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What Bothers a Bear



Several Minyans, after reading me for a quite a while now, have asked that I just come out and give them my long term view of the markets. I didn't think I needed to, but here goes-

The short answer is I am bearish on stocks, bonds, and the dollar (some would say that those are not consistent, but I believe they are). But this answer does not describe how I think, which is in probabilities. A more accurate way of describing my view is I think that there is a higher probability (than that which the market is assigning) that things just won't work out. This is important because I do admit that there is a probability that things will.

In light of David's piece "A Distinct Possibility the Sky Won't Fall", I thought this was a good time to articulate my views by talking about what I see out there that bothers me:

Despite record low interest rates, at levels that I consider really negative, economic expansion, while on paper has been strong, has not had the ability to generate real income. Income is the life blood of an economy, and while the excess liquidity generated by the Fed has found its way into financial assets, which has had the affect of bolstering wealth and therefore spending, it has not found its way into productive assets that generate income.

David says that the 'psychology' of jobs is improving. That may be true, but I say it is about time and has come with quite a cost. That cost is more debt (surprise!). Debt is the process by which liquidity enters the system, but just like eating too much, over time it is like getting fat: it slows an economy down at the margin as more resources go to paying down and servicing debt than into productive assets. While debt service is currently not at alarming levels, it could quickly become so if rates rise. To make matters worse, the risk of debt service becoming unmanageable is not controlled by us, but by our friends out East.

And so I worry, unlike Mr. Bernanke, not only about the sustainability of low rates, but about the lack of control that we have over them. If the yen breaks 105 the Japanese become net losers in the extraordinary U.S. bond position that they own (currency losses will overcome interest on the bonds). I worry that the Japanese will behave differently once they are net losers: if their appetite for our bonds wanes, our interest rates will rise.

Make no mistake: the Japanese and Chinese are cooperating with us because they feel it is currently in their best interest to do so. That could change anytime.

Commodity prices continue to rise and are signaling inflation, but we see no signs of inflation in government statistics. An extraordinary worry of mine is that our government is not giving the markets a clear picture of inflation because they know the ramifications. Our economy, as I pointed out, is extremely vulnerable if interest rates were to rise here. I have yet to see a reasonable explanation as to why the Bureau of Labor Statistics has chosen to eliminate commodity indexes from the PPI releases, when and if they come.

Instead of clear government statistics, we are routinely subjected to a chorus from Federal Reserve officials coordinated to assuage the markets.They understand that psychology is very important, at least in the short run.

Those bearish believe that liquidity is like a drug. At first it does the trick, but then you need more and more of it to work, and then it just doesn't anymore. And then we are just left with the problems. The bulls do not believe that: monetists believe that it is just a matter of how much money is in the system and that debt does not come home to roost.

David is certainly right, there is a definite probability that the sky won't fall. The Fed has engineered us out of tight spots before. But it is my contention that this maneuvering is precisely the problem: each maneuver makes it more and more difficult going forward.

The sky may not fall this time, but each day becomes shorter.


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