Dow 12,000? Yawn...

The business and mainstream press are breaking out the party hats with the Dow going over 12,000. It's a nice number and milestone to report on, I just don't think it has that much merit as an accurate measurement of the health of the US economy.

As I said in a previous post, there's a difference between the financial economy and the 'real' economy. The financial economy in the US is based on increasing asset values in stocks, mutual funds and real estate. As folks found out from the dot-com crash, just because a stock has a high price doesn't mean it has high value.

The 'real' economy is based on honest-to-Pete business profits, savings and investment. Unfortunately, most Americans look at the financial and not the real economy as the barometer of our country's financial health. If you think of the US economy as a company and look at our financial statements, they don't look very healthy at all.

Peter Schiff talks about 'getting real' on deficits, and a recent Federal Reserve report by Lawrence Kotlikoff asks the question: Is The United States Bankrupt? Because the US Dollar has been the world's reserve currency for most international transactions, we've gotten away with this excessive borrowing and spending at the household, corporate and government levels.

Unless my economic history is wrong, I've never seen any country or company borrow and spend their way to prosperity. I realize the economy is chugging along pretty well now, but I'm bracing for the day when the US has to pay the pipers who have financed our paper prosperity.

Real vs. Financial Economies

Russ Randall has an excellent article from his Austrian Enginomics site that talks about this. My simple definitions are this: The Financial economy is based on the increasing valuations of assets - mainly paper assets such as stocks, and real estate (which the increase is based on cheap credit and mortgages).

The "Real" economy is based on actual savings, investment and profits from the private sector. A good example of the contrast between these two concepts is General Motors. Although it's losing over $10/share, GM's stock price has increased from $19 to about $33/share in 2006.

This is due to speculation that a 'white knight' such as Nissan will merge with GM and temporarily relieve their financial problems that include high levels of debt, and large pension liabilities. It's a short-term fix that doesn't address poor management, dwindling market share, and a heavily indebted US economy and consumer.

Even though the Dow has reached a new all-time high, I don't buy into the 'fact' that it reflects a healthy economy. The American economy today is like a exquisitely-furnished home with plush carpeting and beautiful hardwood floors. However, if you look at the home's foundations, you'll find these wooden beams shaky because of severe damage by termites - or in this case, debt.

That's what the high levels of debt do to a company and a nation. It's like a long-term financial cancer that gradually spreads. Once the damage is realized, it takes a long time to undo the damage, and a long time to get back to good financial health.

Classic Case of Complacency?

Martin Weiss has a good take on investors' opinions of GM and Ford. The same can also apply to the recent (and welcome) drop in crude oil and gasoline prices.

Don't get me wrong - I'm glad to see $2.50 instead of $3-something/gallon gas. I'm just not sure how long it'll last. Check out the recent FSO interview with Matthew Simmons, energy expert and author of the book Twilight In The Desert.