Eric Sprott and Sasha Solunac
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.
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