Posted on Friday, 31st August 2012 by Robert Domini

THE NATIONAL ECONOMY SEPTEMBER 2012

To understand where we are today with our markets it’s important to look back on our economy to late 2008. At that time our financial markets were in free fall. Lehman and numerous other financial institutions failed or were failing at a frightening pace in the September-October time frame which, it just so happens, was almost exactly four years ago. As the 2008 election was in its final stretch the economy was in wholesale collapse. To avoid disaster the Federal Reserve stepped in and became the lender of last resort offering a wide variety of loan opportunities for financial institutions and business. It was not until November 2008 that the Fed began printing money, or as it is euphemistically called, bond buying, to stimulate the economy. In its first move called QE, they bought $600 billion of mortgage-backed securities issued by Fannie, Freddie and Ginnie. When the Fed buys bonds, they simply write a check to a bank for the bonds, although there is no money in the checking account. The next Fed move, QE1, in March 2009 was in the amount of $1.75 trillion. As QE1 was being completed in March 2010, the stock market began a sideways movement. Then in November 2010 the Fed instituted QE2 for $600 billion. In September 2011 they sold $400 billion of short-term securities and bought the same amount of long-term securities, a process known as Operation Twist.

 

 

The Dow Jones Industrial Average was 14,000 in late 2007, but fell to 7,000 by January 2009. With the Fed pumping printed money into the economy late in 2008 and early 2009 the stock market soared from 7,000 to 11,000. The market dropped during mid-2010 to 10,000, so in late 2010 the QE2 was implemented taking the market to 13,000 in early 2011. With no monetary stimulus the markets dropped to 11,000 in August 2011. At this point the Fed vowed to keep rates low till mid-2013 and began Operation Twist which took the market to where it is today at 13,000.

Thus, if you were a stock trader during these times, each time the Fed infused money the stock market surged. The 08-09 infusion resulted in a 57% increase. The 2010 action resulted in a 30% increase and the 2011 efforts caused an 18% increase. Obviously, there were numerous other governmental and market forces at work during these times, but the end result was a surge in stock prices each time the Fed increased the money supply. The results have been profound these last four years.

At the same time the stock market is reacting, there are three other measures of economic activity at work which are also very important, namely the unemployment rate, the GDP growth rate and inflation. Thus far inflation has remained tame due to the anemic economic recovery. If inflation were to increase dramatically the interest rates would be forced to increase and a market collapse would probably ensue. As to the unemployment rate, national unemployment reached a peak of 10% in early 2009 and began a very slow and steady decrease to it’s current level of 8.3% where it has been now for nearly two years. The rate was 8.5% at the beginning of 2011. An important fact to keep in mind is that the method of calculating the unemployment rate has changed over the last ten or twenty years. Those no longer seeking work are not counted as unemployed.  Conventional wisdom is that the unemployment rate would be 16% if it were calculated as it was during the Depression. Thus, with all of the stimulus of the Fed’s printing presses, this rate has remained stubbornly high by historical standards.  

 

The GDP Growth Rate is illustrated in the chart above. The economy was in a deep slump during early 2009 with a -6.7% rate of decline at the low point. With the massive Fed stimulus and with dramatically increased Federal Government spending, the economy quickly emerged from the recession by the end of 2009. Yet, as the stimulus has been moderated somewhat, the GDP has taken on a slow-growth pace the last several quarters. A low growth rate such as this has not stimulated inflation to any great extent, but it has also not lead to lower unemployment.
At the present time as we approach September 2012, our economy is at a precarious point. The stock market has been addicted to the Fed liquidity these last four years as has the general market. The Fed has just about run out of bullets with a national debt soaring to nearly $16 trillion. The annual budget deficits have averaged somewhere in the range of $1.2 to $1.4 trillion during most of these years, and we are fast approaching a crisis point where we may no longer be able to print our way to prosperity. In the not-too-distant future the debt will undoubtedly overrun our ability to make principal and interest payments. The need for government borrowing has been reduced by $3.35 trillion as a result of the money creation.  To illustrate, in the last 4 years our borrowing needs have gone from 5 trillion to 1.65 trillion as a result.  It is unlikely the global markets would demand that level of U.S. Treasuries.  The U.S. has already experienced one credit downgrade and others are sure to follow if we continue on this pace.

Although there are some signs of recovery at the present time such as an increase in housing prices and building, these improvements are from a very low level. At the same time the Government is facing several extremely important issues which are sure to be delayed until after the election, not the least which is the Bush tax cuts which are set to expire at the end of this year. Additionally, there is yet another debt-ceiling increase on the horizon in addition to mandatory cuts in spending unless Congress and the President find a solution which is not going to happen until after the election. Bear in mind that the extraordinary stimulus spending of 2009 has been locked into the budget since that time. In fact, with the growing appetite of the entitlement programs and other “mandatory” spending, the prospects for fiscal responsibility are not very promising. Yet, on a smaller scale, several states have brought large spending deficits under control in as short as a two-year period and have actually increased tax receipts and balanced budgets. The solution to our problems is to somehow come up with a formula to get the economy moving again. During the 1920s a treasury secretary with the name Mellon came up with the ideal amount of tax to supply the government and still allow the economy to flourish. Such a balance will need to be found once again.

This Report Has Been Brought to You by:

Robert D. Domini, MBA, MAI

Certified in Ohio, Michigan and Florida 

p.s. This is property-tax-appeal season.  I will consult with you for a very modest fee to help to determine if you have a good case for tax appeal.  Give me a call!  Please visit our website at www.continentalvaluations.com.

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