Thursday, August 16, 2007

Wobbly... At Best

There's been a recent swan dive in the stock market. In the last twenty-seven days, stocks have tumbled from a record-high 14,000 to 12,800. At one point today, it was down to 12,500.When the stock market value falls like this, hundreds of billion of dollars in wealth are erased.

But where on earth does all that money go? What exactly does 'erased' mean? And for that matter, when it is going up, where does all of that money come from?

I recently asked somebody (my stockbroker) that question. His answer, after hesitating a little, was something like, "Well, basically the Fed adjusts the level of money in circulation. When the stock market is up, they print more money. When it goes down, they take money out. They try to keep it stable, you know?"

This was one of those answers that sounds like it makes sense just long enough for somebody to change the subject.

In the last four years, the market has gone up 75%, going from 8,000 to 14,000. Now keeping in mind it took some 70 odd years to get to 8,000, an increase like that (in four years) seems a little fishy. It's great, don't get me wrong. And I'm thrilled. But why the sudden race to the top? What has fundamentally changed to allow that kind of growth?

Did the Fed just print lots of money? And if they did, isn't that basically the same thing third-world dictators do when they get in trouble...just print more money?

We've been hearing an awful lot about the sub-prime mortgage mess. It's causing uncertainty about how much bad debt is out there and what other sectors might be affected. And sure, all that makes sense. Bad debt is bad. I get that.

But why isn't anybody uncertain about what exactly has driven the stock market so high in the first place? Why isn't anybody uncertain about where all of that money is coming from?

The answer everybody gives is that, "the economy is booming".

But first of all, that only answers half the question. And second, what exactly is it about the economy that's going so well, anyway? I know people in Detroit and a few other places aren't exactly sure.

Of course, GDP has doubled roughly every ten years since the Depression. That's hard to argue with.

But at the same time though, we've transitioned from an economy that produces things into an economy that consumes things. One estimate (that might be wrong) says that 70% of US GDP is currently based on consumer spending... keep that figure in mind:

Wages for just about everybody are falling (including college graduates). Foreign Affairs published an article recently, pointing out that for everybody except those individuals with "professional" advanced degrees, (basically law degrees, MBAs, and PhD's in useful things like chemical engineering, etc.) wages have actually fallen 2-plus percent in 'real dollar' terms since 2000. For college graduates, wages have shriveled 2.3%.

Add to that, the fact that for the first time in American history, consumer debt has exceeded consumer earnings. People owe more than they make. The average American household spends 15% of its 'disposable' income on paying off interest on debt alone. And at the same time, prices are increasing- not inflationary- but increasing nonetheless. (Just take a look at your college tuition bill or hospital bill if you don't believe me.) Oil prices have sky-rocketed, driving up costs in every single sector of the economy. And those costs are getting passed on to consumers.

But...we like to buy things anyway. So we swipe our credit cards.

Then we pay the minimum balance and we swipe again...

Debt has sky-rocketed as a result. The chart below shows US Consumer debt. If you look closely (click on it), it's doubled in the last 9 years.

So... there's a credit crunch alright. But it isn't sub-prime mortgages.

Needless to say, the debt curve looks an awful lot like the stock market, only steadier. And if trillions of dollars in wealth has been 'created' over an incredibly short period of time, and a good chunk of this nonsense seems to be financed by debt that nobody can pay, aren't we actually in kind of a tight spot?

If the global economy is dependent on the stability of the US economy, and the US economy is dependent on consumer spending, and consumers are leveraged to the breaking point, aren't we actually in a really dangerous spot?

Don't look to the government for too much help. They themselves have a few trillion dollars in debt. What are they doing throwing money around? As I understand it, they're borrowing billions of dollars every day. And what's more, they're borrowing that money to offset (at least in part) the fact that we import a whole lot more than we export- meaning oodles of money is flowing out of our economy and into somebody else's. And that's a trend that's probably not going to change... ever.

So is the economy perhaps "teetering" and not "wobbling" as the pundits suggest?

Well, the easy answer is that the Fed is keeping it steady. And I'm glad they're doing that.

But on the other hand, if it's the Fed keeping things steady, aren't they 'keeping it steady' with tax money they've collected and bonds they've sold? (Tax money that comes from shrinking, iffy, wages and corporate earnings that are being financed by trillions of dollars in unpayable debt... and bonds we'll eventually have to pay back.)

So here's how I would explain the problem to the big-wigs:

"I just talked to the American people, they said I should tell you guys that 'they don't have trillions of dollars to pay you back with. Especially if you're gonna keep charging everybody 20% interest on the trillions of dollars they already owe.' But they also said, 'you go right ahead and tell your accountant to mark them down as being good for it.' If you don't, their credit will get messed up. They said, 'they'll just fill out another credit card application and then send you the money'."

I understand why it's important for the Fed to inject billions of dollars to keep the economy steady. And I understand why free markets themselves are so valuable. But what I don't understand is what all this growth and optimism is really based on.

And if I do understand it, then we're in trouble.

Hedge funds are responsible for some 70% of the volume on the New York Stock Exchange. That means that a relatively small number of individuals can change the 'value' of the market hundreds of billions of dollars (up or down) in a matter of hours. They can trade in intervals of just a few seconds, leaving companies and individual investors gasping for air.

But companies don't change in intervals of just a few seconds. And they don't all double in value in just a few years either.

Technology has empowered brokers and analysts (and individual investors too, for that matter) to move money around much more quickly- into and out of every corner of the global economy, regardless of the consequences. It seems, in doing so, they've convinced themselves that they can 'out-smart' the market (a notion that's never needed much encouragement).

From where I'm standing, the bottom line is that all of this stock market growth better be based on something real and not just wheeler-dealers types fiddling with fancy computer algorithms.

The important question to keep asking is, where is the real value being added? And where is the real equity being created?

My extremely non-expert opinion is... I don't know. I have no idea. But it looks to me like they have parlor-gamed themselves (and us) into a serious problem- that basically, everything just simply isn't as peachy as it seems.

It looks to me like they're just playing games, pushing buttons... kind of like the guys over at Enron.

And then, when things get 'wobbly', they just print themselves more money. Or rather they get the Fed to print some more money for them.

The Federal Reserve, of course, calls it "adding liquidity".

And that's what I'm going to say to a judge if I'm ever indicted for counterfeiting, "What... I was just adding liquidity."

Now I'm certainly not trying to knock the Fed. It truly is a wonderful institution. And I'm not trying to suggest that there is as little substance behind the US economy as there is behind least I hope not.

But what I am suggesting is, all of this confidence may not be based on as much as we think. It may in fact be reckless overconfidence.

I'd like to know, for instance, what the difference is between "keeping things steady" and "propping things up".

I'd like to know exactly what the difference is between "wobbling" and "teetering".

And perhaps most importantly, I'd like to know the point at which we will have left one model and gone to the other. And will it be apparent once we have?

As I was doing some research for this post, I Googled, "US consumer debt". The first thing that came up was an article from 2004 posted on a socialist web site. That's not good.

When the stock market comes down like this after a huge run-up, they call it a "correction".

But if you ask me... they haven't corrected shit.

No comments: