Point of Inflection
Mark M. Rostenko
Webster's dictionary defines inflection point as "a point on a curve that separates an arc concave upward from one concave downward and vice versa." In colloquial terms, it's basically a high falutin term for "potential turning point".
Today some analysts tell us we are at an inflection point. Writing in the London Times this May Day, Anatole Kaletsky recently informed us of the following:
"The world economic cycle appears to be at a point of inflection. With the war in Iraq successfully concluded, with oil prices falling and with interest rates at record lows, economic growth is likely to pick up strongly in the months ahead. If this happens, the world economy could soon find itself enjoying a long period of sustained expansion similar to the 1990s...If a recovery does not happen soon, however, financial markets will probably plunge into another crisis, dragging the world into a long period of stagnation."
It does look like we may be at just such a point. Half of the U.S. stock market has disappeared over the past few years. Trillions upon trillions of dollars were wiped off the books. The economy waved farewell to big growth and the promise of a golden age that would supposedly know no bounds, be they physical or temporal. Interest rates were slashed to record lows and a war was won in record time. Surely all that nastiness must now be behind us, no? The curve appears as though it is just about to change because surely it can't keep going one way for much longer, can it?
Indeed we are likely at an inflection point. A lot of stuff has been done over the past couple years and things are probably about to get a whole lot better or a whole lot worse. Measures have been taken, strategies have been followed. That's all about to pan out. Or not. The foundation for something has been put in place, but no one is quite certain exactly for what.
The trouble with the optimists, those who believe that "the world economy could soon find itself enjoying a long period of sustained expansion similar to the 1990s" is that their case is founded upon evidence of a particularly flimsy nature.
Let me dismiss this notion of "expansion similar to the 1990s" straight off. I don't care how low interest rates are nor how low oil prices get, we won't be poised to replay 90s growth for a bloody long time. Periods like the 90s don't come around often. They are generally founded upon the "next big thing", technology that promises a golden future for all, a new age unlike any other. The Internet. Automobiles. Railroads. All huge shifts in technology that would create massive changes in how business, and life, were done.
Periods like that don't tend to stack one on top of another, decade after decade. It takes time for breakthrough technologies to develop. (Although arguably, given the pace of technological growth today, "the next big thing" won't take quite as long to arrive as the last one.)
Nonetheless, does it make any sense to think that we, who are still dealing with the fallout of "the last big thing", are on the verge of the next big thing? Are we, who still haven't fully paid the price for the absurdities of the 90s on the cusp of the next explosive expansion? What will it be based upon? The failed business model of the 90s, the one that made 19-year old video-gamers temporarily rich at the expense of a naive investing public? Will this new expansion be built upon the flimsy foundation of over-leveraged, over-indebted consumers who struggle from paycheck to paycheck while living in homes they can barely afford?
This isn't about pessimism, folks. It's about reality. On this planet, in this dimension, you don't get something for nothing. Booms don't happen simply because "we've suffered long enough and we miss the good old days of the 90s." Wealth isn't created by taking out more and more debt. It isn't created by handing over paper gains on one's home to the bank in exchange for a check and a coupon book. Prosperity isn't manufactured simply by lowering the cost of taking on debt. It requires something of substance at its foundation.
It's really very simple: prosperity must be built upon something, and the promise of becoming indebted for a relatively low cost is not something. In fact, it's nothing. So the 90s aren't about to replay themselves. You don't get two booms separated by a frivolous bust during which consumers suffer very little, buy more and more new automobiles and enjoy oodles of extra cash from rising home values. You don't get something for nothing, folks! Anybody who believes otherwise ought to slowly back away from the crack pipe.
But let's set reality aside for a moment and pretend that indeed it would be possible to toss a ball twenty feet into the air, watch it fall back four feet, and then have it turn right back around and rise another twenty feet into the air. (We're not really talking about balls here. It's a metaphor for nearly impossible forms of economic growth.)
What are the economic bulls pinning their prosperous hopes upon? Not much. The main arguments fall along these lines:
1) We've fallen far enough. The bear market has done a lot of damage and the economy has been weak for a long time. Enough is enough. It can't go on much longer.
