We've said often here that these are strange times for predicting markets and besides the normal curveballs thrown by the market gods there are other huge distorting factors stemming from the activities of the Federal Reserve under Alan Greenspan, the countermeasures of foreign central bankers and the bitter infighting of a presidential election year. This week has been no exception.
For those who are of the persuasion that this is a sustainable recovery there was more bad news on the job front last week. We've been saying all along that it is impossible to reckon how a consumer driven economy (over 70% of GDP) with its great reliance on debt financed spending can somehow hold up as fewer and fewer people find good jobs. One of the most striking facts has been the continued depression in real wages for American workers who haven't really shown any gains since the 1970's.
You only have to read the many articles that have come out of Elizabeth Warren and Amelia Warren Tyagi's book "The Two Income Trap" to get a good idea of what's going on in a lot of American homes. The authors have looked carefully at personal bankruptcy cases over a fairly long period of time and found a number of so-called counterintuitive facts: Their main point is that personal bankruptcy is much more likely to happen to families where both spouses work and there are children in the household. As the authors put it, and we paraphrase, it's those people who do all the right things, who work hard and who have an abiding interest in finding good schooling for their offspring and invest in a home of their own who are most likely to fall into economic ruin. In other words, these people tend to be striving for what they and most of their peers regard as the life any American couple who play by the rules ought to expect.
What happens is that in order to get their kids into a "good" public school district these parents pay a major premium for the price of their home. And because they both work, they are required to have two cars and the overhead of daycare.
Since real wages have stagnated in real terms and there has been an enormous inflation in the cost of housing it now takes two salaries to keep pace. So when one wage earner loses his or her job the debts begin to mount. Yet there is little way to cut back. American family saving is at its alltime lowest following a long pattern downward. Credit is, of course, abundantly available, and may provide a short buffer but at some point either a job gets found --impossible if one of the two gets seriously ill-- or the family flounders.
The authors point out that in the old days the stay at home mom was a kind of reserve player who could enter the job market, albeit at lower wages, but provide back-up support. The reality is that it now takes two wage earners to carry pretty much the same burden as it used to take one.
And so when with a grindingly monotonous rhythm the job figures came out last week several things occurred. For one, interest rates dropped back to record low levels and consumer confidence also fell a notch or two. Now, when interest fall like an ice cube on Jupiter you can usually expect some other things to follow suit. You might have expected the dollar to head into its own Jupiterian free fall while the price of gold made its way up over the moon.
Instead, the dollar actually firmed against the euro and gold, well gold managed to just barely hand onto its $400 an ounce price level until dipping Friday to slightly below where it's been stuck for the last few months.
As we've also said many times over in the few months we've been writing this letter, that the US is dependent upon the kindness of strangers, mainly Japanese and Chinese, who must make up for the huge trade imbalance by buying US T-Bills as they are issued to cover domestic debt. These Asian central bankers can put their excess dollars to work for much higher rates in more stable currencies by merely looking around. But they have decided that they are going to subsidize their American customers even if it means giving back their hard earned profits in the form of poor rendering US paper. These guys are clearly not crazy so they must have a good reason for their actions and that, of course, is, we'll hazard, that if the US consumer ever decides they've had enough in Wal-Marts there would be no where else to turn to sell their goods.
The present US economic fix has sometimes been compared to the long dive of the Japanese economy that started in the late 80's and is only now starting to turn around. Many economists have pooh-poohed the comparison. The economies, they say, are just too different for comparison. So when someone points to the recent bulge in the stock market that brought the NASDAQ back to 45% of where it peaked at over 5,000 in 2001, as similar to a move in the Japanese market that occurred 3 years after they peaked, critics find the whole thing risible.
And of course there are vast cultural differences in the two leading economies. For one thing, Japan runs a trade surplus and for another, the Japanese are still basically a very frugal bunch who have one of the world's highest savings rates. Americans, of course, have believed that their innate creativity, flexibility and capacity to absorb foreigners give their economy a level of superiority over the Asian islanders.
But still another factor is that the US is the only country in the world that can print its own money and get away with sending it abroad where it is kept in bank coffers as an official "reserve currency". America got that unique advantage back in the 70's when Nixon caught off the dollar from any last links it still had with the price of gold.
Europe, of course, would like to substitute its euro for the dollar as a second reserve currency. And the world economy would be a lot more stable if Europe, taking the pressure off the US, started growing again at the rates it did up into the 80's but, alas, that hasn't happened. For a number of reasons but we should not overlook the effect a weak dollar has had on world trade in the last year as it went from 83 cents for one euro to a peak of $1.30. In effect, while the Bank of Japan literally sank 100's of billions of dollars to keep the Yen from not diverging too drastically from the dollar and the Chinese held tight to their lockstep with the dollar, the Europeans could see their euro making strong gains.
But at what cost? Recent figures point to a slowdown in Germany and France just as their economies were beginning to take on new life. And so, you might say, as US interest rates took a dive back down last week (meaning you get less money when you invest in US T-paper) the dollar should have taken a dive. Instead, it actually stiffened against the euro and the yen.
Does this mean that the bonfire of Japanese and Chinese dollars on the altar of the American consumer will now also be fed by the European central bankers as they scramble to soak up dollars before they become worthless to keep Volkswagen et al. competitive?
Never before have massive interventions like the ones going on right now, or potentially contemplated, ever been able to hold back an imbalance forever.
There's a potential avalanche out there and you would be wise to take some precautions.
rmb
Copyright 2004 Richard Mendel-Black All Rights Reserved
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