Streetwise for Sunday June 7, 2009

Streetwise

Lauren Rudd

Sunday, June 7, 2009

Deal With Fact Not Fiction

As you analyze your investment program going forward, deal with fact and not fiction. Do not let the protégés of Chicken Little, with their never ending list of upcoming economic debacles, derail your investment plans.

For example, in the news of late is the conjecture that the Depression of 1929 was merely a prologue to upcoming events. Well known technical stock analyst Robert Prechter said as recently as May 19 that, “We are in a long Elliott Wave downswing, which would take the Dow down to around 2,000.”  Nuts; the resiliency of the economy, combined with current technology and regulatory tools render that idea implausible.

The mania that erupted over a supposed plan to nationalize the banking industry ran rampant for weeks, implying that transformation to a socialist economy was just around the corner. Yes, the banking industry has demonstrated an abysmal lack of ethics, judgment and responsibility. Furthermore, based on the American Banking Association’s position of opposing new regulation, the industry will not change unless forced to. Nonetheless, we are a capitalistic society and will remain so, despite what a few suddenly less wealthy and uninformed souls might espouse.

Neither does having the government bailout General Motors imply socialism. The auto industry has been on a path of impending disaster for years. Columnist David Brooks pointed out recently that Elmer Johnson, a GM executive, wrote a memo back on Jan. 21, 1988, stating that, “We have vastly underestimated how deeply ingrained are the organizational and cultural rigidities that hamper our ability to execute.”

The critical question is not whether GM should have been allowed to fall on a petard of its own making but whether the government has supplied a shield of protection for the GM mindset of “business as usual.” Although I admit to being in favor of the petard idea, hopefully GM has seen the light.

Keep in mind that three lobsters in a tank creates one fat lobster. Also, economic theory states that resources are allocated to the most efficient producers, forcing the others to fold their tent. The end result here could be a fat lobster sporting the Ford emblem. Ford had the wherewithal to drive a stake through the heart of its coterie of executives. If GM and Chrysler cannot read the tea leaves at this juncture then lunch is served.

This brings us to the scariest assertion of all, that a pandemic like reemergence of inflation is inevitable. Here is a simple rebuttal, it will not happen. As Nobel laureate Paul Krugman recently said, the inflation scare is in large part politics rather than economics.

There is no hint of inflationary pressures in the economy, in part because consumer prices and wage increases have stalled in the face of high unemployment, so why all the concern?

Primarily because the Federal Reserve is adding to the money supply, which some claim must be inflationary, while others claim that budget deficits will eventually force the government to inflate away its debt. I agree with Krugman that the first idea is simply wrong. The second, although logically possible, is not realistic and no modern country has ever attempted it.

It is true that the Fed has taken the unprecedented step of buying government debt and paying for it by crediting banks with extra reserves. In ordinary times, that could be inflationary.  Banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices. However, these are not ordinary times. Banks are not lending, so the inflationary effect is severely restricted.