macro predictions for 2010 and then some

Value of predictions is different than a goal. A goal is a picture of the future that you work backwards from. A prediction is simply a chance to look at the world and see what you think will happen and then see how you have done. It is a skill that one can and should develop. The more you look at a specific area the more you will begin to see how the system fits together. Then you can make better predictions and so on and so forth.

Predicting the future is fun way to hone and check your thinking skills. Predictions also allows you to mentally prepare for the future by creating a picture of it so that when things begin to happen you have already started planning for it. Strategic planners call this effect “creating a memory of the future”. So as you see I am big fan of predicting the future as an exercise.

When looking at the upcoming year I went through the following thought process. What are the items that I believe are unavoidable. Then you can look at what are the possible scenarios that arise from those unavoidable factors.

So I look at there are five major factors or drivers that will shape our economy for the foreseeable future and certainly for 2010

1> We have structurally been set up to a point where inflation and interest rates have to go up – I think to start sometime in the 3rd quarter
2> There is an election in November
3> Government will continue to spend more than it has (i.e. continuing federal budget deficit) and will continue to issue more debt to finance it (i.e. growing national debt) – going on right now
4> We will continue to remain at war with the extreme Islamic, fascist, terrorist regimes – going on right now
5> Taxes on all people have to go up (realization will hit people right around election time although the actual tax increases do not happen until 2011)

So then the question is what does this mean for the market, overall economy, small businesses etc...?

For the overall economy this means nothing good to be honest. It means there will be no real growth and as long as the government is trying to manage the economy at a micro level (which I feel it will) you will not see considerable GDP or employment growth. It is basically going to be flat with a possible second dip late first quarter to early second quarter discussions about “was the recession really over?”.

You will see a very confusing dance going on with this reality. The government will try to stimulate lending as a part of economic recovery. This is a misfire but I will get to that in a bit. They will look at the fed interest rate at 0% and treasury yield on intermediate term money at 2-3% and realize that they are the reason why banks are not lending. They have put themselves in the middle of the market as an overlord regulator AND they have set up an arbitrage that no bank could resist (or should from a shareholders point of view). There is often a spread but it is at an historical high and rarely does it happen with such a financial crisis combined with unprecedented actions of government intervention directly into the marketplace. So that means you will have the government trying to raise the fed rates without pushing the intermediate term treasuries too much. That combined with the looming and uncertain specter of the financial reform bill banks will start looking to loans to make money but will have to price in the risk. So businesses will have to start thinking about 9-12% interest rates. And the government will spend much more than it brings in (and even more than it currently projects) and this will also put pressure to raise the fed rates and treasuries so that we can continue to finance deficit spending. All of this means the cost of capital is going up from everyone and by the end of the year.

The Stock market will remain flat and I believe that is largely due to the fact that there will be limited other places to put money until interest rates go up and then the money will leave the market. Additionally I think the market will stay flat because the US Dollar will have to weaken and the beginning of inflationary pressures will be felt. (you simply cannot print a trillion dollars into the system and not have inflation) So in inflation adjusted terms I would say the market will be down a little. And the real threat of serious inflation (over 5%) will be rearing its ugly head by the end of the year.

I do think that companies that put out strong consistent dividends will find some individual favor this year. In particular I think the utilities industry is in a strong place because I think at some point on the election cycle people will start pushing the words “energy security” and “energy independence” and I think the utilities sector will benefit from this realization. Plus they tend to produce dividends since they can change their rates to cover costs under what amounts to a government imposed monopoly. Not great if you want to be in that industry – but it is OK if you are a shareholder. There is some possible upward movement in the health care world – particular basic service and product provider as there will be several million new customers being forced into the market. I think the policy is a terrible one – but it is going to happen in some form so the question is how to best think about response to the reality. There will need to be more clinics, doctors and basic supplies built and set up to support this need.

Small business will be where this recovery comes from. When you hear the language and action of supporting small businesses get real you know we are heading in the right direction. But I think unfortunately between our macro trends and micro tinkering, plus the costly environment that the government is continuing to set up you will see more businesses shut down than start in 2010. Traditionally you see the market turnaround after the birth vs. death rate goes negative. It is almost certainly negative in 2009 and I believe we will see it continue negative for 2010. The increase regulatory cost of running a business as well as the increased government involvement in many aspects of the business market coupled with the increase in taxing that are coming have eliminated incentives for starting new businesses. Until this turns around the economy will remain relatively stalled. The proposed reduction of capital gains is a good start as would be a permanent reduction or elimination of the estate tax. But the key will be an environment that allows for business to quickly and for a low cost get started. Right now the hurdles to get to any size create a cost that make it unattractive for an entrepreneur to want to take the risk for a much longer time frame and lower relative return. So this also limits the potential for economic and employment growth.

Some other thoughts on the economy:

• Housing market will remain relatively depressed (again I feel until the government gets out of the way they are holding up a needed clearing out in the market)
• Personal Saving and deleveraging will continue. Long term this will be one of the best things for our country – hopefully government will follow suit.
• I think the unemployment rate stays at above 10%

In politics I think you will see the republicans pick up about 15 seats in the house and 2 in the senate – it should be more but they will misplay the opportunity.

There are some other areas I am thinking about but not able to make an informed prediction. Commodities and energy prices are a very powerful force of expenses in our overall economy and should be watched (for the record I think they are going up to the drop in the value of the US dollar).

This does not predict a wonderful economic picture for the next year or two. Unfortunately this is where I believe the economy is heading. Now is the time to protect against the risk areas and look at the map for 3 to 5 years out and lay the groundwork for the places to go in the economy when it begins to return. This will start when many of the factors mentioned above begin reversing.

Now I have put it down on paper – now I can watch the calendar and see if I am right or wrong.

