“The world is on a journey to an unstable destination, through unfamiliar territory, on an uneven road and, critically, already having used its spare tire(s).”
This metaphorical sentence, which came from PIMCO’s annual Forum, nicely encapsulates the uncertainty I feel; the sense that all is not quite right, and that we don’t yet understand exactly what it is that’s not quite right about it.
For now, as I have predicted for almost a year, we are in a recovery that is moving in an irregular and sluggish fashion, and insufficiently strong to reduce unemployment.
The two spare tires in the metaphor, fiscal stimulation and monetary ease, have been used and are wearing thin, and the next crucial step must be to construct a credible plan to reduce the federal deficits. On this point I see no progress.
- Housing and commercial construction remain in a distressed state, with no recovery yet in sight.
- Employment gains remain anemic, below previous recoveries
- Personal income minus transfer payments, relative to the previous peak, is at the lowest level of any recovery in the past 50 years.
- Inflation is dormant, even bordering on deflation.
- Retail sales are still well below (about 7% on a per capita basis) pre-recession levels.
- Auto sales are bumping along at about 11 million units, down from over 16 million.
- A rise in net exports that I and others had hoped for has not developed; exports have risen but imports have risen more.
- States and municipalities, facing serious fiscal problems, are reducing spending and employment.
- While there has been some strength in infotech spending, it’s not a large enough sector to significantly affect overall activity or employment.
- The stimulus package is close to having run its course, and any new stimulus faces strong political headwinds.
I do not believe we will see the much-feared “double dip”. GDP gains will be positive, in the area of 3%. But what we have been seeing, irregular pockets of strength alternating with disappointments, is what we will continue to see for some considerable time (6 to 12 months) ahead.
At Last….A Tiny Bit of Help From China
In several postings to this blog I have expressed the hope for a revaluation of the Chinese currency, but until a few days ago, the Chinese stonewalled the rest of the world on this. Now they have said they will make gradual adjustments. From 2005 to 2008, the yuan was allowed to rise at a 3% annual rate, inadequate at best. Will the appreciation rate now be allowed to rise faster than 3% annually? I seriously doubt it. I think it’s very safe to say that China will remain a very strong net exporter for some time to come.
The Coming Social Contract Fights
I have written several times about social contracts, both here and abroad, coming under stress as it becomes both more obvious and more urgent that we deal with unaffordable social benefits.
After watching Greek workers riot in the streets, and the French unions striking in protest over raising the retirement age to above 60, I was both chagrined and amused by a recent Blackstone-Byron Wien incident. It seems that Byron, a respected Wall Street strategist now with the Blackstone organization, made a public statement about state and municipal retirement benefits being too high. Here is what he said:
“The retirement benefits for state workers, really not only in New York, California and New Jersey but throughout the country, are very generous, too generous……………… We literally can’t afford the benefits we have given our retirees in state and local governments and we have to change that.”
The problem is that Byron works for a firm that is a major manager of City of New York pension money. So the next scene was Blackstone’s management apologizing on bended knee to their client.
I cite these instances because they are forerunners of the immense controversy, political fighting, and nastiness that is coming.
It will not be confined to state and municipal pensions. Social Security and Medicare tax revenues and benefits must also be modified.
Social Security, according to the report of The Senate Special Committee on Aging, can be “fixed” by tweaking some combination of eligibility requirements, taxes, and benefits. Such changes don’t appear to be very painful, and are conveniently outlined in the Senate Committee report on pages 12-15. But there seems to be no sense of urgency about doing anything.
A bigger problem is Medicare.
While the tax burden on Americans will be increasing to begin to address the problem, the sheer magnitude of the promised entitlements makes a solution solely based on taxation a practical impossibility. I admit to complete puzzlement and skepticism about the CBO’s conclusion that the healthcare legislation will actually shrink the deficit. The necessity of moving toward reduced and/or more tightly controlled benefits and means-based testing will be painfully obvious at some point. What a political circus that will be!
Some Comments on the Stock Market
The U.S. stock market has been range bound now for over seven months, responding to fluctuating degrees of optimism about the economy. Only two months ago I remember listening to the talking heads at CNBC who were slightly mocking the “new normal” outlook originated by PIMCO. At that point the economic news seemed to be all good, and some analysts were saying that we were in an “old normal”, robust variety of economic recovery.
I warned against that thinking, and it has now become painfully obvious that a robust recovery was just a fleeting mirage.
What has not been a mirage is corporate profits. The benefits from cost-cutting have been quite dramatic as volume, even though still well below pre-recession levels, has recovered from the depths of late 2008 and early 2009. The more optimistic analysts are now estimating 2010 S&P 500 earnings at $85-$90, and 2011 at over $100. If they are correct, and such earnings are sustainable, the stock market is historically quite inexpensive. It’s important to recognize, however, that such estimates have often been too optimistic, so use them only with caution. Here’s a chart covering the past 25 years to prove that: