I have been thinking about the the forces distorting the global economy.? In the long run, the distortions don’t matter, because economies are bigger than governments, and eventually economies prevail over governments.? Here are my dozen problems in the global economy.
1) China’s mercantilism — loans and currency.? The biggest distortionary force in the world now is China.? They encourage banks to loan to enterprises in order to force growth.? They keep their currency undervalued to favor exports over imports.? What was phrased to me as a grad student in development economics as a good thing is now malevolent.? The only bright side is that when it blows, it might take the Chinese Communist Party with it.
2) US Deficits, European Deficits — In one sense, this reminds me of the era of the Rothschilds; governments relied on borrowing because other methods of taxation raised little.? Well, this era is different.? Taxes are high, but not high enough for governments that are trying to create the unachievable “permanent prosperity.” In the process they substitute public for private leverage, and in the process add to the leverage of their societies as a whole.
3) The Eurozone is a mess — Greece, Portugal, Spain, etc.? I admit that I got it partially wrong, because I have always thought that political union is necessary in order to have a fiat currency.? I expected inflation to be the problem, and the real problem is deflation.? Will there be bailouts?? Will the troubled nations leave?? Will the untroubled nations leave that are the likely targets for bailout money?
4) Many entities that are affiliated with lending in the US Government, e.g., FDIC, GSEs, FHA are broke.? The government just doesn’t say that, because they can still make payments.
5) The US Government feels it has to “do something” — so it creates more lending programs that further socialize lending, leading to more dumb loans.
6) Residential real estate is still in the tank.? Residential delinquencies are at all-time highs.? Strategic default is rising.? The shadow inventory of homes that will come onto the market is large.? I’m not saying that prices will fall for housing; I am saying that it will be tough to get them to rise.
7) Commercial real estate — there is too much debt supporting commercial real estate, and too little equity.? There will be losses here; the only question is how deep the losses will go.
8 ) I have often thought that analyzing the strength of the states is a better measure for US economic strength, than relying on the statistics of the Federal Government.? The state economies are weak at present.? Part of that comes from the general macroeconomy, and part from the need to fund underfunded benefit plans.? Life is tough when you can’t print your own money.
9) The US, UK, and Japan are force feeding liquidity into their economies.? Thus the low short-term interest rates.? Also note the Federal Reserve owning MBS in bulk, bloating their balance sheet.
10) Yield greed.? The low short term interest rates touched off a competition to bid for risky debt.? The only question is when it will reverse.? Current yield levels do not fairly price likely default losses.
11) Most Western democracies are going into extreme deficits, because they can’t choose between economic stimulus and deficit reduction.? Political deadlock is common, because no one is willing to deliver any real pain to the populace, lest they not be re-elected.
12) Demographics is one of the biggest? pressures, but it is hidden.? Many of the European nations and Japan face shrinking populations.? China will be there also, in a decade.? Nations that shrink are less capable of carrying their debt loads.? In that sense, the US is in good shape, because we don’t discourage immigration.
@dm: “In the long run, the distortions don?t matter, because economies are bigger than governments, and eventually economies prevail over governments.”
I believe history is replete with governments destroying national economies. Today we can watch Hugh Chavez destroy Venzuela and the Kirchers striving to wreck Argentina (again). Recently Iceland destroyed its economy and today Greece, Portugal, Spain, Ireland and Italy are following suit. It is arguable whether the US government (and not any one administration) is making great strides at destroying America’s economy.
It seems to me that the common thread in items 2-11 is excessive debt and the failure to deal with it in a responsible manner. Item 1 China is valid as is item 12, demographics although China is immediate and the demographic bomb will be slowly (?) exploding over the next 20 years.
I am no longer sure deflation is a big problem. It might just force the solvency issue to be resolved whereas inflation will permit it to continue to fester.
RS — my long run is longer than most. Like the Soviet Union, governments that ignore economics get destroyed after a generation or two. My view is that economies express human wants, and if governments thwart those for too long, they get eliminated.
RS ? my long run is longer than most. Like the Soviet Union, governments that ignore economics get destroyed after a generation or two.
This makes absolute sense but doesn’t seem applicable at the individual investor level and the 20-30 year window of his/her capital accumulation stage of investing life.
