Friday, October 13, 2017
The Perfect Storm
Could a number of individual factors combine into a perfect financial storm? Possibly.
Poor Herbert Hoover. He has been vilified in the press and in the history books as either causing or aggravating the Great Depression and stock market crash of 1929. In reality, much of what happened during the Great Depression was already in the process of happening before he took office. However, his lack of action and some of the actions of the Republican Congress certainly made things worse than they had to be.
History has a way of repeating itself, although never in exactly the same way. The housing bubble of 1989 was similar to the housing bubble of 2008 but not nearly as large. There were differences between the two bubbles, the causes of them, the extent, and the resulting devastation. However there is an underlying pattern in both cases - people started to think that ordinary houses were more than just places to live, but instead as gold mines in their backyards.
Our economy and our stock market and our housing market are all cyclical. We even have names for this, we call the market a bull market when it is charging ahead and a bear market when it is falling behind - this is a known pattern throughout history. And usually a bear market follows a bull market in a very predictable pattern. And until very recently, we've been in a record-setting bull market that is going on since Obama's inauguration. What always follows a bull market? Always?
The question is, can this bull market continue forever, or will it retract? Are we on the cusp of a recession or on the edge of a new, even larger bull market that will allow the economy to take off even faster than it has been? Some on the Right think the latter - that unfettered by regulations and Obamacare requirements, the economy will take off like a rocket. Others, such as myself, remember what happened in 2008 when regulations on banks and mortgage lenders were reduced and all hell broke loose.
Sadly, I think we are in for a bear market, and for a number of reasons, not just one single one. There is not any single reason that will crash the economy in the short-term, nor do I think it will be a significant crash, but rather a small recession as we've had in the past. However, there are a number of warning signs which are very troubling.
Optimists will point to the low unemployment we currently have, as well as the record prices in the stock market, record prices for homes, and robust home sales. It would appear that the economy is going well. Cars are selling well and everyone has a job. But when you scratch the surface, you start to see some troubling signs of problems.
Consumer debt is at an all-time high, which is to be expected, as in an expanding economy, everything goes up in value over time. However a lot of this debt is to is for subprime loans, particularly car loans and also for credit cards. And the default rates are starting to ratchet up, and in fact, are pretty staggering. Bill Ford warned about this several years ago, when car makers started offering 7-year loans. This was longer than most people actually own a car, and forces them to be upside down on their car loan for a longer period of time. The net result is that people either default on their loans or are locked into a car loan for longer than they want to be and can't trade in and trade up to a newer car.
Or if they do trade in and trade up, they fold in the negative equity into a new loan which puts them either further behind the eight ball. Eventually, like a person taking out a payday loan, they default and end up in bankruptcy has one loan folds into another loan and eventually they're paying very high interest rates and owe more on their car than they possibly will ever be worth. This is a well-known pattern and I described before how a friend of mine did just that in the 1990's by going from car to car (which she never changed the oil on) and folded negative equity into higher and higher interest rates loans until she went bankrupt. She ended up marrying a guy from Saudi Arabia and is probably under a Burkha somewhere today.
Granted, unemployment is it all time record lows, but wages seem to be stubbornly stuck in the past. As a result, these very same people who are taking out these subprime loans don't have the income to service them. Something has to give, and banks are going to be stuck with an awful lot of bad debt.
But what about the rest of the economy? What about manufacturing and production? Well here, we are starting to see signs of trouble, an America's manufacturers are already sounding the alarm. The Trump Administration was elected on the promise of enacting punishing tariffs against our trading partners in order to protect and promote American industry. This is the core of Trump's "American First" policy.
We are seeing this already at the International Trade Commission, where the ITC is recommending a 200% to 300% import duty on Canadian build jet airliners. While arguably it is true that Bombardier is dumping these planes on the US market for below cost, or at least at a very reasonable price, there really is no competing American product that is being harmed by the sales. Boeing's argument the 737 is competitor for Bombardier's much smaller regional jet is someone specious.
But already, even the threat of these import duties is having the expected effects. The affected countries, which include not only Canada, but also Ireland and England, are promising retaliatory tariffs or trade actions which could damage the US and even Boeing in particular. Boeing is one of the largest exporters of American products technology, other than agricultural exports, and stands to lose a lot if our foreign trading partners decide to switch their allegiance to Airbus instead.
Moreover, since Boeing is also heavily into the defense business, sales of Boeing-made fighter jets and other defense products may wither as our trading partners decide to look elsewhere for their defense needs, in retaliation for the trade tariffs. Trade wars never end well for anyone.
This is a nearly exact mirror of what happened during the Hoover administration after 1929. In the olden days, Republicans stood for God, Country, and the Tariff. Tariffs were very prevalent early on in American history as a means of protecting American industry from foreign competition. In the infant days of our country, American manufacturing companies couldn't compete with cheaply manufactured British and European products, and the import tariff was seen as a way of allowing the nascent American industry to thrive.
But economists have argued that free trade is a much better alternative to restrictive tariffs. And they argue that restrictive tariffs end up tearing down an economy, not building it up. If each country has restrictive tariffs on imports, it doesn't necessarily mean that domestic industry will thrive, only that the cost of goods will soar in the economy be stifled. We see this in Central American countries, which often slap 100% import duties on automobile sales. If you want to move to Costa Rica to escape Donald Trump and retire on Social Security, you will find it very difficult to bring your car with you or have one imported, as it will cost twice as much as it does here in the United States. For that reason, you tend to see very small, inexpensive cars in Costa Rica, which often cost more than a Mercedes does in the United States.
