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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

The Next Three Government-Backed Asset Bubbles Unveiled

Stock-Markets / Liquidity Bubble Aug 04, 2009 - 12:47 PM GMT

By: Q1_Publishing

Stock-Markets

Best Financial Markets Analysis ArticleThe good times are back!

U.S. GDP declined at a mere 1% annualized rate, after inflation, between April and June.


Barry Norris, a partner at Argonaut Capital in London, explained how the world economic recovery “could be V-shaped after all."

To top it all off, the “cash for clunkers” program sparked an auto shopping spree. Dealers moved 250,000 cars off the showroom floor in a few short days. This is great news for an auto industry which was hoping to sell 10.5 million cars this year (a rate of about 30,000 cars per day).

At the risk of stating the obvious, it really does appear the good times are back.

For many, it’s probably a pleasant surprise too. The markets are up, corporate earnings are coming in much better than expected, folks are feeling a bit more secure in their jobs, and there’s hope businesses will start hiring again.

But we’re not concerned with feeling pleasant or joining up with the herd. We’re looking for reality. In this case, reality is looking pretty good now. But the costs over the next year or two are going to be tremendous. And investors who realize what’s going on, why, and how get positioned perfectly for the next two years will be much better off.

Right now, there are three popular initiatives underway which are going a long way to making this recovery a V-shaped one. But remember, there are two “V’s” in a W. And the next “V,” thanks to many unintended consequences, is shaping up to be a lot worse.

The True Cost of Cash for Clunkers

On the surface, it looks like “Cash for Clunkers” has been a smashing success. The $1 billion program was initially expected to run through November. A few days after it began though, it has already run through its entire budget.

The U.S. House of Representatives, noting the popularity of the program, quickly passed a $2 billion extension to the program today.

The actual economic value of the program, however, is questionable. And the eventual cost of it will be much higher than the initial $1 billion (or maybe $3 billion) price tag – or $33 ($99) per taxpayer.

You see, the Cash for Clunkers was an indirect subsidy to the automakers. It took borrowed money and handed it to people who wanted to buy new cars.

It’s a great deal if you were looking for a new car. One U.S. citizen’s bill for the program is $33 (or $99 if it’s increased by $2 billion). So if you were eligible and wanted to take advantage of it, you spent $33 to save $3,500 or $4,500. Not a bad deal at all?

Well, it turns out a lot of people thought the deal was a good one. They took advantage of it in droves.

Wall Street loved the program too. Today shares of Ford (NYSE:F) led the automakers higher with an 8% surge in price.

But here at the Prosperity Dispatch, we’ve learned to look beyond the headlines and, when it comes to government programs, to look at the unintended consequences.

In this case, the unintended consequences will be severe. The problem is the deals were too sweet and they brought in too many buyers too quickly. The program is accelerating demand.

Think about someone who was thinking about buying a new car. They may be waiting a few months to save some cash or just trying to squeeze a bit more life out of his car. Seeing the $4,500 handout, they forgo waiting and buy their car now.

It wasn’t just him though, it was 250,000 people. Many of the would-be car buyers

Basically, the federal government which has demonized the bubble-bust nature of the economy has gone to great lengths to create another bubble. This one is a micro-bubble in autos. They’re creating a spike in demand now and it will only result in reduced demand later.

I can’t find a single reason not to expect it to turn out like every other government infused bubble either.

I know, I know…I can see the local news reports about car dealers having such a great time and the temporary euphoria created by the program. But the actual wealth created here is nothing. The Cash for Clunkers program is the economic equivalent of you stealing your neighbor’s car, driving it off a cliff, and forcing them to steal one from the local car dealer. There was a transfer of wealth, but no new wealth was created.

But let’s face it, this is a relatively small program. It will have consequences, and there will be a great time to short automakers shares in due time, but there’s a much bigger program that will likely be even costlier.

The True Cost of “Cap and Trade”

The current Cap and Trade legislation making its way through Congress hit some pretty big roadblocks in the Senate.

The bill doesn’t seem too costly - at first.

The Congressional Budget Office (CBO), which estimates the net costs of proposed legislation to be $22 billion - $175 per household. Now, whether you believe in climate change or not, $175 a year doesn’t seem too bad. Sure, it’s another expense. But if this stuff does turns out to be real, finding $15 per month to possibly prevent the end of human race wouldn’t be that tough.

