The Fundamentals Are Bad

Since 1929, when Wall Street plunged, the president of the United States can only say one thing: “The fundamentals of the American economy are good.” This sentence, with a few close variants, has been systematically used by all political leaders and central banks when markets tumble.

First, because it’s the only thing to say. One cannot say: The stock market is wrong. Because, if it continues “to be wrong,” it will end up being right anyway. A head of state cannot deny reality for long. Reality always ends up winning.

So, by saying “the fundamentals do not justify the markets’ behavior,” one tries to politely tell the markets that they exaggerate. And, sometimes, it’s true. Markets are often wrong. They correct themselves. The correction is not even the exception; it’s the rule.

So that’s what the Europeans said this weekend. Italy would not deserve to be treated like Portugal. That may be true.

The problem is that those who say this today have been telling us for a decade that Portugal deserved to be treated like Germany. So, of course, they are no longer believed. How long will France and the United Kingdom deserve to be AAA like Germany?

Who really believes that the United States, now AA+, is a worse risk than France? With comparable public debt, does France have more growth potential than America? Is its political system more solid? Maybe. But it is not obvious.

Today in Europe, as in the United States, the fundamentals are not good. Markets are not wrong. They are right.

The United States is short of ammunition to revive demand. Companies do not need cheaper credit, they need customers. Citizens do not need cheaper credit or lower taxes. They need jobs and higher wages.

Budget deficits are at the highest level tolerable by the suppliers of capital. Central banks have gone as far as they could without officially giving up their final principle: ensuring that paper money is worth something more than the market value of the paper.

The European Central Bank is forced to buy back the government bonds of states whose debt is too high, whose growth is shrinking and who are now shunned by the holders of private capital. The Fed, for its part, has reached the limit of diminishing returns with its own quantitative easing. Unless it relies on inflation, it too is short of ammunition.

We can no longer pretend to believe that American and European fundamentals are good. Thus, investors, anxious to preserve the value of their holdings, sell their shares and buy gold. They also buy Treasury bonds. But for how long?

Gold is useless. Gold does not produce anything. But the precious metal is seen as the best way of retaining the value of financial assets. And if inflation is the final solution, gold is the last defense.