Saturday, April 18, 2015

Could the Economy Crash? Probably Not.

A lot of people waste a lot of energy hoping the world will come to an end.  Why is this?

I saw a discussion group the other day, and the topic was "collapse of the world economy" and everyone on the group assumed this as a baseline assumption - the only questions were, when and how?

As I have harped upon time and time again, in any discussion or debate, challenge the underlying premise.   And here, the premise is, everything is going to fall apart.

You can never go broke selling bad news.  People love to hear it - depressed people.   Folks are pining for the end times, and are easily convinced they are around the cornerHollywood loves to make movies about it.

If you are broke because you spend every last dollar on new cars, smart phones, and designer coffees, then such thinking is comforting.   After all, why bother saving, when the world is just going to end anyway?

Or, instead of saving, just spend your money on a bunker, ammo, and gold coins.

Problem is, thoughout our history, people have thought this way, only to end up with damp, water-filled bunkers, moldy ammo, and worthless gold coins.  We saw this in the 1950's with the "red scare" and we've seen it since then.   In the late 1970's, people were 'hunkering down' for the end of the world, as gas was being rationed, along with coffee and peanut butter (I kid you not).

Things got better, though.   Ahhh, the best laid plans can be ruined by stupid optimists!

Will the stock market go down?  Of course it will.  It has been on a tear since 2009, the longest post-war bull market except for that under Clinton.  An adjustment will come.

But you know, a funny thing, in 2009, we had a helluva "adjustment" to the stock market, and yet, six short years later, here we are, still hanging on, and the world ain't ended yet.   And prognosticators have been predicting a "second recession" for years now.

Could we see a market meltdown?  Maybe.   There are a few possible scenarios.

1.  Stock Market Meltdown:   If stocks become too over-valued, a correction could be due when people realize that they are not worth what the market is charging.  We saw the same effect in the Real Estate Market, when there were too many houses, and not enough buyers.

But are stocks over-valued?   Some are, to be sure.  There is a lot of hype in our stock market.  The media only reports share prices, not earnings or dividends.   We hear a lot about hyped IPOs and trendy tech companies.   We never hear about the guy who makes bulldozers or whatever.

The reality is, there are still a lot of companies out there paying dividends on a regular basis, who have P/E ratios in the 20's.  These are companies that are profitable and whose stocks are rationally priced.

There are a lot of other companies out there with P/E ratios in the hundreds, with no real earnings to speak of, no real plans to make earnings, and no real way to make a profit in the near or short-term.

Most of these are website-based companies like Linked-In, which has an astounding P/E ratio of over 2400.  (Look at it this way, the P/E ratio is the number of years you'd have to wait to earn your money back).   People "project" the ratio will go down over time, but there are no real concrete plans on how this is supposed to work.   "Social Media" doesn't make much money, if any, and trying to put ads on it seems to kill the buzz.   Plus, the fad-aspect of it is coming to the fore, and many younger people are moving on to other things.

So yea, we could see yet another "dot com" meltdown, which would pull down the market as a whole, at least for a while.   But I don't think it would spell the end of our financial system.  We've had two "dot com" meltdowns before, and we've survived them nicely, thank you.

Another prospect is that in 10-20 years, all us 401(k) babies will start retiring and spending our money which means taking it out of the market.  Supply, meet demand.   As money starts going out of the market, we could see a big drop in stock prices.


2.  The Oil Meltdown:  The price of oil is down, and down artificially - as the Saudis have flooded the market with oil.  Why they are doing this is the subject of conjecture (although I suspect more than a few people know the real score).   They are trying to get even with Putin, who is meddling in the Middle East.  They are trying to lower oil prices to kill off the fracking boom.   They are lowering oil prices to kill off alternative energy.   They are lowering oil prices to get us all to stop conserving.  My theory?  All of the above.

What is clear, though, is that it is an artificial market adjustment, not a real one, and any day now, the Saudis could close the tap, and prices might skyrocket. 

Or maybe not.  With Iran's reserves coming online, we may see the market flooded.  And the Russians have to sell oil or go broke - further broke.

And then there is the question as to how this will hurt the US economy.   Oil companies are the last of the vertically integrated businesses.   Think about it - they explore for oil, they drill for oil, they transport oil, they refine oil into gasoline, and then they sell gasoline (and beer and donuts) in their name-branded stations.   Complete vertical integration.

The price of oil really isn't relevant.   Do you have a barrel of light crude in your living room?  Of course not.  But you buy an awful lot of gasoline.   So the price of oil doesn't affect profitability of major oil companies as much as you think it would.   They still sell us gas - at a profit.  The price of oil is down, but the demand for fuels is not.