But if we delve a bit beyond the headline $175 figure, we see how truly costly this bill will be. You see, the way the CBO calculates the net cost for households makes very little sense.

Dr. Robert Murphy of the Institute for Energy Research details the egregiously flawed accounting method in Enron Accounting: CBO and EPA Cooked the Books on Cost Estimates for Waxman-Markey Energy Tax:

The CBO’s reported annual cost estimate of $175 per household in the year 2020, does not refer to the tallying up of the price hikes acknowledged in the quotation above. The CBO reduces the “gross cost” by mixing in all of the financial benefits that will accrue to “households” from the cap and trade program…

The CBO’s logic makes sense from a certain point of view: A firm that makes solar panels is owned by shareholders who live in houses, right? So when that solar panel firm sees huge profits in the new scheme, the wealth showered on its owners will accrue to households. Even though all electricity consumers will be paying higher prices, the “average” hit will be mitigated to the extent that some of those consumers happen to be on the receiving end of the cap and trade gravy train.

Basically, since the cap and trade transfers wealth from one household to another, it views the net costs as very low. The CBO’s estimate is the economic equivalent of your neighbor stealing your TV and then explaining it to you since he now has the TV and you don’t, the net cost is nothing.

Absurd, right? Well, it certainly is. And the unintended consequence of the cap and trade transfer of wealth will simply mean more of a greater misalignment of resources in the economy. This move will only exacerbate the next decline and slow down any genuine recovery.

Worst of all, probably, it’s all done under the guise of combating global cooling and preventing the next ice age…no wait, that was the 70’s.

I mean global warming…no wait, that was Al Gore’s deal. And it’s based on the  “sound” scientific principle of a positive feedback loop. The same principle which would make it physically possible for a glass of water to freeze when you put ice cubes in it.

I mean climate change…that’s the ticket – just vague enough to sound reasonable when you apply the same reasoning to calculating “saved” jobs.

Reflating the Housing Bubble

Finally, one of the largest programs being rolled out is aimed at reflating the housing bubble.

Market forces, in the form of falling prices, show there are too many houses and not enough buyers. Never one to be held back by reality, the governments have stepped in to try and reflate the housing bubble.

The Federal Reserve is keeping interest rates as low as possible and buying bad mortgages. The federal government is handing out $8,000 tax credits to subsidize down payments for first-time homebuyers. Since the government is deficit spending, it’s the same as borrowing $8,000 so the homebuyer doesn’t have to. And a few states have temporarily banned foreclosures which reduce supply by cutting back the number of houses for sale.

All three have helped get the housing market moving again. In the short-term, it has been effective. Housing prices ticked up for the first time in over a year this month. In the long-term, supply and demand will reach their natural meeting point at whatever price that may be. Considering the shadow inventory of houses, that price is much lower than the current price.

But again, this program is only helping in the short-term. It’s helping to bring those potential homebuyers who were on the fence into the market. It’s not creating any more genuine demand. It’s just borrowing future demand and moving it up.

 Boom and Zoom Today, Doom and Gloom Tomorrow

In the end, these are all parts of the ultimate, “kick the can down the road” strategy. The consequences and problems the economy was on the verge of last fall have merely been put off for a while. I’m thinking a long while.

The “success” of the Cash for Clunkers will have a long impact. It seems the government just realized that if it gives money to support the demand side of the equation, it’s much more popular. They’re probably kicking themselves for not handing out $60 billion in auto discounts instead of giving it directly to GM, Chrysler, and GMAC to ensure they keep pumping out cars for which there aren’t enough buyers. Cash for Clunkers has been much more popular.

The next steps are likely to be tax holidays and other incentives on the demand side. It will seem very good. However, as we’ve seen with all these government-backed bubbles before, they all end very badly.

That’s why I continue to be bullish now and bearish later. We’re in the second part of a V-shaped recovery. It is boom and zoom now and probably for another few months – maybe even a year – and then it will be doom and gloom time again.

As we’ve been focusing on for a long time, the next five years are going to create tremendous opportunity. However, it will only be for those who look at what’s going on, why, and are getting prepared to profit from the unintended consequences.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Disclosure: Author currently holds a long position in Silvercorp Metals (SVM), physical silver, and no position in any of the other companies mentioned.

Q1 Publishing is committed to providing investors with well-researched, level-headed, no-nonsense, analysis and investment advice that will allow you to secure enduring wealth and independence.

© 2009 Copyright Q1 Publishing - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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