It is the time of year when all the pundits weigh in with their outlook and
investment advice. As I don’t have any official position that requires me to make specific recommendations, I have the freedom to raise questions and uncertainties — and there are plenty
of both.
I start with a review of recent developments in the financial sector and the economy.
The Opposing tadalafil Forces
Opposing forces are pushing on the economy and asset valuations.
Financial Implosion: On the one side is the implosion of the credit market that started slowly in August of 2007 (16 months ago!) and kept gathering momentum as one calamity after another occurred. The government kept patching things together, taking over Freddie Mac and Fannie Mae, arranging levaquin mergers, and keeping the balls in the air. Then, when Lehman Brothers came to the government to keep it out of bankruptcy, the Treasury and the Federal Reserve declined. On September 15, 2008, Lehman Brothers declared bankruptcy.
The balls fell out of the air.
A full-fledged financial panic ensued. Stock markets around the world plunged.
An incredible flight from risk swept the bond and currency markets.
More and more financial firms teetered on the edge on insolvency. The loan markets completely seized up.
It is hard to buy real viagra without prescription | buy cialis fast shipping | low price levitra believe that the huge downdraft that enveloped the financial markets began only 3-1/2 months ago. In that short span of time, the world’s perception of the stability of the financial system viagra soft changed dramatically. amoxil online Only a few months earlier, the prevailing view was that the continued functioning of the financial system despite the repeated shocks demonstrated its robustness and underlying strength. Now, everyone recognizes that the global financial system buy pfizer viagra online | buy cialis pills online | buy levitra vardenafil is perilously close to meltdown. The burning question is "Can the meltdown can be avoided?"
Government Response: The U.S. government, especially, has made clear it will do all in its power to prevent a collapse and to create conditions for a recovery in the markets. Initially, the actions of the Treasury, in particular its call for $700 billion to bailout banks, seemed the most important. But, soon the steps taken by the Federal Reserve in coordination with other government financial agencies dwarfed those of the Treasury (which got only $350 billion). The combined actions of all government agencies have, by various accounts, guaranteed or distributed into the private financial system $7 to $8 trillion.
The Federal Reserve has acomplia 20mg pills more than doubled its balance sheet since September and quadrupled its loans to the private sector — to a total of about $2 trillion dollars. The striking magnitudes of actions of the Fed are shown in the chart below (from James Hamilton). The silver at the bottom are the Feds holding of U.S. Treasury bonds. All of the colored parts of the graph are for various loans Cialis Jelly to the private financial sector (collateralized by credit instruments the private sector has had extreme difficulty in selling in the open market). The $2 trillion of Fed loans make the $350 billion handed out by the Treasury seem paltry indeed.
Federal Reserve assets in billions of dollars. Data source: Federal Reserve Release H.4.1..
Fed Chairman Bernanke has reiterated again and again that he will do "whatever is necessary" is to keep the credit system functioning. In addition to taking over much of the formerly private credit market, the Fed has dramatically lowered interest rates it charges for loans — effectively to zero as of December 16, 2008. At that time, the Fed announced it intended to buy long-duration treasuries — causing an almost instantaneous 10% rise in the price of 30-year Treasuries (and corresponding fall in interest rates). Since then, the Fed has announced $300 billion of loan purchases to be made through it Term Auction Facility (TAF – or "TAC" in above chart). The Feds actions in the current crisis are without precedent. Clearly, Bernanke is not timid.
But, will he succeed?
To succeed, banks need to be willing to lend to business and consumers, and consumers and businesses need to be willing to borrow. There are plenty of funds in the banking system, but it takes more than funds. It takes a willingness to lend and a willingness to borrow. This willingness depends in very great part on people’s expectations about the future course of the economy.
The Collapsing purchase viagra | buy cialis generic online | levitra buying Economy The acomplia cheap BIG problem is that the financial crisis is not happening in isolation from the real economy. The two are inextricably interconnected, and as the financial sector imploded and banks refused to lend to anyone really needing credit, the real economy started to collapse. The fall in housing prices and the tightening of credit standards shut off borrowing against home equity to finance consumption — a big underpinning of the economy in recent years. Credit card companies stiffened their standards and raised lasix buy online interest rates — further reducing the financing of consumption. Commodity prices collapsed, bringing Buy Viagra investment for capacity expansion to a virtual halt. The auto industry collapsed. Unemployment shot upward, further reducing income to support purchasing.
