Crisis Updates

“Synchronized recession”… The real consequences of bailing out Detroit… The next shoe to fall in the real estate sector… The death of the great American consumer… Betting against deflation…

* A UCLA Anderson Forecast report has predicted a deepening of the U.S. recession next year. Here’s a quick rundown of the main points it makes.

1. The U.S recession will get worse before it gets better
2. Lower oil prices are dragging down consumer prices in general
3. Real GDP will shrink by 4.1% this quarter and by another 3.4% and 0.8% in the first and second quarters of next year
4. The global economy is in a “synchronised recession,” the first since the early 1990s
5. Employers will shed an additional two million jobs over the next year.
6. By late 2009, the U.S. unemployment rate will hit 8.5 percent, compared with 6.7 percent in November

** The Bush administration has gone back on its promise not to use TARP funds to ‘rescue’ the U.S auto industry. It will now give GM and Chrysler $17.4 billion – $3.4 billion more than Congress was willing to payout.

This will tip the U.S. economy further towards a prolonged recession for three reasons.

1. The $14 billion will be only the first of many bailouts. But the U.S. has no savings to pay for these rescue efforts.This means the country will have to go further into debt to foreign creditors via Treasury auctions or print more money via the Fed’s printing presses.Either option will lead to serious consequences for the economy – consequences few are willing to face.Already there is a steep decline in foreigners buying U.S. government debt. This is because at the same time as the Treasury is auctioning off dollar-based securities the Fed is busy devaluing the dollar via the printing press. If this trend continues, we can expect one of two outcomes: higher interest rates or a significantly weaker dollar.The U.S can’t afford higher rates right now. So in the end, Uncle Sam will attempt to attract foreign capital the only way it can: by further devaluing the dollar to make U.S. assets cheaper to foreign buyers.
2. The auto bailout will create more “zombie” companies like those created by Japan in the 1990s.This will reduce U.S. competitiveness and stymie any genuine economic recovery.
3. The decision to extend public funds to the auto industry will create a cascade effect of more incompetent American companies looking for government money. This will leave President-elect Obama in a no win situation. If he says no to the bailout of the other companies in trouble, he’ll be seen as playing favourites with the automakers. If he says yes, he will be handing over a blank check to corporate America drawn on the U.S. taxpayer.

** The commercial real estate sector looks like it will be next shoe to fall in the credit crisis.

This from a recent Bloomberg article…

U.S. commercial properties at risk of default could triple if rental income from office, retail and apartment buildings drops by even 5 percent, a likely possibility given the recession, according to research by New York-based real estate analysts at Reis Inc.

The relationship between consumers and businesses is very clear. Businesses shutdown when consumers cut back on spending.

This drop-off in spending is already taking place. The U.S. Commerce Department announced that sales in November dropped 9%, compared to November of last year.

* My prediction of a decade-long Japanese style slump is picking up steam in the mainstream press.

This from Stephanie Pomboy, the founder and president of macroeconomic research firm MacroMavens. Pomboy is one of the few analysts to foresee the current credit collapse.

The economic deleveraging has barely begun … It all revolves around the idea that U.S. consumers are actually going to do the unthinkable - they are going to save - and that we will be more like Japan than anyone believes is possible.

Like me, Pomboy sees a disastrous collapse of consumer spending in the U.S.

Wages have been silently crowded out by benefits as a share of total compensation, as companies look to offset rising health-care costs. The result is that the share of income that consumers can actually spend is at its lowest in the post-war period. It had not been a problem, because consumers would just borrow to fill that gap. But now, they don’t have appreciating assets against which to borrow.

* One of the biggest questions investors need to ask themselves right now is whether we are looking at an inflationary or deflationary future.

Bill and I touched on this in our emergency report. As we put it, “People fear dandruff now more than they fear inflation.”

The market is now betting heavily on a deflationary outcome. Most investors see the reduction in credit leading to a general decline in prices.

You can see this in the spread between January 2010

inflation-protected (TIPS) bond yields and the yield on regular

January 2010 Treasury bond yields.

January TIPS bond are yielding 6.95%. Regular January bonds are yielding 0.39%. The market is pricing in a decline in inflation of 6.56% over the next 12 months.

This represents a great opportunity for contrarian

investors. The market is currently long on deflation. But there are good reasons to believe that inflation, not deflation, will be the outcome of the current crisis in the long run.

Although the current deluge of fiscal stimulus has yet to show up in the money supply (as measured by M2), the government has increased monetary base (the amount of currency in circulation plus commercial banks’ reserves with the Fed) by about $11 billion a day since September. This works out at about 370% on an annualized rate.

The banks are not yet lending this money. So it is not yet feeding into the money supply. But as soon as banks start lending, supply will increase dramatically and lead to price inflation.

That’s because the more dollars there are in circulation, each dollar buys a smaller percentage of a good or service.

In fact, some investors are already beginning to price in inflation. In the past month, the U.S. Dollar Index – a measure of the dollar’s strength against six major currencies – has dropped 10%. During that same timeframe, gold has moved higher by 175 points – a 25% climb.

There are two easy ways to bet against the crowd here. You can buy into gold through an exchange-traded fund (ETF) such as the SPDR Gold Trust ETF

(NYSE:GLD). Or you could look into the MarketVectors Gold Mining ETF

(NYSE:GDX), which tracks gold mining stocks.