Post Mortem for the Stock Market

There’s class warfare, all right, but it’s my class that’s winning.

— Warren Buffett, investment tycoon

The real estate market is crashing faster than anyone had anticipated. Housing prices have fallen in 17 of 20 of the nation’s largest cities and the trend lines indicate that the worst is yet to come. March sales of new homes plummeted by a record 23.5% (year over year) removing all hope for a quick rebound. Problems with the subprime and Alt-A loans are mushrooming in previously “hot markets,” resulting in an unprecedented number of foreclosures. The defaults have slowed demand for new homes and increased the glut of houses already on the market. This is putting additional downward pressure on prices and profits. More and more builders are struggling just to keep their heads above water. This isn’t your typical 1980s-type “correction”, it’s a full-blown real estate cyclone smashing everything in its path.

Tremors from the real estate earthquake won’t be limited to housing — they will rumble through all areas of the economy including the stock market, financial sector and currency trading. There is simply no way to minimize the effects of a bursting $4.5 trillion equity bubble.

The next shoe to drop will be the stock market which is still flying high from increases in the money supply. The Federal Reserve has printed up enough fiat cash to keep overpriced equities jumping for joy for a few months longer. But it won’t last. Wall Street’s credit bubble is even bigger than the housing bubble — a monstrous, lumbering dirigible that’s headed for a crash-landing. The Dow is like a drunk atop a 13,000 ft cliff: inebriated on the Fed’s cheap “low-interest” liquor. One wrong step and he’ll plunge headlong into the ether.

The stock market cheerleaders are ooing and ahhing the Dow’s climb to 13,000, but it’s all a sham. Wall Street is just enjoying the last wisps of Greenspan’s low interest helium swirling into the largest credit bubble in history. But there are big changes on the way. In fact, the storm clouds have already formed over the housing market. The subprime albatross has lashed itself to everything in the economy, dragging down consumer confidence, GDP and (eventually) the stock market, too. The real damage is just beginning to materialize.

So why does the stock market keep hitting new highs?

Is it because foreign investors believe that American equities will continue to do well even though the housing market is slumping and GDP has shriveled to the size of a California raisin? Or is it because stockholders haven’t noticed that the greenback is getting clobbered every day in the currency markets? Or, maybe, investors are just expressing their confidence in the way the US is managing the global economic system?

Is that it? They admire the wisdom of borrowing $2.5 billion per day from foreign lenders just to keep the ship of state from taking on water?

No, that’s not it. The reason the stock market is flying high is because the Federal Reserve has been ginning up the money supply to avoid a Chernobyl-type meltdown. All that new funny money has to go somewhere, so a lot of it winds up in the stock market. Evergreen Bank’s Chuck Butler explains the process in Thursday’s Daily Pfennig:

The Fed may have quit publishing the M3 data, but they continue to publish all the data that goes into the calculation and our friends over at Shadow Government Statistics have a chart which demonstrates why the Fed decided to keep M3 under wraps. A look at the chart shows the Fed is pumping up broad money supply at an astounding rate of 11.8% per year! All of this rapid money supply growth is reflected in an increase in equity prices. The stock market needs to rise just to keep pace with all of this newly-created money. As long as the Fed doesn’t rock the boat with another rate hike or by turning off the spigot of money flowing into the markets, the equity markets will continue to run.

Ah ha! So the Fed gooses the money supply, stocks shoot up, and everyone’s happy . . . right?

Wrong. Growth in the money supply should (closely) parallel growth in the overall economy. So if GDP is shrinking (which it is) and the money supply is increasing then — viola! — inflation. (“11.8%” to be precise)

Of course inflation doesn’t affect the investor class or their fellow scoundrels at the Fed. The more money floating around the markets, the better for them. It’s just the opposite for the pensioner on a fixed income or the salaried wage slave who gets a 15-cent pay raise every millennia. They end up getting ripped off with every newly-minted greenback.

But then that’s the plan — to shift zillions from one class to another through massive equity bubbles. All it takes is artificially low interest rates and a can of WD-40 to keep the printing presses rolling. It’s so simple we won’t dignify it by calling it a “conspiracy.” It’s just a swindle, pure and simple. But it never fails.

