Truthfully, we’re not even close . . .

Source: BEA & Census Bureau

Recent machinations of government agencies making repeated attempts to talk up the US economy are not only another exercise in willful ignorance, but they are now failing to inspire the political supporters who were responsible for them gaining power in the first place.  A simple analysis of rudimentary (but frequently ignored) output statistics makes this trend painfully clear. Let’s begin with Gross Domestic Product.  The government has nearly broken its arm attempting to pat itself on the back over a recent proclamation that the recession “ended” in June of 2009.  However, the ‘real’ way to measure national output and affluence is not with aggregate GDP, but GDP per capita.  Put another way, what really matters is not the total level of output, but the total output per person.  When measured in this fashion, the current economic state of the United States still looks dour.  Currently, per capita GDP is 3.6% below its Q4’07 peak.  The recovery has been very slow and anemic, with the appearance of gains only emerging when compared to the depths of the financial crisis. Further analysis of the economic data shows an even more disturbing trend where real private sector output is

Source: Bureau of Economic Analysis

shrinking as the government assumes an ever increasing role in the economy.  This removes the luster from any faux gains in per capita GDP as the increased numbers are simply resultant of more government spending that is being financed with debt.  It always is and always has been true that the only real driver of economic affluence is the private sector.  By definition, the government must extract every dollar it spends from some corner of private enterprise.  When the real output of this private enterprise contracts, it simultaneously arrests any real advancement in national affluence. In many cases, government entities will attempt to conceal this erosion in national affluence with entitlement programs and stimulus projects that spend money they don’t have on things they don’t.  Namely that the ‘real’ economy is being bled out by a bloated and increasingly authoritarian government.  As astute investors, we need to become educated in strategies for financial survival that will allow us to weather this economic storm until a (hopeful) return to fiscal sanity and pro-growth policy.

Source: Federal Reserve

Analysis of yield curves for government borrowing and lending rates shows a disturbing trend that has emerged since the Financial Crisis of 2008.  Under Ben Bernanke, the Federal Reserve has reduced the Fed Funds rate for bank lending to nearly zero.  This has had the ancillary effect of pulling down rates for treasuries, as banks borrow from the government at near-zero interest rates and earn arbitrage profits by purchasing treasury notes.  This strategy is being intentionally employed by the government to prevent capital from leaving the banks in the form of loans to individuals and businesses that would create inflation, thanks to the rapid expansion of monetary reserves pushed on banks by the Fed.  The net effect of this move has been a contraction in the availability of financing for individuals and businesses, which is further concentrating financial power in the hands of government.

A counter-intuitive side effect of expansionary government can be increased corporate profits and stock valuations.  The reason for this is because large corporations hold more political power than smaller entities, and can capture benefits from political lobbying when government is very powerful.  On balance, this phenomenon is hurtful to the average citizen, because it arrests the natural process of competition and directs profits to entities with political connections instead of those with the best products and services. Thus, an era of excessive government can simultaneously produce high levels of corporate profits.  The hitch is that these profits do not result from healthy economic expansion, but originate from the political favor earned from extensive lobbying efforts on the part of major corporations.

Because of this, it is possible that a market value expansion may coincide with the trend toward more government seizure of power. In light of these trends, there may be an emergent opportunity for investment in the stock market since the current ratio of total market capitalization relative to GDP is at approximately the same level as was experienced after the before the technology bubble and after the tech crash.  It is important to note that the gains from increased government power will not be spread equally among all stocks and asset categories.  The sectors most likely to see disproportionate gains are the ones who control commodities such as oil, food and energy or who directly benefit from government contracts. In the end, our current trend of economic decay is not good news for average citizens, but can contain a sliver of opportunity for astute investors.  By concentrating your investments into assets like income properties, which will benefit from rent increases that result from reduced affluence pushing people out of the pool of buyers and into the pool of renters.  This migration of people away from home ownership will reduce vacancy, strengthen rents, and provide fantastic cash flow opportunities for astute investors that purchase this kind of investment property.

Action Item: Protect yourself from a government entitlement collapse by becoming self sufficient and investing in the businesses, products, and services that will increase in demand as more people slip into subsistence.

 

Upon reading the headline of this article, most people begin to think of company evaluations similar to those performed by Jim Collins in his book “Good to Great”.  (Incidentally, two of the companies highlighted in “Good to Great” were Fannie Mae and Circuit City, both of which have subsequently become epic failures)  The purpose of this analysis is much more broad than corporations.  Begin by considering that the notion of a corporation is only a few hundred years old.  However, there is another entity with a much longer track record, and much more spectacular results.  This entity is the family.

