Tuesday, October 30, 2012

The Great Anxiety

The Great Recession has morphed into the Great Anxiety.  Economic growth is tepid, enough so that it inspires little confidence.  Unemployment, still high, is falling, but so slowly that consumers' animal spirits remain tame.  Individual investors, confronted by three year highs in the stock market, celebrate by fleeing.  The members of Congress devote their energies to calling each other finks, rat finks, double rat finks, and triple rat finks, while the nation veers toward a fiscal vortex.  Both candidates for the Presidency, although individually quite intelligent and accomplished, swap lies about how the other is lying and inspire little more than resigned sighs from their supporters.  The Federal Reserve is operating the only show in town, and its program consists of printing money, printing money while riding a bicycle sitting backwards, printing money while juggling eight balls and printing money while doing double somersaults on a trapeze.  But the Fed can't do much to resolve the problems in Europe, which is now sliding into recession even as the sovereign debt crisis gets kicked farther down the road.

If the Federal Reserve Board is correct in believing that public confidence is crucial to economic growth, then we are a long way from healthy, sustainable growth.  By all current indications, whichever candidate for President wins won't inspire much confidence.  Congress appears likely to remain divided between a Republican House and a Democratic Senate.  Gridlock isn't that big a problem when the economy is strong.  But it is deadly when the economy is moribund.  For better or for worse, a somnolent economy needs a decisive government, and we probably won't have one. Can kicking isn't a sound federal economic policy.  Both Japan, and more recently, the European Union, have vigorously kicked the can numerous times.  The problem, though, is that business people and consumers all know that the can is still there, and can bite them in the butt big time.  So they don't make big commitments; they don't go exuberant.  Can kicking virtually guarantees stagnation.  Yet can kicking has been the order of the day in Washington.

In a time when lukewarm coffee is all that you can hope for, invest cautiously.  It's not a bad idea to hold some risk assets.  But limit your exposure, and avoid the riskiest.  Hold a good dollop of stable assets, and don't stretch for yield.  One important way to give your net worth a boost is to save more.  Remember that the thriftiest squirrels have the best chance of surviving winter--and the coming winter could be cold indeed.

Sunday, October 21, 2012

Manufacturing Matters

In the end, Steve Jobs got his revenge.  Once marginalized by Microsoft and its monopoly on PC operating systems, and then kicked out of Apple, the company he founded, Jobs was recalled to Apple as it was sliding into a death spiral.  He proceeded to rebuild his brain child into the most successful business corporation today.  Apple is the leader of its market segment--that segment being the mobile world.  It manufactures visually attractive and highly efficacious mobile devices.  Okay, they had a problem with maps.  But Apple has overcome its previous belly flops, and it will surely overcome this one.  Its high prices may keep it out of the reach of some consumers.  But those that can afford its products tend to be the well-off who are highly sought by advertisers.

By contrast, Google and Facebook are now looking at the abyss.  They haven't figured out mobile, at a time when mobile products are the fastest growing consumer high tech segment.  Both Google and Facebook rely heavily on advertising, but mobile screens are too small for the kinds of ads that have proven successful on PCs and traditional laptops.  There isn't yet a mobile-specific advertising strategy that really works.  As the world becomes more mobile, Google and Facebook face the potential for a Yahoo-style decline, unless they solve the advertising problem or find alternative revenue sources.  Solving the advertising problem requires gathering more and more detailed information about individuals using their products.  But that could bring them into greater conflict with governmental protections for privacy.  This is a particular issue in Europe, and a growing issue in America.  These privacy protections will ultimately limit the extent to which Google and Facebook can facilitate the targeting of ads.  One interesting notion is perhaps Yahoo, with its banner ad business (which doesn't rely on detailed personal information), will eventually prove the tortoise in its race against Google and Facebook.

In part, Google and Facebook confront the problem of all successful high tech companies.  No matter how well you're doing, the next big thing is coming and you'd better be prepared for it or others will out-innovate you and leave you in the dust.  IBM didn't anticipate the PC, and it lost its standing as the predominant computer company.  Microsoft didn't anticipate the ubiquity and importance of the Internet, and it's in a slow fade.  RIM didn't anticipate how consumers would flock to the smart phone, and it's barely staying alive on its corporate customer base.

But failure to anticipate the next big thing isn't the only dynamic.  Part of the dynamic is that Apple manufactured the next big thing.  By creating products that elevated the mobile experience by quantum leaps, Apple made consumers want mobile products.  By manufacturing and selling these products, Apple derives a very large part of its revenues from selling hardware and software packaged together.  It doesn't give consumers stuff for free and hope that it can slip in a few ads here and there.  It makes and sells stuff for cash money.

