Forget the Fiscal Cliff; This Problem Presents More Risk

When I write in these daily columns, I try to give my readers insights and ideas they will not find in the mainstream financial news sites. The media likes to harp on what they believe is a popular news story. Right now, for the financial media, the focus is on the fiscal cliff—but the reality is that the effects of the fiscal cliff happening or not happening have been discounted by the stock market long ago.

Here’s what I believe the real news is…

As we enter 2013, the global economy is facing an economic slowdown. No matter which continent you look at, countries are facing economic pressures.

And what happens when individual countries facing economic slowdowns reduce their purchases of exports from the U.S. economy? Or what happens to the profits of U.S.-based multinational companies when world demand for their goods or services softens?

Japan, the third-largest economy in the world, has fallen back into recession, joining debt-infested eurozone regions. As the Japanese economy—or any other economy for that matter—sees further economic slowdown, its demand for goods and services from the U.S. will decrease.

To put it into context, in 2011, the U.S. economy exported $66.2 billion of goods and $47.6 billion worth of services to the Japanese economy. (Source: Congressional Research Services, May 29, 2012.) These figures will be lower this year and lower in 2013 as Japan grapples with another economic slowdown—its fifth recession in less than 20 years. (See “Following the Example: Eight Rounds of Money Printing Later, Japan Falls into Recession for the Fifth Time.”)

Right now, Japan and the eurozone are not the only regions in the global economy facing severe economic slowdown. Other major countries are slowing, but not to the degree of the slowdown in Japan and the eurozone. The Chinese economy is slowing—exports are falling, corporate profits are declining—but it will still see economic growth this year (albeit, at the slowest pace since 2009).

It doesn’t stop there; Australia has been going through an economic slowdown. Australian retail sales in October were stagnant from the prior month, as consumers cut back on spending. (Source: Reuters, December 2, 2012.) Up to October of this year, the U.S. economy has exported $26.1 billion worth of goods to Australia. (Source: Census Bureau, last accessed December 13, 2012.)

With what you have just read above, is it realistic to think that the U.S. economy to get going in 2013? The answer isn’t a difficult one. Negative earnings growth for the S&P 500 companies in the third quarter of 2012—the first time that has happened in 11 quarters—is a signal of how American companies are starting to suffer because of the worldwide economic slowdown. We all know what eventually happens to the stock market when earnings growth deteriorates; the market moves lower to reflect the lower earnings of the companies that trade on it. (See “First Time in 11 Quarters; Corporate Earnings Growth Turns Negative.”)

Michael’s Personal Notes:

On December 12, 2012, the Federal Reserve announced further quantitative easing. Aside from its $40.0-billion-a-month mortgaged-backed securities program, starting in January, it will buy $45.0 billion a month in U.S. Treasury securities. Why? “…to support a stronger economic recovery,” according to the central bank. (Source: Federal Reserve, December 12, 2012.)

While announcing more quantitative easing in the U.S. economy, our central bank also promised that it will continue to keep interest rates artificially low (near zero) until the unemployment rate reaches 6.5%. Its projection for inflation for two years out is 2.5% per annum.

The creation of new money and keeping interest rates artificially low isn’t anything new. This has been happening in the U.S. economy since 2008, but there are no specific dates for when the “money printing” will end. Hence, I get the impression that quantitative easing may go on for a long, long time!

The U.S. unemployment rate in November stood at 7.7%. (Source: Bureau of Labor Statistics, December 13, 2012.) This means that if the Fed desires an unemployment rate in the U.S. economy of 6.5% before it stops printing new money, the unemployment rate has to decline by 15.5%.

Looking back at recent unemployment rate numbers, if the rate of decline stays the same as in recent history, it will take roughly 15 months for the U.S. unemployment rate to reach 6.5%—if there are no hiccups in the economy.

Inflation, according to the consumer price index (CPI), is running at 2.2%. (Source: Bureau of Labor Statistics, November 15, 2012.) Unfortunately, as we have established in these pages, the current CPI calculation doesn’t capture the real inflation rate that U.S. consumers experience. The real inflation rate, if I had to estimate, is above five percent per annum.

And if the Fed prints for another 15 months, at $85.0 billion a month, the Federal Reserve will create $1.275 trillion in money out of thin air. Inflation rising at a real rate of five percent, while the Fed prints another $1.275 trillion in paper money, is a real problem. Rising inflation and more money in the system, as we have already experienced, results in a decline in purchasing power!

So let’s look two years out. Two years from now, the U.S. unemployment rate falls to 6.5%. At the same time, the balance sheet of the Federal Reserve has mushroomed to $4.0 trillion. Under such a scenario, I see real inflation being a real problem. As inflation rises, gold bullion prices will rise; as inflation rises, the buying power of the U.S. dollar declines; as inflation rises, interest rates rise.

Our economy can’t handle higher interest rates; our housing market cannot handle higher interest rates—even two years out. At this point, you can see why I am more pessimistic than optimistic about the future.

Where the Market Stands; Where It’s Headed:

Enjoy the traditional Christmas rally, dear reader. It won’t last. I see many signs that 2013 will be a challenging year for the U.S. economy, a challenging year for the stock market. In fact, I believe 2013 will be a major reversal year for the market.

What He Said:

“I’ve been pushing gold bullion and gold shares for over a year now. Back in January 2002, I personally started buying gold shares.” Michael Lombardi in Profit Confidential, December 13, 2002. Gold bullion was trading under $300.00 an ounce when Michael first started recommending gold-related investments.