Market Watch

Last month we wrote about the new economic realities that are here to stay. Bottom line: Get used to asset values, which are 30% less than the value of those assets at the top of the market. What a recession does is devalue assets to a price that becomes more palatable with changed economic conditions.

Given that, let’s examine the new economic trends that have arisen as a result of our economic downturn.

1. Durable goods are off 23% to $1.125 trillion annually. Durable goods are the heart of an economy and include cars, refrigerators, washing machines, etc. With real estate construction off over 50%, and the automobile industry in the tank, it’s really good that durable goods sales are off only 23%.

2. Imports are down 44% to $1.875 trillion from $2.650 trillion last year. This $875 billion downturn has severely hurt China, because a lot of what China was making and selling in the U.S. were goods that consumers simply do not need and now will not buy. This has hurt China tremendously. Unemployment in China is increasing rapidly. It also owns more U.S. Treasury notes that are decreasing in value, more than in any other nation.

What’s good for the United States might not be good for China. U.S. exports are also down, but they are down $400 billion less than the $875 billion reduction in our imports. This favorable swing in our trade balance of $475 billion will benefit America, because it will reduce the need for the U.S. to borrow money.

3. U.S. money market funds are up to $2.5 trillion from $1.15 trillion in 2005. Funds have more than doubled in less than five years. This is money available for investment in plants and equipment, which is the good news, but it is also available to help finance the huge $2 trillion of government financing required in this fiscal year. This is an example of funds for which both business and the government will be competing.

4. IRA and Keogh retirement accounts are up to $700 billion from $430 billion in 2005. This is in spite of the huge sell-off in the stock market, so, like money- market funds, retirement funds have increased significantly, too.

5. All economists agree that our national savings rate is at least 4%, and many economists feel our savings rate is now approaching 8%. Whoever is right, we are headed in the right direction. In a short period of time, our national private-balance sheet has been repaired and is in really good shape.

6. The world’s economy creates a GDP of roughly $47.5 trillion annually. The U.S. economy represents about 30% of that, and, historically, savings of 4% (about $2 trillion) of world GDP would be average.

Although it’s unlikely a 4% world-wide savings rate could be obtained in this economy, let’s assume that it could. The U.S. government alone needs at least $2 trillion or more than all the savings in the world available from one year. Think about that.

One government borrows all the money available saved from one year of world economic production. Then, the government competes for funds with private borrowing. Because government borrowing results in money transferred to citizens in our welfare state who do not work and are not productive, all government funds that can be loaned go into entities that produce nothing that can be given back to the economy. No jobs, no income, no savings, and nothing for the future investment. $2 trillion gets added to the national debt, and U.S. taxpayers pay the interest forever. Government debt never gets paid off.

7. There are 13 states that have jobless rates exceeding 10%. Eight states reached their highest level of joblessness in May since records began to be kept in 1976. These unemployed workers will have a hard time finding jobs, because all of the money is being borrowed by the government, not the private industry that creates new jobs. This is an overwhelming problem that must be faced.

8. Seventy-seven million baby boomers are beginning to retire from the workforce. The problem is that they expect Social Security and Medicare. However, the federal government who set up the trust funds to accumulate the cash has “borrowed” all the money. The government has borrowed all of the cash out of the trust funds over the years to spend for current account expenditures. The Social Security and Medicare trust funds consequently have $0 available to invest. Every single payment must come out of current taxes, so the “trust” we put in our government has again been misused.

These trust funds instead hold a collection of IOUs from the federal government that will never be paid off. Moreover, for every dollar of government spending this year, another 50 cents will be borrowed and financed. The only way to pay this debt off is higher taxes and inflation. The dollar is going down, which causes interest rates to go up in order to make dollar investments more attractive to foreigners. Increasing interest rates make real-estate mortgages more expensive, which adds additional problems to housing recovery. Government borrowing “to help” the economy is driving interest rates higher, which also hurts economic recovery.

9. According to the Fed’s latest statistics, bank loans aggregate just under $8 trillion (March 2009). Upwards of $500 billion of those loans are troubled, so somehow that will have to be funded, too. That adds additional demand for funds available for loan, which is certain to put more upward pressure on interest rates.

The private-sector balance sheet is looking good. The problem is too much government spending and debt.
The government is trying to spend its way out of a crisis that was created by government spending and government borrowing. The government compounded problems with laws that required lending institutions to loan money to high-risk borrowers. And, when not enough money was loaned, the laws were changed, requiring a percent of a bank’s assets to be available for loans to borrowers with substandard risk profiles.
It is the government that forces the Federal Reserve (50% owned by the government and 50% owned by Wall Street) to continue to sap the borrowing of funds available to loan. This competes with business.

Directly or indirectly, business pays every tax in this country: no business, no economy.
Today’s U.S. economy has striking resemblances to the United Kingdom economy of the last 64 years. The federal government has become a bigger and bigger percentage of our GDP, as did the English government. The size of government, an unproductive part of the economy, and the government becoming a larger percentage of our GDP reduces the opportunity for us to have economic success and to pull ourselves out of this existing abyss.

The continuing build-up of government, coupled with government’s borrowing of the most available and loanable funds in the economy, causes foreigners to think twice about investing in U.S. assets. That, in turn, has caused the dollar to go down in value. A decreasing dollar value makes it difficult to sell bonds unless the interest rate on the bonds is increased to make them more attractive to foreign buyers. Rising interest rates means rising mortgage rates. The one thing we need to pull us out of this mess, lower rates, becomes frustrated, again, by government borrowing.

Furthermore, China, Japan, Russia and Brazil own U.S. Treasury notes, aggregating $767 billion, $687 billion, $138 billion and $127 billion, respectively. With considerably reduced cash flow from U.S. business, how will they continue to buy U.S. Treasury bills to help fund our deficit like they have been doing the last several years?

Conclusion
The wise investor will continue to work to improve his or her personal-and-family balance sheets. As interest rates continue to rise, cash looks better and better. We have been through a 25-year economic boom, the likes of which history has never before seen, all set up by U.S. government spending. The continuation, and increased velocity, of government spending and money manufacturing to solve a problem created thereby is also unprecedented in economic history.

The endgame of this is unknown but cannot be positive because it’s all built upon debt. In the long run, too much debt brings an economy to its knees. To solve the problem with more debt can only create havoc.
The increase in debt payments, plus increasing interest rates, adds an element of risk that could frustrate economic recovery for years.
Caveat emptor!

George Rauch, Longboat Key, is chief executive officer of Bradenton-based General Propeller and a former Wall Street investment banker.