THE STREET VS. THE VOLCANO

10/30/07

At Mass this morning, the Gospel included the parable of the mustard seed. Jesus started the parable by asking “To what shall I liken the kingdom of heaven?” My mind was wandering, as it too often does, during the Gospel, and, at the risk of sounding profane or sacrilegious, I conjured up a similar parable for our economy.

To what shall I liken our economy and our stock market? It is like small children playing on the side of the volcano, pointing out the beauty of the surrounding plants and trees while dismissing as a mere inconvenience the massive lava cap that is about to explode and rain destruction upon them. We get a good earnings report here, a favorable economic statistic there, and, most delightful to the economic experts, a Fed “rate cut” now and then, and the pundits and cheerleaders declare everything is fine. They don’t ignore the debt problem; they see it. But they opine that the underlying economy is strong enough, as evidenced by a scattered healthy earnings or economic report, to withstand a temporary credit setback. Soon the lava will come cascading down the side of the mountain and engulf them, and these notables will never know what hit them.

One of the arguments that we often hear is that the job market and wage growth are fine, or at least decent, so the consumer should be in good shape even if he can’t “tap the equity” in his home due to a complete absence of equity in his home. What those who make this argument are missing is that this economy, the whole worldwide economic shell game, really, has only been sustained because the American consumer has been able to spend well beyond his pay check. If the consumer is forced to spend within his means, even if those means are as healthy as some claim, the whole system gets gummed up. If he is forced to actually service his debt with his paycheck, the whole system collapses. In fact, that the world economy has depended for years on Americans’ living well beyond their means shows how overextended the typical American is. The bills are starting to come due. Further, as I have said in the past, this isn’t a “sub-prime” problem. Angelo Mozilo, Chairman of Countrywide Credit, admitted last week what the Pontificator was telling you months ago: the problem has reached into the prime mortgage market. But this debt problem isn’t only a mortgage problem. Levels of all forms of consumer debt have reached astronomical heights. And it isn’t only a consumer debt problem. Corporate balance sheets, for years bastions of sanity in an otherwise debt-crazed world, are becoming increasingly saddled with debt for stock buybacks and leveraged buyouts. And it isn’t even a private sector problem. After seven years of George Bush and a (until 2006) Republican Congress with all the fiscal restraint of Juan Peron, federal debt is virtually incalculable.

Another argument we hear from the experts is that the debt level is manageable, and therefore the economy and stocks should do fine, because household balance sheets are in good shape. But household balance sheets are in good shape only because cheap debt has enabled investors to grossly inflate the prices of stocks and (until recently, and, in historical context, even now) houses. So this argument is tantamount to saying that the debt level is manageable because we have created so much debt, and that stock prices should be fine because they are so high. This is much like the argument that the same experts used to make (but now have somehow forgotten they ever made) that house prices should remain healthy because they were so high. After all, homeowners’ balance sheets were in fine shape!

A third argument with which the experts comfort themselves is that the economy might be “slow” over here, but that things are going gangbusters overseas. But these are the same guys who trumpet the interconnectedness of the world economy. Can’t they see that the health of the world economy depends on the inebriated mariner spending habits of the American consumer? Eventually, when the emerging nations develop a larger middle class that can sustain growing production levels in developing countries, the American consumer will no longer be as vital a cog in the world economy. But such developments will involve a long and traumatic adjustment period, and, when they are completed, what will America have to bring to the table? That is a long run horror, though. Sufficient for today is today’s horror.

Back in 1988, Lloyd Bentsen, Texas senator and Democratic candidate for Vice-President, uttered a famous line in his debate with his Republican rival, Indiana Senator Dan Quayle. I am not referring to the “…you’re no John Kennedy” line, but rather to Bentsen’s reply to Quayle’s trumpeting the success of the “Reagan” economy (as if any politician can claim credit for the success of the economy; note Bill Clinton’s frequently repeated canard “I (sometimes we) created (some outrageously high number) jobs.” The private sector, not the bloodsucking leaches in Washington, creates jobs, but that is another matter.) that he (Bentsen) could have created such a great economy, too, “if I could write hundreds of billions of dollars of hot checks.” That particular gem from Senator Bentsen, who was given to such gems, was quickly overshadowed by the Kennedy comment and soon forgotten. However, it resonates today. We have written trillions of dollars of hot checks, and the world is growing more hesitant about taking our post-dated rubber. The day of reckoning is upon us.