Sovereign risk doesn’t usually dominate the headlines on any given day, but in the wake of last year’s financial cataclysm there’s a sharper focus on the fallout that flows from governments that mismanage their debt and economy.
The elephant in the room, of course, is the U.S. The discussion of America’s fiscal condition has heated up in recent history for obvious reasons, starting with ballooning debt. As the overseer of the world’s reserve currency, which happens to reside in the world’s largest economy, the U.S. enjoys certain advantages that other nations can only dream of. That includes the ability to harbor mountains of red ink.
THINKING ABOUT THE GREAT EGRE$$ION
Everyone knows it’s coming, but when? Everyone recognizes that at some point it’s essential, but the associated benefits and risks are debatable.
One thing we can be reasonable sure of, as we discussed on Monday, is that central bankers are prone to misjudge the future. Indeed, there’s plenty of that to go around. In any case, it comes with the territory when wielding supernatural decisions over money with the conventional processing power of wetware.
AUTUMN HEADWINDS
There are no major economic reports scheduled today and so a day of the data vacuum awaits. That offers an opportunity to review the latest numbers in the dismal science in search of clues about where we’ve been in recent history and where we might be going.
First up is the Philly Fed’s Aruoba-Diebold-Scotti business conditions index. Its steady climb for much of this year through late-August suggested that the economy was rebounding, albeit off of severely low levels of commercial activity. More recently, the index slumped, although the latest albeit incomplete data hints at the possibility of an uptick in the weeks (months?) ahead, as the chart below shows.
Source: Philadelphia Federal Reserve
That mildly positive view jibes with the overall outlook of 41 economic forecasters surveyed by the Philly Fed. The economy will expand in each of the next five quarters, this survey advises. For the current quarter, the economists surveyed predicted that real growth in GDP will rise 2.7% in Q4. If so, that’s down from the 3.5% rise reported in the initial estimate of GDP for Q3. All of which implies a slowing in the rebound but well short of sinking.
WASHINGTON’S NEW MATH
Only in the hallowed halls of Congress could the notion of spending vastly higher amounts of money convince so many that the net result will be a reduction in spending. But such is the conceit with the new health care bill being hammered out these days.
The new legislation to expand health care insurance will reportedly cost $849 billion. But this massive increase in government spending will, we’re told by Senate Majority Leader Harry Reid, reduce the federal budget deficit by $130 billion.
If $849 billion will get us $130 billion in deficit reduction, will $1.698 trillion bring us a $260 billion decline in red ink? Have we, in other words, stumbled upon a budgetary fountain of youth? Ah, if it were only that easy. But attempts at spending our way to prosperity has a long and discouraging record. We can debate the social merits of expanding health care coverage by way of colossal increases in public expenditures, but promoting it as a deficit reduction measure as well strikes us as, well, unhealthy. Progress, or apparent attempts at such, cost money. There’s just no way to turn that mule into a horse.
Meantime, the last time we check, two plus two still don’t equal 5, or 3. In most cities, at least.
SLOW BURN
The danger is not the past, but the future.
Today’s update on weekly jobless claims may be the warning sign. New filings for jobless benefits were unchanged last week, hovering at 505,000, matching the previous week’s tally. Although this number is down sharply from it’s recessionary peak of 674,000, set back in late-March, 500k reflects distress in the labor market. In other words, job growth is largely MIA.
It’s too soon to tell if the drop in claims is stalling. But there’s a case to be made that the big, easy reductions are behind us. As we discussed many times this year, there was always a strong case that a snapback on multiple economic and financial levels was in the offing for 2009. Unless the system was truly headed for a collapse, the natural order of the business cycle was righting itself after such a sharp deviation from equilibrium. In short, much of the events in 2009, particularly since the spring, aren’t a huge surprise to students of economic history. But the world is likely to become increasingly nuanced and complicated, and not necessarily for the better.
We’ve commented often in 2009 that the main threat was a stalled rebound in the job market. The risk was less about a double dip recession and another cataclysm and more of meager growth in the all-important labor market. Today’s data point in jobless claims isn’t proof that our forecast is turning into reality, but neither does the latest number do anything to dispel our worry of what may be looming.