Every time the Fed prints up another batch of crisp $100 bills, they’re confiscating the hard-earned savings of working class people and retirees. And, since the dollar has dropped roughly 40% since Bush took office in 2000, the government has absconded with 40% our life savings.

That’s the truth about inflation; it is taxation without representation, but you won’t find that in the government’s statistics. In fact, the Consumer Price Index (CPI) deliberately factors out food and energy so the working guy can’t see how the Fed is robbing him blind. The only way he can gauge his losses is by going to the grocery store or gas station. That’s when he can see for himself that the money he works so hard to earn is steadily losing its purchasing power.

The big question now is, how long will it take before foreign creditors wise up and see the maxed-out American consumer is running out of steam? As soon as consumer spending slows in the US, foreign investment will dry up and stocks will tumble. China and Japan have already slowed or stopped their purchases of US Treasuries, and China has stated that they plan to diversify their $1 trillion in US dollars in the future. This has lowered demand for the dollar and decreased its value in relation to other currencies. (The dollar hit a new low just last week at $1.36 vs. the euro)

A slowdown in consumer spending is the death knell for the dollar. That’s when there’ll be a stampede for the exits like we’ve never seen before — with each of the world’s central banks tossing their worthless greenbacks into the jetstream like New Years confetti. According to Monday’s Washington Post that moment may have already arrived. As the Post’s Martin Crutsinger says, “Consumer spending rose at the slowest rate in five months in March while construction activity managed only a tiny gain, weighed down by further weakness in housing.”

The connection between housing and consumer spending is critical. Housing has been the main engine for growth in the US in the last five years accounting for two out of every five new jobs and hundreds of billions in additional spending through home-equity extractions. A downturn in consumer spending means that foreign investors will have to look for more promising markets abroad, which will trigger a steep reduction in the amount of cheap credit coming into the country via the $800 billion trade deficit. This will slow growth in the US while further weakening the dollar.

Can you say stagflation?

The present currency and economic crises were brought on by Bush’s unfunded tax cuts, unsustainable trade deficits, and the Fed’s hyperinflationary monetary policy. These policies were executed simultaneously for maximum effect. They were entirely premeditated. Many people now believe that the Bush administration and the Federal Reserve are intentionally creating an “Argentina-type meltdown” so they can privatize state owned assets and usher in the North American Union — the future “one state” alliance of Canada, Mexico and US — along with the new regional currency, the Amero.

Stay tuned.

Nevertheless, monetary policy is not the only reason the stock market is headed for a fall. There’s also the jumble of scams and swindles which have been legalized under the rubric of “deregulation.” New rules allow Wall Street to take personal liabilities and corporate debt and repackage them as precious gemstones for public auction. It’s the biggest racket ever.

Consider the average hedge fund for example. The fund may have originated with $10 billion of its own cash and swelled to $50 billion through (easily acquired) credit. The fund manager then creates an investment portfolio that features CDOs (collateralized debt obligations) and Mortgage Backed Securities (MBS) to the tune of $160 billion. The majority of these “assets” are nothing more than shaky subprime loans from struggling homeowners who have no chance of meeting their payments. In other words, another man’s debt is magically transformed into a Wall Street staple. (Imagine if you, dear reader, could sell your $35,000 credit card debt to your drunken brother-in-law as if it was a bar of gold or a vintage Ferrari. That, believe it or not, is the scam on which bond traders thrive.)

So, the fund is leveraged, the assets are leveraged and (guess what?) the investors are leveraged too — either buying on margin or borrowing oodles of cheap, low interest credit from Japan to maximize their profit potential.

Get the picture: debt x debt x debt = maximum profit and skyrocketing stock prices. That’s why the face value of the market’s equities far exceeds the world’s aggregate GDP. It’s all one, big debt Zeppelin and it’s rapidly tumbling towards planet earth.

KABOOM!

Deregulation works like a charm for the gangsters who run the system. After all, why would they want rules? They’re not thinking about capital investment, productivity or infrastructure. They’re not building an economy that serves the basic needs of society. They’re looking for the next big mega-merger where two monolithic, maxed-out corporations join in conjugal bliss and create a mountain of new credit. That’s where the real money is.

