Random Thoughts from the High Desert
Written by Sig Silber
There have been many alarmist predictions recently. Some of those I have paid close attention to are by Scott Brown, Leap/Europe 2020 and John Hussman. These articles suggest that the U.S. and the World in general may be heading for really hard times.
The Raymond James piece by Scott Brown is pretty much the standard fare that the economy has not been performing very well and we may have become increasingly dependent on bubbles for what growth we have been achieving. This is pretty much a call for a War on Bubbles.
I am not very familiar with LEAP but their article is far more upsetting. They show a particularly interesting set of data:
Number of prisoners, engineers, nurses, secondary school teachers, etc., in the US.
Source : Huffington Post.
More prisoners than engineers! That is a dynamic economy - NOT. Much of the paper deals with the threats to the U.S. dollar as a reserve currency. Along these lines and separate from the LEAP article we see that Russia has intimidated the Ukraine to be allied with Russia rather than the EU. We see surveys showing the citizens of Turkey are not very interested in joining the EU and some nations in the EU are not that interested in having Turkey join. We see Israel and Saudi Arabia potentially becoming more neutral rather than aligned with the U.S. Egypt has already taken steps to detach from the U.S. Empire. Clearly, U.S. foreign policy is in disarray.
And what about the economic condition of the U.S. Empire? Here one pays careful attention to what John Hussman has to say. Although his funds may have been a bit too timid about joining in on BubbleMania, he remains one of the most thoughtful financial analysts. I am hoping I have not gone too far in relying so heavily on one of his exhibits and other information in his article but since it is called an Open Letter to the FOMC (Federal Reserve Open Market Committee) I have to assume that John Hussman wants his position publicized.
Lets start with:
This shows the ratio of corporate profits to GDP. One might interpret this as a sign of business vitality. But then we take a look at the National Accounting relationships (works for international accounting also) which Hussman reminds us of.
Investment = Savings
Corporate Profits = (Investment - Foreign Savings) - Household Savings - Government Savings + Dividends
Investment = Household Savings + Government Savings + Corporate Savings + Foreign Savings (the inverse of the current account)
I will take exception to the first relationship as it is clearly true for the World but not necessarily true for an individual nation. Certainly investment can only come from production (including services) not consumed but instead "saved".
But that which is "saved" may remain "saved" (for example gold bullion) or invested in another country or vice versa rather than "put to use". And savings from a prior period can be consumed or invested in the current period. So it gets a bit complicated but, in the long run, investment can not exceed savings. So the savings rate of a nation becomes quite important. I do not believe we are seeing strong investment in the U.S. or sustainable household saving.
The next relationship is perhaps the more critical one. Not only is it stated here but Hussman provides empirical data to show that this relationship reduces to Corporate Profits being basically the inverse of the change in Household Savings and Government Savings. Thus, for all practical purposes, the extraordinary increase in Corporate Profits represents government spending and transfers from households to corporations.
Hussman does not actually come out and say it but corporate profits are way up because household income is down and people are depleting their savings or going into debt to jack up Corporate Profits. That is not sustainable.
One aspect of this is the revival of the trend of increasing home equity loans. One source suggests that $29 billion of home equity loans will need to begin paying off principal next year. This need to start paying off principal will rise to $73 billion in 2017.
On top of all that, we all know about the large increase in student loans with few jobs available to graduates.
So basically we have impoverished the Middle Class and turned the Lower Class into kept persons.
In Switzerland, voters voted a week ago on a proposal to cap executive salaries at twelve times the compensation of the average worker. It did not pass but the fact that it even got on a ballot indicates an undercurrent of dissatisfaction with Capitalism as it currently operates.
In essentially all the developed nations, demographics are putting a strain on the ability to fund social programs. And what are we to make of Larry Summers, the once presumed new Fed Chair, suggesting that the natural rate of interest may be as low as -3%? Can you spell "deflation"?
Bubbles and deflation do not go together. One can imagine that negative nominal interest rates, if that fantasy somehow became reality, might provide one more boost to asset bubbles since it is better to own a questionable asset than suffer a guaranteed loss by keeping money in your bank and being charged a stiff penalty for doing so. But deflation means declining wages and labor strife. There is a limit to how much household income can be transferred into corporate profits. Thus there is a limit to the strategy of creating asset bubbles. The discounted future earnings stream will not support inflated asset prices.
In some ways this appears to fit with Classical Marxist Theory as to what will eventually lead to the overthrow of Capitalism. But do we indeed have true Capitalism? To the extent businesses survive and prosper to a large extent based on their relationship with the government in power, this relationship seems to have evolved significantly. In my career which has involved working for the Bell System, IBM, and Kennecott Copper and being a consultant to a large number of businesses, the relationship to the Federal Government was far less symbiotic than what I see today. In many cases it is now essentially impossible to identify where government ends and big business begins.
It is difficult to lay these problems at the feet of any particular political party as this process has been going on for some time. But the recent acceleration of the extraction of the wealth of the middle class and essentially turning the lower class into wards of the State, has accelerated recently, especially in the U.S. Only seniors (due to social security) have bucked the trend. But you can be sure that one way or another, Corporate America or Government will find a way to gain access to their savings as well.
This looks to me like a negative feedback loop that creates a distinct risk of leading to a Worldwide Depression or a World War or both.
It is not a process that necessarily will come to a head over the next weeks or months and most likely will involve a series of mini-crises with actions taken that are claimed to be solutions but which will trigger either a worsening of the problems intended to be mitigated, or the creation of new problems, or both. Thus it is difficult to see how the situation can fundamentally improve. Think of it as a whirlpool which is sucking the world economy into depression.
To expand on the empirical relationships that Hussman has assessed in the scatter diagrams in his article, he detects a weak relationship between the inflation of stock prices and the employment rate. He calculates this as being at most a 1% decrease in unemployment for a 40 percent increase in the S&P 500. But however weak the wealth effect, it works in reverse as well. So pricking the stock market and other asset bubbles is likely to increase unemployment. Hussman sees the same sort of relationship between the Fed balance sheet and interest rates. Although he again sees only a weak relationship between increases and decreases in the Fed balance sheet and interest rates, we know that increases in interest rates negatively impact housing prices.
So, in this Federal Government / Big Business alignment, the only real planning function is the Fed and they are caught between a rock and a hard spot. This dilemma is not unique to the U.S. It is pretty much the situation worldwide but it is especially problematical for an Empire such as the U.S., since reserve currency status has value and is difficult to maintain if a nation is perceived to be in serious decline.
The worst case scenarios for how this situation will play out may indeed make the economic and geopolitical impacts of Climate Change seem like a secondary issue over the next twenty years and could definitely dramatically impact political and strategic relationships worldwide.