Wither Now Economics?

I have been reviewing different opinions on the economy and trying to decide where things are going.

One point of view is the Uber-Inflationist, which hold the US Federal Reserve has pumped so much money into the system that through Quantitative Easing (QE2) that a crash is not far off, followed by rampant inflation, far in excess of anything we have previously experienced, culminating is a complete reset where the US $ is reset to zero and all debt, would be wiped out.

This is a plausible scenario, since the US FED is indeed pumping money into the economy, and one presumes Canada is as well, at an unprecedented rate. Which is certainly cause for concern, and the long term effects, to the extent they are known, (Post War Germany for example) are disastrous. The run-up in gold would tend to confirm some investors are thinking along these lines.

As Charles Hugh Smith points out, if that were true, we could all max out our credit cards and in effect money would be worth nothing, and we wouldn’t have to wait for a crash, it would happen now, since everyone would be in the thrall of believing money has no value, and expectations would self-fulfill.

But that isn’t happening – the US is saving more, though Canada continues to rack up debt and spend like drunken sailors. The other problem with the Uber-Inflationary scenario is that the Ruling Elite would have to put their money, estimated at some $45 Trillion, somewhere outside the US. Of course there is nowhere to invest such a sum, especially not on short notice.

The alternative view is the US Government stimulus is the only thing keeping the economy ticking over and once that expires, they system will collapse (again), except this time it really will go down the drain.

Gloomy thoughts for a rainy day in Victoria!

I am inclined to disagree with both however. There are some rather serious clouds on the horizon.

1. Government spending, fraud as a business model and speculation are the only thing keeping things going.
The financial industry, which has captured the government, will keep the stock market rising for some time, whereas the stock market ‘should’ have crashed before now, but ultimately they will be unable to prevent a crash. Which will probably be fairly harsh and happen later in 2011 or the first half of 2012. More Details here at The Big Squeeze. This is an extreme position which I don’t agree with entirely, though there is some truth to it. Ponzi schemes abound, and fraud and casino speculation seem to be the prevalent business model.

2. Oil and recessions. The price of oil is highly correlated to recessions. See HERE for all the gory details. If the economy is improving, then demand for oil and price will increase, and tend to damper a recovery. If the ‘recovery’ isn’t really a recovery at all, as some would suggest, then demand and price will tend to fall, which is good for consumers, but bad for petro currencies like the Canadian dollar.

Or, if we continue on a 2-speed recovery with North American and Europe continuing to muddle through with high unemployment and slow growth, while China and emerging markets expand rapidly, then the price of oil increases, which will dash any hopes for recovery in the US, although Canada would benefit from higher prices.

It also seems Saudi Arabia has been less than truthful with their ‘estimated’ reserves. None of the Gulf Countries will allow independent audits of their reserves, so we have to take their word for it. In a recent Wikileaks cable from Riyadh, US diplomats pass on conversations with Saudi engineers who confided the Saudi reserves are 40% less than publicly stated, and as the largest oil exporter, they may not have enough to prevent oil prices escalating. Detailed analysis at The Oil Drum.

Any way you look at it, oil is a real problem for the economy for the foreseeable future and is only going to get worse.

3. Debt and Government. All levels of Government have too much debt. California once again is the pioneer and leads the way. Newly elected Governor Gerry Brown, who I remember as the guy who didn’t inhale with my teenage heart-throb Linda Ronstadt, has made some surprising announcements which will define the scope of government everywhere.

Radical as it may sound, he announced there will be no government programs they can’t pay for. LOL! No putting off debt, no financial engineering or any of that. Paying for what they can afford – that’s it. Like the draconian budgets forced on Greece by bondholders, this is the future of Government and it is coming here.

Governments at all levels face decreasing revenue and increasing expenses for the foreseeable future. Taxes are going to increase and services are going to be cut at all levels. The civil service will be cut and paid far less and entitlements of all types (health care, pensions etc.) will be cut back. This movement is well underway in the US, driven by huge deficits. The Canadian Provinces are just as bad and will be doing the same thing once the credit bubble here bursts, if it hasn’t already. Canada‚Äôs debts are at a ratio of 90% of GDP mostly due to chronic overspending by Quebec and Ontario.

For more detailed information, see A Look into our Future.

In addition to cutbacks in Government spending at all levels, high Government debt drags down the real economy.

when the ratio of debt to GDP rises above 90 percent, there seems to be a reduction of about 1 percent in GDP. The authors of this paper, and others, suggest that this might come from the cost of the public debt crowding out productive private investment.

Think about that for a moment. We (in the US) are on an almost certain path to a debt level of 100 percent of GDP in just a few years, especially if you include state and local debt. If trend growth has been a yearly rise of 3.5 percent in GDP, then we are reducing that growth to 2.5 percent at best. And 2.5 percent trend GDP growth will not get us back to full employment. We are locking in high unemployment for a very long time, and just when some 1 million people will soon be falling off the extended unemployment compensation rolls. more …

4. China. China is is the midst of a property/building bubble which may be the largest in the history of the world. Estimates vary, though many say 60% of the Chinese economy is construction. How long can they continue to build empty cities? Only as long as the interest rate is zero.

Property bubbles never end well, and are impossible to ‘manage.’ Talk of ‘soft landings’ and ‘managing’ are nonsense. When this one pops, it will have a severe effect on the North American economy. More info HERE and HERE

With those headwinds, how fares the real economy? In the US, manufacturing has picked up considerably, which would be considered excellent news if this were a conventional bounce back.

But this is anything but a conventional recovery. US manufacturing has enjoyed a renaissance, not because of good old fashioned American ingenuity and hard work, but because American labour costs have been forced down so low they are now Internationally competitive. The outflow of work (outsourcing) has stopped – anyone that was going to Outsource has already done so.

companies are increasingly finding that it makes business sense for them to keep their remaining production in the US. (Or even move some of it back to the US.) For example, the Seattle Times recently reported that Boeing is now regretting its decision to aggressively push much of the production of its new 787 Dreamliner jet overseas. It turns out that they would have been better off leaving more production in the US.

My suspicion is that nearly all of the low-hanging fruit that could be gathered by shifting production from the US to low-cost countries like China has already been picked. Companies for which it made sense to shift production to other countries have already done so. Most of the manufacturing left in the US is, by and large, stuff that I think will probably stay in the US. More…

So, in other words, yes manufacturing is booming in the US again, but only on the backs of very low wages – Great if you are a factory owner, not so great if you are a factory worker. Low wage manufacturing jobs are better than none at all I guess, but they certainly aren’t going to fuel a consumer led recovery.

Where does that leave us? Continued volatility in FOREX markets, significant risks to the downside, high and rising unemployment and Government cut-backs at all levels, and slow growth.

But all in not gloom and doom! , Many industries are growing like crazy, and can’t hire enough staff. The web continues to grow in leaps and bounds.

Consumers do have money to spend – witness the success of pricey toys like iphones & ipads – if you can line up with something they want.

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3 Responses

  1. Sheila says:

    Thank you Brian. That was most interesting, and cautionary for Canadians to be more “grounded” in best financial decision-making, especially in the coming year.

  2. George says:

    A very thoughtful article. What a pity people didn’t start thinking along these terms some time ago!

  3. Alicia says:

    I was interested in the different points of view that you provided. Thanks