Electing the Janitor-in-Chief
October 31, 2008
By John Mauldin
This week we survey the economic landscape that the new president will inherit. It is a polite understatement to say that he will be getting a serious mess. In reality, the US goes to the polls this next Tuesday to elect a Janitor-in-Chief. He will face a task that rivals that of Hercules in cleaning out the Stygian stables (legendary huge stables that had not been mucked out for ten years). However, there are no convenient rivers at hand for a probable President Obama to redirect that will quickly be able to clean out the mess left in the stables of our economy. This will indeed be an Herculean task and one that will take most of the first term of the next administration. So, let’s look at what will face the next president. It should make for an interesting, even if not optimistic, letter.
But first, a quick commercial. My friend Steve Blumenthal at CMG wanted me to remind you that there are money managers who have been able to create value in these markets. If you are wondering where to turn to in this rather difficult environment (to say the least!), I suggest you go to his website, register, and then let them show you what a blend of active managers that are on his platform would have done over the past few months and years. These are primarily managers who will trade a managed account (using various proprietary styles) in your name and are quite liquid. And if you are an advisor or broker and would like to see the managers on his platform and how you can access them for you clients, sign up and let Steve and his team know you are in the business. The link is http://www.cmgfunds.net/public/mauldin_questionnaire.asp.
CMG is the firm to which I refer investors who typically have a net worth of less than $2 million. If you are an accredited investor with a higher net worth and would like to see what a portfolio of alternative investments, including hedge funds and actively managed commodity funds, has done this year, I suggest you go to www.accreditedinvestor.ws and my partners at Altegris Investments in the US (and Absolute Return Partners in London and Europe) will be glad to talk with you. And if you are a registered investment advisor or broker in the US, you should seriously consider signing up and talking with the team at Altegris. Some of the solutions they have might be ideal for your clients. (In this regard, I am president and a registered representative of Millennium Wave Securities, LLC, member FINRA. Please note that past performance is not indicative of future results and pay special attention to all the risk disclosures at the websites and at the end of this letter.) And now to the letter.
Electing the Janitor-in-Chief
I normally do not get into politics in this letter, as my beat is economics and investing. But this election has large economic implications. Even though I am a long-time Republican, I can still read polls. And it looks like Obama will be our next president. (I have already paid off my bets made last year, for what it’s worth.)
First, let’s look at what will be the main problem facing the new president. George Bush came into office with the country already in recession. Over time the economy recovered, albeit somewhat slowly. As I have demonstrated numerous times, the recovery was fueled by Mortgage Equity Withdrawals. Over 2% and sometimes over 3% of GDP growth in 2002-2006 was the result of rising housing prices, allowing consumers to borrow against their homes and spend on whatever they chose.
I have used the chart below on a lot of occasions, but as it is central to today’s letter. Let’s review it.
The red bars show how the economy would look without that borrowing power. George Bush would most likely have been a one-term president, as the economy would have been in a serious recession for two years, followed by a very slow recovery of less than a 1% growth in GDP in 2003-04. Unemployment would have been dismally high. The slogan would have been “It’s the Economy, Stupid” all over again. That was what beat his father in 1992 and would likely have done it to the son in 2004.
But the nation was in fact growing at over 4%, and 9/11 was not so distant a memory. The focus was on the War on Terror, and Bush won a close election.
But that is not the situation today. The economy is in recession. Over one million jobs have been lost in the last 12 months. The preliminary number came out today for third-quarter GDP and it was down by 0.3%, the first negative quarter since the last recession. As it is the preliminary number, and does not really have much data from September, it is likely that future revisions will see the number be even worse. 1% is not out of the question.
The fourth quarter that we are in will again be negative, and even worse than the third quarter. Bush came in with a recession that started in the waning months of the Clinton administration, and he will leave his successor with a much deeper recession and a consumer that is on the ropes.
Let’s review this table from a few weeks ago. To understand the real economic problem facing the new administration, you have to understand this table. These are not normal problems that a likely President Obama will be facing. The above chart stopped at 2006. James Kennedy recently updated the data. Notice below how net MEWs have fallen precipitously in 2008, down 95% from three years ago. On this data alone, GDP should be off by 3% this year. No wonder we are in negative economic territory.