Small oil companies, oil exploration companies, and companies that supply the oil business are sure to get slammed if depressed oil prices continue for another year.   But Exxon and Shell?   Maybe less so.

A complete market meltdown?   Probably not.  While low oil prices may negatively affect the energy sector, they positively affect other sectors.   The boom-boom Clinton years were fueled in part by cheap oil and cheap gas.   When gas was 87 cents a gallon, well, people had a lot more money to spend, and places to go.  Production costs were lower.  Airfares were lower.  It stimulated the entire economy.

Low oil prices could turn around the lagging economies of the rest of the world.  We'll see.

3.  Government Debt Meltdown:   One scenario posited is that mean old Obama has been mortgaging our future with government debt, and that China (or Japanese, take your pick)  will "call in all that debt" and we will be bankrupt.  This is, of course, a childish view of the world.  Treasury notes are not callable, except by the Treasury.   The Chinese are more beholden to us, than we are to them.  By holding our debt, we have them by the balls, not vice-versa.

Ask anyone who has a bunch of Greek debt, how this works.

But a more mature argument is that the increasing national debt could lead to increased inflation, if interest rates rise and short-term notes have to be refinanced.   This is at least a valid argument, but one that has qualifications.

Alarmists like to point out how many "Trillions" of debt we have, or how it has risen over the years, in proportion to the GDP.    But in 2009, the GDP went into the toilet, so the ratio went up (numerator versus denominator - remember fractions?  Oh, right, they were "hard" and "you don't need to know this in real life" - I wonder why I bother trying).

But of course, our real debt load wasn't accumulated by Obama, but by Bush, and since the economy has recovered, the national debt - as a percentage of GDP, has leveled off slightly or gone down, depending on how you calculate this.

Given that interest rates are so low, the Treasury department has been busy buying back older, higher-interest rate debts, and issuing newer, lower interest-rate debt.   Some on Wall Street criticize this move.  They were the ones holding the older, high-rate T-bills.

One scenario that is scary for us oldsters is that if the debt does not go down over time, and interest rates rise, the government will have to pay more to service this debt, and as a result, raise taxes or print more money, fueling inflation and effectively wiping out our savings.

The budget deficit on the other hand, has started to fall, and if the economy continues to grow, should continue to fall.   The national debt could be paid off in a relatively short time - as it has in the past (after WW II, and during the Clinton years, where we flirted briefly with a budget surplus).

So, this ends up being another one of those "maybe" kind of things.   So long as the economy improves and interest rates stay low, we're fine.   If these things go south, there could be a snowball effect.

4.  Foreign Crises Meltdown:  War in Syria, Yemen, Iraq, Ukraine, whatever.  The rise of ISIS, sabre-rattling by the Chinese, Putin's ambitions - it all sounds so scary.   WW III is obviously going to break out any minute now!

While not trivializing these problems, we should not let the media magnify them, either.  Syria is an important country in the middle-east to be sure.   But it is hardly larger than the State of Georgia - about 1/3 the size of Texas.    While what is going on there is horrific, it is not clear that these relatively small regional disputes are really going to seriously affect the world economy.

In fact, it appears that continual war in the Middle-East is good for business - as sick as that sounds, and is.   So long as Sunnis fight Shiites, we pump out the oil at bargain-basement prices, and then sell these folks (on both sides) highly overpriced munitions and arms.

The real threat to the world economy?   If Arabs got together and realized that they should form a pan-Arab union, pool their resources, and support, rather than fight each other.  That would be truly scary.

If that sounds crass, so be it.  But it is reality.   We will keep using "divide and conquer" so long a Sunnis and Shiites are dumb enough to see each other as the real enemy.   And we will keep driving a wedge between them, using a wedge-shaped country known as Israel.   We don't want an end to the "Palestinian Problem" - we want it to fester like an open wound, and keep the Arab countries obsessed with Israel.   We are just baiting them - trolling them - on a massive scale.

What would really be scary would be a pan-Arab alliance that recognized Israel.    How could we control such a thing?

But alas, that does not seem likely to happen.   The Arabs will always call for the destruction of Israel, and it never will happen, of course (it is just like Latin American leaders blaming all their problems on us - it is good domestic politics!).

And the really crass thing is, war is good for business.   So long as these folks keep fighting one another, my Lockheed and Boeing stock continues to climb.

Could a global war trigger a collapse of the US Economy?  Only if peace breaks out.

But what about Russia?  What about the Chinese?  I heard they were building runways on an island!