What I am struggling with these days…maybe struggling isn’t the right word, but instead intense deliberation is how does one crank out a 8-10% annualized return the next decade in what is likely to remain a very challenging overall macro environment. I’m sure the S&P 500 will do better then 00-09, but I don’t think we will be anywhere close to 80-89 or 90-99 when 2019 rolls around so “buy and hold” probably isn’t the route to go. So, does one focus on concentrated deep value individual stock-picking, sector rotation, learning swing trading, etc.
China’s demographic bomb doesn’t seem as bad because they will still have an entire country of Chinese people. The west is importing people from all over the world who not only are uneducated but who after multiple generations of educational opportunities in western nations lag so far behind as to be incapable of inheriting an modern technology-based liberal democracy. See South Africa. China will still have human capital. The west won’t. Modern technology based societies need a critical mass of able people. So immigration doesn’t help because very few of the immigrants are highly able. If they were predominantly Japanese, I would agree with David that immigration helps the USA.
http://blog.vdare.com/archives/2009/03/28/medical-school-test-scores-gpas-and-acceptance-rates-by-race/#more-12109
Mike – Deep value is the route I’ve been taking. It seems like the safest approach, if I can buy companies for NCAV or less I have my margin of safety, liquidation. The only problem I see with this approach is we’re at the point where most net-net type stocks are so thinly traded it’s very hard to move in and out of them, especially with any type of money. I have been taking this as a rough market value indicator.
I wonder if this is just they way humanity works. I can’t think of a time without a significant risk (wars, diseases, etc). We’ll allways have risks or threats….
Great post. I would also add the flaws being exposed in the US retirement system. 401K’s and IRA became popularized at a time (1982) when Baby Boomer’s were still in their 20’s and 30’s. It was also a time when we were heading into lower tax rates, a rising stock market (shaking off the doldrums of the 70’s), declining energy prices, lower union membership.
We also had the fall of the Berlin Wall in 1989. This led to the opening up of Easter European markets and resources which expanded capitalism. It also led to the fall of many leftist leaning governments and military juntas in Latin America which also opened up more areas to capitalist forces.
These forces of change are either over and assimilated in already, or the demographic trends have changed.
Much is discussed today about the need for tech innovation to bring back the 90’s Internet and TelComm driven period of Innovation. But it wasn’t just tech that drove the growth (even though it was 1982, the first year of the stock market boom, that the PC was Time Magazine’s “Person of the Year”) it was also these demographic, geopolitical, and policy changes.
What forces are driving the next 20 years.
David Crais
New Orleans
Is the bond market rally over? You called the rally in high yield, then got off a bit early, and now its correcting.
Depending on what happens with sovereign risk, we could see dollar bonds rally a lot further. Watch the European fringe.
Mortgage Bonds are overpriced, and the Fed is done (for now).
Can corporate spreads tighten further? Yes, but I think the market will have a tough time if the default cycle recurs either due to insufficient growth or sovereign defaults affecting the creditworthiness of foreign and domestic financials.
Thanks for asking, anon.
you are wrong about USA demographics . the attractiveness of working in USA for foreigners is not exactly going up compare rooting their life in their countries. reason for rooting in USA for foreigner in term of social, economic reward are not going up. not mentioning about they need to deal with discrimination.
We allow more people in of of more different sorts, and are more tolerant of differences than most places in the world. Please ignore the noisy anti-immigrant sorts — there are fewer of them in America than immigrants.
Note: I am pro-immigration, in general. Immigrants are beneficial to the US, because most of them are hard working.
So much of the equity rally has been due to tightening corp bond spreads (both inv and high yield). But since Jan spreads are widening, and therefore high debt equity names are getting derated. It just seems that the high yield bond rally is over.
anon, it seems that way, but credit almost never has a V-top. That is why I am diffident at present.
You left out lucky 13 – the residential real estate bubbles that haven’t popped yet. Canada, Australia, and the UK have property bubbles more than twice as large as the US’s property bubble, and they haven’t even started to deflate. Not to mention the insanity that is going on in places like Singapore.
David, I am pro immigration, too. Especially immigrants with something to contribute. We should make sure that newcomers possess some real human capital, because their children will grow up in the culture of the USA which is not conducive to character building. You are very thorough in your analysis of financial matters. Similar scrutiny of the data of the performance of immigrants will render a more reasoned and cautious view of immigration. Charles Murray at AEI has analyzed immigrant performance and found that human capital matters.