Making and selling stuff has, for millenia, been the heart of economic activity.  The evolution of the industrialized world revolved around elevating the manufacturing process to a grand scale, so that vast quantities of stuff could be made efficiently and sold at prices a lot of people could afford.  Steve Jobs' relentless commitment to manufacturing--and thus control over product design and quality--placed Apple at the core of the industrial process.  By manufacturing high quality and innovative stuff, Apple avoided the commoditization of PCs (which bedeviled Dell, Hewlett Packard and other companies) and elevated itself to the top of the high tech world. 

This isn't a sales pitch for you to run out and invest in Apple.  Its stock, on a tear earlier this year, has been falling back recently.  Its maps debacle hurt, and its future--always uncertain because it's in the most volatile of industries, high tech--has been made more unpredictable by the death of Steve Jobs.  The point here is that Apple's business strategy of manufacturing made it strong, and is a sound idea for American economic policy.  America increasingly doesn't manufacture.  But you can't build a strong national economy on management consulting, investment banking, hedge funds, law practice, health care, restaurants, and services like hair salons, pet walking, personal shopping, and the secondary and tertiary retailing in websites like eBay.  The foundation of a strong economy is manufacturing.  Look at Germany.  Look at China.  America was once the manufacturing giant of the industrialized world.  While it can't return to that status, it can look for ways to encourage manufacturing.  We all know Apple manufactures a lot of components in China.  But well under half of its revenue dollars are spent in China.  Much more is allocated to spending in America, for things like retailing, distribution, employee payroll and so on.  Successful manufacturing companies make their home countries strong. 

Most of the debate today over fiscal policy revolves around the amounts of federal spending and federal taxation.  But fiscal policy isn't just a matter of accounting.  The nation benefits by spending and taxing wisely.  Keeping Social Security, Medicare and Medicaid in the black will be easier if we have a robust manufacturing sector.  The pie is much easier to divide if it's bigger.

Sunday, October 14, 2012

Pan Europeanism's Gambit

It would appear that a group of key European leaders combating the EU financial crisis have coalesced around the banner of Pan Europeanism.  Mario Draghi, head of the European Central Bank, has positioned the ECB to start financing struggling EU governments.  This is a paradigm shift from past ECB policies, and moves the ECB toward the money printing mode of the Federal Reserve and the Bank of England.  Recently, Angela Merkel, Germany's Chancellor, has spoken of cutting Greece a break on its austerity obligations under the terms of the EU's bailout for that nation. Such magnanimity is at rather sharp odds with her tough stated positions not many months ago.  The recent election in France of Socialist Francois Hollande shifted the EU's political center of gravity toward more accommodative measures--Hollande's notion of austerity is to raise taxes on the wealthy and give them a taste of austerity. 

The award of the Nobel Peace Prize to the European Union may be the latest move in the gambit to persuade skeptical northern European taxpayers of the need to keep the EU together.  The point is that failure to stay together will raise the specter of another continental war.  Although actual war seems highly unlikely in today's non- and often anti-militaristic Europe, the subliminal message is clear. 

The Nobel award is like a mutual admiration society of Pan Europeanists high fiving each other. The political in-crowd on the continent has to be very pleased with itself at the moment.  But the baseline problem for saving the EU remains whether or not northern European taxpayers are prepared to foot the bill for keeping the whole shebang together.  If not, the $1.5 million or so that comes with a Nobel Prize won't matter.  An interesting question is who will the EU select as its representative to receive the award.  Here's betting it's Angela Merkel, who needs political cover.

Sunday, October 7, 2012

How Government Adds Risk to Risk Assets

The Federal Reserve has been on a tear, squashing interest rates in order to coerce investors into risk assets.  But investors, especially individual investors, have been zigging where the Fed wants them to zag.  They have succumbed to post traumatic stock disorder, and abandoned equities with abandon. 

Fear of stocks isn't just a product of the market busts of recent years.  It's also driven by too many known unknowns.  The role of government in pumping up asset prices has become so great that it receives more attention from financial news services than economic fundamentals.  But, as mandated by the law of unintended consequences, government actions have made risk assets less attractive.  Here's how.