In 2005 there was almost $595 billion in mortgage extractions that went into some kind of consumer spending. Remember, according to the graph above, that translated into a 3% rise in GDP. In 2007, MEWs were down to $470 billion, for a boost of 2% to GDP.
The second quarter of 2008 saw an anemic $9.5 billion. At that run rate, we could see a drop-off of well over 90% from 2005! Now, think what the second quarter would have been without the federal stimulus program of $150 billion. It might have looked and felt like this quarter!
In the economic data which came out today, consumer spending was down 3.1%. You have to go back to the intense and deep recession of 1980 to find a worse number. And we are just in the middle innings of what is likely to become a much worse recession.
Can’t Borrow on Your Home? Whip out the Credit Card!
So, did American consumers cut back on borrowing? Not if they had a credit card! Total loans from commercial banks to consumers grew by $89 billion for the 12 months ending in September. $61 billion of that was credit card debt, and the amount in recent weeks has exploded. Let’s look at this analysis from my favorite slicer and dicer of numbers, data-wizard Greg Weldon (www.weldononline.com). Going with a Halloween theme:
“FAR MORE ‘telling’ is the LOPSIDED degree to which Credit Card balance growth is ‘contributing’ to total growth in Consumer Loans, a sign of intensifying ‘stress’ on consumers, amid accelerating job loss, home price deflation, and equity-market paper wealth devaluation.
“Even the raging Frankenstein stops to note the shockingly UGLY data details:
Commercial Banks, Outstanding Credit Card Balances … SOARED by an eye-opening + $7.1 billion in the WEEK ending October 15th, representing a +1.9% single-week rate of expansion … or … nearly ONE-HUNDRED PERCENT annualized (+98.4%).
“Even more ‘telling’ is the ‘read’ acquired by contemplating the following pair of data FACTS:
* Credit Card Loans, 10 months Sep07-thru-Jul-08 … up + $29.1 billion
* Credit Card Loans, 10 weeks Aug-08-to-mid-Oct-08 … up + $32.3 billion
“In other words, Commercial Bank ‘exposure’ via the total amount of Credit Card ‘loans’ outstanding has risen MORE in the last ten WEEKS, than it did in the previous ten MONTHS COMBINED !!!
“Moreover, the growth in the last ten-weeks, $32.3 billion, or about $600 million per ‘shopping day’ since the beginning of August … represents nominal growth of + 9.3% … or … + 48.3% annualized over the last ten weeks.
“According to American Express, delinquencies on credit payments rose to 4.1% of all credit outstanding in the 3Q, up from 2.5% in 3Q of 2007, with Bank of America’s rate rising even more steeply, to 5.9% in the quarter.
“Moreover, the ‘pool’ of loans deemed ‘uncollectable’ rose to a high 6.7% in the 3Q, soaring from 3.6% last September.”[Emphasis mine.]
What consumer spending there is has been fueled in part by credit card. Greg notes this uncomfortable piece of data: the second largest “merchant-vendor” for credit card use is now McDonalds. This suggests that many consumers are in serious distress when they need to get their $4 Big Mac and fries with a credit card.
This is the problem facing the economy next year. Credit card growth like we have seen in the last few months has never been sustained at such a level, and is unlikely to be this time either. This is especially true as credit card delinquencies have been rising, as noted above.
The next administration is going to be faced with a retrenching consumer, which will likely push the economy even deeper into recession. This will of course result in higher unemployment. In the first year of the next president’s term, he is likely to see another one million people lose their jobs, pushing unemployment to almost 8%.
Peter Bernstein, in his regular letter, notes the rising levels of the DURATION of unemployment. It is now over 9 months, close to 38 weeks. As the recession deepens, this means a lot of people will stop receiving unemployment benefits. Oh, and of course, unemployment is not good for consumer spending. And it will put even more pressure on homeowners behind on their mortgages. And unemployed people do not pay taxes, widening the deficit.
If you thought the recovery under Bush was the “jobless recovery,” wait until you see the next version without the benefit of profligate consumer borrowing and spending.
Deficits as High as an Elephant’s Eye
Congress, in a sadly bipartisan way, aided and abetted by a Bush administration that simply did not use its veto power, has given the next president deep and growing deficits. Official projections are close to $500 billion. In a recession that will reduce tax revenues and increase costs due to rising unemployment? Can you say $600 billion? $700 billion? Add in the costs of bailing out various entities and it could be much higher. Is a Democratic Congress likely to pass another huge economic stimulus program? Add another $150 billion.
