Obama Starts Budget Cuts With The Obvious

I have been writing about public sector debt recently in this blog and the opinions of those in the know about it’s likely impact.

The first major shot in what will probably become a global political war to reduce deficits has been fired. President Obama has announced a new budget which contains cuts to many areas. While the obviousness of reducing debt levels is hard to deny, personal and corporate interest will create mass cries of ‘not this’ to many of the proposed reductions.

The fact that President Bush’s proposals to get NASA really moving again are for the chop is being criticised, for example. It is hard to deny that no further space flight can be seen as a disappointment. But really, when you are forecast to owe US$1.56 trillion, do you really need to send Man back to the Moon? Aren’t there more important things to do with the money?

To make this seem a little more real, an example would be a family on the verge of bankruptcy, with a massive mortgage and other unsustainable debts. The husband has just been asked to take a pay cut by his employer and to celebrate, he bought a Porsche!

If your neighbour were in such a situation, you would - rightly - blame them for their financial demise. When they ought to be switching off the cable channels and looking for additional part-time work, they are spending big money on an unaffordable luxury.

Is it really so much different on a national level?

But this is the easy end of the scale. With such high national debts, there will be many more important projects that will need to be cut. In time, a couple of years perhaps, there will be medical projects, childcare, road safety and much more that will be dumped to stave off national bankruptcy. This will be happening in many Western democracies.

And in those same democracies, there will be political argument after political argument.

Of course, this will all be very tough for private investment. When state plans change, so will personal circumstances - possibly removing vital capital from stock markets - leading to knock on effects in areas I dare not try to forsee.

This is - to my mind - the real start of the hang-over after the party. So far, we have simply been getting home to bed. But the spiral down of reduced spending from governments, causing reduced spending from corporations and the public, leading to further reduced spending from all three will take a long time to balance. Just as the party was pushed upwards by ever increasing public sector spending - based in large part on borrowing - the recession will be exacerbated by it.

Hold on to your hats…

Thoughts ‘Borrowed’ From Davos

No, sorry. I didn’t make it to Davos 2010 - I wish. After Copenhagen, this would have been an event too far…

In a blog post from Davos, the Beeb’s Robert Peston discusses the thoughts of some of the world’s top bankers about the state of things now.

It seems that these guys agree with the opinions recently alluded to in this blog in this post about Public Sector Debt and this one about my estimates for the length of this recession.

I’d like to bring your attention to points 1 and 2. “prospects are particularly poor for the heavily indebted economies of the west” and “a meaningful risk of sovereign debt crises in economies with large and rising deficits“.

Why do I do this?

Because I am mean and like to write depressing things? Because I like poking fun at politicians and their lies? Because I like to delude myself that I understand economics?

Well, yes, all of those. Of course!

But this blog is aimed and written for investors. To be an investor - especially a successful one - requires a mindset that is realistic and sees the world as it most likely is.

Making poor judgements about economic conditions or business and market reality will most likely lead to buying the wrong asset or company and - sooner or later - losing money.

Therefore, we need to see the reality. And the reality is that more and more of the people that really ought to know, are starting to say that this will be a very long recession.

It is almost a year ago that I was involved in interviewing Paul Krugman where he called it ‘The Mother of all Recessions’. Despite being a Nobel Prize winning economist, the tide was against him - as he has published a book about depressions (a clear bias). But now the world is agreeing more and more with him.

In between then and now, just about every politician in the world has seen ‘green shoots of recovery’, ‘an end in sight’ and all sorts of other hopeful things. They can’t really say much else, of course. But as an investor, it is our job to see through the smoke and past the mirrors to get to the underlying reality.

What is that underlying reality?

It seems clear - at least to this amateur economist - that real GDP growth in major economies will be hard to find and that this recession will last and last. It also seems clear that we as investors need to think very deeply about how to best manage our finances. In a world where either inflation or deflation takes hold, the correct decisions will make or break family finances.

The low interest rate ‘stimulus’ environment ought to have a finite lifespan and has probably built something of a bubble in stock markets. When cash on deposit earns less than 1% pa gross, why keep money in the bank? When governments are borrowing like a drunken Admiral, why buy or hold bonds? That, in combination with quantitative easing (I suspect) has pushed money into global markets when the majority ought to be selling.

We all need to be thinking deeply and clearly about our financial positions right now.

Public Sector Debt And The Everlasting Recession

Back at the end of July 2009, your author wrote a post titled: ” 2016: The End Of This Recession? “. At the time I felt a little bonkers, it was the out-loud musings of an amateur economist and nothing more. But the tide of economic thought seems to be moving in this direction…

In The Economist this week (16th January 2010 - Economics Focus | Digging out of debt) is analysis and opinion of the analysis and opinions of another. The other in this case is a report about debt and global deleveraging by the McKinsey Global Institute. No lightweights here then.

Both report and article are worth the read if you have any interest in the medium-term economic future of the world.

As The Economist notes, there are only three ways to reduce the debt levels of us all (government, corporations and individuals) to a sensible level. They are default, inflation and a prolonged period of belt-tightening.

As you might imagine, both report and article focus on prolonged belt-tightening as the preferred route out of debt. It is fair to say that the prospect of countries such as Spain, Britain, the US, South Korea and Canada choosing default - and the consequences for us all thereafter - is not an appealing one. However, the elected officials of the day may well choose inflation as their preferred escape hatch. While this is obviously unappealing to economists and the general public, it may prove to be popular with government officials. Regrettably.

When looking at past examples of deleveraging, The Economist tells us that, “Typically deleveraging began about two years after the beginning of the financial crisis and lasted for six to seven years. In almost every case output shrank for the first two or three years of the process.”

It continues, “big increases in public debt, while cushioning demand in the short term, increase the overall debt reduction that will eventually be needed. Once private deleveraging is done, the public sector will need to cut back.” And closing with, “Investors may worry about the sustainability of public debt long before private-debt reduction is over, forcing a lot of belts to be tightened at once. The most painful bits of deleveraging could well lie ahead.”

Thus, it seems that more respected voices than mine fear that this recession could run and run.

The part of this that never ceases to amaze me, is the capacity of politicians to avoid the reality. The pronouncements about the recession being over have slowed a little to my mind in recent weeks, but that might simply be a change in focus to Christmas and climate change. Of course, the sales numbers on the high streets of the world have had their temporary December fix and so consumer spending has - at least in the very short-term - come to the rescue.

But the article seems to suggest - though not actually say - that this process of debt repayment will have the effect of dragging the recession out for more years than we are currently hoping for. Of course, the economists are saying something slightly different, “If history is a guide, many years of debt reduction are expected in specific sectors of some of the world’s largest economies, and this process will exert a significant drag on GDP growth.” which I think is the same thing…

Thus, my thoughts remain the same, if slightly enhanced. I know that recommending yourself is no recommendation at all, but I shall end this post as I ended the previous post, “What this all means is that we all ought to be managing our finances as if we may never see the good times again and that things are going to get much worse before they get any better.”