- Editorial Commentary -

June 15, 2010 (FinancialWire) (Investrend Forums Syndicate) (Via Craig Drill Capital) (By Dr. Albert M. Wojnilower) (Go to http://www.financialwire.net/?s=cmmtry for all recent commentaries.) — Slow and plodding (but sustainable) economic recovery in the U.S. continues.  The abrupt turnabout from breakneck inventory liquidation to sizable replenishment has been the major driver, but other sources of strength are emerging.  Consumers have been more willing and able to use credit to buy big-ticket items.  Although small business remains constrained by reduced sales and credit, the profits and cash flows of larger firms have rebounded strongly, allowing a revival of capital spending.  The decline in homebuilding and possibly even nonresidential construction appears to have ended, although at abjectly low levels.  For the recovery to speed up, some domestic banks will need to (re)learn that small business and consumer loans, while unglamorous, may offer the best returns in the long run.

Paradoxically, the most important improvement in the outlook stems from the banking crisis in Europe.  This has all but erased the most serious threat to continued expansion in the U.S.:  a premature tightening by the Federal Reserve.  In addition, the capital flight to the U.S. from a shaky euro is likely to boost our economy and financial sector, both in the short and long run, much more than any slowing in exports to Europe might hurt.

The outlook is for real U.S. GDP to grow at about 3% over the next year or so.  (In the current quarter, the pace will be transiently faster because of the bulge in outlays and employment stemming from the decennial census.)  It would take much faster GDP growth to shrink unemployment rapidly or, for that matter, to generate inflationary symptoms.  Consequently, interest rates on Treasury securities and government-backed mortgages are likely to stay low well into next year.

The tangibly brighter business outlook is grossly at variance with the financial market mood.  The divergence, while neither particularly unusual nor dangerous to the economy, is nevertheless a curious one.  The most frequently-heard rationalization for the recent stock-market weakness is the “news” of the huge exposure of some major European banks to dubious sovereign risks in Europe. (Of course, as happened earlier with subprime mortgages, this problem was widely known for a long time before lenders paid it any heed.)  Conceivably the Greek crisis has reminded market participants how broad a range of borrowers, lenders, and financial instruments is tainted by falsified financial statements and credit ratings.  While much of this dirty linen has now been aired in the U.S. and Europe, probably there are other places with indifferent or corrupt regulation that have not yet been heard from.

But sovereign risk problems cannot fully explain the market gloom, because the disarray in Europe is good news for the U.S. dollar and American finance.  When the euro was created, many problems posed by differing cultures, languages, and histories of intramural conflict were “papered over” rather than resolved.  They would be mitigated it was hoped by joining in a common currency.  Clearly, however, a coherent European foreign and financial policy, both within the Euro-zone and vis-à-vis the rest of the world, remains a long way off.  Lender and borrower governments, as well as the European Central Bank, have been forced to swallow large doses of bitter medicine, with no assurance that these infringements on their jurisdictions will suffice to quell the panic.

For maximum safety, private and governmental investors will prefer to hold their wealth even more predominantly in U.S. dollar assets.  The current experience demonstrates the enormous sway of a common monetary unit that is widely accepted.  For Greece or any other country to opt out, their citizens and public servants would somehow have to be compelled to accept their pay in a new currency.  Euro deposits held by Greeks in Greek banks would be severely devalued or even wiped out.  Transactions in foreign currencies would have to be harshly restricted, which is all much easier said than done.  Citizens of many other countries would be justifiably concerned that the same might happen to them.  It is the fear of such contagion that forces European authorities to defend the euro.

Think, then, of the exponentially greater chaos that would ensue if the world tried to abandon its universal U.S. dollar standard!  The previously unthinkable policy changes happening in Europe teach that only in extreme, virtually unimaginable circumstances, would the dollar lose its primacy.  What would be the alternative, tradable store of value?  The value of money does not reside in the computer bytes or the pieces of paper (or seashells or knotted strings in some past civilizations) by which it is measured.  It inheres in its usefulness and acceptability for trade which permits the division of labor.  Some day in the far-off future when the United States no longer exists, the U.S. dollar might still be the world’s store of value.

Wall Street’s depressed mood may at bottom reflect mainly the growing probability of regulations that take the narcotic excitement out of finance.  This would also mean much narrowed opportunities for addicted public shareholders to ride piggy-back on the shoulder of financiers, paying them for a fraction of their windfall gains but free of the risk of going to jail.  Perhaps recent market volatility reflects gamblers’ realization that this may be the last opportunity, for a while, to play for giant stakes at public expense.

Guessing the price of a financial asset in the near future is essentially a bet on what the mood of the market crowd will be at that time.  Guessing what the price will be in the more distant future (say, when we retire) is essentially a bet as to who will be writing and enforcing the rules of the game.  By then, the game and the enforcers are sure to have changed in a manner that cannot be hedged today, no matter how clever the players…and their computer programs.

Source: Dr. Albert M. Wojnilower, Craig Drill Capital.  Go to http://www.financialwire.net/2010/04/30/craigdrill-capital/ for important disclosure/disclaimer information and more about Craig Drill Capital.

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