Guest Post: Why The U.S. Economy Could Go Haywire

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Submitted by Dan Dorfman courtesy of TrimTabs Money Blog

Why The U.S. Economy Could Go Haywire

Americans participating in a recent Gallup poll showed the highest level of confidence in an economic recovery in a year.  Sounds great, but you can’t ignore the nearly 13 million unemployed, the 46 million people on food stamps and the roughly 29% of the country’s homeowners whose mortgages are under water. They would find it hard to subscribe to the poll’s sunny conclusion. On the other hand, there’s no getting away from a bevy of seemingly increasingly favorable economic data, which, more recently, includes falling weekly jobless claims, four consecutive monthly gains in the leading economic indicators, somewhat perkier retail sales and a pickup in housing starts and business permits. Pounding home this cheerful view is the media’s growing drumbeat of increased economic vigor.

Confused? How can you not be? But President Obama has to be elated at this widely perceived peppier economy. During much of his presidency, he’s been roasted by some critics as an economic illiterate, with one Internet poster recently reading: “Obama had a dream and we got a nightmare.” Now, though, thanks to the public’s growing acceptance of the idea that things are getting better, Obama’s approval ratings are on the rise. Even a number of his Wall Street critics are starting to acknowledge his chances of winning a second term have greatly improved and some believe he’s almost a shoo-in should the current economy continue to pick up steam.

The favorable economic news has also been a big plus for the stock market, what with equities off to a rousing start in 2012 and the Dow recently ballooning to a four-year-high of around the 13,000 level.

That also sounds great, but there’s still a lingering amount of economic scare talk around that’s probably a lot scarier than most haunted houses, namely the chatter and economic commentaries that raise such ominous prospects as a new U.S.  recession, a global depression and unemployment in the West (Europe and the U.S.) reaching 20% or more and further toppling of European  governments.

It all raises the obvious question: are we out of the woods yet?

No,  says James Dale Davidson, an editor of Strategic investment, a Florida newsletter, who writes in the latest issue that “the U.S. economy is staggering, like an over-the-hill boxer trying to shake off a jab to the chin.”

Of concern to Davidson, among other things, are an unfavorable demographic trend (an aging population) and a global debt crisis, both of which he views as essentially insoluble, a contraction here of real personal income,  a developing recession in Europe, which will mean a downturn in the U.S., and the prospective toppling of more European governments on top of the seven that have already toppled, a grave situation magnified by the shaky financial condition of European banks.

All told, there are about $87 trillion of assets in the world banking system, around $40 trillion of which are estimated to be in European banks. On average, Davidson points out, European banks are woefully insolvent and leveraged at 26 to 1, meaning, he said, a 4% loss would wipe out their capital. Conservatively, he points out, these banks are about $300 billion short of the capital needed just to make adequate provision for the sovereign debt they hold.

To our economic bear, the handwriting is on the wall, contending “there is no longer a question of whether Europe will fall into a downturn. It already has.”

Davidson further notes that slow growth (which is the case now) has always been an indication that the economy was sinking into a recession, was already in a recession, or was just emerging from a downturn. In this context, he believes the most likely scenario is that we will soon find ourselves in a recession since there is very little in recent data to encourage optimism about robust growth.

This year’s economic and financial news, as Davidson sees it, will detail the painful and gradual awakening of investors to the grim reality. Among what he sees as headline developments:

–Savings rates will rise again following a plunge in home equity values that the Financial Times estimates at $650 billion.

–P/E ratios will continue to be compressed as the prospects of real growth evaporates.

–We will move from “a rising tide lifts all boats” buy-and-hold market to a stock picker’s market.

–With median incomes falling and little prospects of real sustained growth, it will be a rare company that realizes significant gains in top line revenue. In essence, you’ll have to find the next Apple to capitalize on dynamic growth.

Davidson also serves up equally grim tidings for our nation’s retirees. “The welfare state is broke, busted, and the expectation of retirement for the majority of people will be exposed as, at best, an even more illusive dream, and, at worst, a hoax.”

With speculation rife that it’s only a matter of time before Greece defaults despite a recent bailout package, as well as the prospects of other countries also defaulting, it’s worth taking note of a frightening observation from Citibank’s chief economist, Willem Buiter.

Focusing on the threat of disorderly defaults–which we’ve already seen in such riot-torn nations as Greece and Italy–Buiter contends such disorderly defaults “would drag down not just the European banking system, but also the North Atlantic financial system and the internationally exposed parts of the rest of the global banking system that would likely last for years, with GDP falling by more than 10% and unemployment in the West reaching 20% or more. Emerging markets,” he observed, “would be dragged down, too.”

So there you have it, a slew of scary events, any of which could clobber the economy and the financial markets at any given moment. How real such risks are is anybody’s guess, but the message from our worrywarts is clear: there’s still plenty of economic danger ahead.

One of the more famous Yogi-isms might sum it up best: “It ain’t over till it’s over!”

 

What do you think? E-mail me at Dandordan@aol.com