But
something just does not add up. In the first quarter of 2009, average U.S.
corporate earnings were down over 30 percent. There is once again a serious
disconnect between stock prices and economic reality. Perhaps these
sleepwalking investors think that the 50 percent sell-off in 2008 was overdone
and great bargains are now available. To believe this is to misunderstand the
economic hurricane of last October, and the gaping holes in America's hull that
it exposed.
In the last
quarter of 2008, investors faced a meltdown of the banking system. World
governments injected trillions of dollars into their economies and changed
accounting rules to ensure that a systemic banking failure was averted. Though
the system has stabilized, investors seem to forget that none of the
fundamental problems have been solved. We may have survived the initial heart
attack, but the system remains wrought with clots.
The
epicenter of the global financial system is still found on Wall Street. Despite
that immense responsibility, the American economy is failing to restructure and
seems to be indulging its traditional vices of over-borrowing and
over-spending. Wherever the private sector attempts to correct its behavior, a
bloated federal government overrides its efforts.
By diverting
trillions of borrowed citizens' dollars into keeping alive vegetative
corporations such as AIG, Chrysler, Citi (C), Fannie Mae (FNM), Freddie Mac (FRE) and GM,
the Administration is crowding out new, enterprising companies from access to
vital labor and capital resources. Enshrining inefficiency in this manner bodes
poorly for the U.S. corporate sector's future capacity to increase profitability.
America needs fundamental restructuring in order to compete in an increasingly
competitive marketplace.
Meanwhile,
profitability in those countries that do the hard work of restructuring can be
expected to rise disproportionately as the world economy revives.
In the
meantime, U.S. banks will face an avalanche of loan defaults and derivative
failures. Clearly, the Good Housekeeping Seal of Approval bestowed on many
banks through the much-hyped "stress tests" were a politically
cynical, confidence-boosting whitewash. Even so, most banks were deemed
undercapitalized! This dark thought perhaps explains the Treasury's apparent
unwillingness to accept early TARP repayments.
When U.S.
corporate earnings fail to keep pace with the blistering ascent of stock prices,
look for investors to reconsider their strategy. As they had in the second half
of 2008, many investors will once again seek safety above all. But the safe
havens of 2008, the U.S. dollar and U.S. government debt, are much more
problematic in 2009. Alternatives will be found.
Despite
severe downward recessionary forces, the apparent passing of a threatened
financial meltdown and worldwide central bank manipulation, the price of gold
continues to hold up. Clearly, many investors, including hedge funds,
corporations, and even some governments, are taking refuge in history's oldest
guardian of wealth.
Most
notably, China, the world's largest gold producer, has recently double its
central bank's gold reserve. China also floated a preliminary idea at the recent
G-20 meetings to replace the U.S. dollar with a gold-linked international
reserve currency. This idea may soon catch on among creditor nations who value
real money but also want the flexibility to undervalue their paper currency for
the benefit of exporters.
It appears
that the world is moving quietly but steadily back to the future. The U.S.
dollar became the world's reserve currency because, at the time, it was
"as good as gold." Through political sleight of hand, the gold
backing was withdrawn, leaving the world floating - and now sinking - along
with the dollar.
This new
standard, if implemented, will help rebalance current accounts, re-opening the
path to growth for those economies that restructure. Riding on its sense of
entitlement, the U.S. is not likely to be one of those economies. Instead, the
world's largest debtor nation will suddenly confront the true weight of its
obligations and be forced to significantly lower its standard of living.
As a result,
the return of gold as a international reserve should not leave investors
optimistic about a U.S. stock recovery. Those that are sleepwalking into this
rally will have a rude awakening when they realize that the dollar has brought
down the ship. Their more prudent neighbors will have already departed for the
bedrock of real wealth: a healthy reserve of gold.