Market Outlook 8/10/11
Did Bernanke kill the Dollar? Yesterday’s FOMC meeting produced major market volatility, the type that we have not seen since the “Flash Crash” occurred. Changes to the FOMC statement from keeping rates “exceptionally low for an extended period” to an actual target date 2 years away “mid-2013” left the market wondering what to do.
The initial reaction, as it usually is, was to sell first and ask questions later. And that’s what the market did. Bernanke acknowledged the declining economy as the reasoning for the policy change. There were 3 dissenters on the FOMC board for the first time since it happened to Greenspan in 1992. Nevertheless, Bernanke went ahead with the change.
So the initial reaction that things are getting progressively worse was correct, however it was trumped by the notion that there will be “free money” for the next 2 years. This takes away some of the fears of potential rising interest rates, but also now limits what the Fed can do. At this point, I think Bernanke is scrambling to do whatever he can as he is fully aware that there isn’t much left he can to for the economy with monetary policy, and that economic growth needs to come from fiscal policy.
So how do we encourage economic growth? I’m going to go into a remedial economics lesson here because I think it’s important. GDP is how we measure economic growth and it is simply a formula that aggregates inputs.
The formula is: GDP= C+I+G+X, where C= household consumption, I= business investments, G= government spending, X= net exports (trade balance).
Now if we address each component of the equation, we can see rather easily why GDP is declining.
C is declining because of unemployment in the US which is officially reported at 9.2% but in reality is north of 15% when you include the underemployed and those who have dropped out of the workforce. C makes up roughly 70% of GDP as consumer spending is the largest driver of the economy.
I is declining because of uncertainty in the markets due to policies of the government. Increased regulation, the fear of higher taxes, and the unknown of Obamacare have left companies no choice but to hold back on major expenditures, as well as hiring despite the fact that corporate balance sheets have never looked better!
G is declining because of the public outrage at wasteful spending of politicians as they attempt to buy people’s votes to keep themselves in power. The recent debate over the debt ceiling was a charade intended to make people believe that politicians will reduce our debt. Not likely!
X is declining (technically the formula is X-M exports minus imports but I’m just using the net figure) because the number has always been negative! We run a trade deficit here in the US, not a surplus despite a declining Dollar. Why? Because China despite being the world’s second largest economy pegs the value of their currency to the Dollar, thereby negating the effects of a weaker Dollar on our exports! China just reported a larger than expected trade surplus despite their currency “appreciation” which has gone up the most in 18 years. The problem is that it is still less than the daily gains we saw in the Aussie just yesterday!
So we are clearly in a bad situation and politician are making worse by continuing to do more of the same! So how do we fix this? We are definitely in a chicken vs. egg cycle where politicians are quick to point out the obvious, but address the root cause.
Ask any politician why we have high unemployment, and they will tell you it is because of a lack of consumer demand. While this is very true, it is not the cause but rather the effect! Businesses will not take a chance on increasing expenditures, if they think that higher taxes or Obamacare will ruin their profitability.
If you roll-back or throw out everything that has been “accomplished” in the last 2 years, then this economy can get moving again. Otherwise, S&P is going to look very prescient with their downgrade as it is only going to get worse.