Forecasting the Future: Is the Recession Over?
‘It is a mistake to look too far ahead. Only one link of the chain of destiny can be handled at a time’
While these words from Winston Churchill are wise, they are also surprising; after all, his was the lone voice that gave advance warning of Nazi Germany’s re-armament. It reflects our natural tendency to be coy where predictions are concerned. The annals of the investment business are littered with the doomed prophecies of the great, the good and even the gormless. Like shipwrecks off the Skeleton Coast, the demise of others leads us to fear – and steer clear of – extreme forecasts. It further serves to reinforce our herding instinct. No one gets sacked for making bad decisions in good company, but you will be sued for being brave and wrong. So is the recession over? To judge by last year’s 61% rebound in the Dow Jones from its lows, it would be tempting to say ‘yes’ as this was the strongest stock market rally since 1933. After all, the market is believed to be the best bellwether for the future as it reflects the collective wisdom of all public knowledge. However, this recent bounce should be put into context as the last decade delivered an overall double-digit loss for equities; surely a more sobering standpoint.
Officially, after 6 consecutive quarters of contraction the UK economy expanded marginally at the end of 2009. Just as few investors questioned the source of earnings when markets were rising, the same effect is apparent when it comes to probing the source of economic ‘growth’. The dominant theme of the great bail-out was that combined government spending and base money production were meant to stimulate bank lending. Instead, the parabolic surge of money creation looks like an ostrich-egg in a snake. A lump of funds has been swallowed by the banking system but is not being fed into the wider economy. Given that banks are not known for their altruism, it is unclear when lending will resume. This is not entirely their fault. The latest Basel proposals require more capital raising, higher buffer levels and limitations on leverage for banks. Their extra funding requirements in Europe alone amount to some €1 trillion. Concurrently, government bond issues will soak-up €2 trillion from markets as competition for capital ensues in 2010. In a debt-based system, the scarcity of fresh loans will trigger corporate defaults. Record-high interest rates on existing company loans are sucking capital into the banks and desiccating the real economy. Given the lack of its recycling into the community it may be the case that the bail-out has simply saved banks while dumping yet more debt and interest payments onto the next generation.
Government intervention has been a temporary cure; the side effects and unintended consequences are yet to unravel. The same old tired formula is now being applied to developed economies that have already failed time and again for developing countries. In order to stem an investor revolt leading to higher interest rates, governments increase taxes then cut wages and public spending in order to look tough for market vigilantes. Meanwhile the public are fed spin that the government is looking for an exit strategy. There is a severe risk of a double-dip back into recession followed by devaluation. Deleveraging cycles typically last half a decade or longer and there is little evidence that this has even begun outside of the financial sector. A painful episode of economic contraction awaits and no amount of public pronouncements can take the edge off it. Developed countries are in a debt trap where interest rates cannot rise so the devious solution is to inflate through further money creation to buy more time. Gold is the true thermometer of money and is to be trusted more than manipulated inflation measures.
The elephant in the room is interest; the essence of how banks make money. The States of Guernsey proved nearly two centuries ago that you can have your cake and eat it. It is possible to increase public spending and avoid both deficits and inflation but entails by-passing the banking system, connecting the public and private sector with interest-free money. More will be explained in the next newsletter.
Toby Birch (email@example.com)