The Fed has become less predictable.  In years past, the Federal Reserve was slow to reveal its thinking and the reasons for its policy actions.  Chairman Ben Bernanke has endeavored to be more transparent.  And he has been more transparent about the workings of the Open Market Committee and its thinking.  But what has been revealed only confounds.  The Fed is quite open about its intention to provide monetary stimulus in order to boost employment.  But no one knows what level of employment will cause the Fed to ease back, or what rate of inflation will lead it to move interest rates up.  No one knows what type or form of additional quantitative easing the Fed will employ if employment levels remain unsatisfactory (however unsatisfactory may be defined).  Will it buy car loans, credit card debt, bankers acceptances, commercial paper, corporate bonds, junk bonds, common stocks, or something else?  Whether or not, why, when, how, how fast, and how much are important, but unanswered, questions concerning the Fed's potential unwinding of its massive $3 trillion plus balance sheet. Any purchaser of risk assets would want answers to these questions.  But answers are unavailable.

The Fed is relentlessly driving its monetary wagon train under the motto "full employment or bust."  By acting so vigorously and creatively, however, it has created a lot of uncertainty even as it has stabilized the financial system.  There are so many uncertainties about the route the Fed is taking that individual investors don't want to hitch up their wagons and join the trek.  What the Fed will do next is anybody's guess, and because of its outsized impact on risk asset prices, this unpredictability makes risk assets riskier.

Fiscal funk.  Congress's dysfunction was on full display last year when those freakin' idiots--excuse me, the esteemed members of Congress--almost blew up America's creditworthiness in the debt ceiling debacle.  Things haven't changed.  Forecasting fiscal policy is like peering into a black hole.  It's impenetrable.  Whatever happens could make things worse.  Also, consider the permanently temporary nature of the Bush II tax cuts, which have fallen into the habit of being extended a year at a time.  The analysis of risk assets becomes labyrinthine when the tax system is established for only a year at a time. Another big, bad black hole is known as the fiscal cliff, which is huffing and puffing furiously.  Yet we don't know if we're in a house of straw, wood or brick.  All these fiscal foulups accentuate the risk in risk assets. 

Rational investors trying to reason their way to well-founded decisions haven't got a popsicle's chance in hell of figuring out the upsides and downsides of risk assets.  They just know that these known unknowns heighten the risks.  In such circumstances, digging the fox hole deeper and hunkering down all the more make sense.

Friday, October 5, 2012

Would You Invest in Government?

Investors have an unusual problem today:  should they invest in government?  No, that's not political rhetoric.  It's perhaps the biggest question facing anyone with cash to allocate.  Asset prices have been manipulated upward by central banks and other government policies.  Stocks and bonds would not be trading at today's prices had it not been for all of the merry money printing by the major central banks during the past few years.  Indeed, the Federal Reserve takes credit for over half the rise in stock prices since 1994.  See http://blogger.uncleleosden.com/2012/07/stocks-are-not-cheap.html.  If you buy stocks or bonds now, you're betting that central banks can continue this juggling act. Is that possible?  Let's look at real estate.

Real estate prices for decades received government support on a massive scale.  Beginning in the 1930s and 1940s, various government lending and finance programs (think Fannie Mae, Freddie Mac, Ginnie Mae, FHA, etc.), along with tax deductions for mortgage interest and property taxes, plus more specialized programs like federal flood insurance, have combined to create a vast support network for real estate, worth trillions of dollars.  Add Federal Reserve easy money policies starting in the 1990s going forward, and real estate prices were boosted leaps and bounds by government largess.  We know, however, how this story ends.  Humpty Dumpty had a great fall, and all the government's programs and bailouts since the financial crisis of 2007-08 haven't put Humpty together again.  To be sure, a great deal of private avarice and stupidity played central roles in the real estate catastrophe.  But the presence of the government, lending a helping hand at every turn, made it easy to believe that real estate prices would never drop. 

Stock and bond prices now seem similarly invincible.  Even though Europe is sliding into recession, China's growth is slowing, and America's economy sputters and coughs just above recession level, stocks keep bubbling up.  Any positive economic statistics add to the ecstasy.  Negative ones slip from short term memory.  Many investors skittish about stocks have no qualms about diving into bonds, even though bond values have been driven to extreme heights.  Central bankers worldwide issue virtual carbon copies of each other's press releases declaring their unswerving commitment to keep printing money until . . . well, until . . . well, it's not clear where the process will end because the printing presses are now set to run ad infinitum.

To invest today, you have to pay the government prescribed price. To assess the risks of financial assets, you have to give heavy weight to political considerations--and those ain't pretty.  Buying financial assets like stocks and bonds is essentially an act of faith--faith in governments, and especially in central banks.  But faithfulness in this respect may not get you through the Pearly Gates.