Thanks

A key to economic recovery you won't hear much about but should watch for...

Accountability. That’s it.

It is a key driver to our economy. So where are we now? For the last few years we have been in a world of little to no accountability. Until we hear language that is restoring accountability expect little to no real recovery.

So what will signal accountability? (note: For the overly partisan who may read this note that many of these ailments have been pushed by both parties. )

- As long as the government is trying to either stop foreclosures or puts a moratorium on them the housing market is shot. Prices must go down and inventory must switch hands. Until we stop the notion of keeping people in houses they cannot afford we are in trouble. So this is a key piece of language.
- Until the government fesses up to its to its role in the financial crisis we have no chance of undoing the problem. That means we got problems until you hear everyone
o Recognizing the poison that the Community Reinvestment Act plays a huge roll in setting up our current situation. Not the concept behind the act but how it has been given teeth and been abused
o Stating that our implied guarantees through Fannie and Freddie caused a huge part of the moral hazard. And our collective unwillingness to remove to guarantee OR discuss the risks was a failure of government
o Pushing for homeownership as a right is destructive (see above)
o Changing the banking capital reserve standards to a formula (BASEL II) instead of a ratio was a mistake
o Acknowledging The Graham Leach Biley act in 1999 set up huge parts of the problem
- As long as we here of the concept of “too big to fail” or how we govern that we are done as a growing, innovative economy. Pushing these ideas destroys the powerful and necessary force of creative destruction
- As long we try to prevent people from owning their own health care responsibility we will be destroying a huge segment of our economy. Not recognizing that Medicaid needs to cut service levels, Medicare and Social Security needs to move the age of eligibility to be continually indexed with life expectancy are examples of not being accountable to our decisions. If we hear the opposite language that is a positive, directional indicator.
- Until the government starts talking about budget surplus we are not owning up to the national risk of our debt and deficit spending. This is a toxic time bomb in our economy we have to deal with.
- We cannot protect people from themselves. If the consumer protection agency that is being is being proposed goes through you will see a destruction of economic engines in our economy. You cannot protect people against bad decisions – just fraud. Those laws are on the books already. We are now trying to regulate for lacks of judgment. Game Over. It is wrong when we do it in the social world and it is wrong in the economic world. You cannot have it both ways.

Until we see a language of accountability in our economy we will not grow. And yes this means failure, but failure does not mean loss. As long as we hold our economy and individuals from the responsibility of our choices we cannot recover long term. And unfortunately I see another 2-3 years at least of this language. So expect a second recessionary dip and little job recovery of a permanent nature until we all start hearing the language and actions of accountability.

Why everything DC tries does not work...

How much does your hand raise the level of a full bath tub? This question is used to show the minimal impact many of our actions can have on a system. What if instead of a human hand in the bathtub it is an 9,000 ton gorilla jumping in the bathtub?

And this is basically where DC goes wrong. In trying to address appropriate issues of the day the government mindset does not recognize that its focus needs to be a small first steps towards an issue not comprehensive overhauls.

Much like the act of measuring an experiment can change the results for that experiment (quantum physics people swear by it)government cannot fully engage with a problem without fundamentally changing the problem in unpredictable ways. Which leaves us with two outcomes possible; either a solution that no longer addresses the problem as it lives or trying to fix the problem to a stationary point which then institutionalized the problems and prevents innovation towards solutions.

Instead of jumping in the bath tub the government should be extra careful to always try to put in a baby toe and disturb the system as little as possible.

Lets look at how even small decisions can have huge impact.

1) a weak dollar policy - started by Bush and being continued. Has caused a huge spike in commodities pricing. Including oil which has fueled the nation states of Venezuela and Iran etc...

2) changing the leverage and capital reserve ratios from a fixed number to one based on a complex financial model (Basel II) - this allowed financial institutions to massively increase their leverage which made their implosions that much more damaging

3) Changing the rules on cloture voting in the senate. In 1975 the senate changed the rules for cloture from 67% to a flat number of 60 votes effectively changing it to 60% to shut down debate, discussion or filibuster. This allowed the party in power to have significant more control and is one of the key accelerators in both the partisan nature of the debate and the extreme legislative agendas that have been continually pushed upon the american people.

None of these were done with massive debate or large votes being tracked by news alerts and C-SPAN and yet these have had huge impact on our economy and world. And note that this is an ailment that both parties tend to suffer from.


Instead of debating massive overhauls of policy, regulation or the economy our leaders need to deal with the reality of the damage they can cause with their decisions. The bigger the decisions the bigger the waves. Our policy focus should be on simple first steps.

For example, health care should not be looking at massive reform but instead should focus on a few small first steps. Steps like selling across state lines, focusing on fraud enforcement, individual benefits having the same tax treatment as company benefits and pooling of associations and individuals are all low cost and small first steps that we should look at before we even consider the larger options that are already being designed.

The more big program we look at the more perilous our economy will become. As you look at the structures put in place and policies being proposed you should ask yourself does this policy show the smart approach of small steps before big ones? Or is it making the same mistake DC always make?

Thinking about the future

There is a power of looking toward the future.

1) it can sometimes let us think past our current limitations and expand possibilities on the horizon

2) in looking at our thoughts as to where we will go we have to understand the consequences of our current actions

3) we can look at our current situations and pressure and figure out where that may lead us - in doing that we one, can get better at noticing these things and two, we can begin to look at how to respond to these pressures and factors we see coming in the future

And that is what I hope this blog gives me the opportunity to do when it comes to current events and policy.

So each post will try to do one of those three things (or all three in many cases)

- look at what we should be thinking about for our future
- look at the potential consequences of our current directions (positive and negative)
- make some forward looking predictions and see how they bear out against reality


Lets see