Reply #14: Either Betting With The House, Or Against It [View All]

http://www.gold-eagle.com/gold_digest_04/ci060104.html

Either Betting With The House, Or Against It...Basically it's your choice, especially as it applies to the economy and financial markets ahead. As you know, the growth of the gaming industry globally over the last half century in this country is a direct message that betting against the house can be very dangerous business. In the gaming industry broadly, the odds lie with the house, not with the individual. How else would these folks stay in business and prosper as they have? And it just so happens that in the real economy of the last four decades at least, betting against the house (US households) has also been a very bad bet. But as we look ahead at both the real economy and the financial markets, we suggest that the current bet either in favor of or against US households just may be one of the most important directional investment bets for years to come. And this really applies to the global financial markets as the US consumer is still the focal point of consumption strength worldwide. This is going to be one of those discussions where we let the pictures do most of the talking. We believe it's meaningful in the current environment to review some of the modern day financial characteristics of "the house", so to speak. After all, it has been this very same "house" that has held up domestic GDP in a big way over the last four years. So, just what has been the price that households have paid to accomplish this Herculean feat over the recent past? And what do current household financial characteristics suggest about what we can expect from households in the years ahead?

With the last revision a few days back, we now know that GDP growth in the first quarter of 2004 continued upon the upward trajectory begun in 2003. Real GDP grew at a 4.4% annual rate in the quarter. Likewise, "the house" continued to do its part in the greater scheme of things as personal consumption expenditures rose almost 4% during the period. What further highlights the important role of households in 1Q economic activity was that although total government spending was up in the quarter in aggregate, state and local spending was down for really the first time in a number of decades. Households were clearly pulling the heaviest GDP load in 1Q. And lastly, it was personal consumption of non-durable items where households really came through in the effort to levitate GDP in the first quarter. Auto sales actually fell in the period. The year over year gain in purchases of non-durable goods, up 5.1%, was the largest increase in twenty eight years. The bottom line is that household consumption hasn't even slowed down to catch its breath. It is clear in the following chart that over the last two decades at least, GDP growth in aggregate owes a very large debt of gratitude to the increasing proclivity of households to consume. Of course how one interprets how this has happened is a key decision point as to either betting with or against the house as we move forward.

big snip - lots of charts>

We constantly hear the chant from the bullish among us that wealth creation has been so significant for households over the last few decades. In the recent Flow of Funds report, household net worth in absolute dollar isolation was quite close to all time highs. But nothing exists in isolation when it comes to the financial markets and economy. The extraordinary bull markets in both common stocks and household residential real estate have been generational in their respective magnitudes over the last 25 years. Simple question. Then just why does household net worth relative to these highly inflated household assets rest near a half century low given the extraordinary gains in asset prices? Simple answer. Because household liability expansion has been even more extraordinary. Simple enough?

Consistently betting against the house in hospitable locales such as Vegas or Macau has been a suckers bet for the general public (non-card counters, professional gamblers, etc.) forever. Betting against the US consumer as a never ending engine of consumption strength has also been a suckers bet for a good long while now. Much longer than we would have ever anticipated. But as we view the current broad US household financial landscape from afar, we continue to ask ourselves for how much longer this will be true. Given the rate of change acceleration in household leverage and deceleration in liquidity and net worth relative to assets over the past four years, accompanied by continued relative softness in domestic wage gains, is the house about to be dealt a losing hand? As a sheer matter of probability and statistics, it's very tough to imagine "the house" in the US being a huge winner ahead. Greenspan has been comping penthouse suites for the high rollers among leveraged households for a good while now. Will an ultimate change in casino management end up sending these folks to the buffet line in the basement at some point? Given that virtually everything human runs in cycles, you can bet on it. The problem, of course, is the timing in terms of knowing when to initiate or double down on a bet against the house. The Fed has stacked the odds in favor of the house in absolutely historic fashion over the last three to four years. Foreign central banks have been completely complicit in this exercise. But are these folks running out of complimentary chips, or have they palmed yet another ace to be played if needed? In Vegas or Macau, it is rare to ever see the house bust. Unfortunately in the real world, this is the exact and consistent history of those living under fiat monetary systems.