Wednesday, August 05, 2009

How sustainable is the current economic growth?

My biggest concern with the breathless race to call for an end of the recession is that we continue to see very little evidence of any improvements for private industries that are not being supported by some form of government stimulus. To be clear, I am not entirely opposed to government stimulus when well targeted and well designed. Without the current round of stimulus our economy would clearly be in much worse shape than it is today, but my principal concerns are:

1) The long-term costs of stimulus. Consider the $3 billion cash for clunker program - since the government never really repays any debt it just refinances, it is safe to assume that this $3 billion is with us for the next century. We will pay about $15 billion in INTEREST on this $3 billion stimulus over the next hundred years. Now consider the huge spending spree that we have undertaken in the past 8 years (despite what the political parties want you to think, they both spend like drunken sailors) and you'll understand why I am so concerned about our future.

2) Pull forward of demand. I may not be like every other consumer out there, but I was going to buy a new car in the next 24 mths. The cash for clunkers deal is too good to pass up so I'll take advantage of it. But now I'll have two new cars and I'll send my kids to college in these cars (10-12 years from now). We're going to see a huge jump in retail sales and car sales this quarter as a result of this program but at what cost to future sales? The desire to soften the blow of the current recession has probably increased the likelihood of another recession in 2011-2014.

Many of my thoughts are reflected in this piece today from a former Merrill Lynch strategist...

The reason why we remain skeptical over the sustainability — the operative word for investors — is because the U.S. economy (or the global economy for that matter) has yet to show any ability that it can stand on its own two feet without the constant use of government steroids. At a time when the U.S. government is running a 13% fiscal deficit-to-GDP ratio, it somehow has enough in the coffers to try and perpetuate a cycle of spending by inducing a populace in which 20% are already three-car families, to go out and buy a new car to support a shrinking industry at future taxpayer (or bondholder) expense.

Look at what happened in that first quarter GDP number — total GDP contracted around $30 billion at an annual rate, but when you strip out all the government activity, ranging from spending, to tax reductions, to benefit payouts, the decline exceeded $300 billion. In other words, without all the government intervention, the decline in GDP in 1Q would have been closer to an 8% annual rate, not 1%.

Motor vehicle sales surged to a 10-month high in July — an annualized 11.2 million units compared with 9.7 million in June. The results largely reflect the “Cash for Clunkers” $1 billion program that ran out of money in barely more than a week.


In the aftermath of 9-11, the Big Three unveiled 0% financing to rejuvenate auto sales, which were moribund at the time. So what happened was that motor vehicle sales soared from 16.1 million annualized units in September 2001 to 21.7 million in October — a 3,643% surge at an annual rate! Retail sales skyrocketed 6.6% that month (+116% at an annual rate), a record that holds today. We never came close to seeing 20.0 million units on auto sales again.

But what all these gimmicks do is bring forward consumption — they don’t “create” anything more than a brief spending splurge at the expense of future performance — the pattern gets distorted as opposed to there being any real permanent change in the trend.

Even as economists start to pen in 3.0%+ GDP growth for 3Q, we remain of the view that we could end up with something closer to 1.0% growth or a touch better.

The U.S. is suffering from a similar deflation in the labor market, with wages and salaries sliding at a record 4.3% over the year to Q2.

Despite the nearly unprecedented run in the US stock market (the best since 1933 - hmm, wasn't that smack in the middle of the Great Depression?) it pales in comparison to the computerized lotto games going on in Asia. In particular, China's stock market is up about 100% THIS YEAR as investors have rushed back in hoping that their stimulus will lead to a robust recovery.

However, one of the best analysts on the Chinese market basically said this week that their market has become little more than a ponzi scheme.....

"Chinese stock and property markets have bubbled up again. It was fueled by bank lending and inflation fear. I think that Chinese stocks and properties are 50-100% overvalued. The odds are that both will adjust in the fourth quarter. However, both might flare up again sometime next year. Fluctuating within a long bubble could be the dominant trend for the foreseeable future. The bursting will happen when the US dollar becomes strong again. The catalyst could be serious inflation that forces the Fed to raise interest rate.

Chinese asset markets have become a giant Ponzi scheme. The prices are supported by appreciation expectation. As more people and liquidity are sucked in, the resulting surging prices validate the expectation, which prompts more people to join the party. This sort of bubble ends when there isn’t enough liquidity to feed the beast.”

The consistent theme with many market trends right now is the US dollar weakness (note that the Canadian dollar is almost back at par).



Anonymous said...

One thing that hasn't been talked about is "what years" cars have been selling under the crush the clunkers plan. Dealers are still sitting on thousands of 2008 vehicles, which I belive are what is being moved do to rebates to the dealers from the Mfg's, plus the Govt checks, just to clean up the old stock. Meanwhile the 2010's are hitting showrooms, and they will be competing with 2009's, which no one will buy because 2008"push sales" have eaten current (09) and forward (10) demand.
The auto industry downturn (production of 2010) vehicles, will be much worse than 2009, and then we will really see the economy falter, because the "fixes" will have been used up.


Scott Atkinson said...

I agree with everything you wrote.

So what's the President to do going forward?



Anonymous said...

It's getting a bit bizzare, because the CFC plan is now going to keep "pushing" sales, which would have occured anyway. Edmunds has great info on this. There is now a rumor that their will be "Cash for refrigerators".

The reality is the "green angle" is the only chance in hell that our economy has. We have to keep coming up with new "perceived necessary gains" in ecology and infrastructure to "print borrowed 'necessary' dollars for" or the world is going to call "Bull----!"

Just think about it for a moment. If the world really beleived that we are just selling bonds to create money to pay road workers to fill potholes, the integrity of our treasury offerings (and perceived real value) would collapse. That's why what we are really doing is "repairing our badly neglected infrastructure to allow for better flow of goods and materials" What a crock. We are filling potholes, because we gave all of our manufacturing jobs away, because it was easier than standing up to union shills.

What i really think is: Buy canadian dollars at $90-, plus some Brazilian money. then just sit back and wait for this joke of an economy's bandaid to fall off, and pick up the pieces.


The Artful Blogger said...

Good questions -- Re: what the President and Congress should do next I'll take a stab at it....

I'll preface it by saying that if I were in Washington I'd work with a 20 year plan and ignore the next election cycle. I know this isn't realistic, but a guy can dream :)

1) Stay on message that things are getting better and start reeling in spending. Without a substantial reduction of spending trends our economy is in deep trouble (especially when we're not creating any jobs).

2) Spur research and development in the new big 3 - clean energy, cheap water, clean transportation. This can be done without large administrative costs if done properly.

3) Hope nothing else goes wrong. This "recovery" is remarkably sensitive to any meaningful dip in any segment of the economy. You need to really hope that housing stabilizes, jobs return, etc, etc.

In summary, I don't think I'd want a job in Washington right now :)