The Big Fight

The way I see it, we have two major forces “working” the economy today.

In one corner, we have the natural market. To this economist, everything is based on the stock market. If the stock market is moving down, our economy is getting soft. If stocks rise, our economy is getting stronger. Sometimes Mr. Market attempts to “fake us out” with rallies only intended to bring investors in so the money they have can be taken away from them. Sound silly? Maybe. But this is how bear markets have always worked.

Today, the natural market has many things going against it: the debt level of consumers and governments are at record highs, thanks to low interest rates; deflation has become a threat to our economy for the first time in decades; and, with deflation, it really doesn’t matter how low interest rates become because the value of our assets deteriorates over time.

Talking about interest rates, the Fed can’t lower them much further because “zero” money is really the only next step. A falling U.S. dollar, while a good idea to get Americans to buy American again, doesn’t help foreign demand for our debt instruments to finance our government debt.


Back to the stock market. Big-cap stocks are trading at historically high price/earnings multiples and low dividend yields. The downside risk for the Dow Jones Industrial Average is much greater than the upside.

And now to the consumer: Does today’s average consumer have any more room left to borrow? My guess is that the consumer is all out of borrowing room. I see it in the average credit card balances, the number of consumer bankruptcies, mortgage applications, and the action of retail stocks I follow.

Today, consumer spending makes up about two-thirds of U.S. Gross Domestic Product (GDP). If consumers cut back on spending, our economy will be in grave trouble. My question is simple: How can consumers not be forced to cut back?

We’ve just gone through our 43rd month of job losses in the manufacturing sector. And, looking at the most recent job figures, the service sector certainly isn’t taking up the slack caused by job losses in the manufacturing sector. Finally, if big cap stocks start to tank, like I’ve been predicting, the confidence level of consumers will plummet, causing further constraints on consumer spending. So much for GDP growth.

Now, let’s move to the other side of the ring, in the non-natural corner we have Greenspan, the Fed, and the government on an all-out war to keep our economy growing. The Fed has lowered interest rates to the lowest level in 40 years and literally flooded the system with “easy” money. The government has cut taxes and increased spending to the tune of an annual deficit of one- half-trillion dollars.

We’ve even managed to lower the value of our dollar against other currencies, which is a brilliant move, unless the dollar has an outright collapse, which would be catastrophic. (A declining U.S. dollar means the debt we repay to our foreign creditors cost us less; but a collapsing U.S. dollar will result in few takers for out debt instruments.)

Who will win the fight? In all the years I’ve studied the market, in the long-run, the natural force of the market has never been stemmed by man-made stimulus. The natural force of the market always wins.

Some of my contemporaries would say that all Greenspan has achieved by keeping interest rates so low is delay the inevitable bear market in stocks from taking its natural path. Maybe it would have been better for business to haven taken its normal course of boom, bust, and back again.

The Feds worst nightmare could be summoned up as follows: a collapsing U.S. currency (at which point it will have no choice but to raise interest rates to protect our currency, but hurt our economy); a run-up in the price of gold bullion (which it will fight tooth-and-nail until the Fed will be forced to buy some gold itself); deflation; and a reluctance by consumers to continue on their current spending patterns or the topping out of consumer borrowing capacity.

Not such a rosy picture, but reality as I see it.