Is the “green shoots” recovery for real?
Special report: Arturo Rosales in Caracas

The much vaunted “green shoots” of recovery phrase coined by Fed Chairman Ben Bernanke and hailed by the corporate media, began to break out into the sunlight during a period of soaring unemployment, collapsing house prices, foreclosures, falling consumer purchases and disastrous consumer confidence levels. This is without mentioning the 81 banks which have failed in the U.S. already in the first 8 months of this year.

What was going well for Bernanke was the rally in the world stock markets which started in early March and the shoring up of the banking system by injecting trillions of tax payer dollars into it at zero interest. In addition, Chrysler and GM as well as many banks were effectively nationalized or, to use the correct semantics, “bailed out” by the Fed.

Economic expansion and GDP growth are driven primarily by demand for credit, consumer goods, cars, houses, vacations, leisure, and financial services which increase industrial production and world trade. Economic growth is not driven by a massive injection of electronic money and a soaring fiscal deficit which is expected to reach a record US$1.6 trillion in 2009.

The “Cash for Clunkers” program which granted up to US$4,500 to buy a new car was a roaring success but that ended last Monday, August 24th. Consumer demand has recovered from the doldrums in the first quarter but this is mainly due to unbelievable discounts offered by stores. In the case of footwear and clothing, especially in the US, offers of up to 70% discount were common.

In a nutshell, “the 'green shoots' that set the pundits alight are nothing more than the direct effects of massive monetary expansion. What we have is nominal growth in the unproductive service and consumption sectors”, according to economic analyst, Peter Schiff.

Let’s have a closer look at the incredible stock market performance since March. This has been a rally of around 50% from the early March lows in the face of corporate earnings which fell into a ravine during the last year. This chart tells the story:

You might say that the stock market reflects the expectations of investors in the future and so there is a recovery anticipated.

Common knowledge knows this to be true but upon closer examination the current Price to Earnings ratio (P/E) of the broad based S + P 500 index is way out of synch so that investors would now have to wait 129 years to recover their investment in dividends.

The P/E is important to consider since real earnings are a trailing phenomenon. For example, if the S+P is trading at 1000 and average trailing earnings are around US$7/share over the whole 500 companies represented in the index in the last year,  you divide 1000 by 7 = +/- 143. So, if you bet on the index, for each dollar invested in stock you would have to wait 143 years to recover your investment from share dividends

As of August 21st the P/E ratio was 129, mentioned above. Unless the economic basics have somehow been altered completely, the current share prices which encouraged Bernanke to coin the “green shoots” phrase are completely unreal when compared to historical precedents in the last 80 years. Here is the historical chart of the P/E ratio of the S+P 500: 

This chart illustrates how the recent plunge in earnings has impacted the current valuation of the stock market as measured by P/E ratio. Generally speaking, when the P/E ratio is high, stocks are considered to be expensive. When the P/E ratio is low, stocks are considered to be inexpensive. From 1936 into the late 1980s, the P/E ratio tended to peak in the low 20s (red line) and trough somewhere around seven (green line).

The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s) and the dot-com bust (early 2000s). As a result of the recent plunge in earnings and recent stock market rally, the P/E ratio spiked and just peaked at 144 – a record high. Currently, with 97% of US corporations having reported for Q2 2009 the P/E ratio stands at 129.

Something has to give. There are two main scenarios:

1. The Fed continues monetary expansion which has found its way into the stock market causing a yawning gulf between Wall Street and Main Street and a triggering of runaway inflation.
   
   
2. The dollar and the S+P will crash, possibly reducing the US debt burden to manageable levels (for everyone with dollar denominated debts) and destabilize the world economy even more. This would oblige the world financial community to adopt a new reserve currency.

The current level of stock prices is unsustainable based on an historical analysis of Wall Street and many professional observers have commented that there is not a “market” anymore – only “manipulation”. Only 20% of the money being pumped into the market originates from money market funds. The rest is generated by “robot traders” using the trillions of dollars as collateral to play the market. Goldman Sachs and J.P. Morgan are suspected of being instrumental in this practice and are being regarded as an extension of the Fed itself.

You can see from the following chart what a mess the US, and by extension the world is facing with current US debt levels on an historical basis: 

Chart courtesy of Casey Research

World GDP in 2007 was US$ 67.2 trillion according to the CIA World Fact Book.  US GDP is at best US$14 trillion so if you multiply this figure by 372% the result is US$52 trillion. “Official” US debt (according to the Debt Clock) in now over US$11 trillion plus unfunded US government liabilities such as Social Security and Medicare/Medicaid of almost US$59 trillion give a staggering total of US$70 trillion total debt. Other analysts put unfunded liabilities of up to US$200 trillion but these figures are so mind bending that the odd US$130 excess trillions are meaningless since all these total figures of US debt are impossible to pay

Whatever the outcome, the “voodoo economics” being practiced by the Fed are a recipe for disaster. The U.S. national debt is impossible to pay unless there is a Weimar Republic or Zimbabwean hyperinflation to wipe out these debts and spawn a new currency. Debtors would gain and savers, well, would be wiped out.

As the subprime crisis spread from the infected US banking system to all corners of the globe, world trade collapsed, since credit was effectively frozen. Freight rates are an excellent indicator of international trade. The more goods and commodities that are shipped, the higher the freight rates. Freight rates are expressed at the Baltic Shipping Exchange in London. This chart of the Baltic Dry Index tells a sorry tale:

Major exporting countries such as Germany, China and Japan cannot export their way out of the crisis when consumer demand has diminished. This is demonstrated in the freight cost chart (above) which shows a collapse of more than 1000% from July 2008 to January 2009. It has recovered somewhat as the chart illustrates but is still way below the halcyon days of 2008.

Wall Street is booming at the moment as are many other exchanges. And Main Street? For the people on Main Street, the “green shoots” have all but withered and died. For them they were a media mirage and if Bernanke continues with such voodoo practices, the world financial crisis of 2008/2009 could prove to be the first phase of a long drawn out depression never before seen in the annals of modern history.

The social and human consequences are unfathomable. A handful of men have committed the train called “Economy” to a track of destruction. Is it too late? It’s a question of whether we as passengers wait until this runaway train runs its course and hits the bulwark or somehow commandeer the engine, take over the controls, apply the brake, switch the track and change our own destiny.

READ HIS BIO AND MORE ANALYSES AND ESSAYS BY
AXIS OF LOGIC COLUMNIST, ARTURO ROSALES