Paul Kedrosky:

What surprises lie ahead, whether positive or negative? And to be more explicit, let’s try not to get hung up in each case whether each thing really is good or bad news, but whether it’s seen that way.

Add your surprises here.

Reason:

“There’s a great misunderstanding of what’s happened,” says economist Allan Meltzer. The main trouble, in his view, is not that Americans are suffering from weak or negative economic growth. It’s that they have suffered a loss of wealth, a very different ailment…

When the economy contracts, the government may use sound monetary and fiscal policy to help revive growth. But when wealth goes up in smoke, the government can’t necessarily bring it back. If it tries, the effect is likely to resemble what happens when you give a recovering alcoholic a drink: deceptively pleasant at first, but ultimately calamitous.

Institute the No-Loss Rule, retroactively, for housing.

Via the most credible news source in America:

The current economic woes, brought on by the collapse of the so-called “housing bubble,” are considered the worst to hit investors since the equally untenable dot-com bubble burst in 2001. According to investment experts, now that the option of making millions of dollars in a short time with imaginary profits from bad real-estate deals has disappeared, the need for another spontaneous make-believe source of wealth has never been more urgent.

Sadly, the “suspicious package industry” is not the next bubble in waiting.

Via Bloomberg:

Rising consumer prices will leave more U.S. consumers unable to pay their debts and may lead to a “financial tsunami,” according to Bennet Sedacca, president of money manager Atlantic Advisors LLC in Winter Park, Florida…

Sedacca wrote that current financial-market conditions remind him of “someone standing on a lonely beach, armed with only a small bucket, trying to stop a rare tsunami that hits the shores. It is how I feel about our markets and the tools being utilized by the Federal Reserve, the European Central Bank and other regulatory bodies. They are overmatched for what they are facing and, worse yet, they helped create the mess in the first place by being far too easy with money and debt creation.”

I’m tossing in the chart that Bloomberg’s site left out:

I suspect the Central Bank is going to meet a pervasive lack of cooperation with regard to quelling international demand - the situation reminds me of how “uncoordinated” world partners (i.e the U.S., Germany and Japan) became before the 1987 market correction. It seems raising rates may only serve to exacerbate the in-house financial crises - meanwhile, if Sedacca’s thesis is correct, demand for (at least) domestic goods and services is likely to falter regardless of Fed action.

Not politics…just facts.

Nancy Pelosi announced today that Congress will be presenting an economic stimulus package early next week.

The S&P 500 Index reacted by shedding almost 40 points (and the Dow was down a cool 307). Maybe Pelosi & Company should stick to stimulating the gourmet food in the House cafeteria?

UPDATE: The markets didn’t like the Administration’s response either. All most people are going to do with $800 is pay their gas and electric bills.

UPDATE 2: Paul Kedrosky calls the Bush Administration response “rushed” and “panicky”.

I was having dinner a few weeks back with an old friend, and the subject turned to the US economic situation. I’ve known this guy for roughly two decades and trust him like a brother; he is a very smart character who doesn’t pull punches. I was inclined to listen - the fact that he analyzes high-yield bonds for a big investment bank’s private client group certainly didn’t hurt his cause either.

I’ve believed that indebtedness at every level of our society, from federal, state and local government, right down to consumers’ credit cards, home equity lines and first mortgages, has reached epic proportions. But when this fellow said he thought we were headed for another depression, my sceptical nature reared its ugly head. I have a predilection for looking at the downside, as I started my career in restructuring situations, but I relish that downside for its opportunity and I also know that nobody likes a doomsayer. It wasn’t until I read about our nation’s savings rate hitting zero that I began to rethink his claim.

Yes, the nation’s savings rate has hit zero, not that anyone should be surprised. We are a consumer society. Our economy is driven by consumer spending. The savings rate has been on decline for some time. And it is now at a level not seen since the Great Depression.

We used to be a manufacturing economy. Then the talk was service economy. Now its consumer economy. What is wrong with this scenario? I heard someone say the other day that the US’s largest export is dollars. With the current account deficit continuing ever upward in mobility, that doesn’t surprise me.

