It is likely the market will continue to significantly
decline over the next couple of years or longer. A lot of this
still needs to be uncovered and sorted out. Among other things,
the country needs to motivate American business leaders to get
a bit more interested in generating business income to benefit
American workers rather than sweat shop operations run by active
duty military officers of the communist Chinese army.
Debt is at historic highs and keeps growing
while credit quality is deteriorating.
According to Doug Noland, author of Credit Bubble
Bulletin, total indebtedness (corporate, personal, and government)
is currently about three times gross domestic product (GDP) compared
to 2.6 times during the Great Depression. Corporate and individual
bankruptcies are at record highs. Consumer spending, which comprises
about 75 percent of GDP, now appears to be slowing down as a result
of higher debt levels eating into discretionary funds, while credit
creation by government supported enterprises such as Fannie Mae,
GNMA, and Freddie Mac outside the banking system continues to
grow by as much as 20 percent a year.
The national strategy of outsourcing manufacturing
and emphasizing services through a very liberal approach to "free
trade" has distorted our economy in both directions.
The mortgage refinance boom has been an important
element to provide consumers with liquidity and keep the economy
going, but this cannot last forever.
Consumer sentiment is low, production is in
a slump, and hiring is at its worst point in 25 years. The U.S.
personal savings rate has dropped to nearly zero.
The balance of trade deficit is over the 5 percent
of GDP "danger zone" and keeps growing.
The United States has gone from being the net
creditor of the world to the world's greatest debtor nation. In
the recent past, foreigners have used their excess dollars generated
by the balance of trade deficits to buy around 15 percent of America's
stocks and about 40 percent of its treasuries. America consumes
6 percent of the world's savings to finance its deficit.
The dollar has lost about 20 percent of its
value against the euro in the last year, and looks likely to continue
sliding much further. Normally a dollar slide could be simply
a cyclic corrective process that will make exports cheaper and
imports more expensive, decreasing imports and increasing exports
to bring things back in balance.
Bears fear that something more ominous has taken
place; that is, America has exported so many jobs and facilities
overseas that it has seriously hollowed out its manufacturing
base and does not offer enough quality products to eliminate its
trade deficit problem even at lower prices. In classical economics,
over the long run, a strengthening currency is a good sign that
a country is increasing its manufacturing base, productivity,
innovativeness, standard of living and quality of its products-from
this viewpoint, a unit of currency is roughly like holding a share
of stock in an entire country.
Countries such as Argentina that went from being
a First World country at the beginning of the 20th century to
a Third World country by its end suffer from continuing currency
A sliding dollar tends to scare foreign investors,
encouraging sell-offs of their shares in the U.S. equity markets
and their holdings of U.S. bonds. If the dollar continues to slide,
the Fed may need to raise interest rates to attract foreign investors
to help finance America's burgeoning deficits. Rising interest
rates can crimp business recovery and reduce stock values further.
Analysts continue, as they have since 2000,
to revise earnings growth estimates downward from initial rosy
projections such as a 20 percent growth rate looking forward a
year to well below 8 percent as the projected time periods arrive.
High-tech companies complain again that inventory channels are
There is no major advanced industrial nation
around to act as a "global economic engine." Japan and
Europe are both in recession. If the Japanese economy becomes
more distressed and the Japanese start pulling investment funds
out of the United States, that could hurt the dollar and U.S.
China has the world's fastest growing major
economy with a large balance of trade and currency surplus, and
the national media usually portrays this as wonderful news. But
there is an important dark side to the "free trade"
miracle of China that American business magazines and business
school professors rarely mention in their discussions about free
trade. On the benefits side, the basic idea is that if all nations
focus on their comparative advantage through free trade, a global
version of the division of labor concept will supposedly make
nations wealthier, and wealthier peoples tend to be happier and
friendlier to each other.
The Chinese work force is effectively engaged
in a labor price war with American, Japanese, and European workers,
working long hours for almost nothing to gain global manufacturing
market share. India is trying to play the same game as China but
is not nearly as significant.
In one sense, this really is a "war,"
that is, rather than operate in muddy trenches while sacrificing
their lives, the contestants work grueling hours under substandard
conditions with low paychecks to achieve the same ultimate goal
as in most shooting wars. They want to gain market share or command
of natural resources that translate into enhanced national economic,
military, and political power.
Most prolonged bull markets have been followed
by bear markets that are proportional to them. From 1982 to 2000
the United States had the longest bull market in its history,
capped by the greatest mania in history from 1995 to 2000. We
are only two and a half years on the backside of all this. Also,
Bill Gross, head strategist of PIMCO Funds, thinks the Dow must
drop below 5000 before it is positioned to offer reasonable risk-adjusted
The stock market decline has hurt business and
A further downward market spiral could threaten
to increase the "negative wealth effect" in which eroding
portfolio values reduce consumer confidence and consumer spending.
The "negative wealth effect" is already impacting corporations,
for example IBM now has to devote 20 percent of its cash flow
for the last year to bringing its pension plan back up.
Lack of capital gains tax revenue and recession
are now causing about half the states in America to talk about
raising taxes. This could threaten to choke off business profits
and capital investment required to create jobs and sustain economic
Interest rates are at historic lows and seem
to have no way to go but back up.
So far dramatic drops in interest rates by the
Fed have been "pushing on a string" to revive the economy.
The problem is that if interest rates start moving back up, rising
debt service could help push America into a liquidity trap. Fed
Chairman Alan Greenspan voiced concerns about reaching a "point
of no return" in his recent congressional testimony.
America's money supply is growing at a torrid
pace threatening to ignite serious inflation.
According to Jim Puplava, the money supply grew
at 16 percent in the fourth quarter of 2002. Its growth has averaged
at least two to three times the officially reported inflation
rate of 2-3 percent over the last five years.
Historically, inflation runs parallel to money
supply growth. From 1995 to 2000 the United States was able to
ramp up the money supply and run balance of trade deficits and
get away with it, largely because foreigners were willing to sop
up excess dollars as a global reserve currency or invest their
dollars in America's roaring stock market. Now the global demand
for dollars is holding constant or even reversing, and meanwhile
the money pump keeps going.
Russians have started dumping dollars for euros,
and many Islamic countries plan to dump dollars for a revival
of the ancient Arab gold coin, the dinar, as a reserve currency.
Dollars washing back at the United States would
encourage inflation. Critics voice concern that by ramping up
the money supply to stave off the impact of the Asian crisis beginning
in late 1997, followed by similar actions regarding the Russian
default in 1998, followed by the Y2K concerns of 1999, followed
by efforts to stave off a U.S. market and economic collapse since
2000, the Fed has created additional bubbles in the economy besides
the stock market bubble, such as bubbles in consumer finance,
the bond market and the mortgage finance/real estate market.
America still has ample natural resources and
in terms of demographics the equivalent of Germany, Britain, France
and Scandinavia inside its borders, so I do not see us necessarily
turning into Argentina or Brazil within the next five to 10 years.
Once the bad debts get liquidated and the middle
class gets unconfused"-perhaps after a period of crisis and
cynicism to finally figure out how badly they have been misled-we
will finally have the basis for a viable rebound.
Bill Fox is VP/Investment Strategist, America
First Trust Financial Services. Bill welcomes phone calls and
responses to this article. Please refer to his web site www.amfir.com
for the most recent contact
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