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Thursday, August 19, 2010

Uncertainty and Double Dip Recessions

August 19, 2010. There are several kinds of recessions: those which are caused by economic turmoil, by some endemic event as we have seen in 2008-2009, and those caused by fear, the fear caused by uncertainty. My mantra is ‘reduce uncertainty’ and I see the current situation filled with uncertainty. This uncertainty is pushing what I call a ‘behavioral recession’.

What is a behavioral recession? It’s when the conduct of the components of the economy alter their economic behavior to the extent their fears are realized. Consider the three legs of the economy: government, consumer and corporate. The US economy is divided with about 60% of the US GDP in the consumer, and 20% each in government and corporate spending. Let’s start with government. The federal government is spending money like a submariner on shore leave in San Francisco after 6 months at sea. However, the state governments (who, unlike the fed, have to balance their budgets) and local governments (who have to get funding from the state governments who cut the local pass-downs to balance their budgets) are not spending, but cutting costs and cutting costs means cutting jobs. So the ‘leg of the stool’ of government is flat.

The consumers, the bulwark of the economy, are rightfully frightened. Although the evidence is that for the most part, consumers are saving and still maintaining their income levels, they are clearly afraid. If you look at sentiment numbers, or if you conduct a simple ad-hoc poll, everyone, from millionaires to working folks, feel poorer. And one of the main reasons is uncertainty. Uncertainty about employment (what will happen to my job?); uncertainty about taxes (what is happening to tax rates?); uncertainty about inflation (inflation or deflation?). The media doesn’t help: we can find a point of view on about everything, from the oil volcano (sorry boys, wrong on that one) to the conspiracy to destroy the US, to the deflationary spiral to the end of the world on 12/21/12 (which will give me a good reason to celebrate my 57th birthday on 12/12/12 using credit cards). Negative news sells.

What about corporations? Well, the stark truth is that unlike consumers or governments, corporations tend to react quickly, so when the real recession started in 2007-08, the corporations went into cutting mode. Cut jobs, don’t spend. The reality is that the S&P 500 is riding on a wave of profitability and cash build-up. Huge amounts of cash ($1.7T) are sitting on the sidelines. If it went to work, there would be new hiring, or mergers, or expansion. It’s not, yet. In fact, the banks are sitting on more money than ever in history, but the velocity of money is only 2, not 9 like it usually is. Why? I picture a bunch of corporate CEOs at their country clubs (I envision they go to country clubs). My image of a corporate CEO is an older guy, a little overweight (so far, sounds like me), with a pink complexion and a very close shave (not me on those two). A bunch of them are walking around the ‘club’ locker room in towels. The conversation goes like this: “How’s business?” “Fantastic, we have great profits, tons of cash.” “What are you doing with it?” Nothing yet. We’re going to wait and see. This Health Care bill has us worried, we haven’t figured out the tax laws, so we’re holding onto the dividend, and who knows what’s going to happen in Washington. It’s all up in the air.”

So you have the three parts of the economy sitting around the campfire, looking at each other. The consumer is looking at the government and wondering when they’re going to make the economy better. Half of the government is throwing wood on the fire and half is pulling wood off the fire. The government is looking at corporations and wondering when they’re going to start hiring and get the economy moving. The corporations are looking at the government and wondering if they’re going to take away their pile of wood. So what happens? Either someone relents and starts building the fire, or they all sit around looking at each other and let the fire go out. Reduce some uncertainty, and maybe the corporate guys will throw some wood on the fire. Hire some people, and maybe the consumers will feel a little better. Economy expands, and tax revenues will go up and maybe the government can stop spending in deficit (Oops, didn’t mean to make a joke.)

This circle of doubt can go two ways: someone capitulates and the economy goes back to growing, or everyone holds to the Mexican standoff and we go into a double dip, and/or deflation. I’m betting for capitulation. People are the system and the system changes because it needs to.

I’d prefer my double dip on a cone. Stay tuned,

Leon