Somehow this, the lamest of all arguments, always sounds the most compelling. What is "enough" damage? What is too much? What is a "long enough" period of stagnation? Is there some big economist in the sky keeping score, keeping track of how long things have been going on and will he stop the clock at some point because it has been "long enough?"
Recoveries have no sense of obligation nor any sense of history. They aren't particularly concerned about how long the setback lasted. Recoveries happen when the conditions for a recovery are set in place, not simply because "we've suffered long enough."
This argument is just a version of the battle cry of all losing traders and investors. "It can't fall any further. It's already down 50%, it can't fall anymore." The trouble is that stocks, just like economies, depressions, recessions, and trends of all kinds, don't know how far they're "supposed to" fall.
In the words of Merle Dimbath of Dimbath Economics, "Things will get better when they stop getting worse." Truer words have never been spoken. Things will start getting better only when they stop getting worse, and not a moment sooner. When one trend has run its course the next can begin. But no trend is on a fixed schedule nor does it abide by anyone's time frame or notions of what is "long enough" of "bad enough" or "far enough".
If anything, the optimists ought to take their cues from the old adage "the bigger they are, the harder they fall." If there is any correlation between booms and busts it's that big booms are followed by big busts. Taking a gander at our economy today, who could argue that the bust has been in any way proportional to the previous boom? With unemployment rising but still at a relatively scant 6% and with consumers still on a borrowing and spending binge, who has "busted"? Who's been really hurt by this bust, other than former Internet millionaires who burned out like shooting stars?
2) Interest rates are very low. That has to ignite a recovery soon.
This is all well and good assuming that low interest rates were the only thing that ever mattered to anyone. Interest rates have been low for quite some time now. Maybe someone needs to tell the economy because apparently it is quite oblivious to the fact that it should have entered full-blown recovery mode sometime last year.
This argument presupposes that the Fed is in control of the economy and can manufacture recoveries simply by jiggling interest rates. Anybody who hasn't been asleep for the past three years can see that this is not always the case. Low interest rates are not the solution to every economic problem and the post-bubble U.S. economy has a lot of them.
I remind the reader that rates have been cut twelve times in a row and stand at record low levels. The economy remains stagnant. And the best that Uncle Al Greenspan can say for it is that he continues "to believe the economy is positioned to expand at a noticeably better pace than it has during the past year, though the timing and extent of that improvement remains uncertain."
Listen folks: every once in a while I stand on my balcony and position myself for flight. I have my arms outstretched and I'm much better positioned for flight than I am when sitting at my desk. But the funny thing is that, no matter how well positioned I am for flight, I can't seem to take off. I pretty much just stand there, looking like a jackass, with my arms outstretched and my crash helmet on.
You know why flight doesn't happen? Because regardless of how well positioned I am, I lack the structure that makes flight possible. I'm simply not built that way, a trait I happen to share with the vast majority of homo sapiens. Unless I address that issue, until I create a structure that make flight possible, I won't be flying.
Anybody who thinks that low interest rates have "positioned" the U.S. economy for growth ought to take a good hard look at Japan where interest rates have been hovering near zero for a bloody long time. And yet the Nikkei stock market index recently fell to a new 20-year low, property values have been falling for more than ten years, and deflation seems to have become a permanent fixture in the economy. Japan went through its third recession in a decade not so long ago. And financial leaders are currently concerned about another crisis.
Of course we've all heard that Japan took too long in lowering rates, that U.S. central bankers learned from that and won't make the same mistake. That's all well and good assuming that the only reason Japan is still in this mess is because they didn't lower rates aggressively enough.
Central bankers are indeed an arrogant bunch. They really believe that they have total control over the economy and that by simply pulling on the rate lever at just the right speed and with just enough force, they'll be able to engineer any sort of effects they'd like. If that's the case, then why are we still in this mess? If Japanese central bankers screwed up, how come they haven't been able to fix their errors more than a decade later?
Obviously, sometimes matters get beyond the control of the central bankers. What makes our central bankers so bloody certain that they have this game all figured out, that they've figured out Japan's errors, and that by jiggling interest rates and messing with the money supply they can reverse the inevitable course of a post-bubble economy?
