Sometimes a confluence of unrelated inputs adjusts one’s perception of current and future circumstance. The adjustment doesn’t always have a re-orienting impact; often, it is more notable for confirming and strengthening a point of view.
At the end of last week, I shared a summary of Bloomberg headlines that seemed to capture a pirouette in the zeitgeist. The political reversal in California, an expedient populist shift on the part of the Administration, increases in the base drivers of economic growth — manufacturing and production — contrasted with a sharp decline in the value of equities driven by a flight away from financials created a sense of a great disconnect, with everyone on the public stage scrambling for survival and opportunity, despite the absence of an overriding plan for health and recovery.
During this cycle I had several informative interactions.
The first came in a note from my mother in reaction to the post I had written about the financial fragility of what the Department of Labor calls the base U.S. Consumer Unit. My mother, who lives in Rhode Island, is a pragmatic soul whose perception of the world is organized by common sense and who is frequently confounded by the absence of common sense she sees around her. Her basic message to me was that reducing the people in the United States to an average loses sight of the real crisis that is unfolding.
Whatever you have, if it is leftover, it is a miracle. Please, take people without extra dollars seriously. It is always frightening, especially if there are children. It is not always a choice of what to eliminate if there has never been enough. Discretionary income is a euphemism. I think the Mass. vote (discounting the awful campaign she had) was about unemployment. Voters are hard to rouse on issues – not on lack of jobs. This is a country where poverty is a moral lack. It is humiliating unless you have a welfare mentality … there are many foreclosures here and many new people in the soup kitchens and food pantries.
Around the same time her e-mail crossed my in-box, a colleague called to point me to an interactive map supplied by the New York Times detailing the results of the Massachusetts election. He shares my interest in the impact of social norms and trends on the political process and was struck by the voting pattern on the map. The urban and quasi-rural parts of Massachusetts voted Democratic; the suburban middle-class voted for the Republican candidate.
I grew up in East Bridgewater, MA, a town about 35 miles south of Boston that was founded in the 1600’s. It was a solid lower-middle class enclave in the 1960’s that was a classic Colonial town, rooted in conservative Democratic values, with a long tradition of military service. When I was a kid, it was a town in decline, as its two primary industries — farming and light manufacturing — were eroding. During the 1990’s, East Bridgewater enjoyed an explosion as it became a bedroom community for Boston and other employment centers around Route 128.
The results from this election? More than 70% of the people in East Bridgewater voted for Brown.
My colleague’s concern echoed my mother’s: the vote for Brown is a vote to change the center of the issues. Jobs is the core, he said. But, Brown doesn’t stand for anything, and there’s no voice in the Republican party that has a pragmatic point of view about what should be done to right the economy. The voters are going to be moved to make a change, but they don’t have anything to change into that is going to be able to make a difference.
Then, John Mauldin’s letter came. As I’ve discussed before, Mauldin’s letter is a good touchpoint. He only writes once a week, so you’re not innundated with his information flow, and he has an exceptional long-term perspective that he makes very relevant to the immediate and short-term. The net net is that because he takes time to think he makes you think.
This week the letter focused on a book that has captured his attention: This Time is Different: Eight Centuries of Financial Folly by Carmen M. Reinhart and Kenneth Rogoff.
Mauldin explains the book’s approach and the impact of its conclusions:
Reinhart and Rogoff have catalogued over 250 financial crises in 66 countries over 800 years and then analyzed them for differences and similarities. This is a VERY sobering book. It does not augur well for the developed world to blithely exit from our woes. The book gives evidence to my adamant statement that we have a lot of pain to experience because of the bad choices we have made.
Look closely at the Reinhart and Rogoff’s research and a pattern develops: economies over-leverage in order to drive expansion and the significant burden of the debt supresses future economic growth. The current U.S. economy, with $3.70 of debt to every $1 of GDP falls into that classic over-leveraged model. The only way out is through deleveraging; there are no silver bullets, the research determines.
In a classic economic model, inflation can help drive down leverage. To generate inflation, an economy needs demand to outstrip supply. But, an economy that has expanded rapidly through the use of leverage has significant execess resources — both in terms of human and physical resources — which augurs a deflationary environment. The way this works is simple: someone without a job will work for whatever they can get, reducing the potential wages for another worker.
Mauldin points to the current imbalance in supply and demand.
