Categories: General Market Commentary
Topics: General Market Commentary

An economic recovery unto death

In the Bible there is a reference to a “sin unto death.”  In the realm of U.S. economic policy a situation is developing that could easily lead to a “death” of the current recovery.  Ironically, this brewing economic destruction is springing from the same policies that are responsible for the recovery (call it a “recovery unto death”).  These policies are supposed to lead the U.S. out of recession and into a “new tomorrow” but as we’ll discuss here, the end result is likely to be something far short of what policy leaders envision. 

By now you’ve probably had your fill of the pronouncements in the media that the economic recovery is advancing and everything is “on the right track.”  Articles which ballyhoo the recovery have been appearing with startling regularity in recent weeks, including a number of features in Time, Newsweek, Businessweek and other mainstream publications.  Less talked about is the likelihood that 2011 will witness the apex of the recovery that began in March 2009, and the further possibility that the years 2012 through 2014 will see another recurrence of the financial turmoil of 2008. 

An example of the bullish outlook that mainstream media reporters have embraced is found in a recent edition of Businessweek (“For the U.S., the Future Suddenly Feels Brighter”).  BW spotlighted the Goldman Sachs 2011 forecast for the U.S. economy, which it lifted to 3.4 percent from 2 percent.  This forecast is significant when you consider that Goldman Sachs economists have long been bearish on the country’s economic prospects. 

The leading service sector companies which are most sensitive to changes in the business economy, including Fed-Ex, Amazon and Monster Worldwide among others, have collectively been forecasting an improvement in the U.S. retail economy for over a year.  As recently as last week the New Economy Index (NEI), a composite of the leading retail and business sector stocks, reached a new recovery high as seen in the following chart. 

Yet what’s good for the international “new” economy isn’t necessarily an accurate representation of the challenges faced by the everyday

Main Street
economy.  Small and micro-cap businesses are still experiencing a hiring freeze and smaller independent companies haven’t fared nearly as well in the last two years compared to their larger multinational counterparts. To get an idea how the current small business outlook compared to that of the last recessions, in the first 12 months following the recession that ended in November 2001, small businesses added 81,000 workers.  After the latest recession began, companies eliminated nearly 500,000 during a comparable time period, according to data from ADP Employer Services.  In prior downturns, small firms have accounted for much of the initial job growth coming out of a recession.  But this time around most of the recovery has been led by much larger companies which, despite cutting their employment rosters, have been able to increase productivity and exploit the efficiencies of technology combined with a smaller workforce. 

Larger U.S. companies with an international presence aren’t the only ones which have benefited from the recovery -- a recovery which has been largely based on the loose money policy of the Federal Reserve.  The Fed has embarked on its second round of “quantitative easing (QE) with plans to purchase $600 billion of long-term Treasury securities through June.  The Fed’s QE program has unquestionably helped sustain the financial market recovery with some spillover effects into the retail economy.  It has also had the unwanted effect of raising commodity prices, which is going to come back to haunt the U.S. and the global economy with a vengeance later this year.

As Rich Miller and Simon Kennedy observed, “The Fed’s actions are designed to make credit more available in the U.S. and stoke a recovery.  Yet a chunk of that money will end up invested in emerging markets, which are struggling already to absorb billions in foreign capital, contain inflation, and keep their currencies competitive.  The reluctance of China and other emerging-market economies to rein in growth too much is boosting demand for commodities and jacking up the cost of energy worldwide, including in the U.S. ” 

Yet in spite of the obvious dangers posed by rising consumer prices in what is by all accounts a fragile economic recovery, Miller and Kennedy observed, “In the U.S., sustained the economic momentum is the priority for now [among policy makers], not tamping down inflation.”  This short-sighted obsession on economic “recovery” at all costs will eventually lead to a resumption of the same set of problems that brought us the financial crash of 2008.  And the straw that broke the camel’s back at that time was rising energy costs.

For the better part of two years U.S. consumers and producers alike got a reprieve from the brutally high energy costs that dominated the economic landscape in 2007-2008.  The runaway oil price of those years ultimately choked off economic growth and fed the financial fires of 2008.  Hedge fund speculation was as much to blame as anything for the price spike but once again we find the usual suspects hard at work in the crude oil futures market.  To be sure, they learned enough from the 2008 debacle to be more subdued with their speculative fervor.  But with the Fed priming the pump in the past year, these interests have taken their cue and the speculative juices are starting to flow again.  Indeed, a repeat of the oil price run-up appears imminent and many oil analysts are forecasting $100-a-barrel oil or higher this year. 

