Wednesday, May 18, 2011

Nomura Equity Research: Batten Down the Hatches -- Obama Is Making the Same Mistakes Roosevelt Made During the Great Depression

Richard Koo of Nomura Equity Research has some bad news for investors. The end of the Obama administration's "QE2" program of money-printing, in Koo's opinion, will likely have devastating effects on the stock market.

When a central bank provides liquidity to the market, it buys government debt or other securities in exchange for cash. The previous owners of those securities, typically financial institutions, take that money and attempt to turn a profit by loaning it out...

...What actually happened, however, is quite different. Market liquidity in the US and the UK almost tripled. But the money supply, which represents funds actually available for use by the private sector, has increased little if at all since the financial crisis in 2008... ...Despite this reality, many investors in both the US and the UK appear to labor under the misconception that an increase in the liquidity supply due to quantitative easing will inevitably boost the money supply...

...The decline in private-sector credit in the US and the UK is attributable to both the unwillingness of banks to lend and the unwillingness of the private sector to borrow. The two factors are rooted in balance sheet problems and are indications that both countries remain in balance sheet recessions...

...In effect, the money supplies of both the US and the UK are being supported by government borrowing. If the two governments chose to embark on fiscal consolidation, their money supplies would contract...

...When the situation is viewed in this light, we come to the realization that Mr. Bernanke’s QE2 was in fact a major gamble. It was a gamble in the sense that the Fed tried to raise share prices with QE2. If the wealth effect resulting from those higher prices led to improvements in the economy, the higher asset prices would ultimately be supported by higher real demand, thereby demonstrating that prices were not in a bubble...

...Recent growth in the US economy also presents a danger in that it is making people complacent. Relatively strong economic indicators—data showing the economy created more than 200,000 jobs in the latest month for which data are available—have encouraged talk of fiscal consolidation. But the economy is far from achieving a self-sustaining recovery.

As indicated in the discussion of the money supply above, private-sector credit is not only not expanding but continues to shrink... That the money supply and GDP are still posting modest growth is only because the government continues to borrow and spend.

...This is identical to the phenomenon observed in the US in 1933–36 and in Japan after the collapse of the Heisei bubble... In other words, the US economy is being supported solely by massive fiscal stimulus amounting to 9% of GDP. It is not growing [in the] private sector.

...This pattern of expansion in the money supply and the economy despite an absence of private-sector credit growth was also observed in 1933–36 as the US economy emerged from the Great Depression. President Franklin D. Roosevelt was unaware of the importance of this relationship and, believing that the economy was already on a self-sustaining growth path, embarked on a path of fiscal consolidation in 1937...

...The US economy consequently fell into a severe recession characterized by sharply lower production and drastically higher unemployment. It took the Japanese attack on Pearl Harbor for the US economy to recover from the resulting damage...

Furthermore, Koo asserts that the US economy may be left "in far worse shape than if QE2 had never been implemented".

I've said it before and I'll say it again: these Democrat politicians are destroyers, not creators. Everything they touch -- whether in states like California, Illinois and New York or at the federal level with Fannie Mae, TARP, HAMP, Cash-for-Clunkers, Stimulus, and so on -- turns to fecal matter.

They are ideologues, not intellectuals. And we are all paying the price for their ignorance.


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