Wednesday, June 07, 2006

Diagnosis: Economic Malaise

Prognosis: Markets will continue their downward drift.

I still think this analysis from "Daily Reckoning" nails it:

1. In the past four years, the U.S. economy has received the most prodigious monetary and fiscal stimulus in history. Yet by any measure, its rebound from the 2001 recession is by far the weakest on record in the post-World War II period.

2. Record-low interest rates boosted asset prices and, in their wake, an unprecedented debt-and-spending binge on the part of the consumer.

3. What resulted was a badly structured economic recovery, which - due to grossly lacking growth in capital investment, employment and wage and salary income - never gained the necessary traction to become self-sustainable.

4. Sustained and sufficiently strong economic growth implicitly requires a return to strong business fixed capital spending. We see no chance of this happening. Above all, the outlook for business profits is dismal from the macro perspective.

This takes us to the enormous structural changes that the Fed's new monetary "bubble policy" has imparted to the U.S. economy over the years. While consumption, residential building and government spending soared, unprecedented imbalances developed in the economy - record-low saving; a record-high trade deficit; a vertical surge of household indebtedness; anemic employment and income growth from wages and salaries; outsized government deficits; and protracted, unusual weakness in business fixed investment.

None of these shortfalls is a typical feature of the business cycle. Instead, they are all of unusual structural nature. Yet the bullish U.S. consensus simply ignores them, bragging instead about the U.S. economy's resilience and its ability to outperform most industrialized countries.

To be sure, all these structural deformations tend to impede economic growth. Some, like the trade deficit and slumping investment, do so with immediate effect; others become repressive only gradually and in the longer run. Budget deficits stimulate demand as long as they rise. An existing budget deficit, however large, loses this effect. Rather, it tends to become a drag on the economy. In the past few years, clearly, the massive monetary and fiscal pump-priming policies have more than offset all these growth-impairing influences.

Or, as Stephen Roach says:

The American consumer is now a prime candidate for the weakest link in the global growth chain. The income side of the equation remains decidedly subpar. Despite a falling unemployment rate, labor income generation has suffered from chronic and, more recently, downwardly-revised weakness, as America has lurched from a jobless to an increasingly "wageless" recovery. By our calculations, over the first 53 months of the current cyclical upturn, the cumulative increase in private sector compensation amounted to only about 14% in real terms -- fully $365 billion below the trajectory implied by a more normal expansion. The weak employment report for May points to a further deterioration of this comparison in the 54th month of this recovery.

No bubbles, no wealth effect.

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