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Equity markets world-wide had a painful start to the week, with US markets leading the way with a 3% fall on Monday. Australia followed up and nearly matched it. In fact the Aussie market is down over five percent in the last two weeks.

This comes after the World Bank decreased its 2009 growth forecast for advanced countries from -1.7% to -2.9%. Then along came the OECD announcing that it expects negative growth in the OECD area as well this year.

These negative forecasts come at the end of the biggest stock market rally in seventy-one years. Maybe the rally had just run out steam. Maybe the World Bank and OECD data just provided investors with validation for concerns that had been gathering for the last few weeks.

They need have looked no further for that validation than the reports from TrimTabs Investment Research Company, or InsiderScore, a company that analyses insider trades. Insiders at S&P 500 companies have been net sellers of equities for the last fourteen weeks, selling a net $2.48 billion of shares during June already. The current pace of insider selling is the fastest in two years.

These are the top players of the 500 biggest US public companies, people who have a good view of events and a keen eye for future economic recovery. And they are not betting their own dollars on it.

The silver lining to the OECD's latest data is that Australia's economic contraction this year is forecast to be the smallest of all member countries at 0.3%. The forecast for next year's growth is the best in class as well at 2.4%.

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Governator Salvation

Arnold Schwarzenegger, "The Governator" of California, is having a tough time. Some days he must wish he'd stuck at making movies. His government has come face to face with the reality of the state's balance sheet.

The Californian budget deficit is nearly $20 billion dollars. Not ideal when the state's unemployment level is 11.5%. To balance the numbers, he has made tough choices. He has given public sector workers mandatory long service leave, shut public parks, slashed educational budgets, and even released prisoners earlier.

Other U.S. states are having the same experience, and really it is an example of what the whole US has to do. Downsize. Embrace thrift. Live within its means for a few decades.

By choice or by necessity, people are undergoing lifestyle changes. They are sharing their homes with friends and family, in smaller homes, and doing what they can to spend less. These ex-consumers are focusing on paying off their debts, although the government would rather see them spending. In Bill Bonner's words "All of a sudden, the consumer is acting as though he had some sense. Naturally, government officials are determined to put a stop to it". It is hard to see where the economic growth is going to come from. A consumer-based economy has stopped consuming.

Dr Eberhardt Unger, the chief economist for Fairesearch, the German based equity research house describes a stark trend of decreasing spending and increased saving in the US. "There cant be a durable economic recovery in the states without a genuine return of household consumption. Manufacturing is in sharp decline. Only the presence of a large amount of liquidity permits Wall Street to fantasise about a new phase of economic growth."

Business investment is an indicator of future economic growth, as it leads to factories and other assets that have productive capacity. This has fallen by 23.3% from last year, and now stands at $1.3 trillion dollars.

American shambles

Warren Buffet, the billionaire investor and market commentator has described the American economy as being in a "shambles". Buffet's annual report to Berkshire Hathaway investors says he expects the "shambles" to last well beyond this year. He believes the financial crisis peaked last year, but that the economic crisis is in full flight. "Everything I see about the economy is that we have had no bounce". "In terms of the economy coming back that takes a while".

Fed stays put

The Federal Open Market Committee gave the market no news to get excited about this week. It left the Fed's target short-term interest rate unchanged at 0.00 – 0.25%. In the statement released this week it said the rate would stay at exceptionally low levels for an "extended period". No changes to the bond purchase program were announced.

The Fed has laid the table. Now it has to wait and hope that the economy recovers before the huge pool of liquidity it's created reaches the wider economy and triggers inflation.

California's deficit pales alongside America's $1.85 trillion fiscal Federal deficit.

The word "Trillion" has made itself comfortable in our vocabulary in recent years, without really explaining what it represents. In order to really comprehend how much money the fed is misallocating, take 2 seconds to look at this staggering demonstration of what a trillion dollars actually looks like!

It's mind-boggling.

Inflation is waiting in the shadows

There has always been suspicion about the reliability of government statistics. It is too easy and profitable to bend them in governments favour. Particularly when they are able to change the methodology for processing the data.

John Williams is an independent specialist on government economic reporting. His company 'Shadowstats' produces economic data that shadows official government statistics. His research provides an alternative source for businesses and investors and makes very interesting reading.

He warns that the doubling in the monetary base over the last year has only started to trickle into the broader money measures, but that the pace of inflation could pick up very suddenly some time in the next five years, even as early as next year. He considers the risk of the occurrence of hyperinflation to have never been higher.

It is hard to foresee the trouble ahead. There is no precedent for unconventional monetary policy on this scale. You can look at Germany in the 20's, the US in the 30's, Japan in the 90's, and Argentina in the 80's.

Last century people said "As rich as an Argentine" . After a long period of financial mismanagement, these days the people say "Argentina has a financial crisis every 10 years and each crisis lasts about 10 years".

Until next time,

Dr Alex Cowie


About the author: Dr. Alex Cowie is holds a Graduate Degree in Finance and Investment from the Financial Services Institute of Australia.

Daily Reckoning