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Newsletter July, 2011

July, 2011

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In the second quarter, the economy continued its pattern of fits and starts. Just when things appeared to calm down from the last round of contagions, the economy showed new signs of weakness, with a wide range of indicators--including employment, industrial production, retail sales, purchasing manager surveys, auto sales, and various housing metrics--all registering disappointing results.  After solid first-quarter gains, the market rally continued through April, but hit a wall in May and slid for a record seven weeks straight.  A run in the final week of June pushed the Dow and S&P 500 just into positive territory for the quarter.

We can all agree that the circumstances leading up to the Great Recession and its aftermath were a long time coming.  As such, we are left to deal with a combination of short-term cyclical dynamics in our attempt to regain current economic stability, but on a deeper level, we must also face some inevitable structural truths.  As the markets and the economy weigh these short and long-term issues and proposed solutions for dealing with them, they react accordingly causing reoccurring waves of volatility.  These cyclical and structural dynamics appear in most of the important economic metrics, but we would like to focus on jobs, the European credit crisis, and our national debt.

Where are the Jobs?

The recession was devastating to our employment picture with a net loss of eight million jobs, leaving the nation with a total number of unemployed workers at over 15 million.  While we have seen some positive momentum at times in this recovery cycle, they have not proven sustainable to date. The June employment report was unexpectedly dismal with job creation coming in at a mere 18,000, well below even the most pessimistic estimates with no growth in hours worked or wages.  Additionally, the Labor Department lowered its previous estimates for May by over half.   The most concerning fact is that after surging to more reasonable levels above 200,000 jobs per month, both the May and June reports averaged just over 20,000. This represents annualized growth of 0.2%, which just isn't consistent with any reasonable level of GDP growth.

The structural problems with our job market have been building for years.  The dot-com bust was our first sign that all was not well in our employment structure, but this was obscured by all the jobs created and sustained during the housing bubble. Since the bubble burst, no other industry has emerged to soak up these workers.  Meanwhile, most anyone employed by multi-national companies over the past twenty years, other than on Wall Street, has seen the number of workers at their US facilities shrink while overseas subsidiaries have been hiring and building new plants and tech centers.   The crux of this vital issue is one of appropriate retooling of our current unemployed and a revamping of our educational system that addresses the needs of our employers.

In The World is Flat, author Thomas Friedman provides a frank discussion of the structural issues America faces regarding competition and education, while exploring the “right stuff”; the educational requirements needed to survive in the flattened world and more importantly, the availability of said education in our current system.

Bond guru Bill Gross of Pimco funds weighed in on this issue with a scathing commentary about the state of our educational system as it relates to future jobs in America as well as the problems with our chronic unemployed.  According to Gross, “A mind is a precious thing to waste, so why are millions of America's students wasting theirs by going to college? All of us who have been there know an undergraduate education is primarily a four year vacation interrupted by periodic bouts of cramming or Google plagiarizing, but at least it used to serve a purpose”.  He goes on to say that, “Those who advocate that job creation rests on corporate tax reform (lower taxes) or a return to deregulation of the private economy always fail to address dominant structural headwinds which cannot be dismissed: 1) Labor is much more attractively priced over there than here, and 2) U.S. employment based on asset price appreciation/finance as opposed to manufacturing can no longer be sustained. The “golden” days are over, and it's time our school and jobs “daze” comes to an end to be replaced by programs that do more than mimic failed establishment policies favoring Wall Street as opposed to Main Street.”  Surely Mr. Gross is not indicting the whole college undergraduate mechanism, but his inflammatory statements underscore a real problem with the fact that our educational system is simply not producing enough of the skill sets that America needs to continue to grow and compete globally.

Author and pundit Fareed Zakaria agrees saying, “We need a program as ambitious as the GI Bill, but one that focuses on retraining existing unemployed workers and redirecting our future students.” Instead of liberal arts, he suggests focusing on technical education, technical institutes and polytechnics as well as apprenticeship programs. “Our penchant for focusing on high tech value-added jobs should be modified and redirected to mimic the German path, which allows people with good technical skills but limited college education to earn a decent living.”

Finally, economist David Rosenberg had this to say about our chronic unemployed, “I'd have a shovel in the hands of the long-term unemployed from 8 am to noon, and from 1pm to 5pm I'd have them studying algebra, physics, and geometry.” Deficits are important, but their immediate reduction can wait for a stronger economy and lower unemployment. Jobs are today's and tomorrow's immediate problem.

