Friday, February 08, 2013 - The State of the Union is Contradictory

The State of the Union is Contradictory

by Sinclair Noe

DOW + 48 = 13,992
SPX + 8 = 1517
NAS + 28 = 3193
10 YR YLD un = 1.95%
OIL -.06 = 95.77
GOLD – 3.80 = 1668.20
SILV - .03 = 31.53

The State of the Union is...

Tuesday.

Do we have a solid economic recovery underway? The evidence will leave you whipsawed. Everywhere you turn, it seems, there is an economic contradiction.

Housing is up, but gross domestic product was sharply down in December, almost to recessionary territory. The economy has lost 3.2m jobs since 2007, but 5.2m have been created since 2009. Even so, the number of unemployed far outpaces the number of jobs. The Center on Budget and Policy Priorities says: "In November 2012, 12 million workers were unemployed but there were only 3.7m job openings. That is about 10 unemployed workers for every three available positions – in other words, even if every available job were filled by an unemployed individual, about seven of every 10 unemployed workers would still be unemployed."

The jobless rate keeps dropping, but the ratio of employed-to-unemployed people is about the same as last year. The economy gained 181,000 jobs a month last year, but the percentage of people who have been unemployed for more than 27 weeks has stayed relatively steady. People are working more hours, but productivity is falling. And economic output has almost ground to a halt, growing by 0.1% in December.

Households are becoming less indebted, which is a welcome development, but that's mostly because they are people are defaulting on debt. A side effect of the defaults is that disposable personal income is rising; when you default on debt you have more cash in pocket. Still, income inequality continues to climb and the middle class continues to shrink.

And whatever progress we've seen on the economy could grind to a halt at the end of the month with the possible implementation of the sequester. It is certainly a possibility, although it was not intended. The idea behind the sequester was that it was so draconian, it would be so lousy for the economy, that neither side would allow it to happen; the cuts would be so deep that no reasonable politician would permit them to pass. Of course, Diogenes could light his lantern and wander through the streets of Washington DC for years without locating a reasonable politician.

What happens if the sequester hits? The Congressional Budget Office estimates the economy would slow to a sluggish 1.4% this year. Job growth and job quality will lag, the housing market will languish. Everyone agrees that the sequester is terrible policy.

In fact, it was designed to be terrible policy. The sequester is a nondescript name for a poison pill, devised as a deterrent so unpalatable that Capitol Hill’s warring factions would be forced to make peace. That was back in the summer of 2011, when the artificial threat of a debt default loomed. So the White House and Congressional Republicans crafted the Budget Control Act, which appointed a bipartisan “super committee” to find $1.2 trillion in deficit reduction over 10 years. The super committee’s failure would trigger sequestration, a package of about $1 trillion in automatic cuts to domestic and security programs which would send the fragile economy into a tailspin. Self-inflicted austerity right now would be a really bad idea. The Federal Reserve in the past has been able to cut rates to cushion the effect of spending cuts. It can’t do anything like this now, because the Fed funds rate has already been cut more or less to zero in an attempt to fight the effects of financial crisis; the adverse effects on demand can’t be offset by cutting interest rates. And so, monetary policy just can't come to the rescue of fiscal policy.

Right now the central challenge is to reignite the economy; getting jobs back, improving wages, and restoring growth. Deficit reduction moves us in the opposite direction. That’s because most consumers (whose spending is 70 percent of economic activity) are still losing ground, and businesses won’t expand and hire without more consumers. 

The impasse has members of both parties warning, once again, that an unthinkable policy is becoming a very real possibility. House Speaker John Boehner has started using the phrase “the President’s sequester”. Back in 2011, Obama warned he would veto any attempt to sidestep the sequester; now he is trying to offer alternatives. For its part, the White House will blame Republicans for refusing to reduce tax breaks that benefit the wealthy. Democrats, who are seeking some $600 billion in new revenues, want to dump sweetheart provisions that protect owners of corporate jets or financiers who benefit from low carried-interest rates.

