 Markets
at a Glance
So You Think 2008 Was Bad?
Welcome to 2009
Eric Sprott and Sasha Solunac
Sprott Asset Management
written January 2009
Posted Feb 4, 2009
By all accounts thus far, it's
already been a pretty bad year... and we're only three weeks
into it! If you will recall, 2008 was a pretty bad year for the
banking sector. For example, the shares of Citigroup, Bank of
America, and the Royal Bank of Scotland fell 77%, 66%, and 92%,
respectively, in 2008. So far this year (remember, this is only
three weeks) the same stocks are already down 50%, 55%, and 74%,
respectively. Like we said, 2009 has already been a pretty bad
year! For as bad as 2008 was, 2009 promises to be a whole lot
worse. The problem isn't just the banking system anymore. The
problem is the banking system and everything else. This
year, the financial crisis of yesteryear is morphing into an
altogether different animal. It's morphing into a financial crisis
that has an economic crisis layered on top of it. In fact, to
call the current environment an economic crisis is likely understating
the situation. What we really have is a global economic catastrophe.
One where weakness only begets more weakness, causing a vicious
circle that is proving nigh impossible to reverse in spite of
all the world's financial, economic, and political brain trust
throwing everything they have, including the kitchen sink, at
the problem.
In our last article, "Surviving
the Depression," [pdf] we mentioned how the world
is witnessing depression-sized declines in economic activity.
We mentioned how auto sales in the US were down almost 40%. How
housing starts were down almost 50%. How industrial production
is falling off a cliff, with each month worse than the last.
How jobless claims are at multi-decade highs. How consumer confidence
is at multi-decade lows. How the company surveys we follow are
showing dramatic declines across the board in economic activity.
We challenged the idea that this is a run-of-the-mill, minus-low-singledigit
recession and we characterized this Depression (there is no other
way to describe it) as "global, pervasive, and deep".
In the month since we wrote
that article, the data points have only gotten worse, and they
will likely have gotten worse still by the time you read this
article. US housing starts fell a further 15.5% in December to
550,000, the lowest on record. US industrial production fell
a further 2.2% in December, to a 7.8% year-over-year decline.
If you think that's shocking try this on for size: European industrial
orders (a leading indicator of industrial production) are down
26% year-over-year, the largest decline on record. Or how
about Japanese exports plunging 35% in December - shocking,
isn't it? Global steel production was reported to be down 24%
in December. All over the world, dramatic rates of decline in
economic activity are being reported. The most disturbing developments
have been in employment, which took a marked turn for the worse
thus far this year. US jobless claims are now running almost
600,000 per week. You don't want to annualize that number, but
you may have to. Layoff announcements have been coming fast and
furious since the beginning of the year. If we were to list them
all here it would take several pages. We are seeing dozens of
layoff announcements on the news each and every day. On Monday
alone there were lay off announcements totaling 70,000 workers.
There isn't a single industry we can think of that is unscathed.
A few examples: Circuit City (retail) laying off 30,000. Citigroup
(banking) is planning to lay off 52,000 over the next few months.
Microsoft and Intel (computers) laying off 5,000 and 6,000, respectively.
ConocoPhillips (oil and gas) is laying off 1,350 workers. Pfizer
and Wellpoint (healthcare) are laying off 2,400 and 1,500, respectively.
This just in... Pfizer
will now be laying off 19,500, or 15% of its combined workforce,
after its just announced acquisition of Wyeth. Philips (electronics)
6,000 layoffs were announced. Sprint Nextel (telecommunications)
8,000 jobs were just lost. Home Depot (building products) 7,000
jobs gone. Caterpillar (industrial equipment) is cutting 20,000
jobs, or 20% of its workforce. The list goes on and on and on.
Lest you think governments are exempt, the state of California
has plans to layoff 20,000 state employees, or 10% of its workforce.
It wouldn't be too much of a stretch to say that nobody's hiring,
and everybody's firing.
Unfortunately, we believe the
announced job cuts thus far are only the beginning. For the most
part, the drop in sales that companies are experiencing has been
far steeper than the announced reductions in headcount. Eventually,
employment will need to be more in line with sales. Which is
why we believe the unemployment rate will skyrocket in 2009.
Remember the 20%+ unemployment rates seen during the Great Depression
of the 1930's? Don't get lulled into a false sense of security
by thinking that those days are long gone, never to return. They
very well might before 2009 is out. As we mentioned in the introduction,
the world is experiencing a global economic catastrophe, where
weakness becomes self-feeding, begetting even more weakness.
As more and more people lose their jobs, their contributions
to the economy will decline. There will be more and more home
foreclosures and credit card defaults, and even more problems
in the banking sector, leading to further wealth destruction.
There will be even fewer people buying cars, or buying anything
for that matter. As consumer spending declines, so will corporate
sales, leading to further layoffs, resulting in fewer customers
and even weaker sales, etc. It's a vicious circle.
So why aren't the solutions
of the brain trust we mentioned earlier working? What about all
the stimulus? Central bank interest rates the world over are
the lowest they've ever been (essentially zero) and they've already
been adopting unconventional monetization/ money printing measures
not seen since the Great Depression. Then there is the TARP and
TARP II, and the hundreds of billions, if not trillions, of dollars
that have been thrown, and are still being thrown, at the financial
system to bail it out. Furthermore, governments the world over
are promising massive spending programs to kick start economies.