The collapse in home, stock, and bond values represent a HUGE decrease in people’s wealth. In 2008, the value of people’s homes declined by an average of about 25%, the stock market lost 40%, and bond markets 10%. The total value of losses in wealth in the US in 2008 are on the order of $15 trillion, or roughly 25% of people’s total wealth accumulated over lifetimes. Add to this actual loss in wealth the possibility of further losses and fears about economy. It is no wonder that consumers have drastically cut back on their expenditures, creating new downward pressures on the economy.
The results for the Christmas buying season are bad news, with declines in some sectors greater than any in many decades. The collapse in retail sales will lead to many retail bankruptcies and more unemployment. This will in turn further impact commercial real estate prices, which have already begun to follow home prices downward. The pace seems likely to accelerate buy Cialis Professional cialis internet in 2009.
Everywhere one looks, the economy is headed downward. There doesn’t seem to be a single bright spot, nothing significant that could expand to offset the certain contraction in construction, finance, autos, and retail sales. Everything is heading downward together — not just in the United States, but all over the world.
The Financial and Business Connection Business cycles are levitra brand price nothing new, of course, and we’ve been through many of them with only minor discomfort for most. What makes this one different and dangerous is the interlinkage between the economy and the fragile financial sector. Many parts of the financial system are still highly leveraged (with loans outstanding that are a large multiple, 10 to 30 times, of their underlying assets). As the economy slumps and bankruptcies rise, more bad Silagra loans and defaults will occur, in turn pushing more financial institutions to insolvency. This in turn propecia buy will push the economy further Viagra Jelly down — a self-fulfilling feedback loop downward.
The banks are all too well aware of the risks created by the falling economy coupled with the difficulty Online Levitra buy of businesses and individuals borrowing money (which difficulty the Viagra online banks are largely creating because of their own fear of risk); therefore the banks are only Buy Viagra, Buy Cialis, Buy Levitra Without Prescription loaning at reasonable rates to the most creditworthy — despite all of the buyviagra | buy cialis overseas | buy levitra drugs Buy Zithromax Online Pharmacy No Prescription Needed funds that Federal Reserve has been pouring into the system. online pharmacy 
As shown in a previous post (Fed Driving Down Long-Term Rates, but Who Is Benefiting?) Fed actions have lowered the cost of borrowing to top-rated borrowers, but not to those with less than impeccable credit. The chart on the right (from Bespoke Investment, December 29, 2008) shows that high-yield bonds have interest rates about 20 percentage points (2000 basis points, or bps) higher than comparable treasury bonds.
There has been a fall buy cialis soft recently, as buy generic viagra professional | buy cialis pharmacy | cheap levitra generic the market has been in a period of calm, but the rate is far above what most business could afford.
(The drop has accelerated in the last few days. This says more about financial market perceptions than financing availability.
online drugs no prescription We will have more to say about this in our outlook for the stock and bond markets in Part II.)
The huge interest rates that ordinary businesses need to pay, if they can get loans at all, is one of the big obstacles to reversing the downturn. But, as long as the dominant view is that there is a significant risk of a major collapse in the economy, these high interest rates for non-prime borrowers will persist despite all efforts of the Fed (unless it decides to start buying up risky bonds in large amounts, driving up their price and driving down the interest rate. Might they do this? Based on recent history, it could be possible, though more extreme than anything they’ve done so far.)
A key to unlocking the interlinked forces driving the economy and financial sectors downward is to have some major upward force in the economy, one sufficiently large to overcome the downward pressures. If Wall Street and the business community start to believe that the economy is going to reverse itself without collapse, then banks will begin to lend at more reasonable rates and businesses and consumers may begin to borrow and spend.
(Note, though, that initially much of the borrowing seems likely to be to acquire assets (homes, real estate, and businesses) at prices that will seem a bargain once people have a more rosy picture of the future. This will be great for asset prices, but it will do little buy cytotec Buy Viagra Professional Online to for the real economy.)
Where is the upward force to come from
? Enter the centerpiece of Obama’s economic plan — The Economic Recovery Act of 2009.
Economic Stimulus to the Rescue? Buy Antibiotics medications The classic economic solution to insufficient demand from the private sector is for the government to step in and step up its spending. The idea is that, just as the Fed has substituted for private lenders in the capital market, the government will substitute for private buyers in purchase viagra online | where to buy cialis | order online levitra the market for goods and services. Of course, it can’t finance its spending by raising taxes
because this would take away from the marketplace an amount equal to what it spends. This is not a big obstacle, though, because the federal government can borrow in essentially unlimited amounts. It just needs to sell as many bonds as it needs, and the Federal Reserve can ensure that there is plenty of money in the system to finance buying the bonds. This may buy Amoxil generic all seem like smoke Order Generic Accutane Online without Prescription and mirrors, but believe me, this apparent sleight of hand has stood the test of time and will continue to work until there is a serious flight from the U.S. dollar and U.S. Treasuries. Such a flight is nowhere in sight (though there are serious financial commentators who think it will occur at some point in the not-distant future if the U.S. continues its profligate ways).
