Why the Dow is So High But Consumers are So Low

Yesterday, I warned that signs of economic recovery are nothing more than a mirage. Today, I’m freaking out because Robert Reich has got an explanation so simple and so obvious. If the former US Labor Secretary’s analysis is correct, as I believe it is, the economy’s in deeper doo doo than even my worst warnings about it.

Robert asks: “How can the Dow be flirting with 10,000 when consumers, who make up 70 percent of the economy, have had to cut way back on buying because they have no money?” I’ve been asking the same question. Robert continues:

Even more curious, how can the Dow be so far up when every business and Wall Street executive I come across tells me government is crushing the economy with its huge deficits, and its supposed ‘takeover’ of health care, autos, housing, energy, and finance? Their anguished cries of ‘socialism’ are almost drowning out all their cheering over the surging Dow.

Before continuing, I don’t know or care about Robert’s political affiliations. I’m pragmatist, which is what every Democrat, Independent or Republican should be. Regardless of politics, Robert’s layperson-terms economic explanation makes sense to me.

“The great consumer retreat from the market is being offset by government’s advance into the market,” Robert assets. D’oh, of course. Yesterday’s New York Times story claiming key indices show signs of economic recovery cited a “jump in building permits” as one indicator. Robert rebuts:

Why have new housing starts begun? Because the Fed is buying up Fannie and Freddie’s paper, and government-owned Fannie and Freddie are now just about the only mortgage games remaining in play.

Robert asserts that:

Heath care stocks are booming because of looming health care reform
Federal contractors are “doing so well” because “the stimulus has kicked in”
Auto sales are up mainly because of the cash-for-clunkers program (now ended)
Financial sectors are surging because of low interest rates and government bank guarantees

What he doesn’t say, I’ll add here:

Consumer mortgages foreclosures are rising again, after banks held back at the government’s request
The first wave of commercial foreclosures are just now beginnning, putting mortgage investments at risk; again
Consumer debt is higher now than during or after any other recession, which chokes Americans’ ability to spend

Robert writes:

The Dow is up despite the biggest consumer retreat from the market since the Great Depression because of the very thing so many executives are complaining about, which is government’s expansion…The problem is, our newly expanded government isn’t doing much for average working Americans who continue to lose their jobs and whose belts continue to tighten, and who are getting almost nothing out of the rising Dow because they own few if any shares of stock.

It’s a sticky problem. A year ago last week, Lehman Brothers failed, setting off an economic tsunami through the money markets. In the Sept. 21. 2009, The New Yorker, James Stewart delivers in “Eight Days” a riveting account of Lehman Brother’s failure, Merrill Lynch’s sale to Bank America and AIG’s rescue. Regulators did not foresee the money market collapse that would follow Lehman’s bankruptcy. From that event, and given the Fed’s and SEC’s leadership, a government bailout was near certainty.

On the one hand, goverment bailout may well have prevented global economic diaster; lessons learned from the Great Depression were appropriately applied. On the other hand:

The government remains the driving force of recovery.
The fundamental economic problems facing most Americans remain.
There is no substance behind the Dow’s rise, which is fueled by false hopes.
Old business practices are back; one new fad is to bundle together insurance polcies as investments.
Economic recovery is still kilometers out of reach and will remain so as long as consumer debt chokes spending.

The true beneficiaries of government stimulus spending are many of the institutions responsible for the econolypse. Where is the moral hazard?

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1

Jeff on September 22, 2009 at 10:31 am

The current administration and the previous administration have talked at great length about the importance of bailing out banks so they can “issue more credit.”

I’m not expert in economics, but that seems to me like a VERY bad idea. More credit? That’s sugar-coated wording for MORE PERSONAL DEBT.

During this current economy, the last thing people should be doing is racking up even more credit card debt. Sure, if millions of Americans go out en masse and buy a ton of junk at Walmart and KMart and put it all on their credit cards, that might give a short spike to the economy, increasing “consumer spending” and demonstrating an increase in “consumer confidence.” But that’s also incredibly dangerous because when you buy junk on credit cards, you have to pay that money back plus interest. And if the economy isn’t doing well and people are already having to shovel every penny that comes there way towards paying the minimum balances on their credit cards, increasing that debt is only going to make matters worse in the long run.

Maybe the economists advising both presidents Obama and Bush know something I don’t, but it seems to violate common sense.

And on a related note, it seems like people who do have the money to spend (not on credit, but from their actual checking accounts) AREN’T spending. They may not be drowning in debt, but they are worried job security. (And some aren’t, but for whatever reason might think it’s unwise to be buying things during a recession, thus keeping the money from moving.) So they’re keeping their money in the same banks that are issuing credit to people who can’t afford it. And that money is being invested by the banks on Wall Street so that the banks can make that money grow (and pay the tiny 1% interest to the savings accounts).

I’m curious, Joe, what your thoughts are about all this.

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Mike on September 22, 2009 at 2:51 pm

I think you’re right, Joe – what we’ve been experiencing is a bear market rally. The root causes that started this slide are still there, and many of them are being exacerbated by current government policy. This is going to get worse before it gets better.

The question is, how much worse? Our economy, deficit spending, debt, etc. are propped up by the willingness of foreign investors and foreign governments to buy our dollars – on the mistaken assumption that we’ll one day be able to pay them back, with interest. What happens when that mythology is shattered and the world realizes that the American dollar, and by extension the American economy, are no longer worth investing in? Or even when they simply run out of money to invest? Our debt and deficit will then have to be monetized (i.e. paid off by printing more money). This means high inflation, which will spur the investors and central bankers worldwide to try and sell before their investments lose value, which means more inflation as the market is flooded with dollars that nobody wants. Basically, the value of the dollar is nothing more than a market bubble. When that bubble breaks, whether next year or in twenty years, we’re looking at hyperinflation that will snap this economy like a twig.

We might even prolong the myth of the American dollar long enough to come out of this recession. Or, we might not. If we do, all we accomplish is prolonging the day of reckoning and increasing the severity of the collapse.

I’m an optimist by nature, but also an amateur economist. We’ve gotten ourselves into a fix, and the political will doesn’t exist anywhere to get ourselves out of it. Nobody wants to face the problem.

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JohnJ on September 25, 2009 at 9:07 am

In addition to everything else:

Low wages increase corporate profits: (short term) good for stockholders, bad for employees.

In the long run, an economy based on low domestic wages and international outsourcing is doomed to collapes. Consumers can’t afford to buy enough to keep the economy afloat.

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Why the Dow is So High But Consumers are So Low

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