Economic Risks and Potential Outcomes – Nov 2011

Guest Post that provides a high level of summary of systemic risk to the economy and the most likely policy and outcomes.

Risk Analysis

1. Unemployment is high. At 9% there are 13.9 million unemployed, while the broader measure of unemployed (U-6) is 25 million. While unemployment has been dropping at a snail’s pace, jobs are not being created at a sufficient rate to substantially reduce unemployment. New jobless claims have been hovering around the 400,000 per week for the entire year.
2. Real disposable income is falling.
3. Personal savings have fallen from a post-Crash high of 5.8% in June, 2010, to 3.6% as of Sept., 2011 because consumers are using savings to fund consumption.
4. GDP is static rather than growing and the latest Q3 boost will likely not continue. It is likely that the Q3 report will be revised downward.
5. Auto sales are related to pent-up demand and are not likely to be sustained.
6. The top 5% of earners account for 37% of all consumer spending and it they who are supporting consumer spending. I call this a “bifurcated economy.” There is no broad based consumer spending rally.
7. Household debt ($13.9 trillion) is still historically very high and has not been substantially reduced.
8. U.S. sovereign debt is 100% of GDP ($15 trillion and growing).
9. All government spending (federal, state, and local) comprises 45.6% of GDP.
10. The euro crisis will have a substantial impact on the rest of the world, including the U.S. That is difficult to predict, but we’ll know very soon. According to recent data, the world is heading into recession in almost all economies.
11. The federal government is currently running a $1.3 trillion annual deficit. 
12. Unfunded liabilities for Social Security, Medicare, and prescription drug (Part D) are $116.4 trillion and growing. This does not include the pending problem with student loans (Sallie Mae) or obligations to GSEs.
13. The MF Global problem is indicative of a declining economy. It is likely that in a growing economy they would have been able to ride out their crisis. In a declining economy, company weaknesses tend to be revealed, as with Lehman. That creates market uncertainty.
14. Oil price have risen from $40 bbl post Crash to $110 bbl in April, 2011, and presently are at $97 bbl. Such oil price increases are associated with and often presage recessions.
15. Bank balance sheets are still weak because they do not book asset values at market, they seems to not properly book troubled loans, and they are encumbered by a substantial amount of malinvested assets that have not been liquidated.
16. 47 million Americans (15%) are on Food Stamps. 48.5% of the population lived in a household that received some type of government benefit in the first quarter of 2010.
17. Americans’ are pessimistic about their future and the future of America according to almost all recent polls.
18. An angry and disaffected population in America is potentially politically dangerous. 

Potential Outcomes

In light of all of the above caveats about forecasts, here are what I believe may be a reasonable future scenario:

1. Recent indicators show that most major economies are slowing down, perhaps heading into recession.
2. The EU is in crisis and weak governments threaten to jeopardize the EMU and the euro. The remedies proposed by the eurozone require bankrupt states to cut spending and increase taxes. This will create economic disruption and economic decline in the countries being bailed out. Greece may withdraw from the EMU. Perhaps only Germany will avoid major problems.
3. If the EMU chooses to inflate (print money through sovereign debt monetization), the euro will continue to decline as the result of price inflation. But, it is likely that will only temporarily relieve the pressure on bankrupt countries and their creditors.
4. U.S. exporters will face declining sales as a result of economic slowdowns in their markets. Pressures on the euro may give the dollar a temporary boost.
5. The U.S. economy will decline and we will see this not later than Q2-2012.
6. U.S. unemployment will increase.
7. The Fed will engage in QE3 as a result of political pressure on them to act.
8. The Fed may charge interest on excess reserves to encourage banks to lend. This will have the opposite effect on banks as credit conditions will actually tighten as money is driven into Treasurys and similar investments. This policy will not create loan demand.
9. QE3 is likely to kick off another round of euphoria in the financial markets, but this time corporate earnings will not be found to support price levels. The euphoria will be short-lived.
10. U.S. savings will decline as consumers turn to savings to fund their living expenses.
11. U.S. banks will accelerate write-downs of CRE debt.
12. Housing will continue to decline in the most vulnerable markets and will remain stagnant in other markets.
13. Bank failures will continue at a steady pace.
14. Prices will start to rise, but the better measure of the declining value of the dollar will be reflected in the price of gold which will continue to rise.
15. At best, the economy will stagnate as monetary inflation continues to destroy real capital.
16. If there are successive rounds of QE, each round will be less effective as more real capital is destroyed, but it will result in price inflation.

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I have quoted just two sections, read the entire analysis here: http://www.zerohedge.com/contributed/economy-jeopardy