We are in the eye of the storm I expected in the “Outlook” of October, 2008. This calm may last as long as a few years. Therefore the economy will probably show modest growth throughout 2010, though well below that usually experienced coming out of a downturn. Do not pay any heed to the superficial ‘snapback’ analyses from some Phd.’s who predict strong growth because we had such a deep downturn. There is no fundamental economic or financial principle justifying such nonsense.
The main reason we will see growth at all is the federal government has showered the economy with $trillions of checks. Like a strung out drug addict getting a fix, those checks temporarily stop the pain. Also, like the strung out drug addict, the new fix doesn’t give the economy that old high before we became so strung out.
When we entered previous downturns since WWII, once the Federal Reserve began lowering interest rates consumers and small businesses could resume borrowing at an accelerated rate. The increased borrowing early on was tied to growth in new home sales and automobiles. Later recoveries added credit cards. This latest recovery was fueled almost entirely by consumers cashing out their home equity. That is illustrated by the chart below:
You can see that despite the massive rise in home prices, net equity did not increase at all in the 15 years leading up to the end of the bubble. Consumption growth during that 15 year period was not financed so much by expanding credit card balances, auto loans, etc. as was the case during most of the post WWII period, but primarily by using housing as an ATM to the tune of $trillions. The ATM is now closed, so any consumption growth from here on will be considerably weaker than would normally be expected. The consumer has gotten the message as well, and is acting accordingly, though grudgingly.
While exploring the financial state of the consumer and its relation to expected growth for the near term, I stumbled across the next chart which is a stunner. The top half shows household liquid assets (cash, stocks, bonds, etc.) as a percentage of total liabilities. It is not surprising that it has dramatically declined over the last 50 years.
What shocks me is the lower half which shows household cash as a percentage of total liabilities. I was so incredulous that I triple checked the data. As a financial advisor I used to focus on money market fund assets for clues to the health of the stock market. I had no idea that households actually had more cash than liabilities, but it was true!! Herewith the charts:
There is no way the consumer can return to anything resembling past behavior. Therefore the economy will grow, but with a case of anemia. The question is why it should grow at all.
The flip side of the lack of firepower from the consumer is the explosion of federal spending and monetary inflation. So far my analysis disdainfully dismisses the superficial polyannish forecasts using recent recession and recoveries as guides. Here we need to confront the more cogent bearish economic forecasts which highlight the apparent ending of spending and printing by the feds during 2010.
Various cyber cash creation programs (e.g. mortgage backed securities purchases) and massive spending programs (e.g. housing tax credits and the “stimulus” package) by both the Federal Reserve and the treasury are set to either expire or wind down by the end or the second quarter of next year. This is causing great angst about the potential for both rising long term interest rates and a second economic dip into recession.
Don’t worry, be happy.
Throughout this year there was considerable criticism that the stimulus money was not spent in 2009, but instead the bulk would be spent in 2010. Regardless of one’s agreement or lack thereof with the administration’s economic philosophy, you have to admire the genius of this move. Why on earth should a politician or advisor of the majority party want to spend money in 2009 when it could be spent in an election year?
Since I believe the spending schedule was deliberate, it would be inconsistent to believe the architects of this politically astute program would suddenly stupidify and fail to follow through with massive spending all the way to November. Anyone with a pulse has to know that ending the home buyer tax credit, for example, will crater the housing market.
Therefore, you can bet that a politically motivated replacement will be found. The same applies to our friends at the Fed. There is no way the Fed will allow mortgage rates to move much higher than 5% because they too understand what that would do to the housing market. My guess is that Fannie and Freddie will become arms of the Federal Reserve. They will purchase distressed mortgage backed securities at par (well above market prices), which will allow them to negotiate dramatic principle reductions.
Therefore, the economy can be expected to muddle through the year, and perhaps well into 2011. The financial markets can also be expected to muddle through. That means I do not expect dramatic moves in either direction for the next year. Keep in mind that I do not consider 15% moves dramatic. That sort of thing can happen at any time.
No forecast can ignore the elections. Republicans salivating at the chance for big gains are not merely whistling, but pissing in the dark. This is not 1994. The republicans have no dynamic leadership and their best known thinkers are really left wing lite, excepting Ron Paul who is not really a republican and virtually ignored by the party elite.
The party in power loses seats in the next general election. This time will be no different. Of course, since political analysis is not my main area of expertise, I could be thoroughly underestimating the politicians’ propensity for screwing things up. Advantage goes to the democrats with an economy appearing to be on the mend when voters enter the booth.
Check out the figure to the right. It shows the average annual increase in spending for presidential administrations since Eisenhower (adjusted for consumer price inflation).
The spending growth shown above excludes interest costs, which is only fair because they are largely inherited and the fiscal authorities have no direct control over the financial markets. Note that the decline under Eisenhower was due entirely to a drop in defense spending following the end of the Korean War.
The next chart also removes defense spending from the equation. This too makes sense because the military is one of only three valid federal government functions.
I give Eisenhower a pass because the federal government had to give short shrift to domestic spending during the war years. Note the biggest spender was that arch conservative tricky Dick. See where Reagan comes in.
For those of you who like to criticize Reagan for his increasing the defense budget, please consider this next chart which puts it all in context. It shows defense spending as a percentage of national income. All Reagan accomplished was to reverse the decline in defense spending under Nixon and Carter.
If you try to excuse Nixon’s fascist fiscal policies because he was such an anticommie, well think again. Defense spending dropped and social spending skyrocketed during his dictatorship.
Lastly, these charts go a long way to illustrate how there really is no significant difference between the two parties, both of which have been lurching leftward on economic policy for over 100 years.