Muwabi Economic Forum

I’m frequently called a pessimist on economic matters but if being an optimist makes me sound like this, I’ll accept that title with pride…

Since this time, Kneale has invited various “critical” bloggers on his television show, accusing those non-acceptors as cowardly and unable to refute his points. One blogger did regretfully accept the invite and was given less than a minute to make his points before being cut off and ridiculed with ad-hominem attacks.

I’ve posted this clip on my website to give a sample of the “recovery” crowd. There are countless more intelligent debates and arguments for a V shaped recovery but sometimes the most ridiculous can best illustrate one’s point. I’ve debated many less informed colleagues on this very point and have yet to hear a single argument that makes me wonder if my thesis is flawed. About 18 months ago, the consensus was for growth at the end of 2008. About a year ago, I’ve repeatedly heard economists proclaiming an end to the recession by mid 2009 at the latest. At the current time, most economists agree on recovery by the end of this year. I have and will continue to stick by my prediction of a prolonged economic slump lasting until a minimum of 2012. The economy possibly might see GDP growth before then, but will not fundamentally recover until the system is cleared of default, losses, and monetary pressures. Yesterday I was asked for a list of reasons for my belief. I could expand upon any of these reasons with ample evidence and analysis, however, will stick to a list for today’s purposes. Here it is…

1) Unemployment will be above 10% at the end of this year and has shown no signs of slowing. Underemployment is even worse, approaching 20%. This means 1 out of every 5 Americans is unproductive, not spending, potentially defaulting on loans, and in a dire economic situation. This will affect every aspect of economic indicators.

2) Housing is nowhere near a bottom. Prices are still historically high and have a long way to go toward sustainable levels. Typically in bubbles this size, the bust runs deeper than true valuation levels. With excess inventory all over, little mortgage lending, and foreclosures still only halfway over, I don’t see prices bottoming anytime soon.

3) Speaking of foreclosures, the data and forecasts are not pretty. Foreclosure moratoriums and Obama’s delay tactics have slowed this process down slightly, but logically those without sufficient income or those under water will eventually foreclose. The high percentage of option ARMs resetting over the next few years will prove disastrous on a scale possibly larger than the subprime population. The 20% earning less than before or nothing simply cannot be expected to maintain payments. The Alt-A population with good credit history but missing income verification will see defaults rise. Since government is intervening and slowing this process down, a housing bottom is even further away than it ordinarily would be.

4) Households are still overwhelmed with debt. Just two years ago, our country went through a long period of near-zero and even negative savings rates. It’s no secret that household debt exploded to unseen, unimaginable levels. Those not defaulting are busy repaying their debt and increasing savings activities. While this is a positive trend for long term analysis, it won’t bode well for the short term.

5) The US economy is fueled by consumption as it comprises 70% of GDP. With credit levels having seen their peak and probably never returning, consumption has no chance of growing to past levels. The economy must correct itself to the proper level of consumption (a negative impact for retailers, service providers, travel, etc). GDP cannot grow without a recovery in consumption and the savings rate figures prove this is not occurring.

6) Because mark to market accounting has been restricted, banks are allowed to hide the massive losses still being incurred. If failed banks are kept in business at the expense of productive asset holders like taxpayers and more efficient banks, we will see a repeat of the Great Depression or Japan’s lost decade. Banks will be too busy keeping reserves high and paying down debt to productively utilize their performing assets.

7) Banks have zero incentive to lend. In today’s economic setting, it is nearly impossible to distinguish between those that are and are not creditworthy individuals because unemployment can strike anyone. Banks don’t have strong enough balance sheets to offer new loans and have little incentive. As long as the government keeps funneling cheap money for their benefit, they’ll sit on their assets and wait for stability.

8) Businesses and households have no appetite for additional debt. Businesses are not looking to expand because most have over-expanded operations in expectations of a bloated economy. Households have learned the lessons of cheap credit and are more concerned with repayment and savings than digging into even deeper debt. As long as this demand continues to be stagnant, expansion will not occur.

9) Earnings expectations are bound to disappoint. Earnings were at record levels over the past decade because credit was obtained so easily. With contraction in credit levels, investors will be disappointed to see businesses unable to approach these record earnings figures.

10) Every level of government is at capacity. Government spending accounts for another large portion of GDP. Eventually difficult choices must be made and spending will have to be controlled.

11) Since government is running record deficits and debt levels, taxes must eventually rise to fund this excess. I believe this will occur sooner rather than later and will choke any possibility of economic recovery.

12) Every effort from government to prevent deflation and credit locks have failed. It would be unwise to expect these government programs to provide the liquidity boost necessary to recover when it ignores basic economic and logical reasoning.

13) Stock prices are an indicator of public sentiment. Even in the Great Depression, there were several bear market rallies. Stocks are still overpriced by historical standards and have been rising in the absence of other positive indicators. I cannot imagine this run will continue much further.

14) China and Russia are publicly questioning the dollar’s reserve currency status. This is the beginning of a path toward more expensive debt funding and the end of the dollar’s dominance.

15) The global economy is in equally bad shape. I wouldn’t advise expecting a European, Chinese, or Japanese led recovery.

16) Commodity fundamentals are still relatively strong (especially for oil supply/demand). With high prices in basic resources, it ensures less budget for discretionary items.

17) In response to these indicators supposedly improving… slightly improving off the worst few months in history is nothing to get excited about. I want to see actual year over year growth or a string of six straight months of solid gains before I believe they indicate recovery.

18) Baby boomers were at their peak level of spending and productivity during the boom lasting from 1981-2007. They’re set to retire soon and have lost a large portion of their savings. Not only will we have to replace this enormous demographic of productivity, but we will have to support them as they retire and become unproductive.

I’m sure I could add a few more items to the list, but you get the point. Now let me list a few reasons for recovery…

1) The American economy has historically always gone up.
2) Equity has performed very well lately.
3) In times of trouble, the world still seeks safety in US Treasuries.
4) A few indicators have beat very low estimates and risen off historic lows
5) The stimulus may temporarily fund a few million jobs

These arguments are extremely weak… I just don’t see these holding up to the enormous pressure of my first 17 reasons. I’ve been wrong in the past and quite possibly could be wrong today. For the sake of argument, let’s assume I was wrong and this glimmer of hope turns into a real recovery. What would happen? The Fed would immediately begin to unwind their policies and rapidly raise interest rates. Oh wait, this is reason number 19…

18) If I’m wrong and we do enter recovery, there will be enormous inflationary pressures on the economy. The Fed will rapidly increase rates, ensuring any possibility of growth is immediately starved. Fed policies will only have limited effectiveness initially, and double digit inflation may be likely. For a picture of what this is like, see the 1970s and early 1980s.

I challenge anyone to dispute these 18 points… I’d be happy to provide more analysis and evidence of their truth. Unfortunately, many people will make the same mistake over again because irresponsible commentators preach the same financial illiteracy plaguing our economy in the first place.

This entry was posted on Tuesday, June 30th, 2009 at 11:23 pm and is filed under Economics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.