September 31, 2011 – The third quarter ended with stocks showing their worst performance for the quarter since 2002. The quarter was marked by the markets in distress over whether the European Union will fend off a financial crisis. In what has become a routine affair for the markets, the past 13 weeks were a series of ups and downs as the markets responded to the ongoing European debt crisis. Would Greece default on its debt? Would the European Union move from a collection of nations organized to promote trade to one with a central banking system? Would German and English bankers continue to get support at home enabling them to hold the Union together…or would the entire thing collapse? And even if the Union could be held together, would nations such as Greece, agree to austerity measures to repay their staggering level of debt by cutting government programs and raising taxes? Or, would the Greeks riot in the streets (which they did) to protest these programs? Fortunately for investors, on Thursday the German parliament agreed to extend its support of the European bailout – assuring investors that despite the problems, there remains a commitment to all members of the European Union to work together – in good times and bad.
While these current events have captivated markets, the underlying theme is as old as Athens itself: debt is much like marriage – easy to get in to and often painful to get out of. History is full of periods where debtors and debtees have struggled over repayment. I would encourage anyone to read The Lords of Finance by Liaquat Ahamed, to gain an appreciation for how indebted nations can impact the world and, more importantly, the tension that arises between nations struggling to repay their debt with those wanting to be repaid.
Unfortunately, if there is a book to be written about this current era, it will be about a generation that places such little value on history that it seems doomed to repeat it. As the United States and many European nations lived beyond their means by leveraging the future in the 90′s and 00’s, the day of reckoning has come and no one wants to foot the bill. As Americans spent, the Chinese lent. And so the debate in Washington is less about whether or not to repay the debt, but instead, who is going to carry the load. Of course the Hail Mary has been that perhaps the U.S. economy could grow its way out of debt, which is ultimately why the government’s hopes have been pinned so much on helping the economy grow. As incomes increase, so do taxes. Unfortunately, this has not worked out and worse still, these hopes were built upon an economic foundation that cutting taxes without instituting equally offsetting budgets cuts would somehow result in sufficient growth to repay the debt. In the end, the growth did not occur and now the concern is how to reduce debt in a slower growing economy.
It should be no surprise that an economy can grow by cutting taxes with no offsetting reduction in services, programs, etc. Who hasn’t at one time felt rich when using their credit card, only to realize that the next month they are worse off – as the bill comes due and they have to pay for the previous month(s) purchases in addition to interest on those purchases. As long as the credit flows, a person can carry on with this charade for a long time; however, once the easy money spigot is turned off, the equation is reversed and instead of spending more than is earned, he/she is now forced to consume less than is earned as a portion of what the were previoulsy spending goew do debt reduction. And so it is that when spending was easy, everyone was happy, but now that the bill is due, the fight has become about who should do with less.
All of this is the other side of debt. It is a familiar tale, but to be honest, seldom taught. Why? Because if it were, consumers would be wiser and less apt to buy things they really don’t need or simply can’t afford. And so, for the past 20+ years the U.S. economy has been based on ways to encourage consumer spending through easy credit, less taxes, and a promoting the idea that “for everything else, there is MasterCard®.”
As sobbering as this phase of borrowing may be (where the debtor now repays the debtee) it is woth noting that the economy is still moving long along. Consumption may be restrained, yet, this just means that consumers will simply be more careful about what they buy and where and how they buy it. While the economy is slogging along, the fact is that not every business is on the ropes. With companies about to report earnings over the next few weeks, investors will get a good look at just how well they are doing in this economy. While this period seems new to many investors, it is as old a history itself – as is the recovery, which will occur after a generation of Americans is reminded why studying history is not simply for good cocktail conversations – but provides the wisdom of the past to those who live in the present
|Week 39 Market Data|
|Market Close||% Change|
|Crude Oil ($ per barrel)||91.4||79.98||79.2||-1.0%||-13.3%|
|Sources: Thomson Reuters; WSJ Market Data Group|