The United States economy reduced speed in the March quarter. That was unexpected because the Federal Reserve was in the middle of a gigantic money printing operation ("Quantitative Easing - Part Two") which should have drawn idle resources back into productive use. It also marked the culmination of two years of fiscal stimulus that drove the Federal budget deficit to $1.6 trillion, an unprecedented 11% of the nation's GDP. Together those moves should have led to an acceleration in real growth, on the order of 4%-6%. In reality the Q1 figure came in at 1.8%. And a full percentage point of that was an inventory build-up that counts in the statistics, but didn't happen on purpose. GDP growth might be impacted in Q2 as inventories are worked back down to normal levels.
The international economy is cooling off, too. Benjamin Bernanke's money creation project wound up flooding Communist China with more cash than it could use, despite the fact it was growing at a 10% rate when the program started. That amplified the Middle Kingdom's inflation rate, which already was climbing due to a free for all real estate market and rapid industrialization. Interest rates and reserve requirements went up, putting pressure on a lot of marginal borrowers. The United Kingdom also implemented tighter policies to get its house in order. The European Union slowed down, as well, due to its uncertain debt situation.
The game plan should have been for the United States to take the lead at this stage. The rest of the world was due for a breather. It should be drafting off our recovery. The stimulus spending and money printing of the past two years should be kicking in, boosting incomes, lifting employment, and driving down the budget deficit. Regrettably, the Obama Administration squandered its opportunity. Little of the pump priming cash was invested productively. Instead of laying a foundation capable of generating recurring revenue and income growth most of the spending went into one shot bailouts, or just completely down the drain. The Administration is laying the blame on bad weather, temporary inflation spikes, Japan's earthquake, and whatever other special factors it can think of. Experienced investors know those excuses always are smokescreens for more serious problems. A downturn is underway. It remains to be seen if it will affect the stock market. But a cautious approach is warranted under the circumstances.
Our nickname for the Obama Administration's economic policy is "Tinkle Down Economics." The U.S. Treasury and the Federal Reserve Board have flooded the capital markets with fresh money, paying face value with cash for securities. Billions of those securities were impaired, moreover, so the sellers got a huge bailout in the process. Additional bailouts supported various public and private unions, state and local governments, and huge companies dangling on the edge of bankruptcy. None of that money went into venture capital, private equity, new business formation, incentives to help genuine growth companies expand faster, or anything that might have generated a high rate of return. There was lots of big talk about "shovel ready" construction projects. But in the end few of those got off the ground. A variety of one size fits all housing market initiatives were implemented. They didn't work because real estate is a series of local markets, all of which are unique. The Administration could have spent resources going zip code to zip code in 2009 to stabilize housing, to get the problem under control. Instead it redesigned the medical industry, boosting its share of GDP to 18% from 16% before. (Europe has healthier people and pays 9%-12%).
Prices are rising faster than incomes. All that new money has sent the Consumer Price Index up by 6% since January 2009. Unfortunately for the average American, it hasn't helped wages. Incomes are up just 1%. The standard of living has declined by 5% as a result. Unemployment still stands at 9.0% compared to 8.2% when the administration took over. The CPI hit 4.0% in Q1 (annual rate). That measure may trend higher in upcoming periods. No turnaround is on the horizon.
All that liquidity could keep the stock market afloat. Business conditions won't be as vibrant as they should be. And marginal companies no doubt will encounter problems, either diminished demand or rising costs. But a wholesale decline in share prices isn't certain. Our advice is to remain invested in a diversified portfolio of Special Situation stocks, with a cash reserve to take advantage of future opportunities. The political scene may be a different story. It will be interesting to see how long today's 20-30 year olds will accept having their aspirations thwarted. For that matter, we'll see how long the 50-60 year olds being laid off every day put up with it, either. At least with Ronald Reagan's "Trickle Down Economics" the rising tide lifted all boats. With "Tinkle Down" the only things we're getting are higher prices, anxiety, and disillusionment.
Walter Ramsley
Executive Editor