Whether the supply curve is in a flat, normal, or upward sloping position depends on the extent of excess resources in the economy. Today it is obvious that the U.S. economy has plentiful excess resources, so any increase in demand will result in little price change. This will be the case until our unemployment rate of over 17% (the U6 measure) drops by a considerable amount and we begin to use our factories well above our current 68% utilization rate.
Thus, our current economic circumstances guarantee there will be no surprise inflation. Employing those who are out of work and fully utilizing our resources will be a slow process. More importantly, it will take time to get the monetary engine reignited. Banks will have to begin lending and people and companies will have to determine that prospects are good enough to take the risk for expansion and investment. It will take years for these processes to get started because of our over-indebtedness and falling asset prices.
The analysis ends with a data point that bears out my mother’s observation about the increasing personal pain she’s seeing around her.
The consequences of excessive debt are already painful at the household level. The civilian employment to population ratio, a highly important barometer of the average household’s standard of living, fell to 58.2% in December, the lowest reading in 26 years and down from a peak of 64.7% in April of 2000 (Chart 5). Thus, the standard of living has worsened as the debt to GDP ratio has marched steadily higher. With debt to GDP still rising, a further deterioration of the standard of living is inescapable.
Mauldin’s assessment of the Massachusetts vote is that voters are getting “increasingly scared.”
While they may not be sophisticated in economics, they understand intuitively that you can’t run deficits at the current levels forever. That risks killing the goose. Obama was elected with a promise of change. McCain was seen as more of the same. The recent elections (Virginia, New Jersey, Massachusetts) were pointedly saying, this is not the change we had in mind.
Three different assessments with one common conclusion: People can see that we’re facing dire straits and they don’t see anyone with resources or power stepping up with a plan that makes them feel confident.
If we were a parliamentary government, I thought, Obama would be standing for election in a blink.
We’re not, though, and so we’re left to our established political cycles to effect change. In the meantime, people worry and pundits commentate.
First, Tom Friedman in his column made it all about one thing: jobs. To figure out what to do, go talk to the people who are going to create jobs, Friedman says, and ask them what they need.
Obama should make the centerpiece of his presidency mobilizing a million new start-up companies that won’t just give us temporary highway jobs, but lasting good jobs that keep America on the cutting edge. The best way to counter the Tea Party movement, which is all about stopping things, is with an Innovation Movement, which is all about starting things. Without inventing more new products and services that make people more productive, healthier or entertained — that we can sell around the world — we’ll never be able to afford the health care our people need, let alone pay off our debts.
Frank Rich, in a passionate column that picked apart the popular unrest, Obama’s off-base focus and the consistent impression that the administration is captive to special interests, not to the interests of the people on the street, pointed to a signature moment in John F. Kennedy’s administration, when he faced down U.S. Steel over an unpopular anti-labor move. Where’s that moment now from Obama, Rich wondered?
Can anyone picture Obama exerting such take-no-prisoners leadership to challenge those who threaten our own economic recovery and stability at a time of deep recession and war? That we can’t is a powerful indicator of why what happened in Massachusetts will not stay in Massachusetts if this White House fails to reboot.
Which brings me back to my initial observation: Sometimes, a shift in perception strengthens a point of view.
A protracted period of economic stress, driven by the distorted economic balance sheet, means that as a business owner I have to remain cautious. The markets that I serve aren’t going to expand. Recovery will mean stabilization. Rebounds in production will accompany that stabilization, but won’t be the harbingers of revised trend lines. Competition in every market will stay high and the participants who are most efficient in managing costs and who are oriented towards reducing their leverage will have the most flexibility in pricing. But, pricing will not be the primary determinant in market success: Service and results will be an equally important, and sometimes dominant, factor in the decisions customers make.
Business planning has to be aggressive, but cautious.
Any downturn has to be reacted to quickly and decisively.
When thinking about creating value in an enterprise, the horizon needs to be set over a long period of time, with an expectation that growth will come through a series of hard-earned transactions.
It’s inevitable that these tactics will be executed in a climate of increased taxes. As a result, businesses will be cautious about hiring.
I’m left with an even stronger sense of what I thought before. The best we can do is approach the challenge with confidence and determination. Do as good a job as we can. Focus as intently as we can on our customers and what they need to do to be successful. Don’t try to answer the unanswerable. And step up as a voting populace to demand that the real issues get real attention. The voters in Massachusetts have fired one of the first salvos; now, our political and economic leaders have to respond by focusing on handling the tough issues, not just playing to win in the short term.