Two Options

Unemployment is high and getting higher. Some say national unemployment may soon reach 10%. It is well known that national unemployment data understates the problem as underemployment, reduced hours and illegal immigrant labor are not factored into the equation. Even though this is true, the reported unemployment numbers are high enough to be a major cause for concern.

What then is an administration to do? There are really two paths: (1) the administration could implement business-friendly policies such as low taxes and reduced government intervention to make the US more competitive globally and in so doing, boost small and large businesses to the point where new jobs will be created locally, or (2) boost government benefits and handouts, extend unemployment insurance, kick in new subsidies for purchasing homes and cars, and otherwise alleviate the pain of a suffering economy.

The problem is that these solutions are mutually exclusive, you can’t do them both. Efforts to increase government spending to “stimulate” the economy or otherwise alleviate the negative effects of the current downturn are not affordable because as it stands, the Government spends more than it takes in. Therefore, the only way to pay for these handouts and bailouts would be to raise taxes, borrow more money, print more money or some combination of these three options. Each of these three options, however, will serve to stifle job growth and perpetuate the economic downturn. This is because increasing taxes makes it harder for US businesses to successfully compete globally and makes it more likely that fledgling businesses will fail under the increased demands of government taxation. Borrowing more money may cause some alleviation of pain in the short term, but this money must be paid back with interest. Thus we are trading an amount of pain today for twice as much pain tomorrow. Printing up more money is perhaps the worst solution of them all. At first, the effects of printing up money would be to prevent the natural reduction in prices during the economic slowdown. As reduced prices increases individual wealth and ultimately helps to reignite economic growth, increased printing of money keeps prices stable even when people are losing their jobs, having hours reduced and are otherwise forced to make less money than they would have otherwise. The Government would have us believe that deflation is bad, but common sense tells us that lower prices are better for consumers. Moreover, as the rate of economic contraction ebbs, that is to say, the rate of new layoffs slows, as must happen once businesses cut payroll as far as it can go, inflation will set in and prices will rise swiftly thereby continuing the pain even after the pace of new layoffs slow.

Accordingly, the two options listed above come down to a trade off between short-term pain and long-term gain. You can reduce short term pain at the expense of long term gain, but you cannot simply send the economy into recovery by spending money that you do not have. It would be great if you could, but you can’t. If you could then there would be no such thing as a poor country because a poor country could always spend itself into prosperity. This makes sense. The way to sound finances is fiscal responsibility and living within your means. Spending more than you have may make you feel better today, but it is guaranteed to make you feel worse down the road.

Our nation is addicted to debt. We are suffering from debt withdrawal. We can increase lending to ease the pain only to find ourselves back in withdrawal down the road or we can reduce our borrowing and emerge better for it after a period of pain. This was the situation George W. Bush was facing in 2001 and his choice was to increase the debt dosage and continue the party. Today we pay for this bad choice with pain that is worse than what it would have been if the recession of 2001 were to have been allowed to play out as it should have.

It is clear that Obama is hoping to do what George W. Bush did and kick the can down the road. Maybe he can do it or maybe we have reached the end of the road.

Obama and his Monkey's Paw

There are many problems with how Obama has been handling the economic mess so far and they all have a common theme: well-meaning idea with unintended negative implications. Governmental interference in the economy is sort of a monkey's paw. You can make the change, but the unintended consequences can be disastrous!

When Obama uses his "monkey's paw" to bail out banks and borrowers, he is encouraging the very failures that he seeks to remedy. When Obama uses his "monkey's paw" to set carbon dioxide caps, he is driving industry and jobs off shore. When Obama uses his "monkey's paw" to get lending "flowing again" he is helping more un-creditworthy people to get into loans they will likely default on. When Obama uses his "monkey's paw" to prop up home values he is ensuring that people continue to stretch themselves to have a roof over their heads.

This "monkey's paw" effect is perhaps the result of a lack of wisdom and/or experience on Obama's part. Obama, and the people he chooses to take advice from, apparently do not fully understand the ramifications of the changes they are making.

Finding a bottom

Unlike housing, which finds a slow bottom over many painful years, stocks are supposed to immediately reflect the current investor sentiment and expectations for the future. Therefore, the stock market's continued decline represents ever increasing pessimism as to the future of the international economy... Or does it?

