Five Years Later: “Advantage America” by Dr. Gary Shilling

Lehman collapseLehman Brothers collapsed September 15, 2008. Five years later, the world is still struggling to recover from the most serious crisis since the Great Depression. Our government seems to be in perpetual dysfunction. The media seems intent on focusing on real and potential problems. It is easy for Americans to feel pessimistic about the future.

There is another side to the story. It is presented by Dr. Gary Shilling who has become quite bullish about the future prospects of the U.S. This is particularly interesting, since Dr. Shilling has been a “confirmed bear” and may be best known as the author of The Age of Deleveraging- Investment Strategies for a Decade of Slow Growth and Deflation, originally published in late 2010.

Dr. Shilling, in his July 2013 issue of Insight, wrote that prospects are bright for a return to rapid U.S. economic growth and a resulting decline in the federal debt-to-GDP. He outlined six key areas where the U.S. is better positioned for the future than any other country- developed or developing. These include:

1.  Demographics. The U.S. fertility rate is currently 2.06 to 1. That is close to the 2.1 rate needed to sustain the population in the long run. All of Europe, and even Canada and Australia, are below the reproduction level. Japan is at 1.30 and China at 1.55. In the long run, this means our population should stay roughly constant and there should continue to be a large percentage of younger workers. This is critical for future economic growth. No other developed country has these characteristics.

2.  Entrepreneurial Spirit. “Despite perceptions of an erosion of U.S. economic vigor, America still seems way ahead of whoever is in second place,” wrote Dr. Shilling. Our educational systems encourage free inquiry and challenging the accepted doctrine. Japan and China discourage individuality and education typically is based on rote memorization and lack of inquiry. In addition, U.S. manufacturing has regained its spot as the most favorable spot for foreign direct investment, pushing China into second place.

3.  Labor Flexibility. In the last 40 years, union membership in the private sector has been reduced from 40% to 6% of the workforce. In the last five years, Americans that are out of work have accepted new jobs, many at lower pay. In the auto industry, for example, the average pay of autoworkers is now less in the U.S. than in Germany or Japan. As a result, American made vehicles are beginning to be shipped abroad in significant numbers.

4.  Declining Need for Foreign Financing. Americans are saving more. Most recognize that you cannot count on double-digit returns every year from your investment portfolio. In addition, you cannot plan on your home equity providing the funds you need for retirement. Therefore, Americans need to save more and they are doing that.

More savings means consumption will grow more slowly. In addition, when spending growth is retarded, this means buying fewer imports. The result will be, in Dr. Shilling’s estimate, a reduction in the U.S. trade and account deficits. This will put fewer U.S. dollars in foreign hands. And, it would mean that America could meet more of its financing needs internally.

5.  Strong Dollar. Despite all of the issues here in America, the U.S. dollar is not even close to being unseated as the world’s primary reserve and trading currency. We have the largest economy, deep and broad financial markets, free and open financial markets and economy, lack of substitutes and credibility in the value of the currency. No other country can boast these attributes. Hence, the U.S. dollar is the only safe haven of any size in a persistently uncertain world.

6.  Energy Independence. America is on the way to self-sufficiency in energy. There are predictions that the U.S. could be relatively free from foreign oil dependency as early as 2020.

Certainly, no one can predict the future. However, Dr. Shilling’s remarks do unmistakably outline the reasons why America is better positioned for the future than any other country in the world. With all the negative media we see, hear, and read daily, it is nice to be reminded and encouraged by positive facts foretelling a brighter future.

Quantitative Easing: QE 4ever?

QE (2)We are all in the midst of one of the biggest global financial experiments ever conducted: Quantitative Easing. Since the world financial crisis in late 2008, the Fed and other central banks have employed this technique in an effort to stimulate the world economy. QE has certainly has had an impact. It has reduced home mortgage rates to all-time lows and helped push the stock markets to all-time highs. Yet, QE is not an elixir. QE can’t cure all the ills of a moribund world economy. Furthermore, QE could ultimately cause major damage to the U.S. and world economy.

Last week, a good friend and client suggested that an update on QE might be appropriate for our readers. Good idea DD; thanks for the suggestion.

Quantitative Easing is an unconventional monetary policy used by central banks to stimulate the economy when conventional monetary policy isn’t working. Historically, the Fed has principally stimulated the economy by lowering short-term (fed funds) rates and cooled down the economy by raising short-term rates. However, by late 2008, the Fed funds rate was as low as it could go-effectively at zero. The Fed needed another tool. QE, last used in the U.S. from 1932-1936, got the call.

QE has the same effect as printing money. The central bank buys treasury and agency bonds from commercial banks and other private institutions (using electronic transfers), thereby creating money and liquidity. The purchases raise bond prices and reduce their yields, thereby reducing long-term interest rates. Interest rates on 10 yr. U.S. Treasuries have fallen from roughly 3% to 2% since QE started. Lower treasury rates mean lower home mortgage rates, which has certainly helped the housing industry get back on its feet.