Wall Street generates boatloads of cyber-cash with every merger. This pushes stock prices up, up and away. Deregulation has turned Wall Street into the biggest credit-generating Cash-Cow of all time — spawning zillions through seemingly limitless debt-expansion. These virtual dollars were never authorized by the Federal Reserve or the US Treasury — they emerge from the black whole of over-leveraged über-transactions and the magical world of derivatives trading. They are a vital part of Wall Street’s house of mirrors where every dollar is increased by a factor of 50 to 1 as soon as it enters the system. Assets are inflated, debt is converted to wealth, and fiscal reality is vaporized into the toxic gas of human greed.

Doug Noland at Prudent Bear.com explains it like this:

We’ve entered a euphoric phase of financial arbitrage capitalism with extreme Ponzi overtones, a pyramid scheme of revolving credit rackets and percentage spread plays completely abstracted from any reality of fruitful activity. The reason we don’t even call ‘money’ by its former name anymore is precisely because we realize at some semi-conscious level that ‘liquidity’ is not really money. Liquidity is a flow of hallucinated surplus wealth. As long as it flows in one direction, into financial markets, valve-keepers along the pipeline, like Goldman Sachs, Citibank, or the hedge funds, can siphon off billions of buckets of liquidity. The trouble will come when the flow stops — or reverses! That will be the point where we will rediscover that liquidity really is different from money, and if we are really unlucky we’ll discover that our money (the US dollar) is actually different from real wealth.

Noland is right. The market is “a pyramid scheme of revolving credit rackets and percentage spread plays” and no one really knows what to expect the flow of liquidity slows down or “reverses.”

Will the stock market crash?

It depends on the after-effects of the subprime meltdown. The defaults on existing mortgages are only part of the problem. The real issue is how the “credit dependent” stock market will respond to the tightening of lending standards. As liquidity dries up in the real estate market, all areas of the economy will suffer. (We’ve already seen a downturn in consumer spending) Wall Street is addicted to cheap credit and it has invented myriad abstruse debt instruments to get its fix. But what happens when investment simply withers away?

According to WorldNetDaily.com’s Jerome Corsi that question was partially answered in a letter from the Carlyle Group’s managing director William Conway Jr. Conway confirms that the rise in the stock market is related to “the availability of enormous amounts of cheap debt.” He adds:

“This cheap debt has been available for almost all maturities, most industries, infrastructure, real estate and at all levels of the capital structure.” (But) “This liquidity environment cannot go on forever. The longer it lasts, the worse it will be when it ends… Of course when ends, the buying opportunity will be once in a lifetime.”

Ah yes, another wonderful “buying opportunity”!?!

You can almost feel the breeze from the great birds flapping overhead as they focus their gaze on the carrion below. Once the stock market collapses and the greenback flattens out on the desert floor, they’ll be plenty of smiley faces preparing for the feast.

Conway is right. The stock market is floating on a cloud of cheap credit created by a humongous trade deficit, artificially low interest rates, and a 10% yearly expansion of the money supply. Like he says, “It cannot go on forever.”

And, we don’t expect that it will.

Mike Whitney lives in Washington state. He can be reached at: fergiewhitney@msn.com. Read other articles by Mike.

7 comments on this article so far ...

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  1. Deadbeat said on May 4th, 2007 at 12:57pm #

    Yeah right. Didn’t Whitney call the recent market dip in February the beginning of the end. Also inflation is NOT caused by the Fed printing dollars. While I agree with Whitney that the Fed pumping dollars into the economy is a cause for concern with the stock market. Because the rich are closer to obtaining those dollars and with the real estate market shaky it is likely to pump up the market. So there I agree with Whitney.

    However Whitney has also linked a market crash with the housing situation. There I disagree. Money fled the market to the housing sector after the 2000 bubble burst. So only certain sectors of the stock market got inflated from the housing activity. What I see is a shift to the stock market from real estate as that sector retrenches.

    Going back to inflation, what cause price inflation is the lack of market power by workers. The past 35 years has been one of wealth and power concentration. The fact is that the U.S economy is an oligopoly and therefore whether the fed is pumping money into the economy or not prices will rise as more of the necessities of life fall into the control of the few. Remember the bullshit of econ 101 is that full employment causes inflation. The reality of the energy shock of the 1970’s should have put that fallacy on the trash heap of history.