And no, there is no car industry in Costa Rica that is being protected or is being promoted by these tariffs, it's just a means of the government to raise revenue. Trade agreements such as our North American Free Trade Agreement would actually allow the United States to sell automobiles into countries in Latin America, which would mean more profits for US manufacturers, which would then trickle down to shareholders and employees. However, these at the very same agreements that the Trump Administration is attacking.
The Pacific Trade Agreement is another example of this, which Donald Trump wrongly claims gives China some benefits. Sadly, many voters also believe this, even though China is not a signatory to the agreement and doesn't have any trade benefit from such an agreement.
The current solar panel cases before the International Trade Commission is another case in point. A small domestic solar panel manufacturing company is claiming that China is "dumping" inexpensive solar panels on the US market. They're asking for 200% to 300% import duty on Chinese-made solar panels so they can remain competitive. However if such a duty were enacted, it would not mean that American manufacture of solar panels would increase, only that people would no longer buy solar panels as they would no longer be cost-effective in terms of returning revenue for the dollar invested. Trump will basically kill off the entire rooftop solar industry in the United States as we know it, as well as a number of large-scale solar projects.
Of course, the Secretary of State is a former Exxon executive, so few tears will be shed when the solar industry dies a quiet death. If only they can figure out a way to destroy wind turbines - much as Donald Trump is trying to do in Scotland.
The death of the solar industry is probably not enough to tear down the United States economy by itself, but it could be a contributing factor, when you add in the cost of defaulted subprime loans as well as a trade war which would severely limit our ability to export products.
Of course, one of the problems that led to the Great Depression, or at least was an early warning sign of the impending doom, was the mass failure of American farmers in the 1920s. We tend to think of the Roaring Twenties is a great time where everybody went to speakeasies and shook cocktail shakers full of bootleg gin, while gangsters drove slick cars with whitewall tires and carried machine guns. It was the era of Flappers and Jazz and modernism. But at the same time, the Joad family was on the road to California after losing their family farm in the Dust Bowl. This preceded the great crash of 1929, although many people seem to remember it is happening later on in the 1930s.
We already hearing stories about American farmers struggling with overproduction, particularly of corn. We've become a one or two crop country, growing corn and soybeans and relying on genetically engineered crops and Monsanto Roundup Ready herbicide, which appears to be killing off anything that is not on Monsanto genetically engineered crops, including trees, flowers, and other plants.
While Monsanto's genetically engineered crops are unsuccessful, they're arguably too much so and now the farmers have too much crop and not enough market to satisfy the supply. If we get involved in a trade war with our foreign trading partners, they may in fact and enact heavy duties and import restrictions on America's largest export, which is crop foods. Trump's trade war will screw American farmers - and no, the "death tax" abolition will not benefit them at all, as farms are largely exempted from the Gifts and Estate tax already.
But what about manufacturing? Reports are coming in that manufacturers are expanding at a rapid clip and manufacturing growth is better than ever. On the other hand, we are hearing that automobile sales are in the toilet and even vaunted pickup and SUV sales are slacking off. General Motors is now offering 0% financing to move its most popular product - pickup trucks and SUVs. Ordinarily, these products have sold themselves and it is troubling that manufacturers are resorting to incentives to move their most popular iron off the lot.
Then there are the IPOs and the tech bubble. We are in an era where we have a lot of tech-that-is-not-tech that is being offered with IPOs for things like delivering food to your house. People have been delivering food for decades if not hundreds of years, we never thought of it as a technology. However today, since we do it from a cell phone app, we call the company a "Silicon Valley startup" and say it is worth billions of dollars. However, the number of people who want their food delivered as opposed to going shopping is far overstated. This and a lot of other tech-that-is-not-tech companies such as Uber (which is just a taxi company that is unlicensed and being hounded out of many of its jurisdictions) may fail in the coming years or at least be severely restricted or diminish in value. Much of these "tech" stocks are just wildly overvalued with P/E ratios in the hundreds or even thousands. Eventually some sort of comeuppance is due.
Again, taken by themselves, each one of these factors is not enough to crash the economy. But if all of them come together at once or at about the same time, it could be a perfect storm of economic malaise. The underpaid worker who hasn't had his salary increase in over a decade can afford to buy a $999 iPhone, much less call an Uber or have his groceries delivered. And this job may be on the line if he works for SolarCity or one of the other companies which may be affected by our trade wars, tariffs, or general economic downturn. This in turn again feeds the downward spiral.
UPDATE: From a personal perspective, the prospect of spending $14,000 a year on health insurance (thanks to Mr. Trump) makes me reluctant to spend money on things like new trucks or boats or whatever. The current economic climate and a President who is going to "give us what we deserve" in terms of health care (which sounds more like a threat of punishment than a promise of good) is putting me personally in "hunker down" mode. I am selling more stock while the market is at all-time highs.
Then there is NAFTA. If we abolish that, it will disrupt the economy in several ways. American farmers could find duties as high as 75% on their products exported to Mexico and Canada, and American car makers will have to scramble to find parts to assemble their cars. Of course, by then, no one will be buying anyway, right?
Oh, shit, this does not bode well!