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The Unfortunate Math Behind Our Economic Plight

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September 09, 2010 – Comments (13)

The Pragmatic Capitalist has a great new post up. Discussed is the Output Gap (Potential GDP vs. Actual GDP) and the fact that every single stimulus program to date is a 'fix' to a misdiagonsed problem. Targeting bank balance sheets helps banks (which are your lobbyists and source of funding, this is called crony capitalism) but does nothing to help the real cause of the problem. I am not saying the stimulus was good or bad (... except I am, It was bad), but rather I am saying that if you wanted to 'stimulate' to help a) solve the problem or b) throw money down a black hole, then government has chosen b) every single time.

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THE UNFORTUNATE MATH BEHIND OUR ECONOMIC PLIGHT
9 September 2010 by TPC

http://pragcap.com/the-unfortunate-math-behind-our-economic-plight

The whole post is good with charts illustrating the Output gap and the size of the problem, but this paragraph is a gem....

As I’ve previously mentioned, this current environment is easier to comprehend than most would like to admit.  What is basically occurring here is a massive decline in consumer spending power which subsequently weakened corporate revenues.   The lack of revenue  strength leads to tepid hiring because visibility is poor.  Margin expansion has helped companies maintain their balance sheets  in recent years, but margin expansion alone can only sustain bottom line growth for so long before the market realizes that there is no organic growth.  At some point, the household must heal to the extent that they contribute to corporate revenues and sustain recovery.  So what we’re seeing now is this frustrating positive feedback loop where corporations are waiting for revenues to rebound so they can expand their operations and hire, but the problem is that consumers are more focused on paying down debt as opposed to spending and accumulating debt.  The problems are now being compounded by the fact that the government is no longer aiding growth.

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Do I think that consumers paying down debt is a 'problem'? NO!!. This is *EXACTLY* what needs to happen.

The 'problem' exists from the stanpoint of corporate revenues. The stock market is priced for a full recovery and resumption of GDP growth that we have seen over the last 50 years. I don't believe this is even remotely close to the reality that we see either now or in the next few years.

Stocks will not fall if earnings are still good.

... But earnings are 'good' through a) organic growth or b) cost cutting / margin expansion. We have seen a lot of b and no a recently. And I think b is 'maxed out'. I think we will see evidence of this next quarter and the market will begin to see, once again, that equities are overvalued.  

13 Comments – Post Your Own

#1) On September 09, 2010 at 12:12 PM, leohaas (31.71) wrote:

OK, so next quarter we will see the evidence?

Or will you write another blog next quarter, saying that we will see evidence the following quarter. And so on, and so on, and so on.

I am not saying the economy is humming along fine. But you have been mostly bearish (and gotten boatloads of recs on your bearish posts) for ages. How do we know you are right this time?

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#2) On September 09, 2010 at 12:17 PM, binve (< 20) wrote:

leohaas ,

>>I am not saying the economy is humming along fine. But you have been mostly bearish (and gotten boatloads of recs on your bearish posts) for ages. How do we know you are right this time?

I am not right, nor will I ever be right. I am a complete and utter idiot wasting everybody's time. You should ignore me and disregard what I have to say.

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#3) On September 09, 2010 at 2:50 PM, eldemonio (98.58) wrote:

binve,

Thanks for the link. 

I don't think GDP is a good measure of economic performance any way you look at it.  But I digress. 

My time isn't all that valuable, nevertheless, you're still not wasting it.

leo,

If you don't agree with him, tell us why.  If you just feel like being a dick, I completely understand.

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#4) On September 09, 2010 at 2:59 PM, binve (< 20) wrote:

eldemonio,

Hey man! no prob :)

>>I don't think GDP is a good measure of economic performance any way you look at it.  But I digress

I agree. It is a highly flawed measure subject to a lot of 'massaging'. ... but, it is the best thing we have. But there are a lot of leading macro indicators (ECRI, CMCGI, ISM, Philly and Empire MIs, etc.) that are all forecasting weakness.

But no matter what GDP or manufacturing indices say, as long as there is earnings growth, then likely equities will stay afloat. But when you dig down and look at 'why' earnings are still good now... then the picture does not look all that great.

>>My time isn't all that valuable, nevertheless, you're still not wasting it.

LOL! Thanks man :).

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#5) On September 09, 2010 at 3:16 PM, outoffocus (22.00) wrote:

I think all these misdirected stimulus programs are masking the truly successful areas of our economy.  I still believe that we need to move from a consumer based/service based economy to one that produces and sells to other countries. But all the government seems to care about is building roads and subsidizing over-priced homes.  As a result we fail to notice the portions of the economy (albiet few in number) that are doing just fine in this Great Recession.  We also are choking out the small businesses that may have the next great idea that could propel us back into prosperity.  And dont get me started on Obamacare...

Right now, if the economy is going to truly rebound, we just need to stop subsidizing. It seems like currently all growth in this economy is tied to some kind of government subsidy.  Government subsidies are like weeds.  They choke out the real flowers and grow in their place, ruining the whole garden.

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#6) On September 09, 2010 at 3:29 PM, outoffocus (22.00) wrote:

And for Leo, if you havent noticed, the DOW hit 11000 in April and hasnt been back since. The DOW can't even break 10500 without falling the next day.  So Binve's bearish call on equities isn't exactly wrong.

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#7) On September 09, 2010 at 4:14 PM, binve (< 20) wrote:

outoffocus ,

>>I think all these misdirected stimulus programs are masking the truly successful areas of our economy.  I still believe that we need to move from a consumer based/service based economy to one that produces and sells to other countries.

