The Reality of an Economy Built on OPiuM .
Team, I want to share some thoughts about an article I read last night on Bloomberg.com, laying out Paul Tudor Jones’ opinion on the economy.In a nutshell, he is saying that Goldman Sachs and Morgan Stanley are just wrong in declaring the start of an economic recovery. The gist of the article is that the massive government spending is delaying–not eliminating–the fallout from the excesses of recent years.
On the other side of the argument is Abby Joseph Cohen — a notorious bull who reality has proven to be either very late or very early, depending on whether you’re looking out your windshield or in your rear view mirron. For those of you who may be rather new to the market (i.e., you were doing something else about 10 years ago), Ms. Cohen is a highly regarded market strategist for Goldman Sachs. I remember her quite well back in 1999 and early 2000. She was using a “super tanker” metaphor to support her very vocal conclusion (for a while, it seemd that she was on CNBC nearly every day) that the U.S. was immune to an economic downturn because of the sheer size and diversity of the economy. The argument was that the various forces that were roiling the economic waters back then were simply too small to do much damage to the momentum of our “super tanker” economy.
Her theory was quite attractive. It made a lot of sense and she was quite eloquent and confident in her delivery. CNBC loved her! The bulls loved her! Everyone loved her. She was as popular as a bartender at a frat party. There was really only one flaw in her logic. That flaw was that it was completely devoid of anything even remotely resembling reality. She was just flat wrong.
Still, 9 years later she remains somewhat revered, albeit with a lower profile.
Without going into greater detail, let’s just say I’d put my money on Paul Tudor Jones, who is one of the traders profiled in Jack Schwager’s “Market Wizards” book.
I’m a pretty simple guy. I have found over the years that the simple answer is typically the right answer; while the complex, overthought and nuanced answer is typically the answer that you prefer, but is rarely proven correct.
Here is my simple thought process that governs my outlook:
As a nation (and perhaps as a planet), that mass of humanity with jobs and a desire for upward mobility was given the means to purchase goods and services they could not afford. What was the “means”? Cheap money! With money so “Greenspanian cheap” (read Bill Fleckenstein’s book for more on the revered former Fed chairman), real estate went “boom”. At the same time, deregulation of the financial industry was occurring at a remarkable rate. The result was that money became even cheaper because of the leverage that was allowed by our new “capitalist-friendly” regulatory structure.
This was a win:win:win! The average Joe was able to buy that new car and a big house with a 3 car garage. Six months later, Joe could simply refinance his house and “unlock that equity”, enabling him to buy even more stuff. The financial industry was happy because profits were soaring due to the demand for loans. The packaging of derivatives was a huge industry (and something that I first learned about in F.I.A.S.C.O., an excellent book by Frank Partnoy which described the derivatives market in detail, including the inevitability of an unhappy ending. His book was largely ignored because the frat party was raging.) Our elected officials were also content because their constituents were doing well. Simply put, the economy was hooked on OPiuM! (No, not the drug. “Other Peoples Money“)
So everyone was a winner until the music stopped.
Almost immediately the financial industry sought help from the taxpayer. We know the rest — big bailouts for the very firms (like Abbey Joseph Cohen’s employer, Goldman Sachs) which got us into this mess. These inefficient and irresponsible firms were bailed out in lieu of allowing capitalism to thin the herd of sick animals.
And the current solution that is likely to make the economic numbers look better in the months ahead? Cheap money and massive government spending! Government spending is included in Gross Domestic Production [“GDP”] numbers. As such, we can literally buy ourselves out of a recession by jacking up the numbers through the spending of taxpayer dollars. We are in the process of doing that right now, and that process will continue through next November.
The notion that spending good money after bad in this fashion has never made sense to me for the simple reason that money is not free. It might be “cheap”, but it is not free. So as a nation (or planet…depending on how far into the distance you wish to look) we are effectively paying off our credit cards by printing more credit cards and using them to pay off the existing balance. Because that has never worked in my personal life (believe me, when I was much younger, I was in such dire straits that I tried it. No joy.), I cannot believe that it will work on a much wider scale. Instead, I expect the same result on a nationwide scale as I experienced on an individual scale: at some point the debt must be paid with something other than borrowed money.
This is a simple theory based on my personal experience and a modest application of logic and sequencing. It is not “results oriented” because I’d much rather see the current strategy be wildly successful. I think everyone would!
One last point — while our current approach is widely justified by the simple conclusion that “things would have been much worse if we had done nothing”, such an approach misses the mark entirely. Our current economic condition is impacted by what is actually being done, not on what would have happened had we done something (or nothing) else. This is a critical point to understand and accept. If you miss this subtle but essential point, then it’s easy to fall prey to the “blame game”.
Assigning blame is not solution-oriented. The market is not moved by blame; it is moved by reality.
My money (and macro-financial behavior) is betting that Paul Tudor Jones is right. I continue to believe that the economy will get slightly better…then much worse. I embrace the equities market and believe strongly that there is always money to be made by those who understand that the market often “de-couples” from the economic picture. We look at the picture…but we trade the market.
Oh, and one last point: Goldman-Sachs (and Morgan Stanley) received significant TARP money. As such, I do not at all believe that Abbey Joseph Cohen can be objective about the economy. I do not see how her stated outlook cannot be impacted by the the receipt of TARP money. To be bearish is to bite the hand that feeds you. Goldman Sachs is far too sophisticated to do that.
Anyway, just my two cents worth. If it provides some insight, great!
–Dan
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