Play It Again Uncle Sam?
By Staff News & Analysis - August 28, 2009

Two facts that should give pause for thought. Japanese data released on Thursday showed that exports fell yet again in July. They are down 39.5% to the US, and 26.5% to China. Japan is the world's second biggest economy. It lives on exports. It is also a key part of the supply chain for the Chinese economy. How can this hard data be reconciled with the extreme V-shaped recovery already priced in by the markets? By the way, Toyota is suspending a key production line at its Takaoka plant in central Japan. It is cutting global capacity by 1m vehicles. … The Baltic Dry Index measuring freight rates for bulk goods and commodities has been falling almost continuously for eleven weeks, dropping from 4,290 to 2,778 on Thursday. Is this just a glut of ships or is this telling us what the Shanghai market is also telling us, that credit tightening by the Chinese government is pulling the rug from underneath the latest commodity bubble? – The Telegraph

Dominant Social Theme: Inquiring minds want to know.

Free-Market Analysis: Often we cover mainstream news from the left, debunking the dominant social themes that the media seeks to promote. But with the UK Telegraph, it is sometimes easier to reinforce a well written article. As we've often pointed out, the paper has several journos – mostly financial ones – who have a distinctly non-mainstream and sensible approach. Among them, as we have noted, is Ambrose Evans-Pritchard. While Pritchard cannot be seen as a true free-market thinker, he does have a good deal of skepticism when it comes to the economic regulation and central banking panaceas. He is anti-European Union and hawk when it comes to price inflation.

The article excerpted above asks questions of which we certainly approve. In fact, we have already brought up some of these points on a regular basis. Like Evans-Pritchard, we believe the various stock markets around the world are virtually decoupling from the reality on the ground. This is possible of course because of the vast amount of money that central banks have printed and thrown into the marketplace. Some of it at any rate has found its way into stock and bond markets, swelling them even as the larger economy languishes. Here's some more from Evans-Pritchard:

There is something wrong with the entire recovery tale, which ignores the fact that excess plant is still at the highest level since the Great Depression (capacity use is 70% in Europe, 68% in the US, 65% in Japan, and as low as 50% in some countries, according to the World Bank's Justin Lin). Companies will have to cut jobs and investment.

Soaring "confidence" indicators have decoupled from reality. The world economy is still prostrate. GDP has shrunk 4%, 6%, 8%, even 12% or more in a large group of countries. There it more or less sits, like a deflated soufflé.

An end to technical recession in France, Germany, and Japan because Q2 (and undoubtedly Q3 to come) ekes out a rise from a collapsed base does not mean anything – except that zero interest rates worldwide, and a massive fiscal stimulus that is pushing public debts towards 100% across the OECD states (and cannot easily be repeated once the first sugar rush subsides), has mercifully prevented the Great Contraction from turning into an immediate catastrophe.

As the Bank of England's Governor Mervyn King puts it: "It's the level, stupid". The level of economic activity is years away from full recovery.

We will remind you, dear reader, as we have many times before, that a real recovery from a financial crisis of the sort the West faces involves a thorough realignment of mal-investments. Japan, for instance, refused to allow failing firms to die, especially financial ones, throughout the 1990s, thus stretching out a financial recovery for over a decade. We see nothing that dissuades us from believing the same sort of behavior is now occurring in the West.

This is the reason, obviously, that the real economy of the West and its financial markets are decoupling. If bad investments and failing companies are not purged, then funding sources are dissipated. Good money is thrown after bad and the jobs that would have been created via new enterprises are never formed. Yes, it is possible to create another bubble of sorts to reduce a depression to a recession. But what is needed is a quick, sharp depression. The kind they used to have. It was over in six months to a year and since various economic regimes and countries were not harmonized, these depressions tended to occur regionally.

What we have today is entire hemispheres sinking into financial ruin all at the same time – and then remedies being applied that keep these vast geographical agglomerations in quasi-recovery for years. The agony is prolonged. Vitality is drained. Free markets are blamed. There is nothing complex about what is occurring. A double-dip downturn is likely in the cards. Here's how CNN explains what is going on in American markets:

Stocks are led by four wounded horsemen. Struggling financial firms Citi, BofA, Fannie Mae and Freddie Mac are dominating late summer Wall Street … They say you can't trust the government. Don't tell that to Wall Street traders. A bizarre trend has emerged during these hazy, lazy days of late summer. Overall market volume is unsurprisingly wafer-thin, but a big chunk of trading has been in just four financial companies that have received a healthy dose of support from Washington in order to make it through the credit crisis.

For the past few days, Citigroup (C, Fortune 500) (which taxpayers now own a third of), mortgage giants Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) (which were placed under government conservatorship last September) and Bank of America (BAC, Fortune 500) (which has needed $45 billion in bailout funds) have been far and away the most actively traded stocks on the New York Stock Exchange.

In fact, these four wounded horsemen of the financial sector comprised 40% of the overall trading volume on the NYSE on Tuesday. These stocks haven't just been active, they've been surging. This is kind of scary. It suggests that the late-summer portion of the almost six-month long market rally is being fueled more by speculation and momentum, not real optimism about a potential recovery in the financial sector and the overall economy.

That even CNN cannot pretend the American stock market rally is something other than ginned-up speculation probably tells us as much as we need to know about the divergence between the market and the economy. European bankers and elected officials are sounding off regularly about the next leg of the financial crisis. Even American central bankers are being unusually cautious in their evaluations of where the US economy is headed.

After Thoughts

It is important to internalize what has occurred in the past year. The Western financial system virtually collapsed. We are aware of course that some believe that a certain element took advantage of the system to extort huge sums of money from panicked governments and scared citizens. But just because some took advantage of the situation doesn't mean it didn't occur. Fiat money eventually finds its own value – which is the value basically of an electron. It is not a sustainable system and there are some (we among them, perhaps) who foresee its death rattle in what has recently occurred. That is why we confidently predict the return to some sort of honest money metals standard in time. Perhaps a shorter time than some would believe. And we don't believe in this rally.

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