Wednesday, December 10, 2014

Crosscurrents Cloud Future Economic Picture

Where Do We Go From Here?
The American and world economy is in uncharted water. Weird crosscurrents are clouding our economic future. Last quarter America's GDP came in at a strong 3.5% but the fact that a 10% jump in federal spending, mostly on Pentagon hardware bolstered growth and was very much behind the numbers. This "pre-election" spending was the biggest increase in federal spending since 2009 when the Obama administration put in place a huge economic stimulus package. Mix in an upbeat November number concerning job creation, falling oil prices and ever higher stock market prices and new record highs and many people have the impression we are on a roll.

The fact is we have created a "Government Centered Economy" and the newly elected  Republicans controlled Congress will have power over the purse stings and government spending. It appears they now sit in the drivers seat and they should by all logic slam the brakes on the destructive policies that have distorted the economy and driven stocks to record highs, but why would they want to take on the hard task of bringing about painful reform? What a tangled web we weave, it is hard to deny that the economy is a manipulated mess propped up by government spending and artificially low interest rates that hurt savers. Politicians never want to be the ones to take away the punch bowl and be blamed for ruining the party, this means expect little help from Washington..

We should understand that demand is the true driver of economic growth and investment, it is not confidence. Lack of real growth is about lack of real demand, and much of the demand we see today comes from artificially low interest rates and QE that distorts the markets. Not only do low interest rates punish savers, but when rates are held at an artificially low level for too long capital is misallocated and flows into speculative investments. All growth is not created equal, quality does matter, we must differentiate the kinds of economic growth and understand that if you spend money but afterwards have little to show for it you have wasted it. Sadly, much of the money America "invests in itself" each year through government spending and programs falls into this category.

Several other acts are playing out on the economic stage adding to the confusion. World growth is slowing while countries remain mired in debt, this is making the dollar stronger in relation to the other major currencies. This will not help American exporters as month after month we suffer huge and unsustainable trade deficits.  When coupled with huge government budget deficits the trade deficits move America in the direction of bankruptcy. It is a myth that we can "export" our way out of this mess, a myth spread by politicians preaching the "no pain" method of solving a problem. Another problem is that the good news to consumers of oil prices falling across the world are adding to destabilizing many countries and disrupting a major growth sector of the American economy. Energy production has been a big job creator for America but lower prices threaten to make drilling unprofitable and stop it dead in its tracks.

Adding to our woes job creation and wage growth has been weak compared to all other post recession periods. Recent Black Friday sales were dismal at best and unenthusiastic consumers suffering from years of poor wage growth and in a protracted state of weakness are unlikely to bail retailers out this season. We have seen a big shift in what consumers are buying, recently they have been spending more on autos and healthcare, but the Obamacare mandate may be guilty of creating stress in other sectors of the economy by redirecting spending away from them. Booming auto sales driven by low cost and sub-prime loans may do the same when payments come due. Many of these sales may be motivated because an automobile owner faced with a costly repair may be oping for this alternative verses putting money they do not have into their current ride. This allows someone in a weak financial position, such as those living on disability or student loans, to kick the can down the road while putting themselves into an ego boosting vehicle that they cannot really afford.

In many ways Bernanke and the Fed have put America on a path that mirrors the same unsuccessful path taken by Japan. A path that avoids real reform and bails out the very people that caused many of our problems. The Fed then upped the ante by setting the bailout and money printing machines on high and flooding America and the world with QE. By selling other central bankers on this solution the Fed now led by Janet Yellen has taken the lead in an experiment that is losing traction across the world. Real momentum seems to ebb shortly after each new wave of stimulus and another fix seems to constantly be needed. While they claim otherwise any thought that inflation is not higher has come from the false illusion brought from a very competitive retail environment and lower payments on auto loans and mortgages. This is a one off and will not continue.

Trouble lurks ahead because debt does matter and it will massively thwart growth going forward. If I'm correct, much of the idea of "so called pent up demand" in our economy is secondary and we are being pushed along by cheap money that is unsustainable. Interestingly, this is all occurring at a time the government continues to pour out billions of dollars each month in student loans, many of these loans will never be repaid. This is in a way its own "stimulus" package. It is hard to predict the future and often we are very surprised how events unfold, expect the unexpected. Remember that great forces are at work here and things are moving rapidly. The currency players and the carry trade is in constant flux. This is not a well rehearsed performance but rather a play it by the seat of your pants and this improvised effort to keep many balls in the air while the ground shifts under our feet. If these balls begin to drop things can go very badly in the blink of an eye.

