Is the U.S. Economy Running Out of Options?

I hoped I would go my lifetime without ever seeing the S&P 500 be down 40% in a year, but the reality is slowly settling in, especially seeing the Emerginvest global heat map for the last quarter on a daily basis:

However, as bleak as it has been, there is no shortage of exceedingly dire news with economic reports or predictions on how long the recession will last. Americans have just begun to feel the first repercussions of the omnipresent economic talk in their daily lives with massive job losses, and an overall pervasive sentiment of belt-tightening.

A few of the news highlights from the past two weeks:

Massive Job Loss

The widely discussed report that 500,000 jobs were lost in November alone, seemed to put a face to the recession for the majority of Americans. While many people only have a vague idea of the intricate workings of the banking credit system, or how credit swaps are conducted, half a million jobs in a single month is a very clear and unmistakable picture. Plus assuming that most economists are right in predictions that it will get worse before it gets better, it depicts a very dark year ahead – with unemployment reaching nearly 10%.

Disastrous Housing Reports

A NYTimes article entitled: “Housing Starts Plunged 19% in November,” put it perfectly:

“The construction of new homes plummeted in November by the largest amount in almost a quarter-century as builders slashed production in the face of a recessionary economy.

The Commerce Department said Tuesday that new home starts fell to a seasonally adjusted annual rate of 625,000 from a downwardly revised level of 771,000 in October.

That is a drop of 18.9 percent, the steepest since March 1984. The total is far below the 740,000 pace that Wall Street economists expected.”

With plummeting housing prices, estimates put the total loss of home value at nearly a trillion dollars for the US. While many Americans are attempting to forestall selling their homes at extremely depressed values (20% or so on average), housing inventory is building up, causing a massive plunge in housing starts.

Failing Auto Industry

We are all intimately aware of the cry for help from the US auto industry. Personally, I believe it has a much more widespread psychological impact than a potential economic one. Congress will not let the three fall at this point – if for no other reason than that the economy can’t absorb the estimated million jobs lost in total from its collapse. If this was in an economic boom era, that answer might be different. However, the mere fact that a company like General Motors (GM) that has been an American icon for fifty years, needs to have Congress infuse them with a large amount of cash to not go bankrupt, strikes a deep resonating chord for most working class Americans.

So, the two questions are:

What will happen with the economy in the next 12 months and what will the federal government do to curb it?

First, to the question of where are we going, John Mauldin’s weekly newsletter was exceedingly insightful about the state of the economy. In addition to the enumerated problems above, he pointed out that a full one-fourth of homeowners are “underwater,” or in other words their houses are worth less than their mortgages. According to Mauldin, that number is expected to climb to nearly half of all homeowners with mortgages. He suggests that the massive number of underwater mortgages will mandate a government subsidy at some point which could equal close to $1 trillion.

He also stated that “retrenching consumers will keep pushing up delinquencies on credit cards, home equity, auto and student loan debt, which will result in big write downs for their many institutional holders. Collectively, these four categories amount to $4.4 trillion, dwarfing the $0.7 trillion in subprime loans.”

Amongst many issues which seem to build on each other - between consumer retrenching, commercial paper and credit institutions freezing up, the housing meltdown, and a number of other equally important issues, he uses an erudite example of a “tsunami in a swimming pool,” where each time the wave hits one sector, it gets reflected back at another – reverberating throughout the different areas of the economy. He describes the federal government’s programs as attempting to build dams in the middle to buffer the sides, however unless they’re big enough, the waves will simple gain momentum as it goes.

Which leads to the question of what the federal government plans to do.

In the short term, the fed is plainly running out of options. The interest rate cut at 0.25% is the lowest rate on record. Unfortunately, the interest rate is typically the main tool the Fed uses to control the economy, and when it hits the wall of virtual 0, mostly theory remains on how to proceed.

A NY Times article entitled: “As Rates Near Zero, the Fed Turns to Unproven Methods,” states that:

In itself, analysts said, the move will be anticlimactic. Because demand for interbank loans has been so low, the actual Fed rate has been close to zero for a month. The real change will be in how the Fed tries to fight the recession from here on.

After Tuesday, the Fed will have to resort to mostly untested tools for promoting growth, because it cannot reduce its benchmark interest rate below zero...

In addition to:

The Fed must now turn to an approach called ‘quantitative easing,’ because it involves injecting money into the economy rather than aiming at an interest rate. The Fed has almost no experience with this approach.

‘This is a whole new world,’ said Richard Berner, chief economist at Morgan Stanley. ‘You don’t have a whole lot of historical precedent for knowing how this is going to work and what the unintended consequences could be.’

The risks include provoking inflation or yet another speculative bubble.

Clearly, the Fed is only half of the story, and Obama’s proposed stimulus packages, the TARP, and TALF programs, the buying of commercial paper, and other mechanisms will constitute the largest response. However, until Obama is sworn in as president, they simply won’t be put into place, and it seems as if the Fed’s new policy, in combination with the new wave of economic stimulus packages from the upcoming Obama administrations, will largely be shaped as we proceed into these uncharted waters.

