Best of the Week
Most Popular
1.Bitcoin War Begins – Bitcoin Cash Rises 50% While Bitcoin Drops $1,000 In 24 Hours - Jeff_Berwick
2.Fragile Stock Market Bull in a China Shop -James_Quinn
3.Sheffield Leafy Suburbs Tree Felling's Triggering House Prices CRASH! - Nadeem_Walayat
4.Bank of England Hikes UK Interest Rates 100%, Reversing BREXIT PANIC Cut! - Nadeem_Walayat
5.Government Finances and Gold - Cautionary Tale told in Four Charts - Michael_J_Kosares
6.Gold Stocks Winter Rally - Zeal_LLC
7.The Stock Market- From Here to Infinity? - Plunger
8.Ethereum (ETH/USD) – bullish breakout of large symmetrical triangle looks to be getting closer - MarketsToday
9.Electronic Gold: The Deep State’s Corrupt Threat to Human Prosperity and Freedom - Stewart_Dougherty
10.Finally, The Fall Of The House Of Saud - Jim_Willie_CB
Last 7 days
Universal Credits Christmas Scrooge Nightmare for Weekly Pay Recipients - 18th Nov 17
Perspective on the Gold/Oil Ratio, Macro Fundamentals and a Gold Sector Bottom - 18th Nov 17
Facebook Traders: Tech Giant + Technical Analysis = Thumbs Up - 18th Nov 17
Games Betting System For NCAA Basketball Sports Betting - Know Your Betting Limits - 18th Nov 17
Universal Credit Doomsday for Tax Credits Cash ISA Savers, Here's What to Do - 18th Nov 17
Gold Mining Stocks Fundamentals Q3 2017 - 17th Nov 17
The Social Security Inflation Lag Calendar - Partial Indexing - 17th Nov 17
Mystery of Inflation and Gold - 17th Nov 17
Stock Market Ready To Pull The Rug Out From Under You! - 17th Nov 17
Crude Oil – Gold Link in November 2017 - 17th Nov 17
Play Free Online Games and Save Money Free Virtual Online Games - 17th Nov 17
Stock Market Crash Omens & Predictions: Another Day Another Lie - 16th Nov 17
Deepening Crisis In Hyper-inflationary Venezuela and Zimbabwe - 16th Nov 17
Announcing Free Trader's Workshop: Battle-Tested Tools to Boost Your Trading Confidence - 16th Nov 17
Instructions to Stop a Dispossession Home Sale and How to Purchase Astutely at Abandonment Home - 16th Nov 17
Trump’s Asia Tour: From Old Conflicts to New Prospects - 16th Nov 17
Bonds And Stocks Will Crash Together In The Next Crisis (Meanwhile, Bond Yields Are Going Up) - 16th Nov 17
A Generational Reset That Will Redistribute Wealth to the Bottom 60% Is Near - 16th Nov 17
Ethereum (ETH/USD) – bullish breakout of large symmetrical triangle looks to be getting closer - 16th Nov 17
Gold’s Long-term Analogies - 16th Nov 17
Does Stripping Streets of ALL of their Trees Impact House Prices (Sheffield Example)? - 15th Nov 17
The Trump Administration’s IP Battle Against China - 15th Nov 17
5 Ways Bitcoin can Improve its Odds of Becoming the Future of Money - 15th Nov 17
These Headlines Say Gold is Building a Base for Something Big - 15th Nov 17
Protect Your Savings With Gold: ECB Propose End To Deposit Protection - 14th Nov 17
Gold on the Ledge, Trend Forecast - 14th Nov 17
The Unbearable Slowness Of Fourth Turnings - 14th Nov 17
Silver Sign’s Confirmation & More - 14th Nov 17
Could This Be The End for Tesla? - 14th Nov 17
Harry Dent’s Fourth Cycle: More Evidence of Stock Market Downturn - 14th Nov 17
Why Having Good Credit Is Important If You Want to Invest - 14th Nov 17
The Bitcoin Bubble Explained in 4 Charts - 13th Nov 17
How the US Has Secretly Subsidized China to Produce Eco-Unfriendly Solar Panels - 13th Nov 17
The Increasingly Unstable Middle East Must Be On Every Investor’s Radar - 13th Nov 17
Stock Market Critical Supports are Being Challenged - 13th Nov 17
The One Chart All Investors Should See Before 2018 - 13th Nov 17
Short-Term Stock Market Uncertainty Following Recent Rally, Will Stocks Continue Higher? - 13th Nov 17
Is Hillary Just the “Fall Guy” for the Intel Agencies and their Moneybags Bosses? - 12th Nov 17
Stock Market Correction Phase - 12th Nov 17
Finally, The Fall Of The House Of Saud - 12th Nov 17
Bitcoin War Begins – Bitcoin Cash Rises 50% While Bitcoin Drops $1,000 In 24 Hours - 11th Nov 17
E-franc, E-krona... E-volution? - 11th Nov 17
Gold Investment Stalled - 11th Nov 17
Smart Ways to Get Loans Online - 11th Nov 17
What Can Pot Teach Us About Economics and Government? - 10th Nov 17
Can Stocks and Bonds go Down at the Same Time? - 10th Nov 17
Gold Market 2017 Will We See a Replay of 2015 and 2016? - 10th Nov 17
Oil markets turn bullish with shift to backwardation - 10th Nov 17
The Strange Behavior of Gold Investors from Monday to Thursday - 10th Nov 17
Where to Start Your Cryptocurrency Company - 10th Nov 17

Market Oracle FREE Newsletter

Forex Trading Free Week

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.


© 2005-2017 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

Catching a Falling Financial Knife