100% agreed!!

>>Government subsidies are like weeds.  They choke out the real flowers and grow in their place, ruining the whole garden.

Exactly. If we want to pull forward auto sales for a couple of months or put a temporary floor under house prices, we can. But that is not sustainable and you are absolutely right, crowds out resources from industries that are growing organically. if you fertilize the weeds, the flowers eventually die

Thanks!..

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#8) On September 09, 2010 at 8:50 PM, scruffy4life (78.41) wrote:

Scruffy likes this chart.

Benner Cycle: The 18-Year Cycle Of Secular Stock Markets

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#9) On September 09, 2010 at 11:19 PM, binve (< 20) wrote:

scruffy4life ,

Thanks scruffy, me too :)..

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#10) On September 09, 2010 at 11:59 PM, atarigod (< 20) wrote:

Binve, you are a man after my own heart. Every month I hear another consecutive month that consumer credit declined I cheer. I believe it is more of a leading indicator than a lagging one. Those 18 months have already passed and are history where consumers chosed to use their money to reduce debt load rather than consume blindly.

That's in all the prior 2 years worth of quarterly reports. Going forward not only will consumers have more free cash not going to paying debt that they can use to consume.

**PLEASE TELL ME HOW THIS IS BAD!!** Seriously, e-mail me, because maybe im just not getting something because this seems like the seeds beeing sewn for some grand new Utopia If we keep seeing month after month of consumer credit contracting and the savings rates rising,

Debt is a natural and essential part of a growing business. A business that wishes to expand essentially has only 2 options. They can either capital or raise debt. With various iterations and calculations you can dermine what the cost of capital will be for each method in undertaking your expansion. Debt is a very wonderful thing used properly in a growing business that wants to expand their brand further.

Just as I was thinking about how Debt is simply a part of the nature of business, I began thinking what is the purpose of individual debt. The only "valid" and allowable debt I came up with is student debt. A student should properly calculate whether or not the cost of capital of a student loan will produce a level of future earnings that will be more than they could have made otherwise less the cost of capital. AND THAT IS IT!

Student & Business debt should be the only debt allowed. Please, I welcome jabs back if you do not share my opinion.

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#11) On September 10, 2010 at 12:53 AM, DarthMaul09 (29.78) wrote:

I picture companies climbing the mast on the ship that is the US economy, hoping to stay dry and not drown.  Their only real hope is that the ship is in shallow water and won't sink too far.  That is also the hope of many investors who look for a change in Congress to bring the ship closer to shore.

I'm beginning to believe that the relatively low trading volumes and lack of any sustained market direction is due to investor saving their cash for a potential rally following the mid-term elections.  I also expected some major sell offs before then but now with the Republicans expected to take back partial control of the Congress, this appears less likely to happen.  If the Democrats make a comeback between now and the election then the markets would likely show increased volitility and a possible 20% correction.  I still believe that precious metals remain the safest investing option within the US until at least the November elections. 

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#12) On September 10, 2010 at 1:52 AM, amassafortune (29.58) wrote:

binve, great line at #2 LOL. I'm going to use that on my resume.This is a tough time for many who intended to make achievement and service hallmarks of their careers. It is a rare Fed official, SEC investigator, president, and lately even hedge fund manager, that can say they have been as consistently effective as they expected to be. 

The voluntary contraction of consumer credit reflects how difficult it is for a private investor to find a strategy that works in this market. Even CDs and passbook savings are only winners if measured against the meager goal of not losing money. Reducing debt and lowering outstanding credit obligations is one of the few low-risk ways an individual can capture more than a few percent of benefit. Successful investment options for the individual or businesses have been pretty much limited to gold or debt reduction in this market.

I agree that debt reduction for individuals makes sense. Just like the banks, individuals are going to focus on their own balance sheets first. The masks have dropped and everyone needs to secure their own before helping others.  

 

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#13) On September 10, 2010 at 7:34 AM, binve (< 20) wrote:

atarigod ,

I very much agree. Debt for corporations to grow strategically can be very useful. Especially if they are allowed to fail from overleveraging and bad decisions. That kind of environment would find equilibrium as businesses would be much more critical of whether the debt was useful (rather than gambling, which is what all the finanicals did because they knew the lender of last resort would guarantee all the bad debt). There is no situation where all of this private sector debt is good for the long run or even the short run (it just blows huge bubbles). I really do think there is a major shift in the perception of debt taking place, and I think that is a very good thing.

Thanks!

DarthMaul09 ,

I very much agree with your position. I am probably a little more imminently bearish on equities, but we definitely have a similar opinion of PMs (no surprise there) :). Thanks!

amassafortune ,

Hey amass!

>>great line at #2 LOL. I'm going to use that on my resume.

LOL! That's what it says on my business cards :)

>>Reducing debt and lowering outstanding credit obligations is one of the few low-risk ways an individual can capture more than a few percent of benefit.

EXACTLY!!! With a crappy equity market that has been in Nowheresville, and bond market that is yielding you next to nothing (which quite volatile price moves), CDs that are BS, savings accounts with 0%, etc. the absolute crystal clear no-brainer move is to pay down debt that is cost consumers anywhere from 5 to 30%!!!! (I am not lying, my sister in law had rates on her credit card jacked up to 35% before she balance transferred it to 0% and is paying that off before the real rate kicks in).

Main Street is sick of paying Wall St via equities and interest and I believe is rightly seeing that paying down debt is paying themselves.

>>The masks have dropped and everyone needs to secure their own before helping others.  

EXACTLY! Thanks man!..

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