Regardless of what form they come in, hopefully the breakers will be big enough for the tsunami.

Disclosure: Emerginvest is an international finance portal, providing analysis and data on 120+ world markets to help individuals find investments from around the world. Emerginvest provides impartial information about world stock markets, and does not have any holdings in foreign equities.

Comments

[John D:]

Jonathan .... Not one to correct but GM has been an icon for 100 years this year 1908 - 2008 .

2008 Dec 17 02:56 PM

[Socialism c...:]

I'm not disagreeing that we could have a depression...but it won't be because of the Big 3 automakers going down -- that's not a small potential blow to take, but at the same time, it would represent an increase of about 1.5% in unemployment...not another 10 or 20%!! Even if we reach 10% unemployment next year, keep in mind that 10% unemployment is NORMAL in the countries of Socialist Europe!! And 10% unemp. is still FAR below what we had in the Great Depression. Bottom line: letting the Big Three fail will not be what causes Depression '09.

What will cause it:
1) Free-spending government --> massive infrastructure spending funded by debt.
2) Continuance of current excessive taxation, including all levels and types of double and triple-taxation!! The fact that earners are taxed on both the front and back-end is a huge penalty to the economy, as well as being unjust and unconstitutional. It is fundamentally counter to personal freedom and the founding principles of this nation. And it must end. Please read fairtax.org.
3) The hyper-inflationary activity of our Treasury and the Fed. Time to end this manipulation of our currency by a small cabal of super-elite bankers and wealthy!! They are penalizing the prudent, wise savers and rewarding the unwise who made poor decisions with their easy money policies!! And they are reinstituting the conditions that CAUSED this bubble to begin with by encouraging more lending and spending, rather than saving and paying down debt to rebuild a good foundation.

2008 Dec 17 05:24 PM

[Mister Jimmy:]

To Mr. "Socialism Cannot Compete", this is not the time for massive reductions in Federal spending. That would be the anti-stimulus, and is precisely what caused The Great Depression. It would be a fitting move, given the incompetent Republican president that we had at that time, and have now. As Cheney recently told his party's members of the Senate, "...we will be known as the party of Herbert Hoover forever". He's right. After Herbert Hoover, it took twenty years for the Republicans to regain the White House. It will likely be at least that long after Bush.

2008 Dec 17 05:40 PM

[Miken:]

"Congress will not let the three fall at this point – if for no other reason than that the economy can’t absorb the estimated million jobs lost in total from its collapse."

Don't worry about this error Mr. O'Shaughnessy, I can't believe their stupidity either.

2008 Dec 17 06:49 PM

[LilBob:]

I have to agree with Mister Jimmy. Right now with the credit markets being so tight (NPR reported today that to get an auto loan in the current market you must have a credit score north of 750) reliance on the private sector is pointless. A WPA style public works program is the only likely solution. Remember, it wasn't the private sector that pulled the country out of the Great Depression, it was government contracts that were dispensed as part of lend-lease policies to foreign militaries as Europe was led into war. The private sector had nothing to do with coming out of the Great Depression.

Also, given how hopelessly backward GM and the other auto-makers are right now, I really don't think they deserve government money. GM keeps touting the Chevy Volt as the car of the future, but anyone who follows the publications that automotive engineers read can tell you that vehicle has several major design flaws and is going to end up an enormous failure. In fact, the whole notion of "plug-in hybrids," is great for ad-copy but a really hopeless design idea.

The economy is in for a rough time, we've built an economy that absorbs wealth rather than creates it; and leaders in business, rather than trying to push new ideas that lead to the creation of greater total wealth, are almost certain to pursue a course that tries to lead consumers and government back to old habits.

2008 Dec 17 07:45 PM

[Vienna:]

Yes in Europe we have 10% unemployment, it used to be much lower, but since opening of the iron curtain we had approx. 300 mio people just in front of our doors, they have since then increased their GDP significantly. These markets where open freely and have caused jobs to move.

What you have with China has been common here since 18 years, and we have survived quite fine with it, and then further on with China.

I have been to Juarez, and the amount of outsourcing there is minimal.

To get to the unemplyment : NEVER; NEVER trust a US statistic. Now you also know it. There are many sources, non governmental which actually do rate the unemployment at at least 10% in the US due to many factors. somehow different as in Europe you do not have to get registered where you live and so on.

Go and read on the theory about the prisoners dilemma, that is where you are heading. many studies of biologists very clearly show, that systems where everybody just does what he himself want will collapse.

I am sure you are a poor fellow, and just simple don't have enough to survive, but just the individual greed of some got us here. People like that just need to be held back and controlled.