The current administration seems to be focusing its energy on sustaining the unemployed with little attention to retraining or changing our existing educational system.  In fact, the administration has grown intensely protective of growing the federal financial aid system that allows students to bury themselves in debt to pursue degrees that, for many, provide little benefit in securing improved future employment.  If we are going to find a long-term solution to the structural employment problems, it is critical that we retrain those unemployed who lack skills and provide our young people with an education that matches their skills and abilities with the needs of employers.

Greek Tragedy and the European Model

The European debt crisis continues to be front page news as the world focuses on the failure of the Greek economy and the contagion effect that has already spread to Ireland, Portugal, Spain and is now engulfing Italy.  The heart of the matter is that the Greek government simply cannot pay its bills. In April, 2010, the Greek government requested and received a $159 billion bailout from the European Union and the International Monetary Fund to allow Greece to avoid default, get their house in order, and prevent the spread to other European Union members.   Just fourteen months after completing this initial package that failed on all three fronts, European political and economic leaders are working frantically on a second Greek bailout package of around $150 billion to keep Greece from defaulting.   The country's national debt, which is currently around 115% of GDP, is projected to rise to 149% by 2013 despite these bailouts.

Greece’s circumstances are symptomatic of the larger structural problems that have emerged in economies built on the European economic and social model.  The European Model is generally described as the combination of high taxes, comprehensive welfare systems and government mediated relations between employers and workers that developed after WWII.  Society takes broad responsibility for the welfare of individuals and reduces their risks by protecting against poverty and providing support in case of illness, disability, unemployment and retirement.   The government obligation created by this promise of benefits is pushing many of these countries to the brink of insolvency.  As bond buyers have become increasingly reluctant to provide financing for the government debt, the cost of borrowing has increased making the situation worse.

Inherent in this system is the fact that it limits the incentive to be productive.  Those who are most productive are penalized by income redistribution through high taxes and those who are non-productive are subsidized.  This inhibits productivity which is the fuel for the economic engine that creates the revenue to pay for benefits.  The false assumption is that all participants in the economy will be productive to their fullest potential in the absence of adequate incentive.

The Struggling US Model

In a perfect world, governments have small budget surpluses, have no debt and accumulate positive reserves.  The reality is that most governments are forced to periodically run budget deficits as a response to recessions that occur in normal economic cycles.  Philosophically, there is no reason to accumulate permanent debt.  Yet, through poor leadership and decision making, the United States finds itself with a growing debt balance as a percentage of Gross Domestic Product approaching that of Greece.   The current debt ceiling debate is academic and largely political.  The fact is that the debt ceiling has been raised ten times in the last ten years and has been approved by both Republicans and Democrats in control of the House and Senate at the time.

Our chronic deficit spending has resulted in a structural debt problem to which there is no painless solution.  The current budget deficit, exceeding government revenue by more than 40%, is largely driven by mandatory spending for programs such as Social Security, Medicare, Veteran and Civil Servant Benefits, Medicaid, and Federal Student Aid.  These expenditures consume approximately 57% of the current budget and most of current revenue.  The rest of the budget is allocated approximately 5% for interest, 22% for military and 16% for remaining discretionary spending.   Even the most optimistic projections show our deficit rising to well above 100% of GDP.

The cyclical issues in our economy pale in comparison to the structural monster we have created.  Despite this fact, our legislators seem unwilling to tackle these issues in a meaningful way.  As the baby boomers continue to reach retirement age, the hole will grow deeper and deeper if it is not addressed.  Everyone acknowledges the need for change, but very few are willing to accept less.  One thing is certain; most of us will not be able to count on the benefits that have been promised.  If we want to avoid a Greek-like ending, we have to make fundamental changes to our educational, political, and social welfare systems now.

As citizens, each of us has a duty to be part of the solution by demanding responsible change at the political level and doing our part to keep this country great.  On a personal level, you have the same duty to your family and yourselves to be excellent stewards of your wealth.  It is our job to make sure you do this in the most efficient and effective manner.

This country was built on thrift, discipline and creativity; a return to these same virtues will assure us all a bright future.

We appreciate your continued confidence in our services!

Wealth Dimensions Group, Ltd.

Investment indices are represented by the S&P 500 and Dow Jones Industrial Average. Performance of these indices is not indicative of any particular investment. The indices are unmanaged and individuals cannot invest directly in any index. The Barclays U.S. Aggregate Bond Index is comprised of a variety of taxable bonds, and is used as a measure, or benchmark, of the US bond market. No strategy including diversification can guarantee a profit in a down market. Past performance does not guarantee future results.