Intersecting Minds: Education, Business and Technology at the North Carolina State Jenkins Graduate School of Management

Some Thoughts on the Economy | January 28, 2010

Last night, President Obama made his State of the Union speech to the nation, during which he spent nearly 30 minutes talking about jobs, the economy and our financial situation. He also outlined a number of initiatives to help create job and to begin reforming the financial system. Instead of breaking down those proposals though, I’d rather talk a bit about why I’m fundamentally pessimistic about any sort of near-term economic recovery.

It’s obvious to anyone who has been paying attention that the American economy is in real trouble. We are burdened by a debt level that will soon reach 100% of GDP. Unemployment is very high at 10% and not likely to come back anytime soon. The real estate market is still relatively unstable. While the stock market has had a nice bull-run, many analysts believe the Dow is oversold. And there are several advanced foreign economies (the P.I.I.G.S) who are also facing a pile of debt and the real possibility of becoming insolvent.

Lets break these down a bit. The debt in and of itself isn’t a direct or immediate threat to our situation, but as it continues to grow unabated, it will continue to exert more and more pressure on everything the United States wants to do, from funding services to fighting wars. While the debt level does not have an immediate impact on economic recovery, it sets the stage for later points.

The fallout from the financial crisis has devastated the American workforce. These massive lay-offs capped a decade that had net negative job growth. In other words, many of these jobs are gone forever. The manufacturing sector has been pummeled, but other service sectors have shed jobs as well. These jobs aren’t coming back.

Even worse, the financial crisis exposed a hard truth about America. We are broke. At every level of society, we are out of money. The federal government is broke. The states are broke. Individual consumers are broke. One direct consequence of this situation is that consumers aren’t spending money. Consumer spending is the engine behind the American economy, accounting for up to 70% of our economic output. Now people aren’t spending money, and if they aren’t spending money, then businesses can’t grow and hire more people. We are witnessing the deleveraging of 30 years of out of control spending, and it’s not a pretty picture to watch unfold.

This alone would be enough to make me pessimistic, but there’s more. The real estate market is still in a highly volatile state. Once the Obama administration pulls out the tax credits and the Fed stops buying Mortgage-Backed Securities, there will be a vacuum of demand created. Oversupply is still the primary threat to the housing market, and I wouldn’t be surprised to see further falls in real estate prices as those policies expire. Another real estate collapse would have a hugely detrimental impact on the recovery. More homes underwater, and more borrowers trapped with payments they can’t afford.

Finally, activity in foreign economies poses a real threat to our recovery. There are five countries in Europe, Portugal, Italy, Ireland, Greece, and Spain, collectively known as the P.I.I.G.S, whose debt situation has become critical. Greece in particular is dangerously close to declaring insolvency. Spreads on their short-term bonds relative to the German bund have grown to nearly 350 basis points, a clear indicator that the country is in financial ruin. If Greece were to collapse, it would send shockwaves through the financial system. A meltdown in Greece could have a domino effect on other advanced economies featuring a cycle of ratings downgrades, higher yields and even more printing of money to pay for all the interest. Rapid inflation is a real threat in this scenario.

Other advanced economies are in creaky shape too. The UK has a well documented debt problem. And Japan’s debt is now at 220% of GDP, and they have experienced over twenty years of anemic economic growth. This is why our national debt matters. We are more vulnerable now to financial and economic shocks than we have been in decades. It’s a scary situation.

When I put all these pieces together in my mind, I see a bleak situation. These are not short-term problems that can be worked out in a matter of months. Paying off debt takes time. Building new economic sectors that can provide real long-term job growth takes time. Letting the oversupply on the housing market readjust will take time. The 2000’s were a rough decade, but the 2010’s could be even worse.

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