Economic Observer 2011-04-04
I started off the 2011-Q1 Economic Observer by suggesting that the new year "offers a rare opportunity for America to earn back some credibility as an economic leader (of the good kind)."
I only wish that I could report that it has worked out that way. Instead we continue to kick the can down the road with no regard for the long-range consequences. So while things are getting better (and they are on a nominal basis), those small improvements are likely to be overshadowed in the long run by the improprieties that "bought" us (and continue to buy) those short run gains.
Sadly, this bodes to deliver the biggest challenges to those who are least able to afford them, but hopefully you will be able to protect yourself from the worst of it.
Economic Medicine - Global Wealth Health
Your financial "body" is no different than your physical body. Your wealth health is dependent upon maintaining a balance of income, expenses and savings. If you eat to much or the wrong kinds of foods, you get sick. If you spend too much or blow your money on the wrong things your wealth health deteriorates.
The national economic body (as well as the global economic body) is no different - Too much of a good thing all at once ends up being a bad thing. The best economies are the ones that are balanced, growing slow and sure without binging or going through periods of excess.
One other similarity is the appeal of the drugs - which only mask symptoms but do nothing to heal the body. It is easy to become addicted to pain relief (treating the symptom and not the problem) just as it is easy for an economy to become addicted to excess liquidity and deficit spending. They both feel good for awhile, but eventually rot the economy at the core.
Balance is important. Today we have none ... and nobody seems to care, but you should.
The Data - US Indicators
The US is doing better - not stellar but not bad.
Business profits are improving. The growth rate in the ECRI Weekly Leading Index is positive. We have finally stopped the plunge in employment although we're a long way from where we were a few years ago. Inflation is tame with the exception of fuel and food (more on that in a bit) and overall recent events are starting to smooth out and dull the sharp edges of our memories of 2008.
The main objective of this game of kick-the-can was to buy time. For the big-shots in Washington and the big banks, the first order of business was to stop the masses from panicking. The bank failures in 2008 were like someone yelling "fire" in a crowded nightclub. The rush to the exits was anything but orderly and a lot of people were needlessly trampled.
That fire has since been smothered. The efforts since early 2009 and especially since the announcement of Quantitative Easing Part 2 (QE2) last August have been to air out and repaint the place, hoping folks forget their painful past experiences and come back to the party.
The main challenge is that they still haven't done anything to address the problems that caused that fire in the first place. Until they do, another flare-up is likely ... and in fact, almost certain.
The Choice - Medicine or Pain Relief
At this point, we are all faced with a choice - one of many in our lives. It is the choice between having it all now and paying dearly for it later, or having less now (and maybe significantly less) but not having that huge burden to contend with later.
I have often used the analogy of "Car Crash" versus "Cancer" to describe the situation in 2008. At that time, the choice was between a lot of pain up front (the car crash) and then a fairly quick recovery compared to much less pain in the beginning but a very prolonged "recovery" period filled with horrible medicine that may actually make you feel worse.
We're past that now. We chose the Cancer - a very long and protracted period of minimal growth but coupled with economic and market volatility.
Now the choice is between (1) doing the chemo and radiation to treat the cancer or (2) doing nothing but taking pills to dull the pain. With the treatment we will feel sick for a while but have pretty good odds of beating the cancer. Option 2 allows the cancer to grow which will eventually kill us but we won't feel too much pain ... at least for awhile.
Being humans, we are hardwired to appreciate immediate gratification more than future benefits so the Pain Pill has been an easy sell. What is sad about this is that the "leaders" (in quotes for a reason) in Washington or anywhere else are not telling you that the Pain Pill does NOTHING to get rid of the problem and comes with it's own (sometimes very serious) side effects.
Challenges - Global Strife
In the past three months the world has become visibly less stable. Mubareck is out in Egypt. Khadafi is fighting rebels in Libya. Bahrain and Yemen are much more serious flash-points due to their proximity to the sea channel through which 40% of the world's oil flows. Even Saudi Arabia is seeing violence in the streets.
While these are new areas to get the attention of our media, nothing has changed in Iran, China, North Korea, etc. and we have some serious issues also flaring up with our friends in Europe (Spain, Greece, Ireland, the UK).
ALL of these problems stem from two major economic dislocations: high unemployment (especially among the youth) and rapidly rising prices for staples like food and fuel. Both are significant but the second could be devastating.
