The second quarter growth numbers have been revised upwards, but they are still nothing to get excited about.
The year-over-year rate of growth of real GDP is now estimated to be 2.3 percent, roughly where it has been for the last three quarters.
About all that can be said for the growth numbers is that the economy continues to recover from its July 2009 trough and will continue to grow for the near term. Economic growth, however, will remain tepid.
To me, perhaps the biggest cloud hanging over the performance of the United States economy is the lack of leadership coming from the federal government. This failure has created an environment of uncertainty that is affecting decision-making in almost every sector of the country.
This is the reason why financial markets, and others, are desperate for Fed Chairman Ben Bernanke to come out with some strong statement this week at Jackson Hole about where monetary policy is heading.
Financial markets, and business leaders, just want someone to step up and lead. Mr. Bernanke is the only act left in town.
Unfortunately, I don't believe that anyone is going to give the markets what they long for. The reason for this is that the economy is recovering, and there is very little more the Federal Reserve can do at this time to get the economy moving much faster. I treated this point in an earlier post.
The Fed needs to remain vigilant, for there are still other clouds that could bring the United States difficult times -- the European situation, along with slowing growth in China, for example.
But as I said earlier, the economy continues to recover and will do so for the near future.
Given this, the Federal Reserve faces the dilemma that it has increased the monetary base, the foundation of credit inflation, to almost $2.7 trillion. That is up over 200 percent from the roughly $840 billion that existed in August 2008. Some day, in some way, the Fed is going to have to deal will all this liquidity awash in the financial system. Pushing more liquidity into the financial system at this time will just create more problems for the central bank in the future -- with very little to show for it.
The federal government faces its own quandary in trying to extract more out of this recovery than is being achieved, as pointed out by John Plender in the Financial Times:
The dilemma for fiscal policy makers is that the austerity necessary to address the overhang of public sector debt could prove self-defeating, while further pump priming might simply inflate the debt mountain further. That brings us to the great market bind. Failure to address debt problems causes government borrowing costs to rise, as credibility with investors is lost. Yet excessive debt cannot be paid down without economic growth, which may call for pump priming deficits.
The government is between a rock and a hard place, facing an election.
The policies of government in the past, both Republican and Democrat, have brought us to this precipice. In order to get elected, or re-elected, governments have attempted to achieve high levels of economic growth underwritten by credit inflation.
Unfortunately, artificially stimulating the economy through roughly 50 years of credit inflation can cause substantial amounts of resource dislocation and debt buildup, requiring restructuring and rebuilding. This is what we face now, and it will not be achieved painlessly.
In this environment, investors must be patient, despite the challenges of doing so. We would like more growth, we would like more employment, and we would like more profits and higher stock prices.
It is highly probable, however, that we will achieve continued slow growth, rising inflation, increasing interest rates, and continued high levels of unemployment.
We already see investors like John Paulson, the hedge fund investor, increasing their positions in gold as an inflationary hedge, according to regulatory filings.
I must admit, I am among the crowd that believes the economy will just continue to chug along at a modest pace. I believe that we will see dramatically rising interest rates and rising inflation in the future. I also believe that at some point, the U.S. dollar will "fall out of bed." And I don't see the leadership around that will help us to avoid these outcomes.
So, there are places for investors to make their play.
The problem is, as usual, in the timing.
I believe that achieving perfect timing is just a matter of luck. The best we can do, intentionally, is to have patience and to be alert. On the up side, I still believe that the crucial sector to watch is the banking sector. Two things are critical here. The first has to do with the health of the banks. Readers who follow me know that I believe many banks still have major portfolio issues that must be resolved going forward. The second has to do with bank lending and when will it begin to accelerate in a way that underwrites business expansion and bubbles. We need to watch these things closely. Here, we need to also keep an eye on the improvement of the housing market.
On the cautionary side, we need to be especially aware of what is going on in Europe and how member governments are working through their problems.
The good news is that economic growth continues at a modest pace. The bad news is that there is a huge amount of uncertainty about other economic factors and about government leadership. Given these factors, I believe that this environment will be with us for some time.