The former president of Shell Oil has also made a high-profile prediction that the gasoline price will reach $5 a gallon by the end of this year.  That’s more than $2 per gallon above the current average price of gas.  The economic recovery will have a hard enough time surviving $4/gallon gasoline let alone $5/gallon.  If this prediction comes close to being fulfilled the recovery will be dead by the year’s end. 

While visiting a coffee shop recently I overheard a conversation between two customers which pretty much summarized the prevailing mood on

Main Street
about the recovery.  Asked to give her opinion of the economy, one customer replied, “As soon as the economy gets better and we start making a little more money, prices start going up and we end up giving it all back.”  Her ironic conclusion was that we would probably do just as well without a “recovery” in terms of the cost of living, a belief undoubtedly shared by many. 

Some 2,200 years ago the Greco-Roman historian Polybius wrote, “What use is a [policy maker] if he is incapable of seeing how and why events begin, where their origins lie?  It follows that there is nothing we should be more aware of, nothing we should try harder to discover, than the causes of every incident.  For the most critical matters have trivial origins, and it is always easiest to correct impulses and remedy beliefs at the beginning.” 

The Federal Reserve sets U.S. monetary policy and since the Great Depression, the official mandate of the U.S. central bank has been to keep prices stable and promote a level of output consistent with reasonably full employment.  As Paul Seabright observed in his latest article in Foreign Policy, “The weight given to price stability increased in most countries over the postwar period, except in Germany , where it had already been high because of the memory of the Weimar hyperinflation.  Price stability also came to be seen as the permanent goal of central banking, whereas maintaining output came to be considered a matter for occasional firefighting rather than permanent tinkering.”

It would be better for everyone concerned if the Fed’s policy was more in tune with the needs of productive, taxpaying Americans instead of the desires of big business.  A monetary policy which tied the Fed funds interest rate to long-term yields and allowed inflation/deflation to takes its natural course instead of fighting both ends of the economic long wave would be far superior to the current policy.  If policy makers think that the health of IBM, Coca Cola and the usual list of U.S. multinationals ultimately takes precedence over that of the millions of individual Americans which comprise the backbone of the economy, they are sadly mistaken.  It’s the multitudes of productive, working class citizens whose decisions to buy or not to buy ultimately determine the strength or weakness of the U.S. domestic economy.  

As it stands the Fed has committed itself to preventing the natural tendency toward deflation from manifesting itself.  In doing so it is setting up a series of artificial price spikes in key commodities in the months ahead.  If the dramatic price increases that many producers and analysts are predicting are realized, it would indeed be miraculous if the economy could absorb them without upsetting the recovery.

As one hedge fund manager has commented, “The stimulus and recovery of 2009-2011 has done little more than paper over the structural problems that led to the credit crisis in the first place.”  His statement may yet prove to be prescient.  As these structural problems haven’t yet been properly addressed, it remains for time (i.e. the cycles) to eventually reveal and correct these problems. 

The toll that the Kress cycles will take on the financial markets, and by extension the economy, in 2012-2014 will come as a shock for the most optimistic observers.  The final “hard down” phase of the extremely powerful 30-year, 40-year and 60-year cycles will begin to exert a distinctly negative impact against market prices across the board as we head closer to the end of this year.  Indeed, the coming Kress Cycle Tsunami will most likely eclipse anything we’ve seen in the prior years of the credit crisis.

The months ahead and whatever remains of the recovery should be used to prepare for the final (and worst) part of the deflationary “winter” season. 

Gold

The gold price recently violated its 60-day moving average and as of Jan. 19 is on top of its dominant interim 90-day moving average.  Gold and silver stocks have been under intensive selling pressure lately and have born the brunt of the upcoming dominant short-term cycle bottom.  If the gold price can establish support above the 90-day MA this week and close back above the 30-day MA we’ll have a confirmed bottom and a potential re-entry point for gold.  Gold’s technical position will be updated in the next commentary. 

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A special thanks to Robert Graham of Smartstox who recently interviewed me for his financial radio show.  The 8-minute radio segment in which we discuss the gold, silver and stock market outlook, is now available online at:  http://www.smartstox.com/analysts/clif_droke/