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  Posted on: Thursday, October 18, 2012
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Why There's No Easy Solution For The Economy

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While the global economy continues to give signs of slowing down, the stock market is not that far off its yearly high.  The IMF recently reduced its forecast of global economic growth yet again, stating that the advanced economies would either decline or grow at a rate too slow to make much of a dent in the unemployment rate.  It added that, while the developing economies were growing faster, their growth rates were falling.  It predicted 2012 growth at 3.3%, compared to their previous estimate of 3.6%.  The IMF also dropped their 2013 number from 4.1% to 3.6%.

 More ominously, they warned that the risks of dropping back into global recession "are alarmingly high" and that "no significant improvement appears in the offing."  We also consider it highly significant that the world organization already knew about the additional stimulative measures being undertaken by the European authorities and the Fed when they made their forecast, an indication that they do not think the additional ease will help very much.

The U.S. continues to slog along at an approximate 2% growth rate at best while facing the prospect of more inaction in Washington and the looming fiscal cliff that can throw the economy back into recession.  While Wall St. assumes that the politicians won't dare to allow us to go over the cliff, they may be ignoring the 70 to 80 congressmen who strongly believe that they were sent to Washington to oppose all compromise.  We tend to agree with Alan Simpson, Co-Chairman of the Simpson-Bowles Commission, when he said that "They (investors) really believe honestly that no congress can be this stupid and, by God, they can."

Europe continues to grapple with the almost three-year-old sovereign debt crisis while slipping into recession.  China's GDP growth has now declined for three straight years, and keep in mind that these are the official numbers that are widely disbelieved.  Other evidence such as electric power production, rail car loadings, retail surveys and U.S. companies that either export to or operate in China indicate that actual growth may be far less than the official numbers show.  The other BRICS are undergoing declining growth rates as well.  Japan is well into its third decade of stagnation and is discussing yet another move toward easing.

Given the stagnant situation, there is good reason for the apparent political paralysis afflicting both the U.S. and the rest of the world.  With the prevalence of inadequate growth and record debt levels, both public and private, the solution is far from clear. The U.S. and the world need more growth and less debt, two objectives in direct conflict with one another.  One group blames our problems on high debt and the need to contain it.  They recommend economic and financial austerity measures and long-term structural solutions.  While this may or may not work in the long-term, in the short-term it causes deflation, recession and declining tax receipts, exacerbating budget deficits even more.

 The second group, on the other hand, aims to increase demand in the short-term even if it means increasing the deficit from its already record levels.  The object is to step up economic growth to a level where it can be self-sustaining.  When that is accomplished, efforts can be shifted to debt reduction and prevention of inflation.  The problem with this approach is that it is more easily said than done.  If the expansionary policy is not in place long enough, the economy may not reach its take-off point, and the entire policy is discredited.  On the other hand, if the expansionary policy is not pulled back in time, we can end up with unmanageable debt burdens, high inflation and currency destruction.

The conflicting goals of higher growth and reducing debt make the current economic problems extremely difficult to solve.  It is also the major reason we have been and remain so bearish on the stock market.  If there was any clear solution to our current economic problems it would have been put in place a long time ago.  In our view, we are in for a lengthy period of stagnant growth at best.  The stock market has overly discounted an optimistic outlook and is now vulnerable to a severe decline.   


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