MACRO MINUTE – THE U.S. ECONOMY IS NOT COLLAPSING

Over the last several years my outlook for the domestic economy has been generally steady – we’re in a balance sheet recession and the government is running large enough budget deficits to offset the effects of de-leveraging to a large degree. This means the economy won’t fully recover and feel healthy again until the balance sheet recession is over and the private sector can run with the baton without the aid of the government’s massive deficits. Based on my estimates, we likely won’t be at that point until 2013 or perhaps later.

The primary reason why the government response has failed to generate a sustainable recovery is due to several factors. First, our leaders misinterpret the actual way in which our monetary system operates. This has resulted in a persistent dissemination of neoclassical economics over the last 30 years which has contributed to a misguided policy response on both sides of the aisle. This contributed to an excessively financialized global economy and helps to fuel the misguided policy response in the current environment in which monetary policy and the Fed is largely impotent. In short, we’ve focused too much on helping the banks when in fact, this was never a banking crisis. It was always a household crisis. Unfortunately, Main Street has been overlooked for the most part.

In terms of the outlook going forward – not much has changed. These broader macro trends are all still in place. The balance sheet recession continues, large deficits continue, the inept government response continues and therefore the malaise (but not a collapse) continues. This all means the economy is likely to remain in a growth phase, but domestic demand will remain stagnant to the point where it feels like a recession (although the NBER won’t classify it as such) and results in a high rate of unemployment and below trend growth. But make not mistake, this is most certainly one long recession – a balance sheet recession.

To my surprise, the corporate profits picture has remained very strong over the years. This has created an even more confusing environment for many. As companies cut costs and Asia recovered, the global diversity of the the American corporate sector led to a robust profit recovery. Contrary to popular opinion, America’s corporations remain the best in the world. But as domestic demand has remained low they’ve been given little incentive to leverage up and hire new workers en masse. Meanwhile, fat profit margins, below trend domestic growth and strong Asian growth has led to a healthy bottom line. This has all been good news for the stock market since the 2008 crisis occurred.

In my opinion, the government’s deficit remains large enough to support below trend growth in the coming year. That is likely to come under pressure as we head into 2012, but the deficit should remain large enough that we can sustain growth and not fall into a technical recession. The major risk to this forecast is international markets. In particular, I believe China holds the keys to the kingdom. If the Chinese economy can thwart a hard landing in H2 then much of the worrying will subside and the domestic economy will get back to business as usual, which, in this environment, means inadequate growth, but top line growth ultimately translating to bottom line growth as margins remain strong (read, no hiring).

The other major risk is Europe. Europe is clearly on the precipice of a potentially serious crisis. It is eerily reminiscent of 2008 and the EMU leaders are woefully behind the curve. The bad news is that there is no structural fix in place yet and that means the turmoil will likely continue. The good news is that every time Europe has been pushed to the brink their leaders have been responsive (and yes, they built this flawed currency system so it is their duty to fix it once and for all). I think there is a fairly high probability of a 2008 type event in the coming year. If Italy is pushed to the brink (and I do think bond vigilantes will continue to push them) then we are likely to see a much broader response which is likely to involve ECB rate targeting or Eurobonds. This is the bazooka and would put an end to this silly crisis for the most part. Then the EMU just needs to fill in the holes with the final pieces of a fiscal union. Easier said than done – I know, but if there is one thing we know, it is that wealthy politicians don’t like to see their wealth collapse due to their own lack of action. And I am confident they will act when forced to. I guess we can call this the Trimerkel Put. It’s there, it just needs to be dusted off once every few months.

All in all, I think it’s unwarranted to panic excessively over the domestic U.S. economy, however, the risks to the global economy are substantial.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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