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01/08/2010
2009: The Perfect Storm
2010: The Imperfect Recovery?
ByEdward L. Snitzer
At this time of the year we look back to evaluate what happened and to peer into the murky future to discern as best we can what to expect next year. It does not matter that the future is unpredictable and unknowable; it is part of human nature to worry about it anyway. This cover sheet will be longer than usual evaluating the dramatic events of the last year and the possibilities for 2010.
2009 was an extraordinary year. We now know a little more about those fateful days between November 2008 and March 2009 when the entire financial system teetered on a collapse not seen in America since the1930s Great Depression. We know how close the financial system came to a systemic failure that would have resulted in unemployment, not of the current 10%, but perhaps 20% or more, leading to civil unrest and disorder, political discord many times that of today and all kinds of unimaginable and unforeseen economic and financial distress. It took scholars 80 some years to arrive at a consensus of what went wrong in the 1930s. It will take as long for scholars to agree what went wrong in 2008-2009.
There was agreement among the educated and political class that one of the central lessons of the systemic failure of both the economy and the financial system in the 1930s was the failure of thousands of banks, the loss of savings by millions in those banks, the contraction of lending, the hostility of the government to the private sector, the raising of taxes and a misguided effort to balance the federal budget, all of which led to chronic unemployment, low growth and tepid demand by consumers. The Great Depression was finally gsolvedh by the demands of a World War, which put everyone back to work, created enormous savings and a post World War II recovery that has lasted to this day. Given this read of history we advised during those dark days of last winter that the government, consisting of the Federal Reserve, the Congress and the President, would stand on its head to prevent the collapse of our financial system.
The Federal Reserve:
And so it happened. The Federal Reserve, led by Ben Bernanke, a scholar of the Great Depression, who, like most, didnft see the crises coming , rose to the occasion and initiated, implemented and invigorated the Fed to take extraordinary, if not revolutionary measures, to insure the viability of Wall Street to prevent Main Street from disaster. It worked. There was a bewildering array of programs to save the financial institutions and to keep credit, which had stopped cold, flowing. Mistakes, such as the failure to rescue Lehman were made, but on balance, the programs worked. Wall Street and Main Street were spared the horrific experience of the 1930s. Ben Bernanke was in our mind a hero.
We further advised that the successful effort to save both Wall Street and Main Street would present new issues never seen before. Today there is much talk about unwinding, gexitingh what the Fed did. Can gexitingh occur without aborting the economic recovery just beginning and before all the excess liquidity, $1-2 trillion dollars, causes inflation? It will not be easy and will be fraught with uncertainty and unpleasant consequences if serious mistakes are made. The problem is front and center. If mistakes are made they will be seen in broad daylight.
Congress:
Congress, during the waning days of the Bush and the early months of the Obama administrations, enacted legislation that was helpful: the various gstimulush and other legislation designed both to rescue Wall Street and Main Street and to fill the gap between the hOutput and Aggregate Demand Gaph. That ggaph exists since 10-17% unemployed or underemployed people donft pay taxes or buy things. 70% of the Gross Domestic Product consists of individuals buying or rendering services. Households have witnessed a 20% drop in net worth, 12 trillion dollars, from losses in housing and the stock market .Saving is now in and buying is now out. Only government can make up some of the drop in what is called gaggregate demand.h And then only until consumer buying resumes.
Unfortunately, now that everyone is breathing easier, Congress is in a mad rush to demonize the Federal Reserve, enact a new health bill, impose new taxes, new and unnecessary costs on industry and new and ill-conceived, instead of thoughtful and well-conceived, regulations on the financial industry. It has one eye towards the public anger over Wall Street handouts and one eye towards the 2010 mid-term elections. 2010 will not be the finest hour for Congress.
The President:
The ratio, between US Federal debt- how much the Federal Government borrows- and the yearly Gross Domestic Product (GDP) for most of our history was very low until the Great Depression. It then became national policy to eliminate the ravages of endemic depressions, to have the national government insure full employment and stable prices. And to enact social welfare programs such as Social Security, Medicare, Medicaid, and the pending health care bill before the Congress. The policy has led, however, to a dramatic national governmental presence during times of crises and during gordinaryh recessions ever since. It took 37 years from 1945 until 1982 for the economy to ggrowh out of the 121% of debt to GDP in 1945, resulting from World War II, to 35% by 1982. For the next 27 years the ratio worked its way up to the 60s level through the first Bush, Clinton and second Bush Presidencies. By 1997, the second term of President Clinton, it was 67% and 65% by 2007 during the second term of George W. Bush.
Whoever was President when the 2008/2009 financial crises came was going to incur massive government costs. The problem is not what was done but what is proposed to be done. The partisan nature of the pending health care legislation, imposing far-reaching consequences on all Americans, may insure a political process akin to what happened after the Supreme Court decided Roe v. Wade. It will cause enormous ongoing dissent and protest and unwavering political opposition, instead of a gbuy-inh of a new and expensive social welfare program by bi-partisan majority of the American public and its congressional representatives.
The Presidentfs pledge not to raise taxes on anyone but the grichh cannot be met. The grichh will not be able to finance the health bill or any of the other costly initiatives being offered, from cap and trade, higher labor costs, ggreening and global warmingh etc. If the American people want all of these benefits they will have to pay for them, either in the form of reduced benefits in Social Security, Medicare and the new health legislation, or higher taxes. There is no other way out other than inflation. It should be the role of our government to reduce the debt to GDP ratio, not increase it, which is now happening. While there is no ratio number representing disaster, the more money a government or an individual has to pay to carry debt, the less money there is for everything else......
Given this read of the past and the future, what will the 2010 economic recovery look like? Will it be a U, V, or W recovery? Will it be the Bill Gross gnew normalh of increased saving, the unwinding of both personal and corporate debt, the imposition of onerous governmental regulations and the pull-back of international trade, leading to tepid growth and a Dow and S&P yearly return of 5-6%? Or, will it be a snap-back, on the theory that the greater the decline the more rapid the recovery, as many others have argued and has happened often in the past? Or, will it be something else, perhaps high unemployment for an extended period, high inflation, a declining dollar or deflation?
The best argument wefve seen is that the recovery will be a square root recovery, ã a good, perhaps even strong initial recovery for a few quarters, followed then by many years of sub-par growth due to the excesses leading to, and the governmental response, to the crises. Of the 19 secular bear markets in the last 110 years there has usually been a 5-7 year period of slow growth with nothing much happening in the economy, until the effects of a crises wears off and becomes a distant memory.
How will PMA manage client portfolios in 2010? The personnel of our firm, whose photos and biographies we attach, are dedicated to bringing the same discipline and risk management that has worked so well for 28 years. While we donft know the future we do know how to manage risk. We will manage your portfolios with an eye to the future but with our hands all around the risk of each client portfolio. Managing risk has been so successful and our record of performance so good, that no client had to change his/her life-style and no non-profit permanently had to reduce its spending. We delivered what we promised before and after the collapse of 2008/2009. We pledge to continue to do so in the future. We offer safety and comfort in what is a very risky environment.
We remain cautiously optimistic about the future, thankful for all of our blessings, for health, happiness and the good fortune of living in this wonderful country.
We share those blessings with you, and wish you a very Happy New Year.
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