Both monetary and fiscal stimulus are set to full bore. Why isn't
al this stimulus working?
It doesn't take a Masters degree
in Mathematics to understand why none of this has made an iota
of difference so far. All it takes is a back-of-the-envelope
calculation of how much wealth has been destroyed over the past
couple of years. Let's begin with the stock markets. At their
peak, global stock markets had a market capitalization of approximately
$60 trillion. Since then they've dropped by half, resulting in
$30 trillion of lost wealth. That's just stocks! The other
major source of wealth for people is houses. Taking the US as
an example, the latest Case-Shiller readings show that housing
prices are down almost 25% from their peak. There are over 100
million homes in the US, and they once had an average price of
just over $300,000. Multiplying the three numbers together we
get $7.5 trillion of lost wealth in the US from the fall in housing
prices. Since the housing bubble was by no means confined to
the US (where, it was in fact quite tame compared to other markets),
let's multiply that number by four (the inverse of the US share
of global GDP) to get a conservative estimate for the global
fall in home values. That, coincidentally, equates to another
$30 trillion, for a total of $60 trillion in lost wealth,
give or take, just from stocks and houses. This doesn't even
include the losses from other asset classes that have been decimated,
such as corporate bonds, commodities, and commercial real estate.
But let's just stop there. This crude but simple analysis already
shows the magnitude of the problem that needs to be overcome.
The global wealth destruction that has taken place dwarfs anything
that has been spent on stimulus and bailouts. This is why it
has failed to stem the tide. A trillion or two or three (or even
ten for that matter) just isn't going to cut it. As desperate
and as generous as government solutions may seem, they are but
drops in the bucket compared to what's already been lost.
That said, we believe there
is another, even more fundamental reason why government solutions
can't work. Although there are those who would espouse that the
'free markets' have failed, we are of the belief that it is government
involvement in the free markets that failed. Specifically: (1)
central bank attempts to keep interest rates far lower than what
free markets would have warranted (especially post-9/11), supported
by the lie that inflation was non-existent, (2) the existence
of government-sponsored enterprises such as Fannie Mae and Freddie
Mac, fuelling ridiculous excesses in mortgage finance and credit
availability from ever-rising housing prices, (3) the moral hazard
that ran amok as it became obvious that financial institutions
can take egregious risks partly because they became "too
big to fail", and (4) the existence of an unprecedented
current account deficit in the world's reserve currency, financed
by government-run foreign institutions (central banks and sovereign
wealth funds). We believe it is these factors, especially the
first, that caused the bubble in the first place. It was predominantly
government-induced and not a failing of free markets. The end
result: too much debt and an economy that, at its foundation,
became dependent on people spending beyond their means. Those
days are likely gone, never to return. There's been a paradigm
shift - a permanent change. People will save rather than spend
more than they make. The implications for the economy are enormous.
Just envision a world where 25% of all shopping malls close down
and try calling that a recession.
So here we are today with governments
the world over taking an increasing role in the functioning of
the economy and the financial markets. But are they trying to
solve the main problem; namely, too much debt? Quite the contrary,
every single solution they've adopted has been trying to get
the good ol' days back. Cutting interest rates to zero. Throwing
money at the banking system so it can lend again. All these solutions
have one goal: to bring back debt. They are ignoring,
at least for the time being, the paradigm shift. But the markets
aren't buying it... literally. Debts continue to implode. Every
bailout is being followed by an even more massive bailout down
the road. The government's solution has been to shift debt from
the financial markets to the taxpayer. Is there a difference?
Instead of individuals living beyond their means, we now have
governments living beyond their means. Substitute taxpayers
for governments and you will quickly realize how the
whole thing is a farce. Take no solace in the fact that the government
is the buyer of last resort. It is really you who are
the buyer of last resort. In the end, people will be even more
indebted than they were before, setting the stage for the next
crisis: a currency crisis. This is why governments aren't, and
cannot be, the solution.
Government deficits are already
out of control, and this is before spending even a dollar on
fiscal stimulus. In the first three months of this fiscal year,
the US government ran a $485 billion deficit. This is already
worse than the deficit for all of 2007. In December, government
tax receipts were down an astounding 14% from last year. The
dramatic fall off in revenues is sure to have a greater impact
on government budgets than actual government spending. We're
seeing the same thing here in Canada. The latest forecasts show
the government going from a $13.8 billion surplus in fiscal 2008
to a $30-35 billion deficit over each of the next two years -
a $44 billion swing, at least. Yet, there have been barely any
announcements of new government spending. Most of the shortfall
is coming from a huge fall in government revenues due to the
weakening economy. Unfortunately, there is no free lunch. Every
stimulus and bailout comes with tremendous costs, not to mention
unintended consequences. These will only be further exacerbated
by the weakening economy.
We believe the problems of
2009 will make people yearn for 2008 all over again. In 2008
it was only savings and assets that got pillaged. In 2009 it
will be jobs and incomes that get lost. In 2008 we had the Madoff
Ponzi scheme, supposedly the largest fraud in history. In 2009
we have the US dollar Ponzi scheme - no contest. But to only
pick on the dollar wouldn't be fair. As governments the world
over take ever increasing roles in markets and the economy, all
paper currencies will be at great risk, pillaging whatever savings
people have left after 2008.
Welcome to 2009.
###
January, 2009
Eric Sprott and Sasha Solunac
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