Sunday, January 08, 2017

What Will Trigger the Next Economic Crisis?



January is the time of year when all sorts of economic forecasts and predications are made for the upcoming year. However, the business of predicting and forecasting future events is notoriously challenging, suspect and, in retrospect, often wrong.

That said, an astute observer can often see trouble coming from a mile away.

Back in March, 2008, I wrote a story, titled “The Perfect Storm,” for Gather.com, for whom I was at the time a Money Correspondent. In the article, I highlighted the numerous problems plaguing the U.S. economy and how they were like spokes on a wheel, converging in a central hub. I could clearly see an economic disaster unfolding. Given that the financial crisis fully exploded just six months later, my concerns proved to be somewhat prescient.

I must admit that, at the time, I thought we were headed for a second Great Depression. While that outcome didn’t ultimately materialize, the fallout was brutal, with millions of Americans losing their jobs and homes.

More than 800,000 jobs were lost in November, 2008 and again in January, 2009. In total, nearly 9 million jobs were lost during the Great Recession, which lasted from December, 2007 to June, 2009.

More than 9.3 million homeowners went through a foreclosure, surrendered their home to a lender or sold their home via a distress sale between 2006 and 2014, the Wall Street Journal reported.

What we all discovered, after the fact, was that we were officially in recession (which is defined as two consecutive quarters of economic contraction) for nine months before the financial crisis ignited. Though the recession wasn’t officially recognized for much of 2008, millions of Americans intuitively knew that things were not all right. I was one of them.

While I was wrong about a new depression unfolding, there was plenty of panic around the country, even in Washington, DC, where insiders knew just how awful the rapidly unfolding situation was.

In October, 2008, Congressman Brad Sherman of California said that some members of the House were told that martial law would begin within a week if they did not immediately pass the TARP bailout bill:

"The only way they can pass this bill is by creating and sustaining a panic atmosphere. ... Many of us were told in private conversations that if we voted against this bill on Monday that the sky would fall, the market would drop two or three thousand points the first day and a couple of thousand on the second day, and a few members were even told that there would be martial law in America if we voted no.”

So, my concerns at the time were not unfounded. I was not alone in expecting the worst.

Henry Paulson, Treasury Secretary at the time, subsequently wrote the following about the crisis:

"That was just a terrible moment for me. Everyone was waiting for Tim [Geithner} and me to come down and report to them, and I wasn’t quite sure what to say. I was gripped with fear. I called [my wife] and said, “Wendy, you know, I feel that the burden of the world is on me and that I failed and it’s going to be very bad, and I don’t know what to do, and I don’t know what to say. Please pray for me.”

“It seemed like there was a good chance Morgan Stanley could go down, and if it did that could take Goldman down. If that had happened, it would have been all she wrote for the American economy."

Yeah, for those who didn’t know it at the time, it was that bad.

Yet, many of the problems that led to the Great Recession have not gone away; in some cases they have festered and worsened. I am still highly concerned.

While I steer clear of outright predictions, especially when it comes to timelines, I won’t be at all surprised when the next crisis rears its head — even if it occurs this year. Recessions are inevitable and the Federal Reserve is often to blame for creating the business cycles that invariably lead to recessions.

Regardless of what triggers the next recession and/or financial crisis (one will likely lead to the other), there are more than enough combustibles at present to spark and then feed the fire.

As Paulson also said:

"I get asked all the time, “What’s the likelihood of another financial crisis?” And I begin by saying it’s a certainty. As long as we have markets, as long as we have banks, no matter what the regulatory system is, there will be flawed government policies. Those policies will create bubbles. They will manifest themselves in a financial system no matter how it’s structured and how it’s regulated.”

With that in mind, I will attempt to briefly outline below what I see as the most likely potential triggers of the next crisis:

High debt levels of all kinds (government, business, household)

The following chart comes from Hoisington Investment Management:



From 1980 to 2013, total credit/debt grew by 8 percent per year, compounded. This is remarkable because anything growing by 8 percent per year will double every 9 years.

As a result, total Credit Market Debt, which measures all forms of debt in the U.S. — including corporate, state, federal, and household borrowing — now stands at a whopping $64 trillion!

Staggering levels of debt prevent investment and consumption. This chokes off future economic growth, which is one reason our economy has endured such struggles over the past decade. Simply put, annual economic growth below 3 percent cannot support annual debt growth of 8 percent.

Hoisington Investment Management wrote the following in its November, 2016 newsletter:

"In the latest statistical year, debt of the four main domestic non-financial sectors increased by $2.2 trillion while GDP gained only $450 billion. Debt of these four sectors (household, business, Federal and state/local) surged to a new high relative to GDP. This will serve as a restraint on growth for years to come.”

Slow growth makes it harder for a nation to pay off its debts. As it stands, debt service is already the fifth largest piece of the federal budget, following Social Security, Medicare, Medicaid and military spending.

