Weekly Commentary

WEEKLY COMMENTARY

January 29, 2002

CREDIT CRISIS

By James R. Cook

While on vacation I read a number of excellent commentaries on our faltering economy. If you haven’t read them, here are some excerpts:

Dr. Kurt Richebacher tells us, “If this recession extends with further pronounced profit declines, credit problems will mushroom. The development of a general credit crunch, like in 1930, under these conditions seems only a question of time.”

Along the same line Bill Buckler warns, “The potential for gigantic fiscal, monetary and market upheavals in the year to come is clearly huge.” Martin Weiss explains, “Debt is dangerous. Deflation is worse – it destroys the ability of borrowers to pay back debts. Throw the two into the same pot, and the resulting explosion can blow up the ‘strongest’ economies, sabotage the most ‘astute’ central bankers, and destroy the wealth of the ‘smartest’ investors.”

Mr. Weiss goes on to tell us, “Nearly every nation is on the verge of a debt-and-deflation blowup, threatening to drive its economy into the gutter and its stock prices into the toilet. As a result:

· “ U.S. banks and investors will be slapped down or even wiped out.

· “U.S.-based multinationals will get killed, their exports gutted, their foreign subsidiaries in shambles.

· “Worst of all, foreign investors, who now own a whopping $10 trillion in U.S. assets, will have no choice but to begin dumping their holdings at any price.

“Don’t underestimate this. Earnings are the most powerful force driving the stock market. And right now, the stock market has recovered…but earnings have not!”

John Hathaway states, “The essential feature of a deflationary climate is that debt burdens drive decision making by corporations and policy makers. Too much debt causes the economy to contract because interest and principal must be serviced by asset sales. Not only do general price levels decline, but so also do asset prices including stocks and real estate. Declining lender confidence in asset values causes credit to contract further. A weak economy amplifies debt burdens by cutting income, cash flow, and expectations. The greatest threat to economic growth then becomes a psychological shift that favors debt reduction over expanded consumption or investment. That is why the current thrust of US economic policy is to reduce the real and psychological impact of debt. The sole sign of its success will be a subsequent increase in the indebtedness of all sectors. Fearing a market-driven full-blown recession, which would restore liquidity and thereby establish a sound basis for long-term expansion, policy makers prefer the short-term solution of digging an even deeper hole.”

Adds Felix Zulauf, “the Fed keeps trying to cure the problem with the same medicine that caused the problem.”

John Myers warns, “Today, the whole world is addicted to fiat money and debt. Debt makes sense when money supply is feverishly being expanded, since future money is always going to a discount. The system keeps the addicts coming back, while eviscerating the saver and the producer. The biggest addict today is the United States government. It has made promises and incurred debts so huge that they cannot be paid in terms of money with anything close to today’s purchasing power.”

States Money Manager, Donald Smith, “In an economy as leveraged as ours, you can’t prime the pump every time there’s some international crisis, and just keep the thing going. You need time, or slow periods, or recessions to correct the imbalances, and we really haven’t had that. Which is why the excesses, particularly in asset valuations, got to such extremes.”

Continues Smith, “I’m not so sure that this recovery is going to be nearly as fast or sustainable as the consensus believes. I certainly don’t think it will flow down to corporate profits enough to justify the current S&P price.” Adds Mark Rostenko, “The economy and the market are falling and to say when they will stop falling is based on nothing but hopes and dreams. We can only say that the economy is improving when we see that it is improving. Until then, it’s not. And no amount of prattling about what will happen makes any difference.”

Concludes Dr. Richebacher, “The most important thing to realize about the present U.S. economic downturn is that its root cause is a savage profits crisis. Profit margins are at their lowest in the whole postwar period. This has several reasons, but high-tech production is the worst performer. Most of these firms’ profits in the past few years came from huge gains in the stock market.

“Another generally unrecognized major risk in the development is the extremely bad and still worsening shape of corporate balance sheets. This increasingly aggravates companies’ already severe difficulties financing capital spending.

“Downside risks remain overwhelming. For the time being, the markets are buoyed by trust in the predicted, imminent V-shaped U.S. economic recovery. Its failure to materialize will come as a tremendous shock to everybody with shattering effects for all segments of the financial markets – stock, bonds and the dollar.”