September 03, 2004
As much as I like to think of myself as a contrarian, I
find it difficult to believe that having a negative outlook on the US
economy and the US dollar is a contrarian opinion. Of course, here, and
at many of the investment conferences I attend, we’re all just preaching
to the choir, so I don’t necessarily expect my opinions to be contrarian
over here. But do the general public, economists at large, and investors
in general really believe the US economy is on solid ground?
Listen to these headlines from the Wall Street Journal:
“GM’s August Sales Fall 14%; Ford Reports a 13% decline…
Consumer Confidence Wanes As Concern About Jobs Mounts… GM, Ford
Plan Cuts in Production… Soft Income Data Suggest Slowdown…”
Just last month Alan Greenspan gave an upbeat review of
the economy in his testimony before the Senate, saying that the current
recovery is broad-based and sustainable. Hmm, this doesn’t sound
like a broad-based and sustainable recovery to me.
In all fairness, Mr. Greenspan has admitted that the economy
is going through a “soft patch”, but he expects that the economy
will pick up again later this year. Growth may well pick up a bit later
this year, who knows? But will a slight upturn in the economy indicate
that the worst is over, or will it just be a counter-cyclical upturn in
what is otherwise a long-term decline?
My money is on red, lots of it. I expect that corporate
profits will decline, stock prices will decline, employment will decline,
bond prices will decline and, as a result, government receipts will decline.
At the same time, the government will increase its spending:
it has to finance an ever-expanding War on Terrorism and soon it will
have to face up to the fact that it stole the baby boomers blind -- their
Social Security Account is empty.
Increasing government expenditures and decreasing government
receipts -- because the economy is slowing down -- imply higher tax rates.
And higher tax rates are not exactly how you stimulate the economy.
Just like the US economic growth during the Nineties became
a self-propagating phenomenon -- feeding on itself to keep going while
being fueled by foreign capital -- so too will the downturn snowball and
grow, with reduced economic activity in one sector spilling over into
others. The whole economy is, after all, connected.
Given that the US government has no restraint when it comes
to spending money you can bet that the budget deficit is going to keep
growing. Financing the budget deficit will ensure that interest rates
keep rising and higher interest rates will reduce corporate profits. Lower
corporate profits will increase unemployment and an increase in unemployment
will put the brakes on consumer spending. Less consumer spending implies
less corporate revenues, which means less profits and more lay-offs.
The government gets its money from taxing corporations and
individuals. If corporate revenues and profits decline the government
gets less tax revenues and so it will increase its taxation of individuals.
But it is highly unlikely that the loss of corporate tax revenue can be
made up from an increase in personal income tax rates, so even if the
government doesn’t increase its current level of spending the budget
deficit will grow. And it’s folly to think that the government won’t
increase its spending. So read the previous paragraph again.
It’s already happening: All three Big Autos reported
lower sales for August, it seems that their incentives are not having
enough impact on consumers any more. I wonder why? Could it be that consumers
are tapped out? After all, how many new SUVs do we really need?
In response both General Motors and Ford said they are preparing
to cut production, and you know what that means… lay-offs. No wonder
consumer confidence is waning. On Wednesday the Conference Board announced
that its consumer confidence index declined seven percent last month because
people are concerned about the job market.
According to the Commerce Department corporate profit growth
in America came to an abrupt halt in the second quarter, apparently due
to higher energy costs and slowing consumer demand. So it’s not
just the auto industry that’s suffering.
But like Bobby McFerrin says: “Don’t worry,
be happy.” Americans are, after all, still very wealthy. The median
household net worth in the United States was $55,000 dollars in 2000.
Eighty-three percent of that, however, is home equity. Without home equity,
the median household net worth is only $13,473. But don’t worry,
these folks are determined to spend the world out of recession even if
it takes all the money they have, and all the money they can borrow.
Realtors are quick to point out that annual median home
prices in the US haven’t declined in the past fifty years; so don’t
worry. On an inflation-adjusted basis, however, the national median home
price has declined in eight of the past thirty-three years.
Mortgage rates will rise as the growing government deficit
forces medium and long-term interest rates up. That is likely to put the
brakes on the housing bubble that has developed in some parts of the country,
such as California, where the median home price shot up twenty-one percent
in the past year alone.
But this is an election year; so don’t expect consumers,
economists and politicians to pay much attention to anything other than
the talking heads on TV. Next year, when the dust has settled, life will
return to normal and American consumers will once again wonder where they
can get money to go spend at the mall.
I don’t know for how much longer the Chinese, Japanese
and other benevolent foreigners are going to send their savings to this
country so that we can buy new digital TVs and cell phones, but I do know
that I am putting as much of my own money as possible into natural resource
stocks -- predominantly mineral exploration companies (if you want to
know which ones, you can subscriber to my newsletter; details are at www.paulvaneeden.com).
As much as it doesn’t feel contrarian to be bearish
on the dollar and bullish on natural resources, gold is still dirt-cheap
(in my opinion) compared to other financial assets and that, alone, is
an indication that gold investors are still contrarian enough.
Paul van Eeden
PS I’ll be at the investment conference in Las
Vegas next week so there won’t be a commentary next Friday. If you
can, you should come too. Details are at www.iiconf.com.
Paul van Eeden works primarily to find investments for his
own portfolio and shares his investment ideas with subscribers to his weekly
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