Economy

Two Scoops

The keyword to watch for now is #doubledip.  Because with the recent uptick in the economy, the investing world is going to start looking for signs of a double-dip recession.

There’s every reason to predict another dip:

  • Profit taking from the current rally causes the market to drop again, possibly below 6500
  • Continued bad news in unemployment
  • Continued bad news in housing
  • Continued falloff in GDP
  • Failing auto companies

The list goes on.  Housing and auto sales are likely to have a double-dip feel to them as well.  Housing and auto sales have fallen far below their historical averages, so we should expect them to pick up, at least briefly.  But we shouldn’t expect strength in either sector as long as unemployment and overall GDP are falling.  That means a brief (1-2 quarter) uptick followed by another drop.

I’m expecting the current rally to end very soon as profit-takers force the market downward.  I don’t think we’ve seen the bottom yet.

The real question is: what is going to happen with the US auto manufacturers?  The government has shown little interest in helping out – about $12B in loans (compared to the trillions given to the financial sector).  The auto executives have gotten a bum rap.  Millions of jobs are at stake. Working class jobs.  Will these be saved?

If not, beware.

Coming Off the Junk

Remember “Change You Can Believe In?”

Remember how we were going to do away with earmarks?  Toss out the lobbyists?  Get away from old-school politics-as-usual?

“Hope” – remember?  Isn’t that why you voted for Obama?

Still feel that way?

Charles Krauthammer sums it up nicely:

It’s not just pages and pages of special-interest tax breaks, giveaways and protections, one of which would set off a ruinous Smoot-Hawley trade war. It’s not just the waste, such as the $88.6 million for new construction for Milwaukee Public Schools, which, reports the Milwaukee Journal Sentinel, have shrinking enrollment, 15 vacant schools and, quite logically, no plans for new construction.

It’s the essential fraud of rushing through a bill in which the normal rules (committee hearings, finding revenue to pay for the programs) are suspended on the grounds that a national emergency requires an immediate job-creating stimulus – and then throwing into it hundreds of billions that have nothing to do with stimulus, that Congress’ own budget office says won’t be spent until 2011 and beyond, and that are little more than the back-scratching, special-interest, lobby-driven parochialism that Obama came to Washington to abolish. He said.

Right.  He continues:

After Obama’s miraculous 2008 presidential campaign, it was clear that at some point the magical mystery tour would have to end. The nation would rub its eyes and begin to emerge from its reverie.

The hallucinatory Obama would give way to the mere mortal. The great ethical transformations promised would be seen as a fairy tale that all presidents tell — and that this president told better than anyone.

I thought the awakening would take six months. It took two and a half weeks.

I don’t blame you if you voted for Obama.  He’s young, smart, charming and progressive.  John McCain is old and Republican and uninspiring.

Let’s face it.  Obama’s message was like a shot of smack to a nation full of people junked out on the drug of mass media messages.  We, as a nation, don’t want to deal with our nation’s problems.  Obama promised that, if elected, we wouldn’t have to.  We got high on that message.

And now we gotta come down from the high.  Because like any drug, it’s a false reality.  The real one is still out there waiting for us.

Look, don’t get me wrong.  I don’t know that McCain would have been any better.  The ruling class in Washington – Republicans and Democrats alike – are all dead-set on one task: aggregating as much power as possible in the hands of the Federal government.

And they’re using the financial crisis as an excuse for immediate action.  We had choices.  There are other ways we could have stimulated the economy.  There were other alternatives.

None were heard.  There just wasn’t time.

So, from all the possible alternative solutions, we just happened to get the one alternative that most grows the size and scope of the Federal government.

Somehow, this country must wake up.  We’re entering a doomsday scenario:

  • a bankrupt government
  • using borrowed money
  • to bail out bankrupt companies
  • who lent borrowed money
  • to bankrupt borrowers.

It’s positively Escherian.

What $1T Could Buy

The recently passed “Spendulus” package has left me totally aghast.

I’m pretty (small-L) libertarian, so when I hear of the federal government taking on this kind of authority and power I naturally pucker up pretty tight.

A lot of my friends – Obama supporters from the go – are big supporters of the plan.  They see good intentions everywhere.  Helping the poor with increased Medicaid funding.  Helping the middle class with more tax rebates.  Building roads and bridges.

Motherhood.  Apple pie.  Who can argue with that?

Well, me, for one.  Because it isn’t our money we’re spending.  We’re not paying for this.  We don’t have the money.  Remember?  We’re ass-over-head in debt.  No, it’s a big loan from our children to us.  They’re the ones who’ll be footing the bill for this.  It’s stated to be about $800B.  In my experience, most government spending runs wildly overbudget.  I would expect this to cost $2T.  Maybe more.  For the sake of nice round numbers, I’ll say $1T.

I could dispute the wisdom of borrowing $1T to stimulate the economy by pointing out that it is excessive debt that has caused the economic meltdown.  How do we think that a nation that is overwhelmed by debt – personal, corporate, and governmental – can borrow its way to prosperity?  Isn’t that like trying to drink yourself sober?