Relax, Cletus.  We spend more on our military than the next ten countries combined.  And that includes Russia and China, combined.   We have 10 aircraft carriers (or 19, depending how you count them).   China is building their first - based on the rusted shell of a Russian hand-me-down.   In terms of military conflict, the Chinese might make a stab at Vietnam over some disputed island, but it is not likely they are going to attack their largest trading partner - whose money props up their economy.

Russia, of course, is a little more unpredictable, as Putin is just nuts, of course.  Or is he just clever?  Her uses nationalism to stay in power, and little proxy wars are ways of getting people to stop thinking about how the economy is now worse than under Stalin.   His little fly-bys and submarine adventures are designed for domestic consumption.   Trying to make the folks back home feel that Russia is a "superpower" once again.   A superpower, however, that is quickly running out of money.

And before you chime in about the "poor folks in the Ukraine!" look into the Ukrainian government - one of the most corrupt and evil in the world.  Four Ukrainian opposition leaders have been shot dead in recent months, and nothing ever comes of it.  There is a reason we are not rushing in to support the Ukrainian government.

So, I am not sure this is a big game-changer, either.  Bear in mind that we just went through two wars that were far more involved that these little regional disputes going on today, and we've managed to do OK, even with the 2009 recession.

So I have to put this one down as a "not likely, and if it does, we'll make a mint out of it!"

* * * 

But of course, this raises the question, is there anything you can do to protect yourself from another economic meltdown?

And the answer is, no, not really.

That is, other than to diversify your portfolio, pay down debts over time, and save up money.   Trying to design a strategy to fit a specific future scenario  is gambling that such a scenario will have to occur.   You are better off betting on all scenarios.

So buy stocks - rational ones, not gambler's bets on IPOs - and hold them.   Buy bonds, government, corporate, municipal, whatever.  Buy Real Estate - and profit from it, not lose money.   Even insurance or annuities.   All in proportion.  Not all in any one thing.

Buying ammo, gold, and canned goods?   A very narrow scenario - complete economic meltdown - would "pay off" with such an "investment."   And frankly, if things got that bad, would you really want to be around to duke it out with your neighbors for that last can of creamed corn?  Of course not.

But there are a lot of folks who believe this way.  Like I said, they have their own discussion group, and the baseline assumption is apocalypse.

But what happens if everything goes horribly wrong and the world doesn't end?  Well, they are screwed, royally, is what.

When I was 17 years old, my Dad sent me to an American Management Association summer camp of sorts.  It was a long-weekend kind of thing, and we had sessions and seminars for "Future Managers of America".  

One of the discussions was about whether we thought, given the horrific economy (10% inflation, 10% unemployment, 14% mortgages, rationed food and gas, hostages in Iran, imported cars, and so forth) whether the "system" would collapse around us.   And I said "no" then and the instructor asked why.

The answer I gave, which I think was the correct one, was that "too many people have too much invested in our current system to let it go" and I think that is still true today.  People are trying to start a drumbeat of discontent - saying that America is no good, or that Obama is going to declare Marshal Law and put us all in detention centers in old Wal-Marts.

But it is silly talk.  Deep down, we know how cush we have it here.   And even when the system seems stacked against us, few of us want to try some other system entirely.  Look around the world, do you see any better alternatives?   Of course not.

Funny thing is, back at that AMA session, I opined that large companies like GM were "too big to fail" and that the system would soldier on.   Within a year, I would be working for GM.  Three decades later, GM would go bankrupt.

Funny thing, though, GM is still around.   And even if it wasn't, something would have taken its place.   People still need and want cars - and all the other crap we consume here in America.

So I guess that is where I place my money - in human nature.   People don't really want the end of the world, they just want to consume more and more stuff.   And so long as people are people, we may have ups and downs, but going back to a feral existence is not likely to occur.

And if it did, there isn't much you could do to prepare for that.

1 comment:

  1. A reader in the oil business says that the reason the price of oil tanked was more due to US production (fracking, Bakken formation) than with the Saudis increasing production.


    "America has become the world’s largest oil producer. Though it does not export crude oil, it now imports much less, creating a lot of spare supply. Finally, the Saudis and their Gulf allies have decided not to sacrifice their own market share to restore the price. They could curb production sharply, but the main benefits would go to countries they detest such as Iran and Russia. Saudi Arabia can tolerate lower oil prices quite easily. It has $900 billion in reserves. Its own oil costs very little (around $5-6 per barrel) to get out of the ground."

    So maybe both explanations are correct. We have increased the supply of oil, driving prices down (and demand is down). The Saudis could curtail production and keep prices high, but choose not to.

    But all it would take is one Arab oil embargo to put our weenies back in the wringer - again.

    The next oil "crises" can't be more than a few years away... if history is any guide!


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