The U.S. economy continues to edge toward recession, although you’d never know it from the way the stock market has been acting. Shares finished the week moderately higher on Friday, up for a fifth straight day on a flurry of reports that together suggest inflation is rather more tame than some evidently think it should be. We’ve always known that this sort of ignorant confusion about the true nature of the economy would make it possible for full-blown deflation to take hold before the eggheads, think-tanks and policy wonks guess what’s clobbered us. All of you geniuses, please note: It’s not  “tame inflation” that you discern, but rather incipient deflation – one that has begun to catalyze a debt implosion that eventually will make the 1930s Depression seem like those by now unmistakably benign Clinton years in comparison.

So why is that so few evidently apprehend the dreadnought of deflation, even as it threatens, first of all, to asphyxiate the housing market? Surely The New York Times, duly skeptical of a stock market that has continued to rise even as the economy has turned moribund, must know the score? Alas, although the Gray Lady gets it about right in the headline – “Hold the Champagne” – the editorial beneath fails to understand that this is not a routine recession that is brewing, or even a perhaps especially nasty one, but a wrenching and possibly fatal emetic for a gluttonous debt binge unparalleled in human history.

Frugal French

The Times notes that a dollar weakened by recession would in theory help the American economy by boosting exports. But by merely suggesting that this is possible The Times implies that it believes we have something of value to export. Ah, the thinking goes, if only those frugal French and Germans would spend less on cheese and visits to the spa and buy more Ford Excursions! In fact, such a change in consumer preferences would not amount to even a drop in the bucket, since our biggest export, the only one that really matters any more to the U.S. and global economies, is financial “products”. We know that this is so simply because there are roughly $300 trillion of leveraged financial instruments in play in a global economy that produces no more than about $55 trillion of actual goods and services.

And if you’ve been wondering how the stock market can continue to rise as the economy barrels toward recession and worse, consider that it takes only a net dollar inflow of just a billion or two a day – a mere trickle from the global financial bladder-bag – to make stocks go bonkers. Shares are rising no matter what the economic news simply because they cannot help themselves; there is too much credit-money in the system to allow them to fall.

Less Bang for Buck

Unfortunately, the effects of gravity cannot be thwarted forever, even if what passes for economic theory these days holds ignorantly otherwise.  In fact, an economy that grows through promiscuous borrowing must eventually reach a limit – lest we believe the Fed can keep the game going as long as it wants. Better think again. It’s now requiring about $5-$6 of new borrowing to create a single dollar’s worth of GDP growth, up from a postwar average that mostly fluctuated between $2 and $3.

As for the so-called “wealth effect” generated by rising real estate values, it too is about to lurch irresistibly into reverse. And as powerful as it was when residential property values were rising by 7-10 percent or more a year, the reciprocal “poverty effect” is going to prove far stronger when home prices begin to fall as little as 2-4 percent  a year. Imagine having your 6 percent mortgage turn into a 10 percent real-rate killer relative to the value of the underlying collateral. Many homeowners are there already, since they’ve experienced falling property values of at least that magnitude in the last year. As for those who took advantage of variable rates to buy homes they could not otherwise afford, those mortgages in real terms are headed toward levels more commonly associated with rent-to-own furniture.       

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Seminar Set at Fort Mason

You’ll want to mark November 11-12 on your calendar as the date of the San Francisco Hidden Pivot Seminar. The two-day class will be held at Fort Mason over that weekend, so if you’re interested and haven’t contacted me yet,  please let me know via-email  as soon as possible. Fort Mason has great views of the bay, a giant parking lot, and is well serviced by the Municipal Transit System – an ideal location for the event.