 Footnote;  As always comments are welcome and encouraged. This article goes hand in hand with the article below that focuses on the destabilizing effects of falling oil prices.


  1. Continuing climbing debt leads to slow growth. Beware.

  2. Thanks Bruce for the informative article. Happy Holiday's

  3. Bruce, I share your concerns and have been expressing similar views on my Seeking Alpha Instablog ( search for Mike Holt).

    Debt and Demographics are the two underlying trends at the heart of the "weirdness" that you describe. We also need to understand that economic growth is a requirement for our economy, as it is designed, to function as we expect. This is especially true when debt levels are as high as they are. But, Demographics (aging populations in developed countries) create headwinds for that growth. So, we rely more heavily upon emerging market countries to provide the needed growth, but as their economies grow, the influence of their heavier state involvement in their economies also becomes more pronounced, and concerns about shifts in power and the existing "world order" prompt further government and central bank interventions that distort markets and our economy still further.

    So, instead of reducing debt to reduce the risk of deflation from a disorderly deleveraging process, debt levels continue to grow, allowing fundamental problems to remain unresolved.

    But, there are two schools of thought that influence how this is perceived, namely the Austrian School of Economics and the Classical School of Economics that has essentially redefined Monetarism as another indirect avenue for government intervention through "monetary policies" implented by not so independent central banks (accompanied by increased influence of banks who hold the government purse strings) in lieu of the direct fiscal policies characterizing Keynesian Economics that were relied upon more heavily prior to the 1986 Tax Act that eliminated the tax loopholes that had been used during the 1970's as an alternative means of artificially inflating asset prices for activities that otherwise would have no economic value.

    Those in favor of greater government involvement (power) argue that the weirdness we are witnessing makes perfect sense and that if desirable outcomes don't result it is due to insufficient intervention that could be maintained through tax increases if limits on debt capacity ultimately caused interest rates, thus debt carrying costs, to increase.

    The Austrian Economists on the other hand argue that artificially low interest rates orchestrated by central banks--acting as policy makers rather than merely lenders of last resort for banks responding to natural market shifts in the supply of deposits and demand for loans--distort markets and contribute to asset bubbles that could lead to a restoration of market equilibriums but because of the pain this would cause are accompanied by even more central bank intervention, and more debt, to achieve an unsustainable "stable disequilibrium" instead.

    The ideologic differences between adherents to these two schools of thought colors the reporting of activities and events, making it more difficult to understand what is happening and where it is likely to lead. The growing influence of state capitalism variously employed in emerging market countries, particularly China and the OPEC countries, adds further to this confusion.

    Traditional analysis of market forces must now be accompanied by geopolitical analysis in which most investors and businesspeople have very little formal training, and would be hard pressed to predict political risks even if they were. Welcome to the New Normal where debt doesn't matter.

  4. Thanks for the comment which you end with "Welcome to the New Normal where debt doesn't matter." Many people believe this and I see this as the glaring flaw in Modern Monetary Theory, referred to as MMT to its many believers this theory removes much of the risk ahead and guarantees that we will always be able to muddle forward by using government-issued tokens and our current units of fiat money. Newly acquired tools like derivatives and currency swaps allow us to print and manipulate away problems. What you pay in interest on debt does matter except in the manipulated land of MMT. An "almost surreal" feeling of indifference towards reality has started to develop.

    Companies have already ushered saving from interest paid on debt into the earning column and a major reason inflation remains low is they are sitting on a hoard of cash this has lowered the velocity of money. We must remember the artificially low FED controlled interest rates are a massive one-off or onetime tailwind that is mainly behind us. When rates stop going lower or reverse the positive effect will ebb and become a major headwind. With massive government debt in many countries and the economy still weak the headwinds we face have the potential to become devastating. The collision of MMT, social unrest over inequality, and other destabilizing factors have the potential to create the perfect storm.

  5. Bruce, this is a well thought out analysis on your part. There seems to be a hidden agenda by the global finance world (including all Central Banks) to just extend household debts to even more EM (Emerging Market) countries, now that the developed economies in U.S. Europe and Canada are drowning in debts, and spur more accumulation of "stuff" by consumers and prolong this debt-fuelled economic expansion, which has been going on 30+ years, without having to worry about paying it, for now anyways. These finance gurus, looking at their world maps, estimate there are at least 2 Billion more potential consumers and credit card holders around the world they can corral, and hopefully 20 more years of debt binging, before we face the Day of Reckoning. We'll see who is right soon enough.

  6. Hard to believe that if debt continues to rise. that growth could expand.