Every year, the US census bureau collects a large amount of data regarding demographic and economic trends.  This data is then reflected in terms of ‘households’ for the purpose of reporting.  Each time that this data is collected, the results show some of the same trends.  The most pronounced of these trends is a trend for lower income households to have fewer people and fewer income earners.  Another trend is for higher income households to have a higher concentration of ‘families’ with two parents and children.  This is one reason why it is fallacious to cite ‘household income’ figures as evidence of economic depravity . . . the average ‘household’ size at the lower quintiles is much smaller than at the upper end of the scale.  With less people in a household producing earnings, it stands to reason that there will be a lower level of affluence.

The logic behind this trend is quite clear.  When a household is populated by people who make coordinated efforts and shared sacrifices, it produces more advantageous economic outcomes.  Consider what behaviors create economic prosperity?  Some of the primary factors are engagement in productive work, innovation, and sacrificing current consumption for future gain.  All three of these building blocks are regularly practiced by family units as the primary breadwinner engages in economically productive activity.  In order to accommodate schedules and stay within the family budget, great amounts of innovation are frequently required.  And finally, families regularly sacrifice short-term consumption and enjoyment for the purpose of investing in the future.  This takes the form of both financial investments and the development of human capital in their children.

However, there are some tricky characteristics of families that make them difficult for politicians to reconcile.  Most prominent is that the government cannot ‘create’ families.  The true benefits of productivity and sacrifice only come from voluntary formation of families.  Attempting to “fine-tune” this process with government policy leads to unintended consequences in the best case (such as fueling a housing bubble) and wholesale disaster in the worst (such as the explosion in single parent households that resulted from government entitlement programs)  Thus, it stands to reason that while government cannot ‘create’ families, it can most assuredly destroy them.

In a strange sort of irony, many in the political class attempt to replicate the family model with society, and cast government as the head of household . . . but with disastrous results.  In the context of a family who loves one another, the notion of making sacrifices is gladly accepted by everybody involved.  However, when the government attempts to force sacrifices onto people, there is no familial bond.  The ‘sacrifices’ only serve to benefit the political class.  Government programs designed to benefit the next generation of citizens frequently foster a culture of dependence that simply perpetuates the mother-government nanny state.

Conversely, it is equally silly to impose a market economy into a family setting.  When my family is eating dinner, I don’t attempt to auction off a cookie and garner the highest price.  We share in the effort and rewards of our life.  The familial bonds of love compel us to forsake a complete pursuit of immediate personal gratification.  Put another way, the phenomenon of family expands the scope of ‘self interest’ beyond simple personal gratification out to the care and development of our whole family.  This simple paradigm shift is the primary driver of the tremendous benefits that families offer to society.

The purpose of this analysis is not to denigrate single people or households that have encountered difficulty.  Rather, it is to highlight the importance of self-sacrifice and delayed gratification and how families have a built-in incentive to practice both of these principles.  There are many people who engage in these behaviors independently, and those people should be applauded.  However, the way that these principles have proliferated broadly across society has been through families.  By making sacrifices for the benefit of posterity, it simultaneously creates a brighter future for society as a whole through the opportunity that emerge from fundamental economic growth.

In the end, the prosperity of humanity is not created by corporations, but by individuals.  Individuals who produce great things and make personal sacrifices that benefit future generations.  The family serves as the ‘front line’ of this phenomenon when individual people make individual decisions to produce and sacrifice for the benefit of their children.  However, the larger society benefits from the economic output, investments, and development of future productive citizens that are regularly conducted by families.

 

A recent report from Reuters reflects reduced economic growth estimates by economists, predicting a 2.7% real GDP growth rate for all of 2010.  Concerns over this slow recovery include the fact that this slow growth is insufficient to make a significant impact to unemployment.  This estimate represents a 0.2% reduction versus last month and a 0.6% reduction versus the estimates released in June.  The reality slowly sinking into economic forecasts is the fact that incentives in the United States are not aligned to spur growth.

The looming expiration of tax cuts from 2001 and 2003 stand poised to raise the tax liability for millions of Americans.  In addition to this, the lending environment with banks remains precarious, as the Federal Reserve is committed to maintain Fed Funds rates near zero so that banks do not loan out their excess reserves and create inflation.  However, this policy is also causing banks to hold onto reserves and borrow short at near-zero interest rates to purchase treasuries for arbitrage profits.  Until this imbalance is corrected, lending will continue to be excessively tight.  However, relaxing the artificially low interest rates is likely to push the economy back into recession.  Thus, the US economy is stuck in an uncomfortable reality with high unemployment, weak recovery, tight lending, and leadership that is afraid to make the tough decisions that will re-align incentives to create long-term growth.