    Also the devaluing of the U.S dollar helps to reduce the U.S. balance of payment. Also what attracts foreign investment to the U.S. is that it is a capitalist haven. The U.S provides far fewer social services to its workers and has curtail unionism. We also have a brainwashed society that loves capitalism and think that being a wage slave is a “fair” arrangement.

    I find Whitney when he discusses the economy to be no better than Robert Chapman is coming from the right. Both are alarmist and does not provide lucid analysis about the economy. IMO Robert Petras provides a much better analysis. See his article right here on Dissident Voice.

    So long as the U.S can continue to drive down the living standards of workers here and abroad and so long as citizens buy into nationalism, racism, Zionism and division then you’ll continue see excellent results on the stock market.

  2. rene arns said on May 4th, 2007 at 6:36pm #

    WHEN TIME AND PRICE SHAKE HANDS.

  3. Zoner said on May 31st, 2007 at 10:24am #

    I’ve heard this argument before about money leaving one market after it crashes and entering another. How exactly does that work? Once a market crashes, money evaporates. Billions were lost in the 2000 market crash so how exactly does it simply jump over to another market. No, the reality is that the housing market was and is fuelled by borrowed money. Assets prices are being driven by credit – plain and simple. There’s a big difference between credit inflation and monetary inflation. Credit has to be paid back.

  4. gary marinin said on July 22nd, 2007 at 6:17pm #

    how anyone can not say the federal reserve is the cause of inflation is beyond me. the more money they print, the more our government is buying, because they’re buying the money from the federal reserve they pay interest on everyone of those dollars, automatically going into debt. the federal reserve is the cause of the depressions before and will be the cause of the depression in front of us. they intentionally inflate our economy and then recall tons of that money leaving many jobless and homeless. we should be printing our own money but that bastard woodrow wilson changed that.

  5. William Schmidt, Ph.D. said on August 30th, 2007 at 9:00pm #

    I agree with you. The potential is there for a huge
    decline in the US stock market. I post on my own blog
    additional reasons for being disconcerted. The Dems
    will probably win in 2009 and will probably finally
    start to tax the rich, quite properly. The stock market will do its typical “CRY BABY” thing and go into a big dive. And the Dems have lambasted Bush for deficit spending, properly so. This means there will be no room for Keynesian public works deficits. And the
    Fed will do what it can to sabotage the Democrats, as Volcker did
    to Carter and Greenspan tried todo to Clinton in 1994.

    http://www.tigersoft.com/Tiger-Blogs/index.htm

    My criticism of what you write is only that you fail to mention the trillion dollars wasted in Iraq and the world of enemies Bush has created. The Democrat who will try to right what Bush has wronged will lament his/her choice to become President in such an inauspicious era.

  6. rene arns said on January 19th, 2008 at 5:22pm #

    The second part of the Kondratieff winter has begun. Do not invest in assets except precious metals and hold cash.

  7. William Schmidt said on February 3rd, 2008 at 5:20pm #

    Can The Fed Rally Save The Market?
    Bernacke’s dramatic cut in the Discount Rate cuts is very bullish. But for how long? The closest parallel was, I argue, the Fed rate cuts of 1957-1958. That led to a DJI rise of 51% over 21 months. I do not believe the Fed’s actions deal the root causes of the coming deep recession. Wealth has now reached the same pernicious concentration levels of the 1920s. This spells dangerous under-consumption and exceessive investments in bubbles.
    http://www.tigersoft.com/Tiger-Blogs/February-03-2008/index.html

    The wastefulness of the Military Industrial Complex is, of course, not touched… And the 2-trillion dollar war makes the US hated more than ever, bleeds the US dry and weakens the Dollar.

    But the rates cuts will boost the market in this a Presidential Election year. And that is all the FED really expects to accomplish. I have written about what Bernacke has learned from Greenspan’s mistakes and what he has learned from studying the Fed mistakes in the Great Depression.
    This can be viewed at http://www.tigersoft.com/Tiger-Blogs/February-03-2008/index.html

    Next year. the Fed will have no political incentive to lower rates. And the Democrat who becomes President will have his/her hands full. They will need to tax the rish and the stock market will drop like a rock.