Michael Farr
President
Farr, Miller & Washington,
LLC

Markets futures are pointing to a positive open for stocks of about 4%. This strength is the reaction to last night’s announcement by the European Central Bank and the International Monetary Fund to provide as much as a trillion dollars to support the weakening balance sheets of several European countries.  The expected surge in share prices this morning is accompanied by sighs of relief and breathless anticipation of new highs. 

THIS IS NOT RESILIENCE! 

This is the effect of a trillion dollar injection.  It represents new debt and commitments to support governments that have not lived within their means.   UPDATE: Stocks Rocket Higher After Emergency Bailout.

John Hussman, Phd wrote at the end of 2009 that, “It is truly mind-numbing that a moment after a temporary surge of trillions of dollars, borrowed and tossed out of a helicopter (though to specific corporations and private beneficiaries), analysts would hail a subsequent improvement in corporate results as evidence of “resilience.”  Make no mistake, markets will surge on this news, and there will be a real and positive short-term benefit to this infusion.  It may even last.  It may be that the downward spiral will be sufficiently stemmed and local economies will be sufficiently stimulated that an organic recovery can grow. 

But, we don’t think so.  

Consumers in the US and in the EU are laden with debt and are dependent on government support.  A report last week indicated that 20% of household income in the US is now a result of transfer payments (social security, welfare, food stamps, Medicare, etc.).  Greek citizens are rioting in the streets and setting cars on fire to protest any deferral of the national retirement age (and government pension) past age 50.

50!   

While short-term pain has been soundly avoided once again both in the US and in the EU, the long-term consequences are apparently much too unpleasant to consider.  So let’s not consider them, right?  Let’s enjoy the Bacchanalian fete!  Carpe diem. 

Laissez les bons temps rouler!    

US debt is officially about 70% of GDP.  It is projected to rise to 90% of GDP by 2020.  I say officially because with the government guarantee of Fannie Mae’s and Freddie Mac’s $5 trillion, the unofficial number is already 100% of GDP.  John Mauldin’s recent letter referred to a study by Rogoff and Reinhart.  Rogoff and Reinhart show that when the ratio of debt to GDP rises above 90%, there seems to be a reduction of about 1% in GDP. The authors of this paper, and others, suggest that this might come from the cost of the public debt crowding out productive private investment.  

Timing is a funny thing.  The timing of economic, and therefore market, consequence has just been further delayed by additional borrowing.  Additional borrowing will have to be repaid someday. 

It will likely be repaid by your children and their children.   

The answer is responsible action. 

European governments and the US government must reduce deficits by cutting spending and increasing revenues.  They must pay down this debt while they can.  The other approach is to monetize the debt.  Monetizing debt is a fancy way to say “print more money.”  Printing more money increases the number of dollars that are available to purchase goods and services and drives the prices of those goods and services higher.

This is inflation: pure and simple.   

“Ask not for whom the bell tolls...”  Wait, you don’t hear the bells?  You’re right; they’re not tolling yet, but sooner or later, I promise, they will.  Until they do, a defensive investment posture laden with large cap, multi-national blue-chip companies is the most sensible course.

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Michael K. Farr is President and majority owner of investment management firm Farr, Miller & Washington, LLC in Washington, D.C.  Mr. Farr is a Contributor for CNBC television, and he is quoted regularly in the Wall Street Journal, Businessweek, USA Today, and many other publications. He has been in the investment business for over twenty years.