It is my view that the recent and protracted stock market declines actually represent a growing feeling among Americans, and indeed people world wide, that the stock market may not be an appropriate vessel for retirement savings owing to its volatility and unpredictability. As people continue to reassess their investment options, investors unhappy with their long term returns are deciding in ever increasing numbers that they would rather have their retirement nest egg as money in the bank instead of having it be in play in the stock market.

In fact, the phenomenal and historically uncharacteristic appreciation we have seen in the stock market from the mid 1980s through to the turn of the century may have been the direct result of average people deciding that the stock market was the best place for their retirement savings. It could very well have been this shift of public sentiment that launched the stock market into a generation of spectacular returns. Therefore, what we are seeing now may very well be the unwinding of that trend.

If this is in fact the case, we may experience a protracted period of stock market declines that will be sell-reinforcing. There would also be no guarantee that this money will find its way back into the stock market when the world economic situation improves. In short, it is entirely possible that the stock market is simply adjusting to a size that is more appropriate for people's reduced appetite for stock market risk rather than or in addition to continued economic pessimism.

A New Phase Begins for Housing Downturn

While it is true that places like Arizona, Florida and California have been hit hard by the housing downturn, many locations nationwide have been relatively unscathed by the market correction. No where would this seem more true than right here in the New York City region, where the market "correction" has thus far only been seen in terms of reduced sales volume, more time on the market and modest price reductions.

Well all of that may be about to change. It has long been argued by the Real Estate agents that there could be no housing down turn as long as employment was high. They were perhaps being over optimistic when they were disseminating this rhetoric back in 2006 and 2007, as the housing downturn had clearly begun by then; but they were on to something none-the-less. You see, there is indeed a strong connection between the housing market and the employment market, and unemployment and underemployment weigh heavily on the housing market.

It is now clear that any American who is not at least a little worried about losing his or her job and/or business is just out of touch with reality. Our whole economy was based on people borrowing money to fuel consumption. Now that cheap and easy credit has become a little harder to come by, our economy seems to be running out of fuel and we are experiencing severe contraction as our economy digests the fact that people will be consuming less and making due with what they have to the greatest extent possible. This will in turn lead to more job losses and that will lead to more belt tightening. The downwards spiral is likely to continue until people have cut back on as much consumption as they possibly can. You can expect unemployment to get much worse than it is now.

This change will clearly have an effect on housing. While up until now, the decline in housing sales has not been a matter of people being afraid to buy a house, it has been about the availability of sufficient credit. As people begin to understand that they should only be paying 1 year's salary for a house and not 4 to 10 years salary, the housing crash will enter a new and accelerated phase. I believe that we are entering this new phase now.

Is Wall Street trying to bully Obama?

Yesterday, shortly after Treasury Secretary Tim Geitner announced his big plan, Wall Street took a nose dive. We have seen this behavior from the markets before. If Uncle Sam does not satisfy Wall Street, Wall Street experiences a punishing sell off. Perhaps this is nothing more than the market reacting to what it perceives as bad news, but perhaps there is something else going on here.

It could very well be that Wall Street is sending a very powerful message to Washington, and that message is that Washington had better play ball or else.

Obviously when stocks go down, everyone suffers. From 401ks to school endowments, the average American is more dependent than ever on the stock market. Perhaps yesterday's impressive decline was a way of turning the screws on Obama, a display of a little shock and awe.

I think we can expect that the next time Geitner opens his mouth publicly, it will be to announce another round of fat bailouts in the works, and on that day the Dow will probably go up about 5% or so.

Making sense out of the bailouts

Today will be announced the second in what will be a long sequence of bailouts.

Eventually all the easy money will reignite debt-fueled spending and lend a boost to our consumerist economy.

Just as the fragile economy begins to pick up, massive inflation will set in as all that extra currency begins to compete for the same raw materials and energy resources.

Our government will be faced with the issue of whether to quickly kick interest rates into the high teens and twenties to rescue the dollar and plunge the economy back into severe recession, or to permit the economy to pick up steam and in the process though the dollar under the bus.

For some reason I think we will see option number 2.

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