Shape of US economy Shows that Spending Your Way Out of Depression Doesn’t Work

Day three, and still nothing from the property spruikers apart from statements such as “of course increased population leads to higher house prices.” There’s no of course about it.

Gee whizz, if your editor used such flimsy arguments when tipping a stock in Australian Small Cap Investigator or Australian Wealth Gameplan we’d be locked up.

Seriously, the basic argument put down by the spruikers is this: chronic housing shortage equals rising prices, and massive population growth also equals rising house prices. Therefore property investors get rich.

In reality, if the housing shortage is that bad, and the population growth as high as they claim, we aren’t looking at a get rich quick scheme, we’re looking at slums and ghettoes as 35 million people squeeze into 7 million houses – not counting the holiday homes of course.

But we’ll give the property bulls a while longer to come up with some real arguments and evidence to support their simplistic claims.

Until then…

We’ve seen a lot of bravado from across the range of politicians, commentators and analysts recently. None more so that Michael Pascoe.

If there is a bigger cheerleader for government intervention and the idea of spending our way out of debt, and that Australia’s banks are the strongest in the world, and buy property now while it’s cheap, then we’d like to see them.

Take his recent effort supporting the bullish view of the economy – rising airline travel. Again, another flimsy extrapolation of data if we’ve ever seen it.

Of course, he’s not the only one. Mainstream economic commentators seem to have lost their marbles over the last year. We wonder if they really are incapable of seeing the poor shape the US economy is in.

Forget rising airline travel, and look at two iron clad proofs that spending your way out of depression doesn’t work.

Reports overnight show that US auto sales fell 41% in September as the ‘cash for clunkers’ programme ended.

That sales fell in a heap doesn’t surprise us. That it surprised the market, well that doesn’t really surprise us either. Not when you consider most commentators inability to understand how an economy works.

The government can’t just borrow a few billion dollars from the taxpayer in order to give it to car manufacturers, so they can give a discount, and then hope buyers keep coming back when the discount ends.

One-off discounts may work for consumption items like peanut butter or bread or cereal. Give a discount this week, hope people give it a try and then maybe they’ll buy again when it’s full price next week.

Funnily enough people tend not to buy cars on a weekly basis. A discount, paid for by the taxpayer achieves absolutely nothing. Or nothing positive anyway. All it does is rip money from the future pay of taxpayers.

Because remember, the US government is broke. It doesn’t have any money to spend. It has to borrow it and print it.

The other news item that should be creating more concern than it is, was news of the 95th bank failure in the US this year.

That’s right, so far in 2009, ninety-five US banks have collapsed.

Why does no-one in the financial markets seem to care about this? Shouldn’t this be a sign that proves things are not good? Shouldn’t this be evidence that not just the US banking system, but every other banking system in the world is unsustainable and on the brink of collapse?

And don’t think Australian banks are any different. Like we’ve written before, we don’t care that they’re up 50% or more in the last few months, we still wouldn’t touch them with a barge pole.

Once you really stop and take a look at how banks operate, no-one in their right mind would ever invest in them again.

But back to the US bank collapses. The reason why no-one cares is the absence of moral hazard. Most depositors don’t care whether banks survive or not. That’s because as far as they’re concerned their savings are insured by the FDIC – a government agency that is effectively insolvent.

It means savers have no need to be careful where they put their money. If there was no savings guarantee or no implied savings guarantee, you can be sure investors would be more cautious with their savings.

If they thought the bank was taking too many risks they’d pull their money out. If everyone did that there would be a ‘run’ on the bank and then it would collapse. But the point is, there would be an incentive for the bank not to take unnecessary risks, and investors would be more careful about where they invested.

The irony of course is that even if savers don’t lose their dollars now, they will lose them over the coming years as inflation eats away at the value of their dollars. It’s the proverbial death by a thousand cuts rather than a swift jab to the heart.

But what about Australian banks? Does any of this have any relevance to them?

The answer is yes. Simply because banks worldwide operate in the same way. The difference is that Australia only has six banks, compared to thousands in the US.

But that doesn’t make things any better. It just concentrates the same problem into a smaller number of financial institutions.

Potentially that could make the problem worse in Australia when one of our banks collapses.

Of course, Australian banks are even more tightly aligned to the property market than those overseas. You only have to look at the spruiking from the economists at the banks to see that.

The fact is, it isn’t possible to borrow and spend your way out of debt. We would have thought even the mainstream commentators could have seen that.

Obviously not.

But does this mean that stock markets will rise, fall or remain steady? As you’ll have read in Money Morning, I’ve been cautiously bullish about the direction of the market, despite recognizing the major problems in the economy.

The key is to know when to get out. The borrowing and spending will have a short term positive impact, as it had with the ‘cash for clunkers’ programme in the US.

But longer term, just as that bail out wasn’t sustainable neither will the other bail outs, including those for the banks or the property market.

A twin collapse in the banking sector and the debt fuelled housing market will be the inevitable consequence.

The stock market won’t be immune, so you should continue to view it as a high risk punt if you’re after capital growth – a strategy we’ve followed and recommended to great success in Australian Small Cap Investigator.

Income producing stocks, while not immune either, should be chosen with care, and based on their ability to maintain dividend payments during another downturn.

The key here is to monitor your portfolio and set your own trailing stop levels to exit the market if you’re nervous. That’s the same whether you’re trading blue-chips or small caps.

Our guess is, the collapse hasn’t arrived yet as there’s still a whole lot more borrowing and spending that governments can do that will prop global economies up for a while longer.

If you’re brave enough to buy into the market before the weekend you could have picked up a few bargains as the economic rose-tinted glasses reappear on Monday.

But, it’s still a risk if you’re prepared to do it.

Other Stuff on the Markets

The S&P/ASX200 dropped 0.90% yesterday, while overnight on Wall Street the Dow Jones Industrial Average slumped 203 points. In Europe the FTSE100 crashed 1.68% and the CAC40 collapsed 1.97%.

The price of gold in Australian dollars is trading at $1,150.80, while in US Dollars it is trading at $999.36. And the price of silver in Aussie dollars is $18.83 and in US Dollars it is $16.35.

The Aussie dollar slipped versus the US dollar and Japanese Yen, trading at USD$0.8699, and JPY77.88.

Crude oil closed overnight at USD$70.43

For the biggest movers on the market yesterday click here…

Shape of US economy Shows that Spending Your Way Out of Depression Doesn't Work, 8.3 out of 10 based on 10 ratings

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