Economic Expectations Overheating

       Not to rain on anyone's parade, but since being optimistic about the economy has become so trendy even Dr. Doom himself, Nouriel Roubini, has gotten in on the act, I say au contraire!  Not only has the 45% rally in the S&P since March been way overdone, I think people are far too positive about the economy recovering naturally as if 2008 was any garden-variety recession.  2008 was a massive shift that most likely will determine the course of economic and possibly political history for the next decade or two.  The only thing we can hope is that we aren't seeing the modern equivalent of this massive sucker rally of 1930.  If I can just throw around some alphabet soup for a minute, it seems that a lot of people are starting to factor in a V-shaped recovery in the credit and equity markets.  I continue to believe we will see a W-shaped recovery with further turmoil sometime in 2010.  This article will lay out several of the problems or issues which might contribute to a 'double dip', giving us another dose of false mania in the markets.  

1. Spending Money Just Ain't What it Used to Be- Although we have seen some stabilization in the contraction in consumer spending, the driver of the American economy, we will not see previous levels again for many years.  There are several reasons why Joe the Plumber won't be sporting his Louis and Gucci around the trailer park circa-2007.  Without such a bounce back in consumer spending it will be nearly impossible for a V-shaped recovery to take place. Conspicuous consumers have been shown to be debt-laden fakes during the past year, it just isn't as cool to be a high-roller (just check out the fascination the public has with limiting executive pay at firms across the country). The personal savings rate has rocketed up from negative to above 5% in the last year, which only barely puts it at a long-term sustainable level. Banks and other lending institutions have tightened their lending standards and even credit card companies are becoming more stingy. People can't draw equity out of their homes to take vacations like they used to. In addition to all this, many aging Baby Boomers and retirees saw their 401(k)s devastated by the collapse in equity prices, meaning they will have to spend far less and increase their contributions to savings. Watch Las Vegas as a barometer for glitzy spending: right now it is depressed.

2. Ain't No Jobs: Unemployment will continue to dog the economy and contribute to the lack of spending. Most economists predict that unemployment will top 10%, some are predicting 11 to 12% unemployment. The current job market is simply nowhere near the condition it needs to be in to facilitate a healthy recovery. Finance will continue to employ fewer Americans because the industry will pay less, have less firms, and be significantly more regulated. Housing will be a bust for at least five more years with the amount of inventory on the market (the industry created the most jobs over the past few years). A higher tax and regulatory environment will also contribute to lower employment levels. Its possible that America may begin to run a higher natural unemployment level as the economy becomes more European (slower growth, more social safety net, older population). Combined with low consumer spending, its possible that unemployment may take a leg higher and become a serious issue over the next year.

3. Uncle Sam's Debt Binge: Facilitated by strong Asian demand for U.S. Treasury debt, the U.S. has been running deficits and a growing national debt for most of the past decade. Currently at around 100% of GDP, the limits of the national debt are being seriously tested by the stimulus bills, TARP, contracting tax revenue, the proposed healthcare plan, and the looming monster of Social Security. Unfortunately, it appears that the Chinese, Japanese, and Russians are continuing to buy large amounts of our debt, keeping interest rates low and allowing us to feel completely comfortable in binging with government spending. Simultaneously, they are talking out the sides of their mouths about diversifying currency reserves away from the dollar. The social seismologist believes we will see a hybrid reserve currency of the dollar, euro, and chinese yuan over the next 40 years. Thus, dollar demand will decrease over the next few years. The value of the dollar is also being questioned by some pretty serious devaluation against every major currency over the past few months. It appears that when the economy recovers, nobody wants to own dollars. This will make the debt even harder to pay. Considering that no politician, Dem or Rep, is willing to talk about taxing anyone but the upper 2% of Americans, I have no idea where any significant revenue will come from, bar a major shift in the political landscape. Social Security problems are still a few years off, but if a few unlucky things go wrong, the U.S. might be staring default in the face sooner than expected.

4. The Myth of China: China has grown by leaps and bounds over the past decade. It has been a testament to a strong free market working within a planned economy. To be sure, we have seen nothing short of a myth out East, but we saw equally impressive and genuine stories during the Tech and Housing bubbles here in the United States. Bubbles always start out as genuine valuation stories. But after almost a decade of 8%-10% growth, its past due a cool-down. Some things don't occur in nature. That kind of growth doesn't happen without serious fallout on the other side. Its interesting that as exports have collapsed (the primary driver of the Chinese economy), the state has report growth above the 6% level. Lets just say that accounting isn't necessarily a strong point for an autocratic state. Another indicator of economic growth in China, electricity demand, has fallen. Massive job losses in Guangdong and Shenzen have caused unrest among the unemployed. Racial and class tensions drove the number of violent political incidents in China higher last year. Most of the stimulus China executed last year was in the form of bank loans from state banks. Credit standards plummeted and most experts have said lending has been worse than in the U.S. during the past few years. Most Chinese experts say that the economy has to grow above the 6% level in order to prevent social unrest. The Chinese political system relies on a implicit compromise: you don't question the authorities if they provide strong economic growth and jobs. Without the growth, China's educated and Westernized population might be quick to turn on their autocratic rulers. You can be sure that political turmoil in China will sap the strength out of markets across the globe.