On Dec 17 05:24 PM Socialism cannot compete! wrote:

> I'm not disagreeing that we could have a depression...but it won't
> be because of the Big 3 automakers going down -- that's not a small
> potential blow to take, but at the same time, it would represent
> an increase of about 1.5% in unemployment...not another 10 or 20%!!
> Even if we reach 10% unemployment next year, keep in mind that 10%
> unemployment is NORMAL in the countries of Socialist Europe!! And
> 10% unemp. is still FAR below what we had in the Great Depression.
> Bottom line: letting the Big Three fail will not be what causes
> Depression '09.
>
> What will cause it:
> 1) Free-spending government --> massive infrastructure spending funded
> by debt.
> 2) Continuance of current excessive taxation, including all levels
> and types of double and triple-taxation!! The fact that earners
> are taxed on both the front and back-end is a huge penalty to the
> economy, as well as being unjust and unconstitutional. It is fundamentally
> counter to personal freedom and the founding principles of this nation.
> And it must end. Please read fairtax.org.
> 3) The hyper-inflationary activity of our Treasury and the Fed.
> Time to end this manipulation of our currency by a small cabal of
> super-elite bankers and wealthy!! They are penalizing the prudent,
> wise savers and rewarding the unwise who made poor decisions with
> their easy money policies!! And they are reinstituting the conditions
> that CAUSED this bubble to begin with by encouraging more lending
> and spending, rather than saving and paying down debt to rebuild
> a good foundation.

2008 Dec 17 07:49 PM

[Tom Armistead:]

Maybe the Republicans will be known as the party of George W. Bush forever, and they will wish it was only Hebert Hoover.


On Dec 17 05:40 PM Mister Jimmy wrote:

> To Mr. "Socialism Cannot Compete", this is not the time for massive
> reductions in Federal spending. That would be the anti-stimulus,
> and is precisely what caused The Great Depression. It would be a
> fitting move, given the incompetent Republican president that we
> had at that time, and have now. As Cheney recently told his party's
> members of the Senate, "...we will be known as the party of Herbert
> Hoover forever". He's right. After Herbert Hoover, it took twenty
> years for the Republicans to regain the White House. It will likely
> be at least that long after Bush.

2008 Dec 17 08:43 PM

[bosun.j:]

Running out? How about RAN out! Using the same tools to "fix" their mess won't "get us out" of their mess.

Socialism seems to be working pretty well for the AFDC crowd. The Aid For Dependent Co-conspirators. You know, the Banksters. You just can't expect there to be any money for the working stiffs....it's all been given to the rich "free market" guys!!

2008 Dec 18 01:37 AM

[johngonole:]

Mr Jimmy you may not like it buy "Socialist can't compete is right". The assertion that Bush is a republican is really quite funny. The Bush white house and mainly congress has done nothing but implement one quazi socilist/fascit DEMOCRAT policy after another starting with the FARM BILL shortly after Bush came into office. Since then it has been one fiscal deficit stimulus after another.

The economy built over the 10 years was built on the expansion of debt and lending. This expansion of debt caused a temporary (because we can't borrow infinately) surge in demand for all kinds of services and goods. Hence the economy expanded. Everytime the econonmy attempted to downsize to meet the real sustainable demand for goods and services another STIMULUS plan was hatched. The ecomomy has been trying to contract ever since the internet bubble.

During the internet bubble the collaspe was caused when overleveraged businesses stopped borrowing so much. The Fed lowered interest rates and the consumers reponded taking on more debt. This new debt led to a surge in consumer spending. I think we can all recall how it was consumer spending that propped up the economy during the first Bush era recession. This recession morphed into the housing bubble. Now the consumer is deleverging. Don't expect businesses to take on new debt because while the balance sheets (not including banks and the like) are much better they still have plenty of production capacity to meet demand.

For the last decade the govt has been expanding its debt at an ever increasing rate. Folks the problem is debt caused. The quickest way out is to reduce debt either through savings or bankrupcy. The debt must be wiped out.

Continued expansion of debt by the Federal government will accomplish two things

1) To forestall the contraction of the economy and make the pain of it longer and possibly worse in total in the long run. A slow grind to socialism and the end of self reliance.

2) Further align the interest of business with government thus entrenching Facsim and classic Socialism in this country and around the world. Look to the study of economics, history, religion, psychology, the human condition, mathematics, and all will yield depressing conclusions of where our freedoms will be going.

The answer to all of this is to allow businesses to fail and be liquidated. Bosun J you will be glad to hear that those rich banksters in my ideal world would end up in the poor house if FREE markets were actually allowed to hurt.

This is the problem that true free market libertarians have. We know the problem is caused by Fascism and Socialism. But no matter how many times the government causes problems through social engineering, currancy manipulation etc somehow all you poor saps think its the Free market to blame when none of the problems were caused by anything remotely Free and legal. So stop blasting the free market and starting blaming the Masters of your Universe who are using fear to convince you to bail them out.

2008 Dec 18 04:14 AM

[drahcir:]

quite contrary to jonathan, i did see the market crash coming, and it isn't done yet. there's a few things the fed can do such as teaming up with the treasury and purchase selected stocks, etc.

www.youtube.com/watch?...

goldieshouse.piczo.com

2008 Dec 18 09:43 AM