view: Fed to buy Treasuries with maturing debt”, August 10, 2010