Home prices are likely to continue to slide. Consumers already shell-shocked by falling home values will face even more pain. Already, one in five homeowners owe more than the value of their mortgages. That number will rise. Aging boomers and retirees who thought they would be able to sell their home as part of their retirement plan now have seen that nest egg cut by a considerable amount.
The stock market crash has reduced global wealth by over $16 trillion dollars. A lot of that has been in US retirement accounts. Consumers are going to start to see the need to save once again, which of course reduces consumer spending. There are going to be calls to rescue the consumer and 401k plans.
Think about this. Broad stock indexes are about where they were almost 11 years ago. If you take inflation into account, you have lost considerable buying power. What cost $1,000 in 1997 today costs $1287. Put another way, the inflation-adjusted S&P 500 is 764 instead of the actual 968 at which it closed today. An entire generation is beginning to learn that “stocks for the long run” means a lot longer than most of them thought it meant.
Let’s sum it up. Here is what faces President Obama. The economy is in a recession that is getting worse by the day. This is the first consumer-led recession in 27 years. Unemployment is rising and the time between jobs is probably over ten months by the time he takes office. The US deficit is likely to be soaring above $500 billion. Consumers are retrenching, hit by the double whammy of falling home prices and seriously lower stock values and retirement savings.
You will not have the luck of George Bush to have consumers borrow $500 billion a year from their homes and resort to a negative savings rate. Banks will be cutting back on consumer lending, and consumers will be cutting back on spending and increasing their savings. The economy is unlikely to begin even a slow recovery until later in 2009, without serious and continuous large deficit-busting stimulus packages. Even then, the recovery is going to be prolonged, because the causes of the recession are the bursting of the twin bubbles of the housing and credit markets. These problems cannot be solved in a short amount of time. It will be several years into your administration before the housing market recovers, and the credit markets will be on life support for some time.
The Fed has run up its balance sheet by over a trillion dollars. Interest rates have been cut to less than 1%. There is no cavalry coming from the Fed to save the economy with more rate cuts.
What are your options? You have made promises to various constituencies. One is a tax cut for 95% of Americans. The problem is that 47% of Americans do not pay taxes, so what you are really talking about it a massive expansion of welfare. But if you use that tax increase on the “rich” to pay for your “tax cuts” to other Americans, you have no money to pay for other programs, let alone get anywhere close to a balanced budget.
And of course, as each year passes there is less net Social Security income to the government. If you use your tax increase to fund more expenses today, you will not have that to fund Social Security in 2017 when the program goes into a cash-flow deficit. Or, taxes will really have to rise later in the decade. But then again, that will be another president’s problem.
How do you offer the increased medical programs you propose if you use the tax increase for tax cuts for 95% of Americans (read – welfare for 50%) without really busting the budget? Or any of the $600 billion in programs that you want to see?
And your serious economic advisors are going to point out (at least in private) that raising taxes on the 5% of wealthiest Americans is eerily similar to what Herbert Hoover did in his administration, along with legislation to restrict free trade and increase tariffs, which you have also advocated. Look where that got him and the country.
75% of those “rich” you are targeting are actually small businesses that account for 50-75% (depending on how you measure growth) of the net new job growth in the US. When you tax them, you limit their ability to grow their businesses. Further, you reduce their ability to consume at a time when consumer spending is already negative.
Reduced consumer spending will be reducing corporate profits and thus corporate tax revenues. Just when you need more revenues.
A tax hike in 2010 of the magnitude you currently propose, in a weak economy, is almost guaranteed to create a double-dip recession. That will not be good for your mid-term elections. Given that the recovery from a second recession is likely to be long and drawn out, it would also make it difficult to get re-elected, as the economy would be the first and foremost issue.
Both Obama and McCain have said they are the candidate for change. And the large majority of the country believes we are headed in the wrong direction and need change. But I am reminded of a quote attributed to Lord Palmerston, a former prime minister of England (in the mid 1800s). Queen Victoria was talking of the need for change in order to help the country. He is reported to have said, “Change, change, all this talk about change. Aren’t things quite bad enough already?”
