Part 1--The US Economy

1 year 10 months is finally over.

To get rid of the rust in my mind, I have decided to embark on a quest that would hopefully show me the path to riches. While school has taught me lots of things, it has not taught me the most important thing of all—money.

Therefore, I will now seek to understand the global economy, the results of which may hopefully enable me to make better investments in the future. At the same time, a record of my thoughts is probably good as I can look back in the future and deduce where I have gone wrong. Without further ado, let us begin.

Is the recession over?

Recently, the press is inundated with reports on the “recovering economy”. Manufacturing data is up, forecasted GDP is constantly being revised upwards, and stock markets worldwide are soaring. In light of all this optimism, it is indeed tempting for the unwary investor to start buying equities in the market. After all, what better way to see one’s beliefs justified in an expanding economy as asset values explode in price?

Yet, a few indicators cast a worrying shadow over all this positive data. One particular indicator would be the stubbornly high unemployment rate. While most would decry the unemployment rate as a lagging indicator, nonetheless, I feel that unemployment rate is quite critical as it gives a clearer picture of the real economy in the country. Unemployment rate has hit 10.2% in the United States. For the uninitiated, consumption makes up for 70% of the US economy. With unemployment remaining stubbornly high, consumption is likely to be curtailed, and any recovery is likely to be subdued. Despite all the rosy figures in the press, the real economy is not doing well. Delving deeper into the unemployment situation, we can discover further sobering facts that serve to highlight this dismal situation.

1) U-6 rate now stands at a record 17.5%, a discrepancy of a staggering 7.3 percentage points from the official U-3 rate. (http://www.bls.gov/news.release/empsit.t12.htm) Looking at the chart below, 7.3 percentage points is statistically significant. Never before has the gap between U-3 and U-6 rate been so wide. Approximately 1 in 5 Americans are now out of work.

2) Number of persons eligible for food stamps now stands at a record high of 36 million, which is around 12% of the US population. ( http://www.fns.usda.gov/pd/34SNAPmonthly.htm)

With chronically high unemployment, consumption by households is likely to decrease over time. With reduced consumption and reduced demand for goods, how likely is it that firms will continue to commit further funds in investment? Firms will only invest more (read: employ more people) when there is increased demand for their goods.

One might argue that the trillions of bailout money supplied by governments can help us tide over this crisis. Shouldn’t the trillions of money have an effect in creating new jobs? My response would be yes, but the number of jobs created would probably be limited in scope. Most of the money is given out to too-big-to-fail institutions. TARP alone accounts for 1/3 of the stimulus funds.

Instead of focusing on the real economy and creating jobs, the money is used to support inefficient institutions, which then have no qualms in paying their employees record bonuses using taxpayer money. When institutions are deemed too-big-to-fail, the process of creative destruction, so vital in a free market, is halted, and inefficiencies in the system remain. The situation is eerily reminiscent of Japan in the 1990s, where inefficient companies were bailed out by the government, leading to a zombie economy and a “lost decade”. Furthermore, too-big-to-fail increases systemic risk as it introduces a “moral hazard”, where banks take on excessive risks because they know that the government will be there to bail them out if crisis strikes.

So, looking at the general economy, I must say that I do not have great confidence in a strong recovery. Reported “profits” seem to be more of cost-cutting measures, than due to increased revenue from a recovering economy.

For all the talk about a recovering economy, Bernanke and Co. do not seem to employ the measures in a recovering economy. Take away all the talk, and just look at their actions alone (keeping interest rates low, etc.). It would seem that we are still in a recession.

Of course, there are still several factors that are unknown, for example, whether the toxic debts of big banks are already resolved or just covered up and hidden from view, whether domestic consumption in China alone can power the world economy out of the recession, whether the soaring stock markets are able to affect the real economy to a significant degree, what is the effect when governments begin to exit emergency stimulus, etc.

George Soros once said "The stock market predicted 10 of the last 6 recoveries." It might do well to keep that in mind.

PS: This is not a recommendation to buy or sell stocks. As of now, I myself had no money in the stock markets. I might very well turn out to be wrong in my analysis…and it won’t be surprising.
Comments welcome!