It is no news that the Obama administration will undertake very big economic stimulus programs. The estimates in the press range from $700 to $1,000 billion over two years, or $350-500 billion in the first year. For perspective, the U.S. national output in 2008 was about $14 trillion; thus the stimulus will be from 2.5% to 3.5% of total national production. This is not an overwhelming amount of extra demand, especially in view of the rate at which buying has been contracting across the economic spectrum. Economists surveyed by Bloomberg last month projected gross domestic product would shrink in the fourth quarter by 4.3 percent, the biggest decline since 1982. The Obama plan is to use the money to build infrastructure components, such as roads, bridges, schools and other public facilities, promote renewable energy investment, as help out state budgets. amoxicillin buy Getting the money from Washington into the hands of those who will do the spending order kamagra is not going to happen immediately. Update: this morning’s news (January 5) reports that perhaps 40% of the Obama stimulus buy ampicillin cheap program will be "spent" on cutting taxes. Such tax cuts will put more money in people’ s hand
s relatively quickly.
Further, the funding emphasis of the stimulus program will enhance the ongoing shrinkage of the retail sector of the economy relative to public investment. The financial sector and housing sectors are continuing to shrink and this seems unlikely to reverse soon.
Thus, the proposed expansion of the economy through government buy xanax spending will need to expand parts of the economy while other parts shrink. Such sectoral shifts within the economy can’t happen instantly. People propecia online will need to move into new and perhaps different jobs.
Businesses in the favored areas will need to expand their capacity. Meanwhile, the downward momentum of the economy that is underway will still be in force.
The determination of the government to expand demand, regardless of the size of budget deficits, seems to make it likely that eventually the economy will be turned around without falling into depression.
At least, this is the conventional wisdom, and it is hard for me to fault this view. Significant questions will continue to linger for some time:
- How big will the stimulus program need to be before it works? Just as the Federal Reserve initially badly underestimated the magnitude of actions that would be required to prevent a financial collapse, the Obama administration may need to revise upward its stimulus program.
As the US is already facing a trillion-dollar annual federal where can buy viagra deficit, further increases will add to the already huge future costs of financing the debt. At 4% interest, which may be a reasonable estimate of the average long-term federal interest rates, each trillion of debt costs taxpayers annually levitra buy generic levitra website $40 billion dollars. The federal debt has reached $10 trillion, about 70% of one year’s total national production, and a long-term cost to taxpayers of $400 billion annually. At what point does the debt become "too large?" What if the rest of the world begins to fear for the security of all the Treasury bonds it holds and begins to dump them?- The US is not operating in
isolation. Its economy is part of the larger world economy, and economies around the world are contracting sharply. Many countries don’t have the freedom that the US has to pump unlimited money and spending into their economies (see Global Economic Meltdown), and other countries are reluctant to spend on the scale of the US. Will the combined actions of the US and other willing and able countries be enough to turn around the world economy? How quickly?
- Will new waves of credit crises threaten the economy? The huge, unregulated market of credit default swaps (CDSs), estimated as upwards of $80 trillion, still hangs over the financial sector like a sword on a thread.
The two-stage bailout of AIG was undertaken primarily to keep the CDS market from imploding. How many more times can the Fed successfully plug holes appearing in the dike
?
The Financial Markets — Part II of the Story
The economy and the credit situation constitute the environment in which the stock and bond markets operate, but these financial markets operate in many ways separately from the "real world" of economics. They are influenced nolvadex buy by expectations of the future more than the current situation, and they have their own internal buy levitra online influences that sometimes appear to have little to do with anything outside of the markets. amoxicillin
Part II of my 2009 investment outlook will look directly at the stock and bond markets. I will draw on sources that I respect and try to give you my sense of which scenarios seem more likely. To give a hint: While the economy is heading down sharply, there are numerous indicators that suggest the stock and bond markets will rally for a while. Longer term, the market is more likely to need to adjust to downward surprises than to be lifted by unexpectedly good news.
Hi Vince,
It’s good to hear from you, looks like you’re off to a good start in the New Year! I appreciated reading your incisive commentary and analysis of our economic problems. I, like many, have been trying to sort through all this to determine an appropriate course of action. I’ll look forward to reading Part 2 of your investment outlook and reviewing some of the past articles. Thanks for thinking of me, and best wishes for the new year to you and your family.
Mike
Mike