A Sobering Dose of Realism

Friday is finally here, bringing closure to a week of topsy-turvy trading and mixed (if not somewhat irrational) reactions to fresh economic data releases. Early morning data was once again on the negative side, and it seems like Wall Street might have caught a case of uncertainty fever.

Initial jobless claims were up 637,000 last week from a previously revised figure of 605,000, prompting fears that the worst is not over yet for the labor market. The 4-week moving average sat at 630,500, an increase of 6,000 from the previous week’s revised average of 624,500. On top of that, the unemployment rate is set to spike this summer due in large part to the combined effect of Chrysler plant closings and GM dealership shutdowns. Earlier this week the markets reacted positively to news that the economy had shed only a half a million jobs. However it seems that economists and investors are now starting to realize that bad news are bad news, even when they’re considered to be “less bad.” On a side note, is there really such a thing as “less bad”? To me that would be like saying that someone is only “a little bit pregnant.” Anyways, moving on…

According to the Cleveland Fed, the median Consumer Price Index rose 0.2% in April. The 16% trimmed-mean Consumer Price Index increased 0.1%, and the CPI less food and energy rose 0.3% on a seasonally adjusted basis. In other words, prices are up but wages remained flat. Aggressive Fed action might have staved off a hyperinflation scenario, but the Treasury’s printing press is still cranking out dollars like it were candy. For the rest of us this means that garden-variety inflation is not quite out of the cards yet.

Industrial production decreased 0.5% in April according to Federal Reserve statistics. This is a slight improvement over the 1.7% drop seen in March, and I dare bet that this will serve as nothing more than fuel for the bulls’ “green shoots” chorus. However, if you look closer you will see that the 1.2% improvement is actually a 12.5% decrease from the same period last year. The rate of decline might be slowing down, but how exactly is a substantial year-over-year drop considered good?

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On a positive note, the Index of Consumer Sentiment was up 65.1 in the April survey from 57.3 in March: a 7.8-point gain. More importantly, the index increased from the 62.6 reading in April of last year, marking the first positive year-to-year change since mid-2007. No doubt this had a lot to do with the approximate $70 billion that came in the form of government transfers and lowered tax payments. The same Reuters/University of Michigan survey showed that four out of every ten consumers thought the policies put in place by the government would be effective in improving their own financial situation. The outlook may still be grim, but at least some Americans are feeling “less bad” about it. (Sorry, I couldn’t help it.)

It is inevitable that a recovery will eventually happen, especially considering the Fed’s aggressive quantitative and credit easing maneuvers. Yet realistically speaking, there will not be a return to pre-credit bubble burst USA; wealth destruction has taken place on too big of a scale. The government is essentially broke and there is simply no sustainable way to maintain debt-fueled growth like we have been doing for the past two decades. The US will still be a major player much in the same way that the UK remained a major player after the decline of British Empire dominance in the 19th century. Having said that, the future of the world is shaping up to be much different from what we’ve seen in the 20th century, and it is unlikely that the US will remain the world economic leader for much longer.

The balance of power is shifting. Growth is in China and other Asian countries, and that is where the real wealth will begin to consolidate over the coming years. There’s no telling how soon it will happen but the financial crisis has brought about a fundamental shift in the way the rest of the world looks at the US and the US dollar. Some economists, the ‘realists’ if you may, agree that the status of the US dollar as the world’s reserve currency will begin to wane after the recession unwinds and real global recovery begins. Some are betting on the Chinese yuan as the most obvious candidate to replace the dollar, others believe that a redesign of the so-called IMF special drawing rights is a likelier scenario. Regardless of what comes next, the era of King Dollar is drawing to a close and it is coming faster than some expect.

In a sign of things to come, Temasek Holdings, a Singapore state-owned fund, sold today its 3.8% stake in Bank of America for about $1.3 billion, at a loss of about $4.4 billion. “The belief now is that the world is not so American-centric anymore”, said a Temasek economist. You have to wonder how seriously they must be taking that belief to be willing to incur a $4.4 billion loss. Anybody else see the irony in the name Bank of America yet?

The latest WSJ economist survey predicts that the recession will be over by year-end, and in this I actually agree. I still disagree with their target date of August, but I do believe that the general macroeconomic environment will bottom out sometime near the end of the year. Likewise I also disagree with their absurdly optimistic view that there will be a return to booming American business growth like we’ve been enjoying since the late 1980s. Things will taper off and there will be a return to positive growth, yes, but the era of big-money party time has reached the clearing at the end of its path. Say true, say thankya.

-Carlos J.