Obama also offered to revive dormant talks to reach a sweeping deal to slash the federal deficit and overhaul the U.S. tax code and entitlement systems. But it would be very tough to iron out a grand bargain in a couple of weeks.

If Republicans won’t give way on new revenues, it would become impossible. And there is no sense the GOP is prepared to cave, particularly because many of its members have sought the deep cuts the sequester would produce. What we’re left with yet another stalemate, and yet another countdown to a self-inflicted crisis.

The National Small Business Association, this week released its year-end survey of economic conditions. The outlook, as their press release stated, is “not so good”. The report says: “there are very few incentives to start or grow a small company” under prevailing conditions. Indeed, the survey shows that pessimism is rampant. Fifty-one percent of respondents say they anticipate a flat economy next year. Thirty-five percent foresee a recession, while just 14 percent anticipate that the economy will grow next year. By a 47-23 margin, surveyed small-business owners think the national economy is worse than it was one year ago. Particularly troubling to small business owners is “economic uncertainty,” which 69 percent of business owners cite as a significant challenge to the future growth and survival of their business.

So are we doomed? Not really. The history of NSBA reports paints a picture of small-business owners as a remarkably grumpy and pessimistic lot. The number of respondents foreseeing a recession next year is the highest since July 2009. It turns out that July ’09 was basically the low point of the recession, and output from July '09 to July 2010 expanded by $357 billion. In other words, small-business owners predicted a recession just as the recovery was starting. The 47-to-23 ratio of respondents saying the economy is worse off today than it was a year ago is alarming. But six months ago the ratio was an equally alarming 48-to-21. 

Perhaps the most interesting indicator in the survey is that small-business owners take a considerably rosier view of their own business prospects than those of the economy as a whole. A healthy 47 percent of respondents anticipate their own gross sales rising, while just 23 percent say they’ll decline. If growing businesses outnumber shrinking ones 2-to-1, then it’s hard to see how the economy is going to shrink.

And today, the major stock market indices climbed to multi-year highs. One headline I read credits optimism about the economy. Go figure.

Apple is sitting on a big pile of cash. David Einhorn, the hedge fund manager of Greenlight Capital wants Apple to issue preferred shares as a way to unlock shareholder value. His other ideas include increasing dividends and buying back its own shares. This is how a hedge fund manager thinks. For a man who's only tool is a hammer, the world looks like a nail. Apple became one of the biggest companies in the world because it invested in cutting edge technology; it spent time and money on design. Now, they can't figure out how to spend their money; they can't find new things to create. The inventors have become gentrified and cautious. They listen to hedge fund managers instead of inventors.

I don't mean to pick on Apple. It's happening to lots of corporations. Boeing started paying more attention to the bean counters than the engineers. The result was melting batteries and Dreamliners full of smoke. Stock buybacks are a sign of innovative constipation and scared management. I'm not advocating reckless behavior. I just don't like business cowardice.

We used to talk about Yankee ingenuity. Now companies are content to sit on cash. And they are sitting on a big bundle. And we know the story of the faithful servant who buried the talents in the yard to make sure they were secure. Nobody should be a shareholder in a company that buries its talents.

So, we have corporations sitting on cash, too stupid to use it; a middle class, or what's left of it, too weak to support the consumer spending that has historically driven economic growth; a middle class racked by debt and unable to invest in their future, too weak to educate themselves, too uncertain to take the quantum leap to entrepreneurship, and too weak to broaden out the tax base; and that in turn means we have a country too poor to invest in infrastructure (which might improve productivity and global competitiveness, education and research ( which might result in innovation), and are crucial for restoring long-term economic strength.

The Inaugural Address a couple of weeks ago was part one of a two part presentation; it focus on vision and philosophy. On Tuesday, February 12th, when the president gives his State of the Union address, he'll have an opportunity to make specific proposals, and build support to fix America's most challenging problem. That will be the nuts and bolts speech.

The state of the Union is...?