Monday, March 21, 2011

Hussman Weekly Market Comment: This Is, Because That Is

The events in Japan have had a tragic effect on individual lives, and they are undoubtedly in all of our prayers. With respect to the global economy, there will likely be supply disruptions, and reallocations of trade, but we would expect these to be mainly of a short-term nature. Given that the most strongly affected areas were not heavily urbanized or industrialized, the increased demand for raw materials is also unlikely to be enormous. Instead, it is likely to be modest and spread over a large number of years. Witness the slow pace of reconstruction in the wake of Katrina, and in other places that have been hit by natural disasters in the past. Invariably, such disasters result in rapid destruction but very slow and long-term reconstruction.

The larger economic problem is that this disruption is occurring when there are other economic pressures elsewhere, particularly in Europe. The U.S. has quite a bit of slack capacity, so the prospects for economic growth over a multi-year period seem reasonably good, but the frequency of weak patches is also likely to be higher in the next several years, and it is worth keeping in mind that much of the recovery we've observed - particularly in the credit markets - is a veneer over continuing credit issues.

Nobel economist Joseph Stiglitz tied the issues together nicely in an interview that appeared in Barron's over the weekend. Speaking about Japan, he observed "The sad thing is that they've never fully recovered from the bubble of 1989 bursting. In that sense it should remind the U.S. of what happens if you allow a bubble to get outsized. It's water under the bridge, but Bernanke and Greenspan have to bear some responsibility for that ideology that bubbles don't really exist, and they clearly do. When we went into this financial crisis, the administration said, 'We won't make the mistake of Japan and delay restructuring.' That's exactly what we did. It's mind-boggling that we haven't learned any of the lessons of Japan."

My only disagreement might be that any of this is actually "water under the bridge," because the same basic policies that produced the bubble are still very active. These policies have driven financial assets to rich valuations and low prospective returns, which compete sufficiently well with zero interest rates, but offer little for long-term investors. Meanwhile, the financial sector has a continuing overhang of delinquent and unforeclosed homes, which the FASB still allows banks to carry on their books at amortized cost. When the main source of "prosperity" is the policy-induced elevation of asset prices - rather than the allocation of savings into productive investment - it helps to remember that present gratification often equates to future unpleasantness.

When we look around the world, we see difficult social tensions, particularly in North Africa and the Middle East where the poor are dealing with enormous increases in the prices of basic commodities (and where the much of their budgets go for food and fuel), at the same time that others in the same societies are enjoying disproportionate wealth, particularly based on strong oil revenues. Certainly, inequality and oppressive leadership has existed in many of these countries for a long time. But we have to ask what has heightened these tensions to the tipping point at this particular time.

The Buddha taught that you can only understand something by looking deeply at its interconnectedness to other things, and to our own selves - nothing has a separate existence. "This is, because that is; this is not, because that is not." The problems and imbalances that have inflamed the world did not emerge from a vacuum. Rather, this is, because that is. It cannot possibly help that the Fed continues to pursue an aggressive policy that drives short-term interest rates to negative levels, which predictably encourages commodity hoarding around the globe, and the unintended consequences that result.