They're not certain, and they can't. If they had indeed learned anything from history they wouldn't have allowed the bubble to have formed in the first place. Yet Maestro Greenspan informs us that he wasn't aware of a bubble forming.
So let's get this straight: the man who was supposedly oblivious to the fact that our stock market was in a bubble is perceptive enough to reverse the course of its unwinding and offer up a solution that will set us on the road to prosperity once again? It's a bit like an axe murderer proclaiming "I chopped this handsome fellow up into pieces, so I'm qualified to put him back together again."
It all boils down to this: if you fellers are so bloody in control of the economy, how come it's totally out of control?
3) The war has been won and it was won relatively easily. We're now poised for recovery.
This argument is the most patently absurd load of prattle that I have ever had the extreme displeasure of allowing into my ear canals.
I don't know when exactly it happened, but somewhere along the line in the build-up to the war, the idea that "war concerns" were impinging upon the economy was repeated enough times that the brain-dead couch potato reality TV masses began to believe it.
In a world of instant gratification, last week's problems are promptly forgotten so long as there's a good "punch 'em up" festival going on in the Middle East, or some idiot is being entertained by twenty lame-brained tarts at a castle somewhere in France while television cameras record their every inane utterance. The masses forget that there was a time not so very long ago when Iraq wasn't even in the news but the stagnant economy and new multi-year stock market lows were on the front page.
But somehow the distraction of war (and war is always a great distraction when the economy sucks) allowed for the surreptitious replacement of logic with the new concept that "war is all that ails us" and thus, by extension, "when the war is done all shall be hunky-dory."
WHAT DOES THE WAR HAVE TO DO WITH A POST-BUBBLE ECONOMY, A LACK OF CAPITAL SPENDING, RISING UNEMPLOYMENT, AND THE BIGGEST BEAR MARKET MOST FOLKS ALIVE TODAY HAVE EVER SEEN? Our problems started long before the war, had nothing to do with Iraq, so how in God's name is resolving the war supposed to resolve any of those issues? Is this really so hard to see?
I've harped on this point before, but obviously not enough, because there are still a lot of media clowns out there concluding that because the war is over, the economy can now set sail into the golden sunrise of unprecedented global expansion. After millennia of humanity chasing after "the great something for nothing", it will finally arrive.
So we've looked at the "rationale" behind the supposedly imminent rebound. Now let's look at the other side of the equation, the equally (if not more so) likely possibility: what happens if these "solutions" don't come together and the global economy doesn't rebound?
Now here's where things can get really ugly. I submit to you that a good portion of economic growth as well as contraction is the result of human psychology, emotions, moods, etc. Think about it. What was it about the 90s that led to huge growth, easy prosperity, massive market gains? Was there really a "productivity miracle"? Arguable. Is the Internet really such an amazing technology? Does this new "cyber business model" hold a genuine promise of increased wealth for all? All debatable points and I have no definitive answer.
But one thing is clear: the mood of the 90s, the enthusiasm and excitement helped to propel the economy and the markets higher. People felt good, people felt confident, people spent money. Regardless of what true foundations of growth existed or didn't exist, it goes without saying that the mood of the people had a lot to do with the growth we saw.
The financial engineers are well aware of this. That's why so much ballyhoo surrounds "consumer confidence." That's why so much of what amounts to propaganda continues to issue forth from the media outlets, despite how patently ridiculous it really is. The important thing is to affect the mood of the consumer, to make the consumer feel good so that he'll get out there and spend.
The hope is that Americans will feel good about their powerful military and their ability to smash up evil dictators. The end of the Iraqi campaign has been offered up as the resolution to our economic woes under the assumption that the confidence engendered by a military victory will send folks scurrying off to the malls.
And that's certainly a possibility. It's tough to predict "the madness of crowds." But ultimately, while psychology and moods can drive economies up and down, genuine booms still require some basis for that emotion. Something for the populace to seize upon, to get excited about.
Rebounds generally occur from a basis of "pent-up demand". Another highly psychological phenomenon. Consumers bite the bullet, withhold their spending until they just can't take it anymore and with the foundation for recovery laid, they get out there and create that recovery. But we have neither. No pent-up demand (the consumer never stopped shopping) nor do we have something to get excited about.
