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The Big Picture


The American people must wake up and realize that they cannot afford to continue to live beyond their means.

A few weeks ago I posted a diagram depicting what is really going on with global capital flows. I drew a picture that debunks the "the U.S. is efficiently using the excess savings of the world" kind of statements we are hearing from our politicians (yes, the Fed Reservists are politicians too).

In Ojai I was on the bear side of the discussion, not because I thought the stock market was going immediately down (I stated then and I repeatedly do so now that the biggest driver of stock prices is sentiment, or the risk premium investors attach to various assets, and that can lead to long periods of overvaluation or undervaluation), although I did warn it is extremely overvalued and dependent on zero real interest rates. I was and am on the bear side of the discussion because I am warning as loud and as often as possible about untenable imbalances, debt, and the structure of the economy in general. The long term repercussions are scary.

Bulls can laugh as stocks go up, but I want to tell them one thing: I am really on their side more than they know. I want this country to grow and be great just like them. I want my children to go to good schools and lead happy and productive lives just like them. That is why I am warning them not to look at stock prices going up (maybe they should view it merely as all currencies going down for no one is wealthier, they just have more currency) as a signal that all is well. All is not and it is getting worse for the reasons stocks are going up.

World central banks have bought into the idea (actually they were created for the idea) that printing currency cures all ills. But all it has done is exacerbate the imbalances between the great economic powers of the world. It is rooted in the requirement that we must depend and trust in each other: the Chinese have our best interests at heart and they will never let us down. This will be true only when they have ownership in large amounts of U.S. assets and thus their economic interests fully align with ours. Until then they could easily change course to our utter detriment. The point is that we have put ourselves in the position of exposure, one reason being that we are politically incapable of doing the tough thing and have been for years.

Globalization is a process of sharing resources. The problem is that the U.S. is not contributing any, we are just borrowing everyone else's. We have shifted our economic production from exporting activities where we have to compete with other nations to activities insulated from competition, like housing. We have been able to do this because our competition has been willing to lend us capital at zero real rates. Our economy is based now heavily on internal speculation. Income is being replaced by capital gains; production and growth are merely a function of higher stock and housing prices.

This is untenable. If we question why Asia is and has been willing to lend us money at zero real rates we see that for now that it helps them build infrastructure, but leaves them with the problem of owning huge amounts of our debt and currency. Bulls argue that any deviation or cutting back in this lending would hurt them as much as us so they would never do it. I agree that has been the case and may be so for a while (or not), but there is a point where the benefit of such will be outweighed by cutting back (I think this is why our short term rates have been rising). At some point interest rates will rise and the U.S. will once again have to produce things the rest of the world needs. As Asia grows and begins to trade more among themselves they may no longer need the U.S. consumer to sell to. All those consumers in China are waiting for goods. What will the U.S. sell them?

I have heard the U.S. ingenuity argument and we have always overcome adversity. But that is in the past and I want to know about the future. People may think P&G soap is something that the Chinese just have to have because of the brand, but I doubt it. Software? Microsoft is already sending that overseas too.

We are selling ourselves down the river. U.S. companies are having a hard time competing because of health care costs; that is true and we need to do something about it. But we also need to do something about education; we need to produce more engineers and fewer marketers.

But first we must get our fiscal and monetary act together. The American people must wake up and realize that we cannot afford to continue to live beyond our means and that every policy coming out of Congress (spending) and the Fed (printing) is encouraging us to do so.
No positions in stocks mentioned.

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