Debt-Addicted Economy Exits Rehab

My primary “big picture” analysts are both predicting that the economic recession ended on June 30. Pent-up consumer demand, government spending, and a relaxation on the business community’s embargo on inventory re-stocking are working together to move the needle positive on economic growth for the next few quarters.

I am extremely cautious however I don’t want to be dogmatic about things. Facts trumpet ideologies and the facts include a stabilization of the economic downturn and trillions upon trillions of government stimulants helping to fuel this modest upturn in spending. The government has taken over banks, auto companies, and now it is trying to take over the role of consumer spending. A few quarters of economic growth, which the econometricians will likely label a recovery, wouldn’t surprise me as the economy gasps for breath after a six-month hiatus in which pocketbooks were locked down tighter than a Jack Benny comedy routine.

So after a few months of counseling (Nancy Pelosi to CEO’s, “don’t fly private jets”) and an injection of stimulants (like the original “Cash For Clunkers” program that bailed out overleveraged and overpaid financiers at Goldman Sachs, AIG, Morgan Stanley and others), our debt-addled economy has been pronounced “cured” because the stimulant cupboard is bare and we really can’t afford to re-fill it. The economy is being re-released into the community with hopes that it won’t re-appear as a multiple offender.

Unfortunately, this debt-addled economy is far from cured. It is still addicted to smack but the bank regulators have screwed the lid down on the banking system. The inmates are still in charge of the asylum on Wall Street, sucking the blood out of corporate America as it lines up to refinance upcoming debt maturities.

The markets may have rallied, but the markets are a manic-depressive with such incredibly bad judgment that companies that didn’t even make sense when scribbled on a napkin were able to obtain billions in financing just a few years back. As the financial system was spiraling out of control in October 2007, Wall Street’s financial sector analysts were writing reports about bargain hunting. Believe me, just because the markets are flashing that “the coast is clear” is no reason for optimism.

Instead, I see long-term interest rates that have risen about 2% in the midst of the most severe economic weakness since 1929 due, I believe, to the trillions of treasury bonds that need to be sold (to somebody) in order to finance the current rehab program. I see a Federal Reserve that talks the talk of easing, but a gaggle of bank regulators who are knee-capping real estate investors when they try to roll over bank loans. I see corporate America trying to preserve profit margins by laying off consumers, and then wondering why revenues are gliding lower.

I fail to take comfort in lower job losses because the job growth that is required for a real recovery to ensue are unlikely in this world where a potential employer health mandate has businesses too frightened to even think about adding to their labor pool.

To be fair, everything is in place for a typical economic recovery. We have stimulus “out the wazoo” (can’t you picture the old E-Trade commercials circa 2000?) and low inventory levels and pent-up demand. Normally, this is enough. But this time we also have a debt problem so oversized that our creditors don’t dare call their loans because it would send us both into bankruptcy. Financing stimulants “crowds out” job-creating private investment. In other words, scarce investment dollars that are desperately needed to finance capital investment and job growth are set to be confiscated by the government to pay for a SuperSizing of the government's role in American life. A weakening U.S. currency threatens to create inflationary pressures that would rob consumers of purchasing power.

The bottom line is that I believe that the economic recovery which may well have started on July 1 will be short-lived. The market has rallied from the March bottom. The rally looks to fully reflect today’s rosy economic forecasts, but what it really cares about is “what’s next.” I think investors need to look forward toward a double-dip recession when the economy falls off the spending wagon early next year.

"Helicopter Ben" Bernanke threw the Federal Reserve’s medicine cabinet at the economy during the past few months. However, an ancient Chinese proverb says that it is easy to get a thousand prescriptions but hard to get one single remedy. We now have a hefty pharmaceutical bill to pay off, and I’m afraid we’re still waiting for the remedy.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

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