Economic Observer 2010-11-28
The past two weeks have seen much improved economic statistics being reported. In reading the newspapers you might be led to believe that our economy has turned the corner and we will be back to fun times in no time at all. While the news IS encouraging, I think that some cynical caution would serve you well.
Good News
The ECRI Weekly Leading Index is turning around. World Business Confidence is up. Many federal studies show improvements in manufacturing and business development. Big companies are hiring (while small companies are downsizing) as is the Federal Government (while the states and cities are letting people go) giving the employment numbers a mild boost. Buyers are showing up in the stores (although they aren't spending as much)
Challenges
The challenge that I see - and the one that will serve you well to keep a jaundiced eye upon - is that while things ARE getting better, there are plenty of major disasters which could easily come along and "upset the apple cart." The two biggest issues are (a) problems in the banking sector and (b) problems within the global economic community. Both are being treated with the same mentality - one that is at the root of our problems.
Two of my favorite economic observers summed things up very well: John Hussman in his weekly letter states:
"My concern is that the surface U.S. recovery is built over a foundation that is vulnerable to further strains. If our policy makers had made proper decisions over the past two years to clean up banks, restructure debt, and allow irresponsible lenders to take losses on bad loans, there is no doubt in my mind that we would be quickly on the course to a sustained recovery, regardless of the extent of the downturn we have experienced. Unfortunately, we have built our house on a ledge of ice."
John Mauldin in his weekly bulletin says:
"But we dug a very deep hole for ourselves, and until we create whole new industries (which we will) unemployment is going to remain high. If you are among the 10% who are unemployed, or the 17% who are underemployed, it is going to feel very much like we are still in a recession ... As businesses adjust, as entrepreneurs respond, we will slowly come out of this. But it is going to take longer than we would like."
Car Crash or Cancer
There are two major potential stumbling blocks ... and both originate from the same "bailout mentality."
The Banking Sector - We have chosen to bail out any big bank who screwed up - and ALL the big banks screwed up. This was done to avoid pain as bank failures can be painful. I understand the logic but point out that the perverted incentives that the bailouts create foster their own set of painful consequences - consequences that are often far worse than the original pain being avoided.
Rather than a quick and sharp pain, this will be a deep and dull pain that will last for years, decades or even generations.
Years ago I latched onto a concept I believe was first suggested by Todd Harrison of Minyanville.com - The choice between a Car Crash or Cancer. We obviously chose the cancer treatment - long and arduous, full of horrible medicine that may or may not kill us as we try to kill everything in our economic body (including the cancer). My personal preference would have been for the car crash. It would have been quick and very painful, but from that point forward we could have begun the recovery.
Today we would be two years into that recovery. Instead we will deal with prolonged instability and a constant feeling of being sick as the doctor tries one remedy after another to cure the cancer. We don't know if these treatments are working, although I suspect they are to some extent. The questions become, "At what financial cost?" and "At what compromise of quality of life?"
The cancer is stupid bankers, an irresponsible Fed and a lot of people making dumb choices with other peoples' money. Unless and until you begin to address these issues, the cancer will linger and all the chemotherapy will just make us feel sicker than ever.
Global Issues - North Korea and South Korea are clashing (again) and that could turn into a bigger powder-keg but there are plenty of places on this earth where people are fighting. This is no different than other times in history and is no guarantee that the situation will escalate. Could it be a problem? You bet, but the bigger problem lies elsewhere.
The more immediate problem includes Greece, Ireland, Portugal and Spain. Our approach to these problem economies has been our approach to the problem banks - Bailouts - an approach that creates more problems than solutions (more Cancer treatments). Right now, the IMF bailouts of Ireland are preparing to stick it to the Irish tax-payers. Why? Because European bankers lent money to Irish banks to support a speculative bubble in Irish real estate (where have I heard this before?).
Ireland's government was rare in that up until now they have behaved responsibly and not gone on a lavish spending spree. ? The only problem in the Ireland economy has been stupid bankers who made bad loans, should have taken huge losses and forced their bond holders (mostly investors from other countries) to take their share of those losses. That's what happens when most people make a bad investment or lend money to someone who can't repay. They lose money on their investment. Instead, someone (the IMF) comes in and says, "We can't let these banks fail - it will cause their bond-holders to lose money."
Ireland is being force fed loads of additional national debt in order to bailout stupid Irish banks and their investors. Taking on this debt pushes the national debt load of Ireland over the EU's allowable thresholds causing the need for more severe austerity measures - measures that will push the economy into a deeper recession and create more austerity measures in a devastating feedback loop.
The Monster is Sleeping
And it is all because of "bailout mentality."
This all brings back to mind an old motor-oil commercial. The scene opens with a car mechanic with somebody's car on the rack behind him, obviously in need of substantial and expensive repairs - all because the car's owner chose not to do an inexpensive oil change and check up. The mechanic states, "You can pay me now ... or you can pay me later."
The choice is ours.
I'm no more into taking pain than you are, and coming to terms with all the garbage we have done over the past 30 years will not be a pleasant experience. This is why the politicians will never suggest it - encouraging their constituents to take on pain will mean losing votes (and with it the power that comes with their jobs). But I would much rather pay to flush all the systems, inspect everything and fix what must be fixed now than wait until everything breaks and we have to build a whole new car from scratch.
Suggestions to Navigate This Landscape
The Car Crash is not a political possibility. We're in treatment for Cancer and getting ready for another course of chemo and radiation. The side effects will be a disturbing form of malaise and we will be building pressures for more severe economic crises in the future. I can't say when these will come to pass. I only know THAT the monster will not sleep forever.
- Be cautious and as liquid and nimble as you possibly can.
- Be extra careful to protect your downside from volatility because you will see it again.
- Do your best to operate your lives well below your means.
- Look for hedges against higher taxes, limited access to capital and the high likelihood that interest rates will eventually rise substantially.
- Work to create as much value for the marketplace as you can and limit your need of handouts from others.
Yours truly,
John