Heavy Lifting: Challenges Dead Ahead
By Tony Allison, November 15, 2004
With Campaign 2004 finally over, it is time to look ahead and assess the economic challenges that are glossed-over in the heat of a presidential election. Our country has a rich tradition of hard work, innovation, and a can-do spirit that has pulled us through many difficult times. Unfortunately, politicians of all stripes today will not deliver the hard truths that require a collective sacrifice of the citizenry (and voters). What politician gets elected by saying no to spending? A Congressional re-election rate of 96% is ample evidence. And of course we citizens don’t really like hearing hard truths either. In the meantime, economic problems that beg to be addressed only get larger and more potent. As a nation, we must deal with reality or it will surely deal with us.
In a recent research article, Morgan Stanley Global Economist Stephen Roach sums up the situation we face when the post election smoke eventually clears.
Our fixation on the here and now reflects both the difficulties of longer-term forecasting as well as the short-termism of the investment community. Each quarter that we escape a problem, the greater the comfort level as to what lies ahead. Such myopic risk assessment misses the forest for the trees. In my view, the US economy is an accident waiting to happen. That’s the message to be taken from a record shortfall in national saving, a record current-account deficit, record levels of household indebtedness, a record deficiency of personal saving, and outsize government budget deficits. The emphasis is on the word “record.” Never before has the United States pushed the envelope to this degree on such a wide array of economic imbalances. America will wake up the day after the election with the most daunting economic agenda it has faced in a generation. Then the real debate can begin.
Columnist George Will has referred to contemporary Americans as “naïve optimists.” I’m not sure about the naiveté, but Americans have always been optimistic, which is part of our national character. However, throughout our history, tough times (wars, depressions, droughts, epidemics etc.) have tempered our optimism with a large dose of clear-eyed realism. The lack of a national crisis over the last 30 years (that severely affected the economy) has blurred some of that realism. Terrorism has certainly shaken us to our core, but the economy has remained relatively buoyant. However, the immense and ongoing cost of the war on terror will be an undeniable factor in the future.
The hard truths are out there for those who wish to see them, and they aren’t going away for those who don’t.
- The Personal Savings Rate and Net National Savings Rate — Both have plunged to all-time lows over the past two years. This historic lack of saving is a clear indication of a nation living beyond its means.
- Current Account (Trade) Deficit — Lacking in domestic saving, America requires $2.6 billion offoreign capital inflows every business day to fund oureconomy. The U.S. is now absorbing 80% of the world’s surplussaving. This huge imbalance puts pressure on domestic jobcreation and may lead to protectionist policies. It also weakensthe U.S. dollar, which will eventually mean higher prices andhigher inflation.
- Budget Deficit — Like its citizens, the government is spending much more than it is taking in, over $400 billion this year alone. This number could grow significantly in 2005.
- Household Debt — The housing boom has allowed asset appreciation to be used as a means to fund current consumption, i.e., the home functioning as an ATM. As a result, household indebtedness is now at an all-time high.
- Demographic Reality Check — It is a mathematical certainty that retiring Baby Boomers will wreak havoc with the Medicare and Social Security systems, given our current political reality. A recent government study on future Medicare and Social Security needs shows a present value “gap” of promised outlays and projected revenues of $51trillion, and rising. To quote the obtuse Alan Greenspan, “significant structural adjustments will be necessary.” One has to wonder who will be able to make those adjustments, and when will they start? President Bush appears willing to address Social Security, but faces strong opposition. Even if successful, Medicare represents the lion’s share of the $51 trillion shortfall, which only grows larger.
A repeat of the 1970’s, on steroids?
What has caused such horrendous imbalances to grow and flourish? There is sufficient blame to blanket all of Washington D.C., but the Federal Reserve appears to be the leading suspect. Looking back to the 1970’s, there were imbalances then as well (beyond platform shoes and disco). In the early 70’s the Fed was creating a great monetary expansion, in part to pay for a very expensive Vietnam War. As a result, money flowed into tangible assets as investors sought refuge from a depreciating dollar. The returns on tangible assets (including energy stocks) toward the end of the decade were staggering. By 1980, the energy sector was 25% of the S&P 500 Index. Today it is 7%.