What? The war? What's there to be excited about? We smashed up a band of underfed, under-equipped, under-trained soldiers who weren't all that excited about fighting anyway. Does anyone really believe that beating up Iraqis is the basis for a prolonged economic recovery?
The bigger danger right now is what happens if the recovery doesn't happen. We've been sold all kinds of tales about how it's supposed to happen and happen soon, because the war is over, interest rates are low, etc. etc. The powers that be have gone to great lengths to convince us that recovery is imminent, that everything they've done (war, interest rates, etc.) will assure prosperity and growth in the very near future.
That's the point you really want to understand: they have not built a foundation for growth, they have only built a foundation for hope and they hope that you'll buy into it!
Nothing has worked. All the traditional boosts have failed dismally. A record string of rate cuts. Record low interest rates. Tax cuts. War. The last remaining hope is that somehow the consumer will be convinced to act confidently and spend, spend, spend and spend some more.
We're at the inflection point, folks. All the traditional solutions have been dumped on the economy and now we're all waiting to see which direction things go. The media is on full propaganda alert, feeding us unceasing prattle about how the end of the war will bring prosperity to all. It has to work, because if it doesn't, "look out below!"
Understand that a genuine foundation for growth has not been built. Understand that the "bust" we've experienced hasn't been proportional enough to the boom that preceded it. Understand that we are still in the process of unwinding a massive bubble of excess.
There is no reason for a boom but the powers that be are hoping that one can nonetheless be ignited by raising confidence and hope. If that fails to work, they will have no more excuses to hide behind and no more tricks up their sleeves. The jig will be up and everybody will know it.
A peculiar aspect of human psychology: when our hopes are elevated, the failure to attain the hoped-for outcome results in an emotional crash that brings us to a level worse than prior to the elevation of hopes. In other words, we learn to adjust to current conditions and get along just fine. But when our hopes are raised and then dashed, we tend to sink back not to our original level, but below it. We feel worse than we did before our hopes were raised, when we were just plodding along, having gotten used to the way things are.
That's the inflection point at which we stand today: our hoped-for outcomes must be attained, we must see an economic rebound happen and happen very soon, or we're going to crash to a level below where we were before our hopes were raised. It's like a last-ditch effort by the powers that be. This has to work, or a lot of folks (and markets) are going to throw in the towel. Nothing else has worked and if this last-ditch effort fails, folks will be might disappointed and mighty frustrated.
Potentially, we're worse off than before. The stagnant economy was a bummer, but we were getting used to it. Now we're expecting things to get better because the war is over and interest rates are low. Our hopes have been elevated and if they are not met, we run the risk of lapsing into hopelessness. And with that hopelessness begins a vicious cycle of tightening our purse strings, followed by economic contraction which leads to more hopelessness and further tightening of purse strings.
I don't know which way it'll go. I am quite certain that a massive 90s type of boom is not in the cards. But a temporary boost is certainly possible, if consumer psychology turns the right way. I do believe we are at an inflection point at which the "solutions" are either going to kick in (by "kick in" I don't mean genuine resolution, but that folks will be sufficiently convinced for the time being that they'll act in ways appropriate to an economic rebound and thus boost growth, for a while) or they won't, and folks will start "throwing in the towel."
You can only cut rates so many times, only fight so many wars, only offer so many promises before the public stops buying it and realizes that years into the decline, the powers that be are simply blowing smoke. It better work, or the inflection point will be followed by yet another curve downward.
Mark M. Rostenko
Editor
The Sovereign Strategist
May 10, 2003
Mark M. Rostenko, a veteran of Chicago's commodity exchanges and editor of The Sovereign Strategist, spends far too much of his time enthralled by the never-ending procession of inane prattle emanating from Wall Street. Nonetheless, it hasn't stood in the way of accurately forecasting the dollar's top, the beginning of the gold bull market, and nearly every significant turning point in the stock market since the bear market began. Please visit www.sovereignstrategist.com to download free sample issues and more commentary. And while you're there, feel free to join our international family of well-informed and successful investors.
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