Money Sage (archive)

It is frequently useful, we think, to read the analyses and commentary of foreigners about our economy. Often, foreign analysts and journalists have a good deal more perspective than their American counterparts. Apart from those among the former irrevocably hostile to us, the generality of informed foreign observers and opinion-makers have no personal emotional involvement with America's current and prospective economic state.

In light of this, we find it very interesting to note the sharp difference in foreign versus domestic commentary and assessment of our economy. Our own analysts and commentators obsess about whether or not we will cross the line from "slowdown" to "recession," as if this tendentious distinction has any real significance. Among those who assert that recession is likely, or will soon be underway, or is even in train right now, there are differences between the large majority who insist it will be a short recession, to be followed by a nice recovery, and the minority who contend that it will be considerably more serious. There is a parallel debate over WHEN -- not WHETHER -- to buy stocks, what stock groups to buy, and what individual securities to purchase. As for those who own stocks, the generality of "expert opinion" is that investors holding equities or equity mutual funds should "ride it out," because the market always comes back, you cannot time the market, if you miss the initial jump you will miss out on most of the gains, etc etc etc. We believe we have heard this claptrap before -- in the spring of 2000, for instance, and in the early stages of other major bear markets.

Not only are many of the preconditions for a milder version of the Japanese disease present here -- as they were in Japan in 1989 and in the subsequent years -- but the response of the authorities is eerily reminiscent of the Japanese response. Thus, we have fiscal stimulus (i.e., heightened deficit spending) though we do not yet have hundreds of billions spent on "roads that lead nowhere," as is the case in Japan. The central bank, FINALLY, is driving rates down and producing liquidity, but American banks, like their Japanese counterparts over the past twenty years, are both unable and unwilling to lend. Finally, borrowers here, like borrowers in Japan, are either unable or unwilling to borrow.

Many foreign analysts and observers, by contrast, are now referring rather frequently to the current economic situation in the U.S. as "the American disease." They suggest that there is a very serious structural problem (or, problems) with the American economy, which will take a long time, and entail much pain, to work out. Implicitly -- or explicitly, in some cases -- they are comparing the "American disease" to the "Japanese disease."

The severe -- and WORSENING -- bear market in residential real estate, the severe impairment of the lending capability of a near-insolvent banking system, the collapse in a number of important credit markets and the intensifying pressure on others, the prospective bear market in commercial real estate, the deepening bear market in "high yield" bonds and junk bank loans totalling hundreds of billions, and the spread of these infections to Europe, suggest to us the mounting possibility that the U.S. has contracted, or is in the process of contracting, a somewhat milder version of the "Japanese disease." In other words, we may well NOT be looking at either a mild, garden variety recession, or a more severe recession (1981-1982; 1974). Rather, we may be looking at an economy moving toward multi-year stagnation, catalyzed by a collapse of the real estate bubble, with the potential of inducing a very protracted bear market in real estate and stocks.

Of course, real estate prices here never reached the insane, astronomical levels of Japanese real estate prices in the late 1980s. On the issue of equity prices, however, the comparisons are less reassuring. The Nikkei peaked at 39,000 in the autumn of 1989, selling at 60x earnings. Our own blue chip equities sold in the 40x earnings area as the recession developed and earnings collapsed in 2001. Our market rallied after only a 50% drop (the Nikkei, by contrast, declined 80% before bottoming). However, a serious economic downturn is now underway here, whether it is defined as "recession" or not. Serious earnings declines are in train, and the price/earnings multiple of the market has ascended to abnormally high levels.

What we are wondering is simply this: has the FED burst one bubble too many? Are the deflationary dominos finally falling? (See our earlier analysis, "Deflationary Dominos.") We are not certain, but we do know one thing: if the credit bubble, the granddaddy of all bubbles, has finally burst, there will be refuge in one and only one place: Treasuries.