US Economic Mendoza Line

Posted by Jeff Carter
on October 18th, 2010

The Dollar is stronger this morning as players begin to take bets off the table ahead of the Federal Reserve Meeting in early November. The domino effect is that commodity prices are down. The precious metals in particular.

In the past couple of weeks, I have heard some bankers give reports on why they think the economy is so great.

The reports have been virtually the same. They cite corporate profits as a sign of strength. They cite the US savings rate increasing as a sign of strength. They point to growth in the BRIC countries, and believe that we won’t need explosive US growth to take us out of the depths of the recession. They say that unemployment will remain high, but it won’t matter. When a chart of world trade is put up, they show increasing activity measured in dollars. Things are great. Put on your rose colored glasses.

When I read the blogosphere, things are pretty bleak. Who is right?

As every economist I have ever heard answer a question says, the answer is, “It depends.”!

The holes in the bankers arguments are many. When I listen to them speak, and look at their charts, I don’t have a lot of confidence that real deep forward thinking critical thought went into the analysis. More like back of a baseball card analysis. The past can guide us to what happens in the future, but it’s best to take into account factors today that were not present yesterday. I don’t think a lot of financial people are doing that.

A double dip recession is probably out of the question for the US. But, a rapid growth rate is probably also out of the question as well. I am not a PhD in economics, but here is what I see.

The bankers cite corporate profits as a sign of strength. They also cite tax revenues going up this year. These two data points go hand in hand. However, because the expectation is that we will have a mucho gigantica tax and regulatory increase next year, the behavior of companies and some individuals was affected. Everyone that could pulled revenue into this year to pay the lower tax rates. This means unless economic activity picks up significantly, they are foregoing next years’ revenue. My expectation is next year, revenue will be flat, or a bit less.

Bankers think that Republicans will win the House, and they will pass a bill to extend the Bush tax cuts. Sorry, the man in the Big Chair at 1600 Pennsylvania Avenue doesn’t believe in that stuff and will probably veto any tax cut bill. My guess is that we will see the insane do nothing policy of “targeted tax cuts”. This really means that someone has to jump through so many hoops to get the tax cut, no one actually gets them.

Republicans are not going to win the Senate. All the things the House, and American public, wants to do will get bogged down there. America, get ready for a lot of Al Franken and Dick Durbin telling us how mean and nasty House Republicans are.

BRIC countries are growing. Their growth is helping some multi national American companies. However, it’s not enough. Next year the US is not only going to have a tax increase, but a regulatory and increase too. Regulatory increases quietly kill business. Some business ideas are abandoned in their infancy because the regulatory hurdles are too steep to jump over. The incentives for entrepreneurship in the US are going down, not up. The access to capital has been significantly hampered by the Fin Reg bill. The US needs domestic growth to heal, not just BRIC growth.

One example of regulatory hurdles damaging business was the recent pronouncement that deep water drilling is okay in the Gulf of Mexico. The headline looks nice. Problem is a lot of the deep water drilling rigs were moved to other waters, and it’s too expensive to move them back. Plus, all the new fine print regulations actually discourage drilling. Hence, we will get much less deep water drilling than we would have.

The other thing these bankers don’t count on is inflation. They buy Bernanke’s line that it will remain in check.

Inflation as measured by a macro index might. But, with the competitive devaluing of the dollar, the things that people actually consume are going up in price. Food and energy are not going to go lower in price. Four dollar a gallon gas is not out of the question. All food prices are going up in the long term. Short term, they are going lower because of a trade war in the meat industry right now. But, luxury goods and goods that are not readily consumed should not go up in price. Technological goods also have a deflationary effect on the index. The effects of inflation may stay hidden behind a number.

Incentives and economic cues are causing people to change their behavior. Savings rates are higher because they are scared. The job market is terrible, and the prospects for growth are poor. People are also switching to substitute goods. Over the course of the past couple of years, cheaper cuts of meat are selling versus prime cuts. The US consumer confidence index is not rapidly improving.

The bankers that I listened to said that housing used to make up 6% of the economy. Housing is not getting better anytime soon-especially with this latest mortgage/foreclosure debacle.

Economic conditions in the US might improve slightly next year. But they won’t improve significantly. Given all the artificial government manipulation that will happen, things can’t get really fertile for growth until at least 2013.

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