Last year the federal government spent $432.6 billion servicing the debt, according to the Treasury Dept. That’s more than was spent on education, science and medical research, transportation, infrastructure, NASA and food and drug safety — combined!

Huge amounts of debt needed to achieve economic growth

Since about 1980, debt has been growing much faster than GDP. In fact, the public debt has grown at 2.6 times GDP since 2008. But it is not possible to perpetually grow debts faster than income.

Total Credit Market Debt rose to a new record high of $64.1 trillion in the first quarter of 2016, according to the Federal Reserve. This was an increase of $645 billion from the previous quarter. It means that in the first quarter, it “cost” $10 in new debt to generate just $1 in new economic growth!

Our entire economic system is predicated on debt to achieve growth. That is hugely problematic… and suicidal.

Persistently slow economic growth

This is a theme I’ve covered many, many times through the years. Despite the huge debt loads incurred annually, growth is becoming ever harder to come by. Debt is choking off growth, as stated above.

Historically, from 1947 through 2016, the annual GDP growth rate in the US has averaged 3.23 percent.

However, since 2001, GDP has reached at least 3 percent in just two years: 2004 (3.8 percent) and 2005 (3.4 percent). In every other year, through 2015, GDP failed to crack 3 percent, a number that was once considered customary.

There are many reason for this, not the least of which is that $64 trillion in total Credit Market Debt discussed above, which is acting as a ball and chain on our economy.

But there's also the matter of stagnant incomes. Though median household income finally rose in 2015, it is still 1.6 percent lower than in 2007, before the Great Recession. It also remains 2.4 percent lower than the peak reached in 1999.

Yet, Americans pay more today for needs like health care and higher education than they did in 1999.

Rents, health insurance, prescription drug costs and tuition have all risen — and are still rising — much faster than the general rate of inflation and, more importantly, much faster than median family income.

Even worse, median earnings for men working full-time are still lower than they were in the 1970s, according to Sheldon Danziger, president of the Russell Sage Foundation, a research group focusing on social issues.

Then, of course, there’s also the fading financial strength of the Baby Boomers, who have passed their peak spending years and are in, or preparing for, retirement. Meanwhile, the Millennials do not have the financial strength (due to low-paying jobs and huge student debts) to fill the void created by the Boomers.

Nearly 40 percent of 18- to 34-year-olds are now living with their parents — the highest percentage since 1940, the end of the Great Depression. That really says it all.

Little productivity growth, despite the technology boom

The working age population in the US (and across the world) is in decline and the number of people past retirement age continues to grow. This is a major headwind and it is already hurting productivity growth, as well as economic growth. Older people aren’t more productive; they’re less productive.

Bureau of Labor Statistics data indicates that U.S. productivity growth from 2010-15 averaged just 0.4 percent per year, down from 1.9 percent during the 1990-2010 period and way down from 2.6 percent during the 1950-1970 period. Historically, productivity gains have been an important engine for wage increases as well as GDP growth.

In his book “An Extraordinary Time," economist and journalist Marc Levinson says the good times are over for good, or at least for the foreseeable future. The economic boom from 1948 to 1973 was extraordinary. What we have now, he asserts, is “the return of the ordinary economy.”

Inventions since 1970, including the internet, don’t live up to the innovations that powered growth from 1870 to 1970, such as refrigerators, cars, telephones, and aircraft. Levinson quotes productivity expert John Fernald of the Federal Reserve Bank of San Francisco, who says, “It is the exceptional growth,” not the slowdown since, “that appears unusual.”

Slow population growth

One of the keys to economic growth is population growth.

However, the population growth rate in the United States has sunk to 0.6 percent, a historic low. According to a December 23 Brookings Institution survey, the rate is at its lowest point since 1936, during the Great Depression.

William H. Frey, a fellow with Brookings wrote:

"It is likely that some of the reduced fertility in recent years is attributable to recession-related delays in family formation among young adult millennials; this trend could reverse in the near future as the economy continues to grow. But higher death rates are likely to continue due to the long-term aging of the population, a phenomenon contributing to projected declines in U.S. growth rates, which could drop as low as 0.5 percent in 2040.”

Huge, persistent trade deficits

The U.S. has run an annual trade deficit every year since 1976 — yes, for four decades.

Half-a-trillion dollar annual trade deficits have been the norm for many years and we surely reached that figure once again in 2016.

As I noted in 2013:

The U.S. has consistently run a gaping trade deficit for decades because we import more than we export. In fact, the U.S. has led the world in imports for decades and is also the world's biggest debtor nation.

Countries with big, persistent trade deficits have to continually borrow to fund themselves. The problem for the U.S. is that we don't export nearly enough to continue paying for all those cheap foreign goods that we've grown so accustomed to.

Year after year, the trade deficit sucks hundreds of billions of dollars, and millions of jobs, out of the U.S. as we continually buy products from overseas that could instead be made here at home.

No nation can continually buy more from abroad than it sells. It's simple arithmetic. Where will the money for all these purchases come from?

