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A Read Of The Tea Leaves
By Stanley C. Clayton
10-19-09
The idea of Tea Leaves is not perfect predicting accuracy but in part as a learning tool for better understanding how thinking changes over time as new evidence emerges. About 5 months have passed (since the last Tea Leaves), and the U.S. economic conditions have worsened by most measures, while the Federal Reserve has attempted to counter the downturn far beyond anyone’s imagination or has ever been done before. So what have we now?
The primary events in play are:
A. Federal spending of money it does not have is far exceeding expectations.
B. The Federal Reserve is putting far more dollars into circulation than expected. The reasons are to [1] fund the huge federal spending and [2] help offset the very strong deflationary pressures (such as declining real estate prices).
C. The value of the dollar is under strong downward pressure from the extreme increase of dollars put into circulation to combat the continuing strong deflationary pressures. [This is a revision on 12-11-09 from the original incorrect statement: The value of the dollar is under strong downward pressure from both the extreme increase of dollars put into circulation and from the continuing strong deflationary pressures.]
D. Governments around the world have become very concerned about the financial actions of the U.S. and are increasingly seeking to reduce their reliance on the dollar as the sole world currency and moving toward using a basket of currencies.
The resulting changes in the predictions:
1. The stock market will eventually reflect the economy, going through many up and down gyrations but settle into the realities of a new reality of modest economic activity.
2. The recovery will take much longer. The higher and longer the U.S. deficits , the longer the recovery. If present trends continue, it will take decades rather than years.
3. Current strong deflationary pressures will keep inflation in check for a while, then inflation will break through. The extra dollars will have to be withdrawn, but the fear is that the Fed will find that very difficult. The more difficult this is, the higher will be inflation.
4. When inflation is taken into consideration, the market will not rise to previous highs well into the far distant future.
5. The world will succeed in replacing the dollar as the sole world exchange currency. This will greatly reduce the ability of the U.S. to force other nations to loan us their money for us to spend. Our nation’s credit binge will come to an end. “Life on the float” for the U.S. government will end forcing our nation to live within its means. This necessarily will result in a notably lower standard of living within the U.S. This will further increase deflationary pressures which may have the positive effect of keeping inflation from becoming a runaway event.
DISCUSSION
With the Fed neck deep in uncharted waters, many fear the untoward effects of what may result in the future, for we are in effect replacing a private sector debt bubble with a U.S. government debt bubble. Simply printing more money is nothing new. Nations with runaway debt have tried this for centuries. The catch is that, as reported by economic historians such as Harvard professor Niall Ferguson, this method has not saved a single country from economic ruin. For the present, however, some has been achieved by so much cash being created by the Fed. Banks are still failing, but at what is likely a much reduced rate than otherwise might have been. Most banks, however remain moribund with little lending going on: banks are not only reluctant to lend, they are calling in loans at a record rate, while companies and individuals are reluctant to borrow and are instead paying down their debts. Banks know huge loan losses lie ahead from more mortgage defaults both residential but especially commercial.
There is a new “game changer”, however. The evidence is mounting that the rest of the world has tired of lending us their money. They see us as a nation addicted to a credit high and no longer capable of acting responsibly on its own. As a professional Criminologist, I agree with those who argue that the U.S. government economic model amounts to a giant and elaborate Ponzi scheme where we borrow from one country to pay our debts to another. It is a game changer because the rest of the world is now catching on to the ruse and is getting serious about replacing the U.S. dollar as the world’s exchange currency. As that takes hold, it will bring to an end our ability to endlessly borrow from other nations. This may take as much as a decade or more to fully unfold, but during that time our nation will increasingly have to live within its means.
The prediction was recovery in 2016. That is too optimistic. A number of experts are predicting decades for recovery. That now seems reasonable. The popular phrase “the new reality” will be a vastly weakened U.S. joining the ranks of other fallen economic superpowers powers such as England and the Roman Empire. Our decline will be orderly at times and less so other times. Many in our nation will watch this unfold in disbelief, while all of us will suffer economically. Our standard of living will decline to yet to be determined levels. Like England, we will survive and adjust to our new lowered station in the world order. It will not be easy and we will not like it, but we will do it because we will have no other choice.
The stock market will continue to do its usual dance occasionally showing some semblance of rationality, though the odds favor an eventual abrupt and rapid decline perhaps testing the earlier lows. Often it will appear as though the market is climbing ever higher, but that will largely be the effect of the declining value of the dollar. Studies show that if you control for inflation, the Dow has been in decline since the nineteen eighties. This will continue and accelerate as the dollar falls: the higher the inflation the more it will appear the markets are going up, but only in terms of dollars and not in buying power (or early nineties). One should be able to invest in a way that will stabilize their buying power, but increasing buying power will be very tough indeed. The rest of the initial prediction remains intact.
ADJUSTMENTS IN THINKING
This comes under the title of “we know so much better than we do”. I know that I focus on long range thinking, but the present exercise has already helped me see that I then expect that others are doing the same. The long range thinking is fine, but I know better than to think others are focused on that as well. Humans are short range oriented both in thought and action meaning they are impulsive based on short term expectations making their actions marginally rational.
Applying this, it seems obvious to me that economic times ahead in the U.S. are going to be challenging with a likely unavoidable substantial erosion in our standard of living. This is clearly already underway and will continue for a long time. This makes me very reluctant to buy into the market at this time. In contrast, the short term thinker may be vaguely aware that some trouble may lie ahead. But even if they sense that, they are not worried - they will cross that bridge when they get to it. They are willing to assume not only will there be a bridge, but they will see it in time to cross it successfully. The evidence is, however, frequently they are unable to pull it off losing most if not all of their profits and may even take a loss.
Now when we apply this to the current stock market, we can make better sense of it. Short term, investors know that when the Fed is expanding the money supply that the markets usually trend higher when this happens. They do not much care about all the underlying dynamics and they certainly do not care that it may all end badly. They focus on the short term, and that trend is up.
Then another tendency kicks in. People abhor change and they want favorable trends to continue. In time, this gets translated into thinking a favorable trend will just keep on going and going. Think about housing prices. They went up for so long, people came to believe that they would always rise. In the stock market, the longer an up trend is in place, the more investors think the trend will continue. They become comfortable and complacent. The market falls off a cliff, and most investors wake up at the bottom in disbelief wondering what happened. Their profits are gone because they failed to see the decline coming in time to cross the bridge to safety.
Then two other tendencies kick in: short term memory and personal charmed destiny. People have been making this category of mistake since the beginning of time. It is like hurricanes in Florida. People quickly forget the devastation caused by earlier hurricanes and soon buy the damaged coastal property. Besides, it would not happen to them - their destiny is charmed. They are so surprised when before long it happens again and their dreams are washed out to sea.
