December 2008

We could recap the markets in 2008 but who would want to? Enough news about the collapsing financial house-of-cards was available to give even a pessimist pause. Despite listening to and reading the fluffed-up rants all year from economists and commentators about not needing to fear recession, touting such things as: the resiliency of the American consumer; the strength of the service sector; the benefits of globalization (and the accompanying deportation of high-paying manufacturing jobs), we find ourselves in one of the deepest recessions many of us have ever seen. And, one of the most puzzling concepts offered by some was a JOBLESS RECOVERY. The service sector is beginning to lose jobs at a faster pace than the manufacturing sector. One should not be surprised by this fact, given that much of the service sector was born out of the productive sector of the economy.

Stop the parade! Nearly a year into recession, the government acknowledges that we were in recession during the fourth quarter of 2007 and have been since. Given the lack of statistical accuracy and thoughtful foresight, we sit on the edge of our chairs now that the federal government finds it necessary to run mismanaged companies in the private sector from its Washington perch. The government is practicing the art of buying anything nobody else wants – nearly worthless paper and proving proficient in degrading its balance sheet. The Treasury’s supply of new debt to market will be enormous in 2009 and 2010 in order to pay for its “necessary” acquisitions. We believe higher interest rate levels will be demanded from willing purchasers of U.S. Treasury debt for the added risk of a debased balance sheet. The real risk to the economy is that all the added liquidity in the market will eventually collapse the worthiness of the dollar and result in hyperinflation. To avoid this economically disabling result, the Treasury’s future role will be to tighten monetary policy and remove the added liquidity without a dramatic rise in interest rates and a rapid decrease in economic activity. All this assumes that we have achieved a period of stability in economic activity, housing, the stock market, and the like. What we are currently witnessing in the credit markets is not a free and open marketplace as long as the government is the backstop to all mal-investments. For this reason alone, economic recovery will be slow in coming.

Let us look to the coming twelve months. The stock market is somewhat forward looking, reflecting current values of future expectations. This is the good and bad news for 2009.

In the months ahead, the economy is likely to be confronted with rapidly rising unemployment and this time around it will include white-collar as well as blue-collar jobs. It is probable that the U.S. unemployment rate will reach double-digits in 2009, in spite of proposed job creations from President-elect Barack Obama’s stimulus plan. Private sector employment remains the key to economic recovery and sustainable growth. Federal bailouts are meant to calm fears.

One of the major questions that will surely confront the U.S. during 2009/2010 is the creditworthiness of the dollar as a world reserve currency. But even monumental issues get slipped under the table in a time of crisis. For now, there appears to be a rush to the bottom. Countries are turning to devaluing their currencies in order to gain a competitive advantage over its trading partners. In our opinion, solutions shouldn’t be called solutions if they result in similarly significant problems. Devaluation of a country’s currency brings with it a host of issues.

The practice of devaluing a country’s currency brings into play the risks associated with floating exchange rates with some experts, i.e., former Fed Chairman Paul Volcker, calling for an eventual single global currency. On New Year’s Day, we celebrate the ten-year anniversary of the euro, a single European currency. The euro has demonstrated itself to be a formidable alternative to floating exchange rates. How this plays out will have a significant impact on our future standard-of-living.

The bad news is that the stock market is projecting dire economic times for 2009, especially for those seeking employment and sitting on a house of debt. The good news is that the markets, being forward-looking, may have priced in much of the bad news already. This is not to say that stock prices are headed back to the levels of previous years, at least not soon. Many problems remain, especially in the financial sector. In fact, all problems remain. They have just shifted to the government’s balance sheet so that all may suffer from the mal-investments of a few. Figuratively, the solutions to the global financial crisis to date have been similar to pumping more hot air (dollars) into a hot air balloon with gaping holes (economy). Taking a page from Milton Friedman, the Fed first turned to monetary stimulus and brought short-term interest rates down to near zero. Now, as preached by John Maynard Keynes, the Fed is focused on fiscal stimulus and is throwing money around, well, like, “paper.” The Fed has said it is willing to do anything in its power to avert deflation. How about suggesting to Congress that we bring our high-paying, productive jobs back home? The government hopes it can spend its way out of the current problem, as it has in the past – but it cannot. Credit availability is highly unlikely to be as accessible in the years ahead as it has been – at least for a generation. We are hopeful that the new Administration will adopt a lower tax policy for all and allow the creative juices and the industrious drive of our citizens to again pick up the ball and run with it. The United States will always remain a great and prosperous country because of the resolve of its people to be so.