It’s a very basic logic: You can't indefinitely buy more than you sell.

New housing bubble

The median price of an existing home reached $234,900 in November, while the median price of a new home rose to $305,400. Remember that median household income remains 2.4 percent lower than the peak reached during 1999. How the hell are people paying higher home prices if incomes remain stuck at 1999 levels?

Back in 1999, the median price of an exiting home was $133,300, while median price of a new home was $164,800 that December.

So, the median price of an existing home has risen by about $100,000 since 1999 and the median new home price has increased by $138,000. Meanwhile, median income remains the same. This simply doesn’t add up. People are being financially squeezed into submission.

National home prices in 2016 finally crossed the previous peak set in 2006. Prices rose every month last year (through October), with a 5.61% increase nationally. Remember, unsustainably high home prices and the associated debt sparked the last housing crisis, which in turn created the broader financial crisis. Yet, prices have now surpassed the 2006 highs. This is reason for genuine concern.

Meanwhile, worker pay had an annual gain of just 2.9% in 2016, which was the fastest increase since the recovery began in mid-2009.

This is further evidence that home-price increases and pay increases are mismatched and have created an uneasy disequilibrium. Homes simply are not affordable for most people and that will likely get many of them in trouble sooner or later. That will create huge problems for all taxpayers, even renters.

Today about 90 percent of all new mortgages are insured by the government through Fannie Mae or Freddie Mac. The taxpayers are backstopping all of these mortgages.

A report by the Social Security Administration had some rather stunning findings.

In 2014, 38% of all American workers made less than $20,000; 51% made less than $30,000; 63% made less than $40,000; and 72% made less than $50,000.

This is likely why there are fewer homeowners now than at any time in the last two decades.

The US homeownership rate fell to 63.5 percent in the third quarter of 2016, the lowest level since early 1995.

Stock market bubble

This is the third-longest bull market in 80 years. There is bound to be a significant correction. As the Romans once implored, “caveat emptor." Or, in today’s parlance, “Buyer Beware."

Equities are very expensive right now. Near-zero interest rates for the past eight years have driven many investors out of bonds, CDs and savings accounts into higher-yielding stocks. But equities are called "risk assets" for a reason. Trillions of dollars are now at stake.

The stock market’s wild advance over the past seven years has been nothing less than a fraud.

A 2016 HSBC research report revealed that virtually all of Wall Street’s gains since 2009 are the result of corporate buybacks. S&P 500 companies have bought a staggering $2.1 trillion worth of their own stock since 2010.

So, individual investors and pension funds haven’t contributed anything to the market’s surge in that span. Almost all of the market’s increases are due simply to corporate buybacks!

Remarkably, this is legal, even though it is outright market manipulation.

Stock buybacks aren't a good use of capital. In fact, they're wasteful. That money would be better allocated to R&D, equipment or other capital improvements. Buybacks don't increase revenues or profits, or even improve future growth. They are a gimmick used to increase earnings per share, but not actual earnings. Buybacks are a fraud.

Buybacks allow companies to spike their earnings per share because they reduce the number of outstanding shares. It’s phony earnings growth. It has nothing to do with demand for a company’s product or services. And buybacks do nothing to promote innovation. It’s all just financial engineering.

Too big too fail banks are now even bigger and more concentrated

The financial crisis only served to make the Big Banks even bigger.

The five largest U.S. banks – JP Morgan Chase Bank, Bank of America, Citibank, Wells Fargo Bank, and US Bank – control nearly half of all assets in the U.S. banking sector.

These five banks collectively held $6.9 trillion in assets as of the third quarter, 2015.

Since 1992, the total assets held by the five largest U.S. banks has increased by nearly fifteen times! Back then, the five largest banks held just 10 percent of the banking industry total.

The mergers and acquisitions that occurred during the financial crisis only exacerbated the problem. The assets held by the five largest banks totaled $4.6 trillion in 2007, meaning they increased by more than 150 percent in just eight years.

This has created even greater systemic risk to the financial sector and the nation as a whole. Such concentration of banking assets is dangerous for our economy and raises the systemic threat to the entire banking sector during the next, inevitable crisis.

Taxpayers are always on the hook for the failures of private banks. Profits are privatized, while losses are socialized

Conclusion

There are more than enough reasons that the U.S. could/will experience another economic or financial crisis. I’ve listed nine of them above, and some of them are inter-related. That makes these predicaments even more pernicious and potentially systemic. I’m sure that some of you reading this may conjure other critical problems as well.

These quandaries are quite easy to see; our elected “leaders” and government officials are fully aware of them, yet nothing is done to address these critical matters. There is no course correcting; there is only finger crossing and keeping their heads firmly planted in the sand… or their asses.

These troubles are not secrets and there should be no surprise when all of this eventually, and inevitably, blows up quite spectacularly. The only question is whether it happens in 2017, or later.

No comments:

Post a Comment