When you have a large percentage of your younger population who cannot find gainful work, you have a problem. Most major economies (even the US) have unemployment rates for the youngest citizens above 20%. Young people have a tendency to be more passionate and prone to protest especially when their interests are not presently focused on their work.
Challenges - Price Inflation
The rapid surge in food prices and other commodities (like oil) is a bigger concern because food already makes up a significant portion of the expenses of the world's poor (and there are a lot of them). The sheer numbers alone are enough to give any national despot pause - when those people get mad or find themselves with nothing to lose (and when you're starving, there is very little to lose) ... the end results are never pretty. Even the biggest and best army is outnumbered when the poor are are up in arms.
High food and oil prices are one of the most major consequences (but only the beginning) of the excessive amounts of liquidity being floated by the world's central banks. That liquidity HAS to go somewhere.
Excess liquidity from 2003 in the United States went into the housing market - inflating a bubble of massive proportions that almost wiped out the world economy when it popped in 2008. Excess liquidity from 2009-2011 has inflated new bubbles: mostly in food prices and oil (although the stock market has also benefitted) both of which will only increase the tensions between the poor who are hit hardest by this inflation and the world's leaders who don't feel that pain at all.
Challenges - Too Big To Fail
As we pointed out last quarter, Too Big to Fail" (TBTF) banks are now bigger than ever. TBTF institutions like Fannie Mae and Freddie Mac now have an even larger share of the mortgage pie as they continue to loosen standards for borrowers (although those standards are nowhere near as loose as they were in 2007).
It was interesting to see that Jamie Dimon of JP Morgan Chase - usually one of the more reasonable of the TBTF bank CEO's - has stated that the banks are not likely to start modifying more loans or offering more principal reductions even though their balance sheets have swelled many-fold thanks to the largess of the U.S. Fed and Treasury. That is the best indication yet that there are a lot more skeletons in the banking closet.
Some could even say that government itself is viewed as Too Big To Fail, accounting for an ever-increasing portion of the nation's GDP but responsible for nothing more than re-distributing the income of others.
Challenges - Interest Rates
The cost of borrowing money will continue to rise.
We're still seeing upward pressure on interest rates. While the effects are somewhat muted in the United States, they are more pronounced in sovereign states in Europe, the Middle East and South America. This will continue to get worse as long as governments and central bankers continue to treat the value of their currency or their debts with disregard.
Opportunities - ???
By nature I am an optimist. I like to find the silver lining in the clouds. I have told many youth sport teams that a big loss can always be viewed as a wonderful "learning experience." While that statement always brought moans from the players when it was uttered, we did find ways to learn and grow from the experience of getting our butts kicked - if for no other reason than to avoid having it happen again the next time.
So where are the opportunities here?
In our 2011-Q1 Economic Observer, I suggested that Europe's problems would be confined to Europe so the US could be OK. I'm not so certain of that anymore since the problems in Europe are rooted in the same poor governance that has taken place in the U.S. except that Europeans actually seem more willing to change their ways and start taking some of that cancer treatment medicine whereas the United States is prescribing nothing but Pain Pills (can anyone say Quantitative Easing Part 3?).
The opportunity was to be the first country to take a leadership role in dealing with the issues. I had hoped that the new election and significant change in leadership in Washington would start us on a path in that new direction. So far, I have seen no indications of any kind of shift. I will continue to hope, but as I have said many times before, "hope is not a strategy."
The Right White-Water Raft
The only place where I honestly still see opportunity is in strategies that take advantage of severe volatility. We are heading into one of the wildest white-water rapids our economy has ever seen. On a global level, this will be far worse than what we saw in 2008. I can't say whether it will start in the next few months or if it will wait to hit until some time in 2012.
It is not a question of "IF" however, only "WHEN?"
This white-water situation was of our own making through misguided policies and the desire to treat the pain at any cost rather than address the underlying problems. We are on this river of liquidity and we cannot turn back. We WILL hit the white water. Hopefully you will be in a raft that can protect you. Here are some things you can do to make your economic raft more stable:
- Operate your life well below your means - create more value than you consume.
- Remain cautious and as liquid and nimble as you possibly can.
- Look for strategies that pay you for liquidity. This may involve investing in companies that thrive in volatile times or may include specialized instruments like futures and options.
Bad Economists
19th century economist and philosopher, Frederick Bastiat once said, "the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil."
Right now, we're living under the rule of some very bad economists and the politicians they have enabled. Sad as that is to confront, I would rather face the reality and understand it for what it is rather than the alternatives.
John