Best of the Week
Most Popular
1.SNP Offers Labour Deadly Death Embrace Alliance, Holding England to Ransom, Destroy UK From Within - Nadeem_Walayat
2.Gold And Silver – Most Widely Used Currency In Western World? Stupidity - Michael_Noonan
3.Election Forecast 2015 - Coalition Economic Recovery vs Labour Collapse - Nadeem_Walayat
4.Election Forecast 2015 - Debates Boost Labour Into Opinion Polls Seats Lead - Nadeem_Walayat
5.Why are Interest Rates So Low? Ben Bernanke, Confused as Ever, Starts His Own Blog to Prove It - Mike_Shedlock
6.Leaders Debate Election 2015 - Natalie Bennett Green Party Convincing Anti-Austerity More Debt Argument - Nadeem_Walayat
7.Labour Economic Collapse vs Coalition Recovery - UK Election Forecast 2015 - Video - Nadeem_Walayat
8.China’s Stock Market Mania; How High can Red-chips Fly? - Gary_Dorsch
9.Gold and Misery, Strange Bedfellows - 31st Mar 15 - Dan_Norcini
10.Ed Miliband Debate Election 2015 Analysis - Labour Spending, Debt and Economic Collapse - Nadeem_Walayat
Last 5 days
Greece: Down and Probably Out - 27th Apr 15
Biotech Stocks and the Power of Context - 27th Apr 15
Strawberry Picking Undervalued Gold Stocks - 27th Apr 15
Rock-Paper-Silver - 27th Apr 15
Gold Flows East - China, India Import Massive Quantities of Gold from Switzerland - 27th Apr 15
Conservatives Start to Pull Away from Labour in Opinion Polls, But is it too Late? Election Forecast 2015 - 27th Apr 15
Gold and Silver - It's ALL about The Big Picture After All - 27th Apr 15
Sheffield School Places Election Crisis - Affluent Schools Demand Increase in Funding - 27th Apr 15
Labour Bribes Voters With Housing Market Stamp Duty Cut and Rent Controls - 27th Apr 15
Stock Market SPX Index at Resistance - 27th Apr 15
Society's Leaders Have Been Digging a Bottomless Economic Pit - 27th Apr 15
Impending Stock Market Top - Trend Forecast Summer 2015 - 26th Apr 15
Desperate Stock Market Bubble Thinking Takes Hold on Wall Street - 26th Apr 15
Stock Market Back into The Bear Suits - 26th Apr 15
One Stock Market Where You Haven't Missed the Bull Market Boom Yet - 26th Apr 15
Migrant Crisis - Europe Has Completely Lost It - 26th Apr 15
What Obama's First-Ever Energy Review Missed - 26th Apr 15
Sheffield Hallam Election Battle 2015, School Places Crisis, Can Nick Clegg Win? - 26th Apr 15
Stocks Bull Market Looks to Resume - 25th Apr 15
Gold And Silver - The U.S. Is A Corporation. Precious Metals Stand In The Way - 25th Apr 15
When the Nuclear Money Option Fails - 25th Apr 15
The War on Cash Special Report - 25th Apr 15
China Economic Slowdown Story - Why “Didi Dache” Is a Phrase You Need to Know - 25th Apr 15
The Trans-Pacific Partnership and the Death of the Republic - 25th Apr 15
Stock Splitting Caused the Stock Market Crash - 25th Apr 15