Or I could tear the plan apart on the merits of its proposals.  Does it really make sense for the government to spend $8B on Healthcare Information Technology?

Instead, I just want to ask the question: what else could we do with this money we’re borrowing?

Here are a few ideas that just come randomly to mind.

  1. Divide the $1T evenly among the approx. 110M households in the US.  That’s about $9K for each one – enough for the poorest households to pay rent for a year and buy a small used car.
  2. Feeling progressive? Divide the $1T among the poorest 20M households in the US.  That’s a one-time payment of $50K for each one – enough to permanently lift them out of poverty, if spent wisely.
  3. Feeling libertarian?  How about a 50% reduction in all federal personal taxes (income, payroll, etc.) for 2009?
  4. Feeling progressively libertarian?  How about eliminating the 2009 tax for the bottom 95% of taxpayers?
  5. Feeling spontaneous?  How about dropping all of it in $20s from the back of a C-17?

You may think I’m being silly, but I’m not.  Even option #5 has something that the Spendulus package doesn’t have: it puts more money into the hands of the people, and it avoids creating Byzantine federal bureaucracies that waste money and take jobs out of the private sector – bureaucarcies that will cost tens of billions to implement and fund.  Money our children will have to cough up.

Realize that the government is already talking about dropping another $500B – $1T next year for additional “stimulus”.  If we spent it using option 2, that means that the poorest class in our society would all receive a $100K income from the government over the next 24 months.

There are various ways we could have chosen to stimulate the economy.  There’s a reason why the proposal looks like a massive increase in government programs.  It is because its proponents are class of people who think that the government can better allocate our nation’s resources than can the people it governs.

Sound familiar?

Dow 1500?

Are we living in a new Depression era?

A few years ago I was working in the IT shop of a national US homebuilder.  Even though the world was chanting “there is no housing bubble” it seemed obvious to me that we were in a major housing bubble.  This company couldn’t build houses fast enough.  Growth was astronomical.  Folks, this is housing we’re talking about.  If housing typically grows at a rate of 2% a year, and you see it growing at 20%+ for several years, you can bet your sweet bippy it’s a bubble.

The burst of a housing bubble set off the Great Depression.  But, like the Depression of the 30s, the burst of a housing bubble is only a symptom of the problem.  It isn’t the problem itself.  The problem was – and is – runaway borrowing and lending.

Check out this chart showing the ratio of consumer debt to GDP.  What was the situation in the late 20s?  People assumed that the market was invincible and bought in ravenously, often going deeply into debt to cover their speculation.  Likewise in the last 10 or so years.

I am not sure what is a healthy, sustained lending rate (expressed as the lending / GDP ratio), but it must be below 100%.  Let’s say that a healthy or stable rate of lending is approximately 50-70% of GDP.  If that’s so, then the banking system is going to have to contract the amount of lending by roughly 30-50% in order to regain a stable aggregate lending rate.

What macroeconomics teaches us is that inreases in lending results in an increased money supply.  And decreases in lending result in a decreased money supply.  When the money supply decreases, we call that deflation. Without aggressive efforts to bolster the money supply, we are going to enter a sustained deflationary period.

Contractions in the money supply from 1929-1933 drove the Dow down 89%.  If the current recession / deflation were to take a similar course, the Dow would bottom out around 1500, roughly erasing the last 25 years of growth.

That doesn’t have to happen.  What is required is twofold:

  1. Banks must be supported by all means necessary.  They must not be allowed to fail.
  2. The money supply must be bolstered through monetary and fiscal policy.

The problem with aggressive monetary policy is that the lowest interest rate available is 0%.  And during a deflation, even a 0% loan is bad for the borrower: deflation causes the money I’m paying back (later in time) to be worth more than it is today.  We already are approaching a 0% federal funds rate.  We can’t be significantly more aggressive than that.

And the problem with fiscal policy is that it’s fiscal policy.  First off, we have to borrow in order to spend aggressively.  Our national debt is already out of control.  It’s inconceivable that we can keep borrowing at an increased rate – especially from other economies who may be even worse off than ours.  Then we have to spend the money internally, which looks like huge inefficient government service programs.

It’s going to get interesting, folks.  We are likely heading into a deflationary spiral – one of the most intractible economic problems that can be faced.  There have only been three significant deflationary spirals in US history: one in the early 1800s, one after the Civil War, and the Great Depression.

Deflationary spirals are economic contractions caught in a self-reinforcing feedback loop.  The logic is this: people believe that times are going to get tougher, so it makes sense to contract (spend less).  Decreased spending causes times to get tougher:  prices drop, and, facing dropping prices and scarce revenue, it makes sense to spend less.

Andrew Muse agrees, and points out

I think the important thing to realize is that people are saying things like “capitalism as we know it may be over” and “the DOW might drop to 3,500? – it doesn’t matter if they are true, it only matters that some people believe they might be true.

I hope 3500 is the floor, Andrew.  If 1933 repeats itself, we’ll all be wishing for 3500.