Monday, August 3, 2009

Why the Current US recovery is Ephemeral ……..

The often read quote in recent times, apart from the “green shoots” phrase is that an increasing number of people are beginning to get convinced that “the worst of the recession is behind us”.

While I wish I could convince myself to join this camp, it seems virtually impossible to turn deaf to the all-too loud message conveyed by economic fundamentals and charting analysis - a perfect synchronization between two diverse thoughts of analysis – an occurrence extremely rare.

As the main culprit to the current mess is leverage, let us begin by assessing certain key statistics pertaining to US national debt:




As can be seen, while the absolute volume of debt owed by the Federal Govt. to the owners of US debt has been steadily increasing, debt as a percentage of total GDP declined following the years after WW II and reached its lowest level just in time when Reagan assumed office (early eighties). From thereon the absolute numbers nearly quadrupled for nearly twelve years through George Bush Sr. tenure.




While Clinton was credited as perhaps, the only man who left office without the guilt of adding to the annual debt, Bush Jr’s infamous polices catapulted the debt by nearly 85% from $5.7 trillion ( when he took office ) to $10.6 trillion ( left office )

Obama could create history for expanding the debt to levels not seen since the World War –back to an approximate 90% in 2009 and 100% of the GDP by 2012 or even by 2010 according to certain estimates.

Despite the extent of fiscal profligacy, it’s quite interesting to note that the US actually has what is called a Debt Ceiling to keep a check on the amount of leverage. At first glance this sounds great, but the only loophole is that they allow the ceiling to be raised higher …and all this backed with legislation!! As recently as February 2009, this ceiling was raised to $12.104 trillion by the American Recovery and Reinvestment Act of 2009.

The mere thought that everything that is produced as a nation goes effectively to repay and service its debt stands as the biggest, if not the scariest possible scenario for the world’s largest economy.

So are we talking in terms of the United States Of America going bankrupt?

Well, the only quote that comes to my mind at this point is this popular adage - “ As goes General Motors, so goes the United States of America….” What this means is that the US may be headed for a catastrophic collapse which will entail among other things – a potential default of sovereign debt together with a downgrade of the AAA rating and an unprecedented fall in the US equity markets probably toward sub 4000.

I’m writing at a time when the Dow has scaled past the 9000 barrier - the highest seen in 2009 and so, even a 4000 to most readers could seem improbable.

However, given that the “Too big to fail theory” went bonkers during the recent crises, I would stick my neck out and say that this rally may offer the greatest opportunity to exit out of US markets.

The whole sub-prime crises as we know it today began with an excessive build up of leverage or debt and the resultant downturn only went to prove that the risks associated with leverage can hardly be overstated.

The “toxic assets” on the balance sheets of most banks in the US (and elsewhere) were the main reasons for the freezing of credit markets and a dry-up of liquidity in the system. So when the Fed ran out of its ammunition of tweaking interest rates, it began purchasing these securities turned toxic and in-turn flushed in liquidity.

So when people talk of a recovery, the first question that hits my head is -Have these assets turned less toxic or have they vanished altogether? .

The truth is that nothing much has changed because instead of sitting on the balance sheet of banks, they are now cozily settled on the balance sheet of the Central bank of the USA. What’s more is that unless the housing market embarks on a sustainable recovery, it is difficult to envision any tangible reduction in the toxicity of these assets.

Also to be noted is that while banks may have done away with a portion of this poison from their financial statements, the actual extent or % transferred is not disclosed to public knowledge. A perfect case of a time bomb waiting to explode……

Technical Viewpoint:

From a scientific perspective of charting and wave reading, we see that price (Dow Jones) can rise to test the falling trend-line resistance at about 11,000 to 11,500 – which could be a corrective B wave.



If the reading is right, then the B wave will set the stage for the C wave in the direction opposite to the B wave – in this case down.

Since the C wave has the characteristic of being the longest wave in the larger scheme of the trend, the decline that is likely to follow post this rally will be swift and deep, targeting anywhere between 3500 and 4000


So what does it all mean for the dollar? While the most instinctive response would be to sell the dollar in such an eventuality; given the phenomenal ability of the world’s reserve currency to trick just about anyone, I wouldn’t be surprised to see the dollar resurging strong in the midst of economic gloom as it did in the recent sub-prime crisis.


As a final word, I’d like to end by saying that it’s not a question of whether or not a deeper crisis is about to unfold, it’s more a question of timing –WHEN???

It would do well for America to turn the search-light inward instead of pointing fingers at the rest of the world to ask itself a simple question - Can a problem which started with unchecked spending and therefore, debt be solved by taking on more debt…..?

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