Fast-forward thirty years and the Fed has once again created a monetary and credit bubble, this time of epic, perhaps biblical proportions. Scary things can happen to a highly leveraged economy, especially when nearly 50% of our outstanding Federal debt is held by foreign creditors. We don’t just “owe it to ourselves” any longer
Mark Twain once said, “History doesn’t repeat, but it does rhyme.” There are certainly differences from thirty years ago. On the positive side, our economy is more technology-based and not as reliant on petroleum. However, today we are a huge net importer of both oil and credit, unlike the 1970’s. We also have a personal savings rate closing in on zero, versus over 8% thirty years ago. If we are in for a variation of 1970’s style stagflation, or worse, many Americans will be ill prepared.
The U.S. debt structure is too large, and growing too fast to be repaid within the realities of our political system. The only politically palatable alternative is to inflate, i.e., pay off the debt in cheaper and cheaper dollars. The current debt on America’s balance sheet is approximately $34 trillion. This of course doesn’t include the roughly $51 trillion in unfunded mandates for Social Security and Medicare, growing at $1.6 trillion per year.
As higher inflation infiltrates the economy over the next few years, interest rates will be forced up. Rising interest rates have never helped the stock market, or the real estate market.
Lightening the Load
As you may have already suspected, I’m not recommending that you fling yourself from the nearest bridge. Nature rebalances after a storm or a fire, and so do economies. There are always new bull markets that emerge and replace those that have run their course.
Emerging trends are usually difficult to discern because investors are still focused on the last trend, not realizing the rules of the game have changed. The 20-year era of paper assets is waning. The return of inflation will usher in the rise of tangible asset stocks, i.e., oil, natural gas, precious metals, base metals, food, timber etc.
The American economy is complicated, and hard to discuss seriously in quick sound bites on the evening news. But the fate of our economy is ultimately linked to the fates of each and every one of us. Americans love the quick fix, the sweeping solution. Unfortunately, these imbalances took decades to create and won’t be solved quickly. It is precisely because there are no easy solutions that they seldom get addressed.
America will need a spirit of bipartisan solidarity to tackle these issues, one that seems be sadly lacking at the moment. Clearly no heavy lifting will get done without a catalyst, a wake-up call loud enough to cut through the complacency and denial. Former Dallas Fed President George McTeer, in a moment of honesty and lucidity, no doubt prompted by his imminent departure for academia, said the following on October 8th of this year. “Some day the flows will turn against us and there will be a crisis that will result in rapidly rising interest rates and a rapidly depreciating dollar.”
A full-blown currency crisis would not only be a wake up call, but a corrective force. If the changes are violent rather than gradual, the lifting will be heavier and the burdens far deeper. As individual investors, those that are prepared can do much to lighten their own burdens and protect themselves and their families.
In today’s market wrap-up, US Treasury Secretary John Snow, in a speech in Ireland, reaffirmed his support for a strong US dollar, but believes the international currency markets should set the dollar’s value. Translation--The US will allow the markets to move the dollar lower in hopes it will improve the massive US trade deficit.
The stock markets closed nearly unchanged today. The Dow, up 11.23 (0.11%) to 10,550.04, Nasdaq up 8.75 (0.42%) to 2,094.09, S&P down 0.36 (0.03%) to 1,183.81.
The Nasdaq was aided by Microsoft ($27.39) up 1.86%, which began trading ex-dividend today. Crude oil futures for December dropped to an eight-week low, closing at $46.87 per barrel at the close. The benchmark 10-year Treasury note dropped 4/32 in price, upping the yield to 4.20%. Traders noted the trend in lower oil prices as a positive for continued economic growth.
Have a great week!
© 2004 Tony Allsion