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Comstock Partners, Inc.
Send in the Magicians - By ALAN ABELSON
June 21, 2011
The economy desperately needs a shot in the arm, all the more so with the end of quantitative easing.

It's time Stephen Sondheim wrote another carnival song, and, more specifically, a sequel to the hauntingly memorable "Send in the Clowns" from his 1973 musical, A Little Night Music, which has proved so eerily prophetic in describing this year's political scene. As a glance at the crowded roster of Republican wannabe candidates for the presidency in next year's election makes clear, the powers that be in the GOP obviously have taken quite literally Sondheim's injunction that served as the title of the song, while the Democrats already have their very own barker and no shortage of mountebanks ensconced in their big tent.

What we propose is that Mr. Sondheim melodically urge the sending in of an entirely new group of performers, and we're not talking jesters or jugglers. We've had our fill of them and, besides, the fix our economy is in is too grave to enlist their jolly services. What we need, pure and simple, is a catchy new cri de coeur by Mr. S.: to wit, "Send in the Magicians."

Just about everyone, even the dimmest wit in Congress, knows the problem-we're still suffering the fallout from a generation of unprecedented credit madness. This mother of all borrowing binges (take a gander at the accompanying chart, which we have lifted from the latest report by Comstock Funds' Charles Minter) came to a crashing end with the onset of the Great Recession and stock-market convulsion late in the last decade, but its sorrowful legacy is still very much with us.

There are signs that, despite the inevitable relapses, the populace is trying to kick the habit, as much out of necessity as a newfound rectitude. But as the graph, the handiwork of Ned Davis Research, strongly indicates, Jane and John Q.'s debt reduction has a long, long way to go to return household owings to something approaching the sane levels that prevailed during the robust postwar years-that is, levels of some 65% of personal disposable income, or roughly half what they are today.

Wall Street, in its maniacal pursuit of profits, thought nothing of leveraging itself 30- and 40-to-1. In the process, ita became a prime agent of the severity of the collapse of not only the markets, but the economy as well-and owes, perhaps, its very existence after the bubble burst to Uncle Sam's generosity.

Now revived and reasonably prosperous, and despite all the avowals of fiscal probity, it just can't quite resist the temptation to backslide.

Corporations, on the other hand, apart from the incorrigibly feckless among them, have sobered up from the near-death experience of coping with a devastating recession and credit freeze. They're adding debt-for the most part prudently-in order to take advantage of absurdly low interest rates.

That leaves the government, which seems to be plagued by all kinds of fits as it struggles to corral those ugly deficits in the nation's accounts. The latest estimate is that the shortfall will run a cool $1.7 trillion this fiscal year ending September, leaving the overall debt at something like $15 trillion. Hence, our plea to Mr. Sondheim.

But truth be told, daunting as we find the financial challenge that confronts the U.S., it doesn't require magical thinking to conjure up a way of addressing it, even by a Washington riven by clashing ideologies.

Imaginative thinking will do quite nicely, thank you. Even worse than stasis would be to-instead of addressing the problem with nuance and patience-adopt the template favored by the European Union of austerity and rigid restraint, which has so far succeeded only proving the cure worse than the disease.

IT'S TOO MUCH TO HOPE, we guess, that some of that imaginative thinking will emerge from this week's scheduled meeting of the Federal Reserve's Open Market Committee, and even more of a stretch to expect it to find expression in the Ben Bernanke press confab that follows.

We found perversely encouraging the lack of Street chatter as to whether Ben would, with a wink and a nod, offer some clue as to what he and his gang might be dreaming up as a possible successor to the quantitative easing due to wind down by the end of this month.

Encouraging, that is, because if any such revelation were forthcoming, it would be quite unanticipated and exert that much more of an impact.

For the moment, of course, all eyes are on Greece and whether or not it will default. It all depends on whether that beleaguered country-which is in hock to the world for a mere 140% of its gross domestic product-gets the 12 billion-euro installment that it's supposed to receive as part of the €110 billion loan it was granted to stay afloat last year.

On Friday, as we're scribbling these lines, Germany's chancellor, Angela Merkel, and France's president, Nicolas Sarkozy, met for a couple of hours in Berlin and announced that the way apparently-and we stress apparently-had been cleared for Athens to get its dough.

Global investors breathed a quick sigh of relief that rampant fears of a domino effect on the other weak sisters in the European Union which could roil markets everywhere would not be realized. Not yet, anyway.

Under the "compromise" disclosed by Merkel and Sarkozy, creditors-mostly holders of endangered Greek bonds-would "voluntarily" participate in the bailout, which had been bitterly criticized by Germany and the European Central Bank; the latter already is on the hook for billions in Greek debt.

Depending on private investors to voluntarily engage in the latest bailout strikes us as very much akin to asking volunteers to be guillotined. But we'll see.

One hopeful note for Greece is that Alan Greenspan contends the country is a cinch to default. If a man can't believe in Alan Greenspan's fallibility, what in the world can he believe in?

THE STOCK MARKET TURNED IN a pretty wishy-washy showing last week. Early-in-the-week strength gave way to a rather sharp whacking before the beset beast mounted a not-entirely-persuasive rally. But given the swell of bearish sentiment, we guess the big story is that the roof didn't fall in.

Investors were served a mixed brew of economic news. Manufacturing took its lumps last month, which were painfully manifest in the absolutely miserable regional reports from the Philly and New York Feds. Consumer sentiment, as measured by the University of Michigan, slipped to 71.8 in June from 74.3 in May.

On the plus side, the Conference Board's Leading Economic Index was up smartly, to 0.8%, after declining in April, enhancing the likelihood that this slow-motion recovery will continue to slough along, but hardly suggestive of a quickening recovery.

However, the two big drags-jobs and housing-are still very much in the dumps, and consumer income remains more or less stagnant. New claims for unemployment insurance were off 16,000 in the latest reported week, but are still uncomfortably above 400,000. All in all, the economy's still gimpy.

With the aforementioned end of quantitative easing, it's tough to see where any thrust is going to come from. As Northern Trust's redoubtable Paul Kasriel and his very able subaltern, Asha Bangalore, observe in a recent commentary, "The Federal Reserve is responsible for all of the combined Fed and commercial-bank credit created since the launching of the second round of quantitative easing at the beginning of November 2010." And they add that "unless commercial banks miraculously crank up credit creation, combined Fed and bank credit will dry up."

To say the least, that obviously won't be great for already weak economic growth.

They point out that the consensus forecasts of private economists and Fed officials (and in a fey aside wonder "is there a difference?") call for an increase in real GDP growth in the second half of this year. To which they "respectfully dissent." Instead, Paul and Asha "expect marginally slower growth and see the risks rising for significantly slower growth."

Gird yourself.



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