The emerging consensus on the US economy is that we face years of slow growth - or no growth or repeated recessions - as we pay off the debts accumulated over the last several decades. The recovery so far has been anemic, jobless and there is increasing concern that it is also temporary. The public is abandoning the stock market, redeeming mutual fund shares on a weekly basis. Instead of stocks, individuals have embraced the illusion of safety provided by government bonds and gold. Individuals are reducing their debts, often involuntarily through default, small companies are starved for capital because banks won’t lend and large companies are hoarding cash. Government is seen as the sole source of spending and therefore growth.
I have been an observer of markets and economies for decades and I cannot remember a time when there was such a dearth of optimism in the US. It isn’t just that the public has turned pessimistic; there is an atmosphere of resignation, a fatalism about the future. There is a sense that our problems are not only difficult but basically unsolvable. Or at least unsolvable in any way that doesn’t involve extreme hardship. There is an emerging view that the recovery we’ve had so far was just an illusion, a mere last gasp of a dying system. The oil leak in the gulf is a visual, graphic metaphor of the unprincipled greed of big business and the venality and incompetence of big government.
Or at least that is how the majority seems to see things these days. Maybe I’m just preternaturally optimistic but I don’t accept this apocalyptic, Mad Max view of the future. We certainly do have problems and they might not be easily solved but they can be solved. I also don’t believe that widespread pain and suffering need be part of some required, austere atonement process. Solving our economic problems does not mean an ever increasing reliance on government and it doesn’t mean allowing the BPs of the world to do whatever the hell they want. What it means is breaking up the marriage of convenience between big government, big business, unions and most especially, big finance. It means enforcing the current regulations before we add more that won’t be enforced. It means holding people and institutions responsible for their actions. Solving our problems may involve some pain but it should be borne by those who caused them, not those who have to solve them.
As I pointed out last week, the key to recovery is convincing individuals, financial institutions and corporations to invest. The capital available to invest is enormous but a change in the grim expectations outlined above is required to pry that capital out of government bonds, gold and other non productive hiding places. With individuals leaving stocks and hiding in government bonds and gold it should be obvious that what we’ve been doing up to this point to fight the recession is not working and it isn’t working in a pretty spectacular fashion. Something needs to change and change soon.
Investment is only one variable in the GDP equation but it is the variable most responsible for changes in GDP.
GDP = C + I + G + (net exports)
John Mauldin’s weekly commentary used this equation to explain that if you reduce G (government spending) too fast right now, before C (consumption) recovers, GDP will necessarily suffer. Now I like John and I think he’s a pretty sharp guy but no where in his commentary did he even mention I (investment). He didn’t discuss how the dramatic increase in G is scaring the bejeebus out of the folks who make the decisions about I and C. He didn’t mention that consumption and investment might be reduced today in response to too much G since taxes will have to rise in the future to pay for the G. And he didn’t mention that net exports are another way to change GDP for the better.
What we need right now is an all out push to increase investment to offset the fact that Americans can no longer be the consumers of the world and that government finances have now become part of the problem rather than part of the solution. There are a number of actions that can be taken to increase the incentives for investment but so far the administration seems ignorant of the effects their actions have on confidence. Just last week the President used his first oval office address to introduce yet more uncertainty by using the BP mess to renew his push for a cap and trade bill. There are good reasons to reduce our dependence on energy imports, most of them having more to do with the economy than the environment by the way, but the cap and trade programs floating around Congress right now are nothing more than tax increases the economy cannot bear right now. And a bad bill is much worse than no bill as we are finding out with the implementation of health care reform. The uncertainty from that mess persists months after passage.
Solving our economic problems is not that hard in concept. It requires more savings and investment to offset reduced consumption and government spending. I agree with Mauldin and others that it needs to happen in a balanced way but it needs to get started and the manner in which it does so is important. For instance, research shows that reducing the deficit through spending reductions has a less negative effect on growth and is more effective than raising taxes. Investment should be increased by providing incentives for private investment of all types rather than favoring investments that serve political ends. Savings should be encouraged by having the Federal Reserve concentrate on a narrow objective of stabilizing the value of the dollar. I’m writing a longer article now that concentrates on the role of the Fed in the economy but for now let’s just say that both the quantity of investment and the results will be improved if the Fed stops distorting the value of money. Confidence in our money is important too.
The biggest issue facing the US economy right now is a lack of confidence about the future that is limiting investment. That lack of confidence is driven by a distrust in governments and the corporations, unions and other special interests that influence them. There is a feeling that our problems can’t be solved because the people we’ve entrusted with the power to solve them are corrupt. I don’t know whether it will make any difference or not, but I suspect that feeling may have a profound impact on the mid term elections. If that proves true and President Obama and the new Congress get the right message, the view of the future could change quickly to one that is more optimistic. And that could have a profound effect on future economic growth. Expectations matter…a lot.
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