We are going to get change. I just hope it is not too much and the wrong kind of change.
Can You Count to 41?
For my international readers, it is likely that Obama will be the next president. The real thing to watch on election night is how many Republican senators there will be at the end of the evening. Under the rather curious rules of the US Senate, 41 Senators (out of 100) can block any given legislation. Things, including polls, are quite volatile this election. It is possible the Republicans will lose as many as 9 senators, giving them only 40. If such a thing transpires, and there is a real possibility it might, the changes we will see will be epochal in nature.
You have only to look at the legislation the House of Representatives passed this last session, only to have it blocked in the Senate, to see what would soon become the law of the land. Let’s just say trial lawyers, unions, and far-left liberals will be happy. Those who believe in free trade and lower taxes will not. And it will not be change that can be “fixed” if Republicans ever get back to power. It is unlikely that we will see the day when Republicans will have the necessary 60 Senators to change things back any time soon.
Republicans deserve to have lost control of the House and Senate, as well as the presidency. They got power and then went on a spending binge, letting deficits get out of control. Shame on them! I just hope we can keep 41 Senators, to have some check on things. We will see if my countrymen agree.
And maybe we can learn from this near-death experience and get it right the next time. But we are going to pay a price the next four years in terms of liberal activist judges who will be around for decades, a real setback to free trade and lower taxes. The Republic will survive, as it always has. But it should not have come to this.
Chairs, Moving, and Tony Bennett
Last Tuesday I went to hear Tony Bennett. He is 82. He still has it. It was one of the more magical music moments of my life. He put down the microphone at one point, and with a smooth Les Paul guitar backing him up, began to sing “Fly Me to the Moon,” in the rather large new Meyerson Symphony Hall in Dallas. The hush in the room was amazing, as everyone wanted to hear this old favorite. I wondered if he could do it in such a large hall, but he did. Just Tony, no microphone and a soft guitar. It was magic. If he comes to a place near you (he is in New York, New Jersey, and Vegas next month), drop what you are doing and go.
We are making plans to move. I will move to a new home in Dallas (leased) the weekend after Thanksgiving, and then we will move the office into it in the middle of December. Rather ambitious while trying to write a book as well. But I look forward to the 5-second commute.
Tiffani and I are doing about 15 interviews a week with millionaires from all around the world as part of the research for our new book, Tiffani asked me to let those of you who have asked to be interviewed to have a little patience if she has not gotten back to you. We had so many more volunteers than we ever imagined would come forth. As we plan a series of books, we will be doing interviews (though not at this pace) for several years, so it is our intention to get to as many of you as possible.
We have had almost 17,000 people take the survey (25% from outside the US). We hope to get 20,000. The survey is quite thought-provoking and takes about ten minutes to complete. If you haven’t taken it yet and want to participate in this research (and we want everyone to take it, as you don’t have to be a millionaire – if you are reading this, you can take it), please visit: http://survey.frontlinethoughts.com/index.php?sid=12431&lang=en
Reading one of those surveys, I was reminded about my recommendation of the Health Chair. The interviewee had bought one, and he agreed with me that it was one of the best investments he had made. I know it has really helped my back, given how much time I spend in front of a computer. Lots of people responded to my recommendation last year and got the chair, and the accolades are still coming in. Freddy V from Switzerland wrote the designer the following letter, which says it all.
“… recently I had to do some truly tedious work on the compy. I sat for days and consequently for long stretches of hours on my new chair. After a few hours my back started with familiar symptoms of pain coming from the muscles. What did I do? I simply moved the back supporters into different positions and wowie, the pain disappeared without me noticing first. I never had to pause, to interrupt my work. I sat for hours and hours and could do the job without being bothered by any kind of tiredness or pain. Am I a fan of your health chair, this is simply outstanding and unbelievable! Congratulations from my side and a huge thank you for making this possible. I will stay grateful for a long time. I only hope this chair is surviving me, it will be the most precious thing my heirs have to fight about. Unless the other two kids opt for one too… Freddy.”
You can read more about the chair by going to: http://www.thehealthchair.com/jmep.html. Your back will thank you.
Have a great week. Let’s hope Tuesday is not as scary as it could be.
Your hoping we can count to 41 next Tuesday analyst,
Copyright 2008 John Mauldin. All Rights Reserved