THE NEW NEW BALANCING ACT
Definitive statements about the future are always suspect in finance and economics, but it’s reasonable to assume that the threat of deflation as a clear and present danger has passed. But we can’t say for sure. To the extent that a double-dip recession remains a possibility, so too will does hazard of a fresh round of deflationary pressures.
Yet those concerns look minimal at this point. The primary challenge, as we’ve discussed routinely this year, is tied to the headwinds of growth. The risk of another of follow-up cataclysm to last year’s drama, by contrast, fades with each passing month. In short, the central issue is one of managing the chronic problems that await rather than the acute ones that recently passed.
Yet we shouldn’t underestimate the complications and potential fallout that are likely to accompany what we expect will be a subpar economic recovery, in large part because of what’s likely to be a sluggish rebound in the labor market. (For some background on our thinking about the job market, take a look at this post from earlier this month and our analysis here, for example.)
THE BURDEN OF FIAT MONEY: REAL-TIME DECISIONS
Central bankers are a powerful lot and so it’s an easy to assume that they’re also prescient. When you’re making decisions that affect the livelihoods of millions of people—billions on a global scale—confusing people with their institutional authority can become habit forming. But central bankers are mortal, and therefore prone to mortal decisions, a.k.a. flawed decisions. Heck, it happens to the best of us at times. The only difference is that most people’s day jobs don’t cast a long shadow over a nation’s money supply.
No less an expert on central banking than Paul Volcker, the patron saint of inflation slayers everywhere, advises that “central bankers suffer from hubris like everybody else.” That’s not surprising, but it does have consequences.
The monetary policy du jour, as a result, may not be exactly what the macroeconomic gods ordered. A mismatch between the optimal monetary policy and current events is in some sense fate. Working with limited information makes it hard to know if today’s actions will suffice for the uncertainty that arrives tomorrow. As a result, we can talk of monetary policy in terms of its degree of inaccuracy or accuracy.
THE RECESSION FADES AS QUESTIONS OF GROWTH LINGER
The news on new filings for unemployment benefits once again favors the idea that economic recovery is continuing. It’s a tenuous rebound, one ripe with caveats, including a big one we’ll discuss below. But it’s a rebound nonetheless.
The Labor Department today reports that initial jobless claims dropped to 502,000 last week, down from the previous week’s 514,000. That leaves us at the lowest level since the week through January 3, 2009. As our chart below reminds, the trend has certainly been our friend this year for the general change in jobless claims.
Back in March, we wrote about the possibility if not the likelihood that a peak in jobless claims would signal the end of the recession. In subsequent months, we revisited the mounting evidence that the initial claims pattern was on a sustainable downtrend, including here and here. Jobless claims alone don’t suffice as a definitive sign of things to come, but this data series is on the short list of clues to watch for judging turning points in the business cycle.
TWO RULES THAT CAST A LONG SHADOW OVER INVESTING RESULTS
The world is filled with recommendations and research on what works best in the money game. But when you reduce the sea of study down to the essential lessons, we’re left with rule number one—diversify within and across asset classes, i.e., asset allocation—and number two—rebalance.
There are other rules, of course, and some of them are actually useful. But for most individual investors, and perhaps many institutional investors, these two rules are the foundation of intelligent money management. That’s another way of saying that it’s hard to succeed in investing if we ignore or abuse these rules.
Granted, it’s possible to violate these rules and still earn big returns. But finding success on this path requires that you’re smarter than everyone else and/or willing to take big risks that will sink most investors. For the rest of us, asset allocation and rebalancing are the building blocks of prudent investing. Intelligent investing needn’t end there, but it’s a valuable beginning.
INFLATION EXPECTATIONS CONTINUE TO INCH HIGHER
One of the supporting pillars in the recent rally is the recognition that inflation isn’t a problem. Last year’s financial crisis knocked the stuffing out of the system’s tendency to devalue the purchasing power of fiat currencies over time. The net result is an unusual level of economic cover for keeping interest rates low–really low. Indeed, the primary goal of the Federal Reserve and its counterparts around the world over the past year has been the unbridled pursuit of higher inflation, though not necessarily high inflation.
In the depths of the crisis, the immediate objective was simply to deliver some level of inflation, which is to say something other than deflation. Allowing deflation to fester is simply too great a threat. The basic prescription has been printing money. How’s it working?