Two Must-Read Articles from Barron’s: 2 of 2

Summary of: Forecast: A Long, Cold Winter

Stephanie Pomboy, MacroMavens

The economy: My fear is that it’s actually just in the early stages and that it is going to get substantially worse on the economic side.

Short-term Outlook: … essentially the Fed poking people to take risk. They are taxing cash by having negative real returns on cash. At the same time, yields on investment-grade and junk bonds are incredibly alluring. At some point, the cattle prod will get people moving, as it did in March of ’03 when the market turned. (Sanjay: exactly what we witnessed during the past two weeks).

… while we could get a rally in risk assets — including high-yield debt — it’s likely to be a short-term rally within a context of a secular bear market.

But the economic deleveraging has barely begun, and that’s my longer-term.

 Long-term: … revolves around the idea that U.S. consumers are actually going to do the unthinkable — they are going to save — and that we will be more like Japan than anyone believes is possible.

Gold and Dollar:  We are going to see a secular rotation from paper assets to hard assets like gold. The whole global competitive currency devaluation, including that of the dollar, plays right into that. We are acting as though there are no consequences to basically running the money off the printing press and handing it to the Federal government to backstop financial markets or bail out homeowners or what not.

I’ve always had a very simplistic view about this: Either we are going to pay for our policy sins via higher interest rates or a weaker dollar. And for an economy that is as levered as the one in the U.S. is, the former choice is not an option. So a weaker dollar is the natural valve.

But right now, we are enjoying some real competition in the ugly contest from the currencies of the European Union and the United Kingdom, and that will probably persist for a while because they are in pretty bad shape, and they are a little bit behind the curve relative to us.

Bernanke and Paulson: My preferred solution would have been to do nothing. I think it’s the meddling of policy makers that got us into this situation in the first place. I would have favored more aggressive action to arrest home-price deflation (Sanjay: agree whole heartedly).

Going forward: I expect that we’ll just have a prolonged period of subpar growth. I don’t think it will be exactly like Japan, but it will be Japanesque.

GDP growth: In terms of nominal GDP, I see it being around 1% for a long time, five years for sure… to suggest that it would take five years for consumers to recover from this seems like a very conservative call.

Unemployment Rates: Having the standard unemployment rate at 10% is definitely a possibility, though it does depend on what is done in terms of the state and local governments. (Sanjay: my models are forecasting 9.1% in January 2010).

Opportunities: I like hard assets in this environment, gold in particular, where basically the major currencies are all being debased. I also think emerging markets, on a relative basis, are going to do much better than developed markets are. I am looking at going long equities in emerging Asian countries, including China, as well as commodities, which move hand-in-hand with emerging markets. (Sanjay: disagree with China investment view, China is going to stumble more badly than India since China is 80% export dependent).

China will lighten its holding of Treasuries: It just seems to be a no-brainer that you would rather support local consumption than buy U.S. Treasuries (Sanjay: totally agree).

Bottom Line: If I’m correct about the economic deleveraging still ahead and that it will continue for many years, that’s a legitimate concern.  That’s why I’m long gold. I view it as the best way to protect my capital. The other worry is unemployment and this vicious circle where as consumers spend less, companies make less money, and they cut back workers.