What left me stumped was what anyone can do about it. Seeking bankruptcy protection used to be a way for consumers to clean up their balance sheets, and they have in droves, with the rate of filing more than doubling in the past decade. Many blame skyrocketing health care cost for tipping them over the edge, and I have to agree that a big medical bill can certainly be a “tipping point.” Unfortunately for many, that option is going to disappear very soon. And it is not an option for a global economy like ours.

I’ve also heard chatter about restructuring the tax code to incent savings. I believe that would be a good start, at least for individuals. And rising interest rates are certainly another incentive to save, albeit at the expense of stock market valuations and (potentially) home prices. And there are some economists crying out for accelerated rate increases, and they say that might very well stem the potential of an out and out real estate debacle.

Me…I see a lot of conflicting forces at work. Can you really cut off the finger to save the hand, or are we going to suffer some extreme pain, somewhere, or order to set things right? I simply don’t know, but I would love to hear some ideas.

Prices are headed up. What a landmark piece of news! The Los Angeles Times reported Wholesale Prices Increase 0.3%. Not exactly a scoop.

Prices increase and decrease in trends. Traders (and the Fed) know this, but the government uses these funny little reports like the colored sign at Homeland Security.

We created a huge ATM network with real estate HELOC’s (home equity lines of credit), allowed the dollar to slide to pathetic levels, subsidized the food producers until we choked on our own gratuity, and gorged on foriegn goods supposedly in the name of cheaper prices, so this recent pop should come as no surprise.

Unfortunately, it didn’t need to happen that way, and Greenspan knows it.

We need to hop back on the bike and continue our ride to economic leadership. Rising interest rates will help us on this path. No I don’t believe it is going to stifle the economy, because the economy never recovered anyway. We are just back to where we were before the year 2000 bubble. Yes, we have another bubble in real estate, but the liquidity has already been sucked out of that cause. People have tapped themselves out of Sunday afternoon movies and shopping excursions already (they can’t afford anything besides their five mortgages).

The best course of action here is to raise interest rates. This will provide some ballast for the dollar. No, the stock market won’t crash, and neither will the bond markets - that would only happen in a closed economy, and the US (and the world) is anything but closed. This may, in fact, provide a big boost to the economy, the one we should be concentrated on instead of pissing and moaning about consumer spending . Business. The reason is two-fold.

First, rate increases start at the bottom, and work their way up. Bond spreads widen, profits are made, and that profit is redeployed capital. Second, and more importantly, a rising dollar will make foreign investors happy, as their balance sheets (in local currency terms), will balloon. But they won’t extract that capital, only to buy dollar denominated investments again later at even higher prices. No, they will keep that profit deployed here, on our turf, and likely leverage it into additional investment as well. Demand for investments puts downward pressure on the cost of capital, so businesses can still fund themselves at reasonable levels.

This (potential) dynamic is good for us. We are supposed to be the great innovators, so everyone should quit speculating on the ramshackle house on the corner, and start putting their minds to work.

As Peter Drucker once wrote:

“The basic economic resource - ‘the means of production,’ to use the economist’s term - is no longer capital , nor natural resources (the economist’s ‘land’), nor ‘labor.’ It is and will be knowledge…..
Value is now created by ‘productivity’ and ‘innovation’, both applications of knowledge to work.”

Now we all know it takes some amount of capital to climb the hump, but I believe rising rates won’t stem its availablility. So, turn off The World Poker Tour (you are the sucker at the table already), pre-sell the single family home build you just invested in (repeat after me: I am not a contractor), and start thinking and doing.

With regard to my comment yesterday on housing prices “already beginning” to correct, here is a report from across the pond: Guardian Unlimited Money | News_ | House prices fell in December.

Note that interest rates in the UK crossed the trough before those in the US. Rates started climbing in Australia round about the same time, and the lines at open houses Down Under have long since disappeared. Also keep in mind that the UK is densely populated, and is loaded with real estate speculators (those buying properties with no intention of moving in and/or investing in developments), much like many of the areas in the US which have see the biggest price increases. Those speculators will go running for cover first. Then the games begin.

I may be way off base, but these three countries (the UK, Australia, and the US), have something else in common too, trade deficits. Wealth being sucked out of the systems, some (like the US) at an alarming rate. With price driven by indebtedness, and liquidity on shrink, I say…

Welcome to the global economy.