08/17/2010 10:27 pm ET Updated May 25, 2011

The Curse of the Yen

With Halloween a little more than two months away, we'll soon be confronted with the traditional array of fiendish masks of Frankenstein, Dracula and Wolf Man.

Economically speaking, I chatted the other day with a combination of the three all wrapped into one: Florida investment adviser Michael Larson.

It was a fitting, appropriate and timely conversation, given our sputtering economy, a jobs market in the doghouse, a housing sector still under attack by termites, waning consumer confidence, signs of a global economic slowdown and an indecisive stock market, notably in China.

Needless to say, it was a frightening chat, especially so on two fronts.

One, a doomsday scenario, was a picture of what might have happened had there been no government aid, and therefore how bad things could be in the future when the funds from the bailouts, stimulus and money printing all run out. The other was an explanation of why Larson calls the U.S. "the United States of Japan."

The doomsday scenario was actually sketched by two prominent economists who are among the closest to the Obama Administration -- Mark Zandi, chief economist at Moody's Analytics, and Alan Blinder, former vice chairman of the Federal Reserve. Their scenario:

--A burgeoning unemployment rate of 16.5%, equivalent to 16.6 million lost jobs, double the amount so far since the onset of the recent recession.

--An entire implosion in the U.S. economy, producing a devastating GDP decline of 11.1%, four times worse than last year's contraction of 2.4%.

What makes their scenario so ominous at this point, observes Larson, is that the government money is beginning to run out right now.

Larson figures government aid was spewing forth at an average monthly pace of about $160 billion between mid-2008 and mid-2009. But that has since shrunk to less than $60 billion and he figures due to the public backlash, there is essentially zero chance Congress will pass another stimulus package this year. There is just no political will power for it, he says. As a case in point, he notes the administration barely got the green light for its recent $26 billion aid package for the states.

The way Larson sees it, the U.S. is in the same bind that afflicted Japan, which -- from the late 1980s to the present -- has experienced anemic economic growth, plus bubbles in real estate and its stock market. In turn, Japan dramatically lowered interest rates and created a number a number of stimulus packages which periodically enabled its economy and equities to pop. The U.S. has done the same thing.

The striking similarities between the two countries is what prompted Larson to repeatedly describe the U.S. during our chat as "the United States of Japan."

Looking ahead, he sees weakening U.S. economic growth. In fact, he argues that "the next phase of the double-dip recession is fast approaching." And once again, he says, Wall Street's fat cats are napping at the helm.

Larson figures the first quarter's GDP growth rate of 2.7%, revised downward from its original 3.2%, is likely to be the high water mark for the year, with both the third and fourth quarters winding up in negative territory.

As for the stock market -- which he says is rolling over -- Larson notes that the Fed's promise of more funny money led to a July rally. But that rally, he says, is fading, prompting investors to awaken from their fantasyland slumber.

With consumers not wanting to spend, business not wanting to borrow, excess capacity and too many workers based on the low level of demand, Larson says caution and savings are the watch words of the day. What's more, he went on, the bond market is telling us deflation is here, it's a serious risk and that the economy is weakening.

Accordingly, he sees no way to escape falling stock prices. And that's precisely what he tells me is on the way, predicting that the Dow -- now around 10,400 -- will soon break the June lows of around 9,600 and wind up the year at about 8,000.

Referring to the "flash crash"--the May 6 market dive when the Dow fell nearly 1,000 points during the
trading session--Larson says that wasn't an anomoly, but a warning.

In a related note, Larson observes that many investors are rushing into bonds for safety, theorizing incorrectly that weaker economic growth will automatically drive down interest rates (and thereby push up bond prices).

The truth, he points out, is that a weaker economy will drive the government's deficit through the roof, risking a sovereign debt crisis in the U.S. and sharply higher interest rates.

His advice: Raise cash and do it now!

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