August 30th, 2011
in Op Ed
by Guest Author Eduard Fischer
(Click on cartoon for larger image.)
So here we are at the cusp of another bear market, or some might call it the next leg down in a cyclical bear market. Or is it just a bull market correction? Why are stocks selling off and what is likely to happen next?
To answer that question we need to look at the state of two of the dominant world economies, the US and Europe.
Devolution in a political sense usually refers to the transfer of powers from a dominant entity to a lesser one, for instance the transfer of power from a federal government to the state level. I want to propose use of a new term, de-evolution, which has a somewhat similar inference, but in an economic sense – this would be when a dominant economic power, willingly or unwillingly, hands off economic power to other entities. I believe that this has happened to both the US and Northern Europe but in somewhat different ways. Let’s start with the US.
Problems in the US
Median wages in the US have not increased in real terms for over a decade. This applies not only to factory and trades jobs but also to many highly skilled jobs in the IT industry where many salaries are now actually dropping. After all, in a highly competitive global economy why would IBM hire a programmer in the US when it can now get a highly skilled recruit who will work for much lower wages in India?
Is this fair? That question should be irrelevant in an article if the purpose should be to get an edge on the market as opposed to presenting moral or ideological points of view. However I want to make an observation somewhat related because I believe that it bears great relevance on how the transfer of economic power has taken place. The technological revolution that has taken place in the last few decades, especially in IT, has largely been the result of the ingenuity of Americans. Those Americans were educated in an education system largely funded by American taxpayers. In addition, much of the basic R and D that led to many technological breakthroughs was largely publicly funded. Now that technical know-how has been taken overseas, legally through outsourcing by American-based corporations, as well as illegally through the theft of intellectual property.
Whether this was fair to the US taxpayer or not, we can’t put the genie back in the bottle at this point. This transfer of intellectual wealth has lifted millions of people out of poverty in other countries. As a non-American I can say: Thank you America.
The problem for the US is that this process is creating global wage arbitrage. Even as American-based corporations have increased profits, Americans, on average, are growing poorer. The very wealthy are, by and large, an exception to this, which seems to be one way the US is regressing into a third world style economic stratification. The reversal of wage growth is a very serious problem for the US because of consumer indebtedness and particularly government indebtedness at every level. Debt per se is not a problem as long as an individual’s income or a nation’s wealth is growing sufficiently. But neither is the case in the US. The credit rating of the US government was recently downgraded by S&P not because of the level of debt, but primarily because every projection of GDP growth presented by the various factions and committees in congress was completely unrealistic. In addition, none of them took into account even the possibility of another recession in the next decade, which is fantasy and denial, bordering on insanity.
"Printing" Money for the World
There are those that believe that the US Federal Reserve can just keep on printing money and so the debt will not be a problem. There are even those who say the term “printing money” is totally misleading. Yet I have heard the chairman of the Fed call it that on a number of occasions, so I guess that he must be as misinformed as I am. Which brings me to another point: many commentators on this site say that those who believe that the federal government debt is a serious problem do not understand the reserve banking system. It’s true that I don’t entirely understand it. But I don’t have to in order to understand this: either Mr. Bernanke, unlike me, understands the reserve banking system, or he doesn’t. It can’t be both. I have heard Mr. Bernanke in testimony in front of congress several times state that the national debt is a huge problem that will cause a crisis if left on its current course. So if the chairman of the Fed, Helicopter Ben, says there is a problem with the debt, perhaps we should listen. And if the chairman of the Fed doesn’t know what he is talking about, then this is a big problem for the economy in any case.
I do understand that in principle there is nothing wrong with the central bank creating new money as long as the industrial capacity of the country is under-utilized and the new money can be quickly mopped up by the renewed output. This would be true in a closed economy, which the US is not. Much of this newly printed money is going overseas.
I personally would prefer to buy a US made product over a Chinese made one, and pay considerably more, because of the generally much higher quality. But where can I even buy a “made in the USA” light bulb or kitchen appliance these days? Manufacturing in the US is now down to about 13% of GDP, considerably lower than even Canada’s, which is considered a resource-based economy. This is why printing money has been good for the multi-national’s profits but has not helped the US economy.
There are those who point to US GDP and say that the US economy is still three times the size of China’s. Well that depends on how you measure. In terms of real outputs China has already surpassed the US. Much of what is measured in US GDP does not create real wealth: fighting wars does not create wealth, lawyering in the most litigious society in history does not create wealth, an expensive and inefficient medical system does not create wealth, locking up and maintaining 1% of the adult population in prisons does not create wealth, and retailing made in China goods to each other does not create wealth. But all this is added as a plus to GDP. My point is that, although US corporations are efficient, the economy as a whole is not.
Consumption over Production
The gross error in US economic thinking has been that consumption, or even gluttony, is always good and perhaps even the highest good. As if America only has to supply ravenous consumers and a printing press and all will be well. American consumers have proven that they will drag themselves to the shopping mall even with a huge burden of debt and two broken legs, but that time may be ending.