China Stock Market Parabolic Mania’s Global Risk - 24th Apr 15
What Will Happen to You When the U.S. Dollar Collapses? - 24th Apr 15
Why 2 of U.S. Dollar's Recent Bottoms Have 1 Thing In Common - 24th Apr 15
UK Economy Debt Timebomb Will Explode After Election - 24th Apr 15
Are Gold Stocks the Cheapest Ever? - 24th Apr 15
God, the Stock Market and Pascal's Wager - 24th Apr 15
Greedy Insurers Are in for a Nasty Surprise – Positioning You for Big Profits - 24th Apr 15
Four Things Missing From Obama’s First-Ever Energy Review - 24th Apr 15
How to Grow a Regenerative Medicine Industry - 23rd Apr 15
Stocks and Bonds Seven Year of Negative Returns; Fraudulent Promises - 23rd Apr 15
The Existential Danger To The Euro Is Elections - 23rd Apr 15
Stock Market No Clear Direction As Investors React To Quarterly Earnings Releases - 23rd Apr 15
Is China The Next United States? - 23rd Apr 15
U.S. Oil Glut: How High Can It Go? - 23rd Apr 15
Distorted Financial System Expect Deflation, Inflation And Hyperinflation - 23rd Apr 15
What McDonald’s Corporate Earnings Report Is Really Telling You - 23rd Apr 15
Gold Price Forecast to Become Priceless - 23rd Apr 15
FDIC Plots a Bank Heist Involving YOUR Accounts - 23rd Apr 15
$GOLD Price Year 2007 Again - 23rd Apr 15
Stocks Bubble - The Spread between Stock Prices and GDP is Blowing Out - 23rd Apr 15
Ukraine War - When Did We All Become Murderers? - 23rd Apr 15
Libya Crisis - EU Leaders Are Indicted for Nazi-Style Crimes against Humanity - 22nd Apr 15
Why Alternative Energy Isn’t Taking It on the Chin Despite Low Oil Prices - 22nd Apr 15
Bill Gross - German 10-Year Bunds Short of a Life Time - 22nd Apr 15
How to Profit from the Drop in the Oil Price - 22nd Apr 15
The U.S. Dollar's Move Is More Dangerous than You Think - 22nd Apr 15
Apple Watch Means Apple Will Become Worlds First $1 Trillion Stock - 22nd Apr 15
Half a Stocks Bubble Off Dead Center - 22nd Apr 15
They Said Go to College - Learning to become Debt Slaves - 22nd Apr 15
Best Cash ISA 2015/16, Instant and Fixed Savings Interest Rates, New Flexible Withdrawal / Deposit Rule - 22nd Apr 15
Unsound Banking: Why Most of the World's Banks Are Headed for Collapse - 21st Apr 15
Bitcoin Recent Low Price Volatility Might Be Deceptive - 21st Apr 15
Currency Wars Back As Russia Buys Gold - One Million Ounces in March Alone - 21st Apr 15
The Greece 'Grexit' Issue and the Problem of Free Trade - 21st Apr 15
Why Europe Lets People Drown - 21st Apr 15
Wealth Destruction for the 99.9 Percent - 21st Apr 15
SNP Publish England's Suicide Note as Pollsters Still Forecast Labour-SNP Election Disaster - 21st Apr 15
Characteristics of Extremely Over-Indebted Economies - 21st Apr 15
Trader Education Week -- a Free Event to Help You Learn to Spot Trading Opportunities - 21st Apr 15

