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Monetary Stimulus, Lack of Will Could Doom US Economy


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?

  • A simplified tax code, closing loopholes, and reigning in spending.
  • Move towards a balanced budget while lowering tax rates across the board to a top rate of 23 percent.
  • Next begin to gradually increase short-term interest rates and slowly unwind the Fed's balance sheet, not re-invest maturing securities.

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.

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No positions in stocks mentioned.

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