Some people are very pessimistic about the economy and that we’re all heading for a depression. Some people say, “Hey, there’s nothing wrong, let’s just work, laugh a bit and enjoy life.” So who is right? Or is there a right and wrong answer? I will explain how I see the economy shaping up going forward for maybe the next 10 years. You decide if you agree with me or not.
When the economy around the world went into a tailspin in 2007-08, major countries got together and quickly started to push money out the door of their central banks. The strategy had several objectives: to prevent major banks from failing, to stop a run on banks deposits, to slow down the loss of jobs and basically to keep economies around the world on an even keel.
However, most countries didn’t have a piggy bank full of money to shake out and spend. So they borrowed money or printed it and started to push it out into the economies. In some words, the strategy was to prevent a serious round of deflation where assets would drop in value, which would likely lead to people around the world shutting their wallets which would slow down the economies even more.
But stocks fell. So the value of investment portfolios dropped. Pension plan funds lost value. Interest rates on deposits dropped to near zero. This spooked the public that had pension funds or portfolios. Since maybe half of the population doesn’t have either, odds are life just went on for them, unless they lost their job.
Unemployment rose to around 10 per cent, officially. Unofficially many say unemployment is a much higher number. In the meantime more and more companies are working at under capacity. The U. S. had one of the biggest financial problems and hence borrowed and printed more money than most countries, except Britain.
So we now have a situation where most nations are not working to full capacity, yet they have a lot more debt than say four years ago when they were working at or near capacity. My guess is that the economies are working at around 80 per cent of normal and that is not likely to go up any time soon.
Therefore we have an equation that I made up as follows: Before the recession, let’s say we had $1 of capacity carrying $1 of debt. So in financial terms we had debt servicing capacity, and maybe some to spare.
Now we have, in my opinion 80 cents of capacity carrying say $1.05 of debt. That surely reduces our debt servicing ability. And it doesn’t really matter if the numbers are higher or lower, the fact is economies are working under capacity and most nations have more debt.
SLOWER VELOCITY OF MONEY
Back in the good old days, we always figured that money moved around seven times as it circulated from person to person to business and so on. From what some analysts suggest, that velocity has dropped to two. This is like slowing a car down from 70 miles an hour to 20 miles per hour. Do that and it takes a lot longer to get anywhere.
Why did the velocity of money slow down? One reason is that as the price of homes rose during the early part of this decade, many people borrowed money against their higher priced home and spent it. Houses were like an ATM machine. Estimates are that the money coming out of those homes made up 1.5 percentage points of Gross Domestic Product (GDP) growth. So if GDP growth was five per cent, the housing money was 1.5 of that. If GDP was closer to three, then housing money was half of that. And that was tax-free money. Plus credit card debt was piling up. Again tax free dollars to spend.
Then the price of homes stopped rising. Unemployment started to rise. Fewer people were earning money. Fewer people were taking
money out against their home. The value of many managed investment accounts dropped 35 per cent in 2008. Credit card companies cut credit limits and wanted debt paid down.
Result: Suddenly several key drivers of the economy reversed. There was no money coming out of home values. Credit card companies wanted money. Seven, then eight, then 10 per cent of people were officially out of work, relying on some sort of government cash payout, which cost countries money. People got spooked by sliding values of their investments and homes and started to save more. People who didn’t have investment accounts started to save money.
So governments tried to offset some of the slowdown in the velocity of money. That is not easy. But debts are piling up by any measure.
There’s more financial trouble ahead. People who bought homes recently may be shocked when their three-to five-year mortgage comes up for reset. The principle on the loan will not have come down much in the first three to five years because most of the money paid on the first few years of a mortgage goes towards the interest. But the value of most homes across the country has come down. So folks with house mortgages to reset may discover that the principle remaining on their loan is higher than the current value of their home. In addition, they will likely face a tougher lender and higher interest rates.
One estimate I saw said that in the fall of 2012 roughly $35 billion dollars worth of mortgages have to be reset for five months in a row.
What to do? Banks are getting ready for this monsoon by raising money in reserve, by lending to better borrowers, by paying very little on deposits. But if the market value of a home dropped by $50,000 over the past three years and the loan has only dropped $1,000, who is going to eat the difference? The lender? The borrower? I guess we’ll have to wait and see but the consequences likely are not going to be pretty and maybe even scary.
The interest on mortgages likely will to go up. More banks will fail, especially regional banks. More cheap houses will hit the market so jobs to build new homes won’t be there any time soon. But people with good cash flow and debt servicing ability will be able to buy good homes at a good price. There’s always a bright side.
LEAN YEARS AHEAD FOR U. S. ECONOMY
Odds are the U. S. economy is going to struggle for years. Odds are deflation is a bigger risk than inflation in most parts of the economy. Odds are governments will have to raise taxes to service the higher new debts coming at them while tax dollars from working folks stay down. Odds are interest rates will stay low for a lot longer than people think. This is good for borrowers, bad for savers. But low interest rates have to hang around long enough to convince people to stop hoarding money and spend it.
This could become a giant screw, twisting people and the economy lower and lower.
Absolutely. Cheap houses mean more folks will be able to afford them. Rental rates are now higher than house payments in most parts of the country. Low interest rates are good for people and businesses that have been smart enough to stay away from financial cliffs. Some baby boomers will be forced out of work, or forced to work at low-paying service jobs which until recently couldn’t find decent help. Much as they might not like it, baby boomers might have to find a job after they retire. Recreational businesses likely will slow down.
But the idea that people could work from age 25 to say 50 or 55 and then spend 30 years of nonproductive time will end for many in the middle class. This has been the thinking. But to think that a person could be retired for as many years as he or she worked likely will disappear. People will need to be productive longer. Or reduce their lifestyle.
That likely is more positive than negative as far as the overall economy will be concerned.
People will survive — they always have and they always will. Sure, fewer will be working for GM or Ford and so on, but there will be jobs looking after seniors, repairing highways, bridges and so on. And there will be opportunities for people to start their own businesses in a variety of industries. The good businesses will survive and come out of this stronger, with hard working people and more efficient and more productive systems. What’s wrong with that?
In a future article I will outline what I call the China effect and how it could affect the livestock and grain business, the price of farm land and what you and I can do to perhaps offset or even overcome any setbacks the future economy might do to you and your family.
Andy Sirski is more or less retired. He manages his own portfolio. He also publishes a newsletter called StocksTalk where he tells what he does and why. If you want to read it free for a month, go to www.StocksTalk.netand fill out the form.