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

The War on Cash!

Economic Steroids Are Toxic Too

Economics / Economic Stimulus Jan 11, 2010 - 11:40 AM GMT

By: Vitaliy_Katsenelson

Economics

Best Financial Markets Analysis ArticleAS THE NEW YEAR OPENS, THE stock market is behaving as if the past 20 years were about to repeat themselves: Another recession will turn into a robust expansion. Stock prices already are discounting an earnings recovery to something only slightly below the level before the financial crisis. Risk-taking is in vogue again.


The global economy, however, is like a marathon runner who ran too hard and hurt himself. This runner has been injected with some industrial-quality steroids, and away he goes. As the steroids kick in, his pace accelerates, as if the injury never happened. He's up and running, so he must be OK, judging from his speed and his progress.

We may think the runner has recovered from his injury, but steroids have their costs. They exaggerate true performance and mask pain, and the longer an athlete takes them, the less effective they are. Addiction is likely.

The world's economy suffered severe injuries last year, and to keep it going governments have injected massive doses of economic steroids called stimulus. It's everywhere, but the U.S. is one of the biggest users.

To help the auto industry, government -- more specifically taxpayers -- subsidized the purchase of cars through the cash-for clunkers program, creating artificial demand. Uncle Sam also seems to be pumping lots of money into GMAC -- the credit company that provides mortgage and auto financing and insurance and which formerly was a GM unit, but now is majority owned by Cerberus Capital and the federal government.

The housing market, the epicenter of this recent crisis, is getting steroids in several ways. The first-time buyer tax credit has been expanded to an any buyer credit. Interest rates are kept low by the Fed's "quantitative easing," the purchase of long-term bonds to keep long-term rates artificially low. And Fannie Mae and Freddie Mac, government-owned in all but name, are the biggest steroid pushers in our economy, because they now buy the bulk of mortgages being originated.

Banks are the conduits through which the government pumps stimulus into the economy, which helps them generate enormous fees.

Their profitability is boosted by short term interest rates near zero, again thanks to the friendly Fed, so they earn a healthy interest-rate spread with little risk.

Government also extended unemployment benefits several times last year, spending billions in the process, and it's likely to continue doing this well into 2010.

The last dose of steroids, though certainly not the least, is the spending on giant, multibillion-dollar infrastructure projects. They weren't "shovel-ready" last year, but they are coming on line now.

JAPAN HAS BEEN ON THE STIMULUS bandwagon for nearly two decades, yet it has nothing to show for tripling its ratio of government debt to GDP.

The Japanese economy is mired in the same rut it was in when its stimulus marathon started, after its stock and real-estate crashes in 1990. It has had a hard time giving up stimulus because the short-term consequences were too painful. Japan is proof that a zero-interest-rate policy loses its stimulating ability over time and turns into a death trap, as leverage ratios are geared to low interest rates. Now that the Japanese are thoroughly addicted to low rates, even a small rate increase would be devastating for their economy.

In many cases, the stimulative measures just accelerate future sales to an earlier date, at the taxpayer's expense. After the cash-for-clunkers program ran its course, demand for autos fell. The same will be the fate of industries thriving on government infrastructure projects.

Though the government can spend money at a high rate for a long time, economic stimulus is a finite endeavor that comes with a heavy cost. In most cases, the stimulus is financed with debt, implying higher future taxes. It doesn't take a crystal ball to see higher interest rates and lower economic growth ahead.

The harm doesn't stop there. Stimulus schemes cause bubbles. The fix for the 2002 recession involved interest rates staying at extremely low levels for a long time, which was one of the causes of the housing and liquidity mess that we're paying for today. The present stimuli will leave us with even more serious damage somewhere down the line. This transition will be slow and rocky. As today's stimulus wears off and we hit the wall in this particular marathon, investors will have to adjust to a very different economy.

Investors today should be asking what a company's true earnings power will be after the stimulus runs its course. They should avoid cyclical stocks, which are priced as if the go-go days of 2002-to-2007 global growth will soon return.

WE CAN'T BE SURE WHETHER the end of the steroid economy will bring inflation or deflation, but it's likely to bring higher real interest rates.

In case of inflation, you want to own companies with pricing power; they can raise prices and pass the price increases to their customers.

In case of deflation, companies with little debt will have freedom to maneuver. Stick with those that have little debt or have the ability to pay off debt in a few years from very stable cash flows.

The hope that we'll transition soon from government steroiding back to an economy running on its own are overly optimistic; there's just too much stimulus for that to happen. Detoxing from the massive dose of steroids won't be smooth or painless.

Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo.  He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007).  To receive Vitaliy’s future articles my email, click here.

© 2010 Copyright Vitaliy Katsenelson - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2015 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

RCW
19 Jan 10, 16:38
Any Buyer Credit

I have a question about the article's assertion that "[t]he first-time buyer tax credit has been expanded to an any buyer credit."

If this is true then I will be elated as I am in the process of buying a second home and I was under the impression that not being my primary homestead I could not take advantage of the tax credit.

So is it possible to get an authoritative source for the "any buyer credit" assertion?

TIA


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Free Report - Financial Markets 2014