Monetary Stimulus, Lack of Will Could Doom US Economy

By Peter Prudden  JUL 18, 2011 10:45 AM

At some point you have got to remove the life support and determine if the patient can survive on its own breath.


“The nation was balanced precariously between the darkness of the Great Depression on one side and the storms of war in Europe and the Pacific on the other. It was a critical time in the shaping of this nation and the world, equal to the revolution of 1776 and the perils of the Civil War. Once again the American people understood the magnitude of the challenge, the importance of an unparalleled national commitment, and, most of all, the certainty that only one resolution was acceptable. The nation turned to its young to carry the heaviest burden, to fight in enemy territory and to keep the home front secure and productive. These young men and women were eager for the assignment. They understood what was required of them, and they willingly volunteered for their duty.”
--Tom Brokaw

Warren Buffet said in an interview on September 24, 2008 that we were experiencing an economic Pearl Harbor. He implored Congress to pass the TARP bill. Five days later they vetoed the bill and the Dow Jones declined 780 points or 7.8% that afternoon. The bill was passed shortly thereafter. Our financial markets were invaded and Washington responded by waging a war of rhetoric and reform on Wall Street. The issue I take with this statement is that Washington gave Wall Street the ammunition to wager the war. The stock market also possesses a different mentality from that period in time; it’s not the market it once was. It’s Las Vegas on steroids and the house has the odds in its favor. The Dodd Frank Act has the making of a reform our financial system requires and a resemblance of a new deal.

Ask any physician and they will testify that at some point you have got to remove the life support and determine if the patient can survive on its own breath. America has been on monetary life support since the Fall of 2008; the car wreck was of a severe nature and it required medical attention at the time.

“While hiding behind the beard of hawkish vernacular, the FOMC has printed and pumped massive amounts of money into the financial system. That liquidity, while providing a rising tide for virtually every asset class, came at a cost. The worldwide response, verbally and structurally, was to shock the patient back to life.”
--Todd Harrison

The problem is we have not implemented a cure, and sadly this is seen as austerity. It's of the community’s belief that the government sees the procedure as too painful. Maybe if we hold out for hope we can will our way through the pain and avoid outright sacrifice. That is precisely what the greatest generation did not do. They took the procedure and added personal will to get them through the darkness of debt defeat, but our morale and motivation has lost its momentum.

This month’s widely watched Michigan consumer confidence came in at 63.8, the lowest level since March 2009 on increasing pessimism over falling income, as goes the consumer so goes GDP, and rising unemployment. An April 21, 2011 CBS News/New York Times poll found that 27 percent of Americans support raising the debt limit, while 63 percent oppose. The underlying message tells me they are more fed up with the Fed and our Government leaders. In fact it was also demonstrated in the lack of voter interest in the 2008 Presidential election when only 42% of eligible Americans voted. Not passing this legislation is not an option for the short-term.

Interest rates are at record lows and have been for 32 months. Not since World War II have interest rates been this accommodative for such an extended period. At $14.46 trillion the US debt stands at approximately 100% of the previous 12 month GDP; the US hit 120% of GDP shortly after WW2. The betterment of such accommodation never materialized. Monetary policy procedures (QE1 and QE2) have done little to revive job growth and expand GDP -- currently at 9.2% unemployment and 1.9% GDP growth. The government has thrown trillions of tax payer dollars at the problem and we have little to show for it, meanwhile manipulating equity prices through the issuance of caustic debt. Nobody is bigger than the market and we are marching towards a debt infused date with destiny. The risk to counterparty purchasers of US Treasury debt is a stealth default through devaluation of the US dollar (down 13% since June 2010).

It is my belief that we are in the midst of a stock market rally in the context of a bear market. It is a stock market that is climbing a wall of worry and has higher prices on the horizon. The bullish audience will argue corporate fundamentals are strong, and they are. The S&P is expected to grow its profits by 19% in 2011. My view is a bit conservative and calls for $96 on S&P earnings with a 14.7x multiple -- providing a target of 1411 by year end. But the crowd's risk aversion has left them on the sidelines. The issue I take is that at some point, when the crowd has bought back in, it will mark an end to the market's climb and I expect it to be a vicious fall. We are in the late innings of opportunity to chart a new course and allow the free market to reign.

What are the measures needed to resuscitate our global posture?

The elephant(s) in the room remain Fannie Mae and Freddie Mac. What should the government solution be? Sell treasury debt, raise cash, and take the losses while you and I eat it. That's the end game, no other way around it.

The proposal of a national sales tax -- a concept is to eliminate the financially irresponsible amount of the debt load and it requires that we all participate -- would take shape as a value added consumption tax aimed equally at all and picks up the flow of funds that currently goes untaxed. It is enacted and managed for the specific purpose of reducing excess debt with a “sunset provision” to wind down once the identified debt is exhausted. The qualitative measure and the mechanics of the message will be: what did our politicians do to get us into this mess? We will witness this reality each time we receive our purchase receipt (VAT) and it will serve as a constant reminder for how we arrived here. The legislative leaders running the country are a one-two step removed from the “greatest generation.” These are not the leaders who evolved from a time when America became a global power. It is often communicated to “trade the market you have and not the market you think you should have.” I believe this is prudent with President Obama’s policies. The platform he preached for change in 2008 is not the reality we live in today. Politicians are too consumed with their message and what they accomplish based upon promises given at the pre-election podium. Upon election Obama pronounced, “change has come to America.” I say it has not. The blame does not fully rest on Obama’s shoulders, it's more directed at those on the hill. Washington reform is what's needed.

“Congress has become a structure that accomplishes little of value and impedes progress made by other sectors of society. Term limitation would create a climate in which talented men and women from businesses and professions would want to run for Congress.”
--John H. Fund, editorial writer for the Wall Street Journal

91% of Americans are employed by the private sector. During the generation of greatness, private sector profits traveled to Washington to provide a service to the country. Our current leaders are overly focused on personal agendas. What we have playing out before us is a showdown at East Capitol Street with each constituent having its six shooter drawn. With a reformed term structure, there will come with it a new breed of leaders. What America needs is a Congressional Dream Team. Mine would include Bill Gross, Bill Gates, Warren Buffett, Phillip Falcone, Jamie Dimon, and Steve Jobs.

Falcone, who came from nothing, had the foresight to see America’s housing horror and he capitalized on it. He now is building a 4G wireless network and is again putting his personal money where his mouth is. Gross knows the bond market better than anyone in the Treasury. Buffett built his business with his bare hands. Dimon possess the moxie to move things forward and isn’t the type of individual to back down from a fist fight in a phone booth. Gates and Jobs have the intellectual insight to solve complex ideas. If these men took to the hill, my guess is half of Congress’ current roster would be completely outmatched.

Outside of Washington and Wall Street we have what Thomas Friedman declared:

“...a values breakdown -- a national epidemic of get-rich-quickism and something-for-nothingism. Wall Street may have been dealing the dope, but our lawmakers encouraged it. And far too many of us were happy to buy the dot-com and subprime crack for quick prosperity highs.”

We need more of our youth to look at the lead by example of Pat Tillman; who walked away from millions when the stakes of his own personal accountability were deemed high and gave his life for what he believed in. Mr. Buffett wrote in a New York Times opinion piece, “Buy American. I am.” If I may sir, I am buying because it’s my profession, but that doesn't mean I’m a believer. This too shall pass…

No positions in stocks mentioned.

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