The average American has been beguiled over the last 15 years or so into believing that he or she is getting wealthier mainly through the extension of credit. The great surge in the real estate market and the apparent increase in wealth that it caused was due to a massive overextension of credit by the banks. After the real estate crash the government has taken over the extension of credit to consumers through tax breaks and the attempt to maintain positive GDP through unsustainable deficit spending. The conundrum for the government now is that any move to reduce the deficit will immediately lead to recession, which in turn, with this level of consumer and government debt and unemployment, will quickly lead to a depression.
Europe’s problems are related but somewhat different. True, the rising Asian economies have offered competition, but the stronger northern European manufacturing economies, particularly Germany’s, have weathered this quite well. Germany’s big mistake was joining the EU. This precipitated a different kind of de-evolution where weaker economies were empowered by joining the common currency and their real wages there went up drastically while productivity was not proportionally improved, or in the case of Greece, actually declined. This monetary union was encouraged by short-term greed on the part of the German corporations and banks that acquired new customers whose wages had suddenly jumped while tariffs were dropped.
Can Germany Carry the Unproductive?
Now the long-term consequences are coming home and the corporations and banks expect the German government and taxpayers to hold this mess together. Good luck with that. Over the last 30 years the Germans have done an amazing job in assimilating an impoverished former East Germany and reviving it. It took hard work and sacrifice. I remember during the fall of the Berlin wall in 1989 one commentator saying, “Now the Germans will have to swallow a porcupine.” Well they did it, but they are not about to try and swallow a rhinoceros, or a bunch of PIGS, for that matter. If Angela Merkel does not pull the plug, then the Germans will elect a party in 2013 that will take them out of the EU. The less productive countries in Europe will have to devalue their currencies; I see no other choice. Right now the countries in Europe are like a group of swimmers chained together, none of whom is free to use life saving strokes.
I do not include Ireland in the group of less productive countries by the way, because it is not. The Irish merely got royally screwed by their banks and their government.
Of course the break up of the EU will cause enormous upheaval. It can’t be avoided now. This sets up the perfect storm as the wheels are coming off the US and European economies at the same time. Even though I have been bearish for some time I am not gloating here. I am just describing the dark line on the horizon that I now see after watching a very red sunrise and the barometer plummet. Every sailor will know what I mean by that analogy.
The Out-look for Multinational Profits
Some will argue that even with the decline of the economies in the West, the profits of multi national corporations will continue to hold or even improve because of the growth of economies in Asia. I personally think that this is very unlikely, at least for a considerable time. The US has been the hub of the world economy for quite a while, and the EU’s GDP is actually even larger. Things are happening much too fast now for economic order to prevail. Cracks are appearing weekly and are spider webbing through the American and European economies. Even a moderate slowdown in consumption in the US and Europe would have an impact on the Chinese economy; a major downturn in the West will wreck havoc and likely cause social unrest.
Financial Analysts: US Market Will Go Up
A CNN poll among professional financial analysts on Monday came out with the average consensus that the S&P index (SPY) will finish the year at 1350. I will refrain from making fun of this because timing the market is hard and I don’t always get it right. And who knows? There may be another unfathomable wave of optimism and the cans on both continents may get kicked down the road once again. But that is beginning to look more and more unlikely day by day.
General Public: Depression
While economists and money managers largely profess confidence, a survey by CNN even two months ago of the general populace in the US found that almost 50% believed that the country would be in a depression within a year. The loss of confidence in the markets in the last few weeks is telling. A series of 4% plus daily drops like we have seen lately is extremely unusual. Combined with the flight to short-term treasuries and gold, it seems that dark clouds are gathering.
Intelligent and cogent rebuttals are welcomed and encouraged.
Michigan Consumer Sentiment 4th Worse on Record by Doug Short
Mistaken Monetary Policy Lessons from Japan? by John Muellbauer and Keiko Murata
Global Economic Downturn: A Crisis of Political Economy by George Friedman
Prediction: Demand Will Rule the World by Michael Pettis
Sophie's Choice for the EU by Dirk Ehnts
Eurozone Crises left to Fester by Daniel Gros
The Eurozone in Bad Need of a Psychiatrist by Stefano Micossi
Eurozone - Caught in a Financial - Sovereign Web by Clive Corcoran
Analysis Blog articles by Elliott Morss
About the Author
Eduard Fischer is a British Columbia mountain resident with a lasting interest in economics, finance, investing and political economy. He co-founded, managed, and sold a couple of reasonably successful businesses including The Edge Climbing Centre, one of North America’s first major indoor climbing gyms. He has also co-owned and managed a manufacturing and export business. He is currently starting yet another business. Eduard and his wife are avid mountain adventurers. Some of their experiences over 26 years can be reviewed at chasingthephantom.com.