THE CUPBOARD IS EMPTY PART II

In my last post I stated that foreclosures would continue and that recovery would be very hard despite government’s best attempts because of structural changes in the world economy. I’d like to elaborate on those themes in this entry.

Foreclosures will continue because the values of homes will continue to go down for some time. Real wages are not likely to increase in an era of declining corporate profits and a larger more desperate pool of available labor. Unemployment will increase due to accelerating decreases in consumer spending and the jobs that remain will have depressed wages and decreased benefits such as health insurance. As there are more foreclosures this puts more houses on the Real Estate market which in turn causes a decline in values which …… you get the picture. It also should be noted that state and local governments facing declining Real Estate valuations and budget shortfalls will likely increase the millage rate on Real Estate increasing the cost of ownership of property.

What will our government do to try and stop these circular degenerative cycles?
Traditionally in recessionary cycles the first thing the US government does is increase the money supply by decreasing interest rates. The Federal Reserve has already done almost all they can do in this area and it has had no effect. Through the taxpayer 700 billion bailout we have of course recapitalized the banks in the hopes that they would begin making loans however the banks realize the precarious state of the economy and are not making loans because they do not see how they will be paid back. I am no fan of banks but if you had money to lend would you lend it to someone starting or expanding a business in this climate?

Government may try to stimulate a direct stimulus to the economy by giving tax rebates similar to what they did last year. This will not work for several reasons. First, given the current financial climate most taxpayers will simply save this money or use it to pay down existing debt. Second, even if they do spend some of the money it will act only as a temporary boost and will not create jobs. Third, the money for these rebates will have to be borrowed by the federal government so there will be no net gain, only a distribution because the taxpayers will ultimately have to pay this bill. In fact there will be a net loss because interest will have to be paid on this money. Finally and most importunately we simply manufacture very few goods in this country anymore. The rest of the economy simply shuffles money around it does not create wealth. Money ultimately ends up with the producer of products. Our accelerating trade and federal budget deficits are now coming home to roost.

Government may also try to stimulate the economy by large public works programs. While this will have greater effect than simply sending money to taxpayers it too will largely fail. It would employ more people for a period of years and it would help replace a crumbling infrastructure that greatly needs replacing which could help increase American productivity. These would undoubtedly be pluses. At least we are spending money on needed projects. On the downside 1)we would again be financing this program with increased deficits which will prove costly in the long run; 2)These projects whether government run or contracted out will be no doubt be fraught with waste, corruption and cost overruns like every other government project of this size in history; 3) It would take some time to implement a program such as this and its effect on the economy would be well down the road; 4) The program would have to be short lived because we could not continue this level of deficit spending for more than a year or two.

The only ways our economy can see an actual long term improvement is by increased productivity, a new products or industry, or an improvement in our trade and federal government deficits, all of these will be difficult.

American productivity had been increasing steadily since the mid nineties in no small part due to increased use of computers in the workplace. In 2004 productivity growth was 2.4%, in 2005 it was 1.9% and in 2006 it was 1%. (US Labor Dept.)American workers are the most productive in the industrialized world and may well be suffering from the law of diminishing returns where productivity gains, absent any new tool such as a computer, necessarily decline as workers reach the top end of possible productivity. Therefore productivity is unlikely to increase greatly.

Suppose for a minute that a new industry was developed by an American company that was the envy of the world and in which millions of dollars would be made. Lets for a minute suppose that someone invented a new consumer product that everyone in the world wanted. This would be a huge breakthrough and the company would no doubt make billions for its stockholders. However there is not also no doubt that this product would be manufactured, within a short period of time, in China, India, Vietnam or wherever it is cheapest to do so. If this was not the case initially shareholders would not doubt force management to maximize profits by doing so. This discovery would no doubt have positive effects on the investor class. It also would hopefully have positive effects on the US treasury by increasing tax receipts (offshore shelters notwithstanding). It would not help the plight of the US middle class, other than any effect it may have on their stock ownership in this new company through direct or indirect (retirement plans) investments.

Our trade deficit is unlikely to reverse itself until we can start to rely on alternative fuels. The price of oil is currently down sharply but this is very likely to be a temporary respite. As stimulus packages around the world kick in demand will return at least somewhat and prices will rise. Even absent the increase in demand does anyone really doubt that OPEC who has become accustomed to $100 plus oil prices will not keep cutting production to support a price structure to their liking?

Our budget deficit is likely to continue to grow with the advent of a financial stimulus package which will be enacted by Congress in one form or another. Many financial analysts are predicting a one trillion dollar federal deficit in each of the next two years. This will in turn cause those buying our debt to demand greater interest on this money which will in turn increase the debit side of the federal ledger. At some point this spending will have to be cut dramatically which must include a cut in military spending, which paradoxically is one of our few manufacturing sectors which has been recently successful. This of course will cause other problems such as unemployment and a decrease in the tax base.

We are structurally trapped in an America in which new manufacturing industries can only survive by either manufacturing their products overseas or by paying American workers an increasingly low wage which makes it difficult for them to afford the products they create. This model can be seen clearly in the automotive industry where manufacturing of cars is being done in some southern states that has enabled these manufacturers to turn a profit. The workers are hard pressed to be able to afford the cars they produce and certainly are unable to comfortably raise a family on income. In previous years those working for the big three could easily afford to raise a family comfortably on the wages they received. Unfortunately these wages and benefits have caused their employers to become unable to compete in a Global marketplace.

The transfer of income and wealth to the wealthiest has left the middle and lower classes of America unable to support the businesses of America anymore. They are simply tapped out. They have no more disposable income to be transferred. This has actually been the case for sometime but spending has been propped up by household deficit spending that was supported and enabled by eased monetary policy of the past eight (or more years). This day was bound to come but now that it has come later rather than sooner due to government and Wall Street enabling the pain to be paid is larger rather than smaller. The cupboard is empty.

Excellent articles can be found at the following links.

Paul Krugman - Nobel Prize winning economist who predicted the curreny economic collapse. http://www.nytimes.com/2008/11/14/opinion/14krugman.html

Nouriel Roubini, - New York University economist who was laughed at when he foretold the financial crisis at a World Economic Summit http://www.forbes.com/opinions/2008/11/12/recession-global-economy-oped-cx_nr_1113roubini.html

For a few articles really out there. (Perhaps)

John Whitehead former Chairman of Goldman Sachs and former deputy secretary of state under Reagan http://www.reuters.com/article/InvestmentOutlook09/idUSTRE4AB7HT20081112


Martin Hennecke - senior manager of private clients at Tyche. http://www.cnbc.com//id/27641538

Gerald Celente - the CEO of Trends Research Institute http://www.liveleak.com/view?i=1ad_1226630673