Thursday, 4 November 2010

US election: What does it mean?

John Mangun
Outside the Box
Business Mirror

Vote counting in the US election is ongoing as of this writing. It is clear that the Republican Party is going to control the House of Representatives while it is likely that the administration Democrats will retain control of the Senate. What does it all mean? Everything and nothing.

The left/socialist legislative agenda of the Obama administration has come to an end. While there may be some significant changes in the previously passed law giving massive government control of the health-care sector, it is unlikely that this law will be repealed. The recently passed financial-reform bill was all political, anyway, and the Banksters will be allowed to continue to appear financially stable when, in fact, the banks are all bankrupt. The two political parties will play all lawmaking for the politics but the gridlock will stop any meaningful reform and changes.

I am sure that the Americans would like to believe that this election will make a difference. It will change the political landscape for the 2012 presidential election. However, nothing will change economically for the better in the short term.

During the last two years, the economic course of the US was charted by the Federal Reserve. The Fed, under the leadership of Great Depression “expert” Ben Bernanke, has utilized its policy power in every conventional way imaginable. The problem is that all the conventional methods that the government uses to manage an economy, particularly a problematic economy, have always failed.

The Fed immediately resorted to the oldest technique to stimulate an economy—lowering interest rates. The theory is that if interest rates went down, people and businesses borrow money which they then spend stimulating economic growth. However, hundreds of years of history have proved that raising or lowering interest rates does not have any affect in stimulating or reducing demand. The reason you borrow money is to make a profit.

If I were to offer to loan you money at 100- percent interest, would you take my offer? You most certainly would if you could take that borrowed money and make a 200-percent profit like in the stock market or a business. In fact, interest rates always go up during good economic times because there is an increasing demand for borrowed funds when it is easier to make profits. Likewise, why borrow money at even zero percent if you were going to lose that money by investing. If there is little expectation for profits, low interest rates do nothing to stimulate economic activity.

The other policy move by the Fed has been to flood the economy with fresh, newly printed money. This has been accomplished by the Fed buying US government debt with that money. The government “borrows” the money, in effect from itself, and then spends it trying get the economy growing. However, we all know how efficiently the government spends the people’s money.

The offshoot of this money printing is that the dollar will decrease in value. Currency debasement is a very old and harmful tactic used by governments, going back to the Romans, to try to camouflage bad management. The economic “theory” behind currency devaluation is that it will make a nation’s exports cheaper and more attractive. It does not work.

Historical studies have shown that a nation’s exports can compete, regardless of currency exchange rates, as long as the exporters can be profitable. An exporter can compete against other exporters who have “cheap” currencies if he can be price-competitive and still make a profit. Labor and raw-material costs affect profits. But the No. 1 factor that determines an exporter’s ability to make profits is taxes. In other words, high taxes negatively offset any benefits of dealing with a “cheap” currency in the same way that low home nation taxes positively offset any disadvantages of having a “strong” currency.

The US political changes will not materially affect corporate taxes and the Fed will continue to pursue a devaluating dollar policy. The negative domestic consequences to a weakening dollar are great. As the dollar weakens, foreign investors in the US begin to sell their holdings. This happened in the 1970s as the Japanese, formerly huge buyers of US real estate and corporations, suddenly found that their return on investment went negative due to the falling dollar. All this foreign selling of assets will further depress the US economy. And, of course, domestic inflation will rise significantly, further hurting the economy.

The same is true of the stock market. As the Fed has pumped a trillion new dollars into the US economy, since business confidence is so low, a portion of that money has gone into the stock market. This is creating another financial bubble. Leading up to periods of economic depressions, the amount of bond offerings is always greater than the amount of stock offerings. It is usually more financially healthy for a corporation to issue equity, stock, than debt. Debt is a burden. Stock offerings spread the potential profit around.

Bond offerings in the US are now enormously higher than stock offerings. While it is true that US corporations have some $2 trillion in cash, their net position (assets-debt) is nearly a negative $1 trillion. This is another somewhat hidden debt bubble that will eventually pop, causing another round of financial turmoil. But things cannot be all that bad; look how the US stock market is going up. One word; nonsense.

The measure of a true bull stock market is a market that is going up regardless of the home currency of the investor, like we see on the Philippines Stock Exchange (PSE). Are the Japanese making money in the US market? Not with the yen rising against the dollar every day. When a stock market goes up in all currencies, then everyone is a buyer just like at the PSE.

The US election will change things but not for the better. The Obama administration is now a lame-duck government and the failed economic policies will continue.

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