Many investors, uncomfortable with lower returns on fixed income, started loading up on stocks and riskier debt. Since the start of QE, there has been an 85% direct correlation between the amounts of money added to QE and the rise in the stock markets. During 1Q2013, the move to riskier assets intensified. The result -stocks hitting all-time highs. Furthermore, increasing stock values have been shown to affect both consumption and investment decisions, which helps the economy as well.

Other developed countries have also adopted QE to stimulate their economies. The UK started in 2009. The European Union started in 2011. And Japan, which used QE in 2001-2006, started a new round of QE last year. In total, about $10 trillion has been invested by central banks world-wide in QE programs.

There are two major concerns with QE. First, many believe that QE will ultimately cause inflation-perhaps hyperinflation. With the money supply expanding faster than the real economy, one would expect inflation to occur. This hasn’t happened yet. Fortunately, the U.S. dollar continues to be the world’s reserve currency. Hence, events in Cyprus and other parts of Europe cause investors to dump the euro for dollars. Certainly if China and/or Saudi Arabia would ever drop the dollar or dump U.S. Treasuries, we could certainly see a run on the dollar and perhaps hyperinflation. However, that scenario, if it does occur, is likely years or decades away.

The second concern of QE is the impact when it starts to unwind. At their FOMC meeting in March, the Fed signaled that it would keep its ultra-easy money policy for now. They will continue this at least as long as the unemployment rate is above 6 ½%. As it approaches this level, it is expected the Fed will taper off QE. However, Chairman Bernanke made it clear that the Fed would discontinue QE long before it would raise the fed-funds rate. And it promised to keep the fed-funds rate at current levels until 2015.

So, the net effect is that once there is a substantial improvement in the economy, QE will stop. This will likely result in higher interest rates and higher inflation- both of which could slow economic growth. As a result, some are calling for the Fed to start unwinding QE now. With the unrest in Europe and around the world currently, perhaps the impact of unwinding of QE now would be less damaging to the U.S. economy than it will be in the future.

Rest assured, DWM is following QE very carefully. This experiment has already had a huge impact on the U.S. and world economy and undoubtedly will for years to come.

Kudos to the Real Job Creators: Small and Mid-size Businesses

Job Creators: Small and Mid-size BusinessesWe all know that job creation is critical for increasing economic growth. The question is: Is it big business or small business that is creating jobs? The answer: It’s not big business.

Let’s first take a look at job growth since the end of the recession, July 2009. Since that time, according to Federal Reserve Economic Data, 2.6 million net new jobs have been created in the private sector. Small companies (those with fewer than 50 employees) have added 1.3 million new jobs. Mid-size companies (those with 51-500) have added 1.4 million new jobs. Big businesses (those more than 500) have cut payrolls by 100,000 people.

The U.S. Small Business Administration (“SBA”) also knows how important small businesses are. They tell us that businesses with fewer than 500 people represent 99.7% of all employer units and about ½ of all private sector employees. In addition small and mid-size businesses have generated 60 to 80% of net new jobs annually over the last decade and have created more than half of non-farm private GDP.  Ronald Reagan knew this. Back in 1981 he said “Let us not overlook the fact that the small, independent business man or woman creates more than 80 percent of all new jobs and employs more than half of our total work force.”

Just last week, the L.A. Times ran an article by John Bunzel suggesting that we need to “nurture the real job creators-big business.” His article, along with others we have seen recently, would like to have us believe that, according to Mr. Bunzel, “big business remains the primary driver of economic growth and job creation.” The facts, as outlined above, just don’t support that conclusion.

If there is any nurturing to be provided, let’s give it to the real job creators in our country- small and mid-size businesses.  Kudos to them!

Vacation Do-Overs in Europe

European VacationOn June 28th, Americans anxiously awaited as the Supreme Court ruled on Obama Care. In Europe, a week earlier, all eyes were on the European Court of Justice. Their case did not concern health care; rather it concerned vacation time, a topic near and dear to Europeans.

The European Court of Justice ruled last week that workers are entitled to additional paid vacation time if they don’t feel well during their original vacation. Amazing.

The question had originated in Spain, where trade unions sued for the vacation do-over allowance some years ago. The European court upheld the right throughout the EU, stating that “the entitlement to paid annual leave must be regarded as a particularly important principle of EU social law; a principle enshrined in the EU Charter of Fundamental Rights, and thus cannot be interpreted restrictively.”

Vacation do-overs add to the EU minimum of 20 paid days of vacation per year and this doesn’t include national holidays, EU mandated weekends, breaks and other additional time off. It’s even better in countries like France, where the minimum is 25 paid days per year and you get an extra 10 paid days if you work a 39 hour week instead of a 35 hour week. In addition, Europeans accrue vacation time while they are on sick leave. Hence, they could end a long recuperation period by going on paid vacation.

The EU Court decision comes at a time when the rate of unemployment in Spain is 25% and Europe is in the midst of an economic crisis. Perhaps the leaders of Europe need to take a look at the EU Charter of Fundamental Rights. Seems some changes might be needed there if Europe ever hopes to return to strong economic growth in the future.