The Everyman Economist

This week’s downgrade by S&P contains one significant message that must be corrected very soon by the Everyman. The US is experiencing a temporary loss of pragmatism in its body politic and the situation must be reversed quickly or we will suffer dire consequences. In simple terms, our nation could ALWAYS be counted on by the rest of the world to make sensible, reasonable and timely decisions. But that is not currently the case. Because of the rise of a small group of Congresspeople who refuse to follow the basic rules of pragmatism and compromise, the world is no longer assured that we won’t go off a cliff and take everyone else with us. Default was an acceptable path for the extremists in Congress and that was sheer lunacy. Raising revenues of any sort at any time was not an acceptable path for the extremists in Congress and that was sheer lunacy. Not touching entitlement programs was an acceptable path for the extremists in Congress and that was also sheer lunacy. If the Everyman does not rid Congress of these extremists on both the left and right, we are sure to see more downgrades and much worse. We live in difficult times and NOW is when we need sensible leadership to pave the way for a reversal of our misfortunes. Pragmatism and compromise are the hallmarks of America and the Everyman needs to get us back there as soon as possible. The Everyman must vote the extremists out and bring our nation back to the high perch where we belong.

The Everyman all over the world shares in the grief that is ravaging Japan today. We wish the people of Japan a speedy recovery from their historic catastrophe and we hope that they get through these dire days very soon. There is much rebuilding ahead, but the Japanese can never rebuild the human loss which will stay with them forever. Some Japanese pundits are calling these events “Japan’s 9/11″ and we Americans can certainly relate. Our hearts are with the Everyman in Japan and we will pray for his and her safety and security.

Many Everyman have asked what the situation in Japan means for the rest of the world. While it’s too early to know for sure, there are some conclusions we have reached and would like to share.

First, Japan is the 3rd largest economy in the world and the triple blows of earthquake, tsunami and nuclear uncertainty will definitely impact their economy for a very long time. With events still unfolding, it is impossible to predict how deep a problem this will be. However, for the immediate future, the psychological and physical damage will bring the Japanese economy to a virtual standstill. That is exactly what happened in the United States after 9/11 and there’s no reason to believe it will be any easier in Japan. And if Japan comes to a standstill, there is danger that every other major economy will suffer severe consequences.

Second, demand for oil and energy will be down significantly across all of Japan for the foreseeable future. The decline in oil prices over the past week reflects that situation. Although the loss of nuclear facilities may mean less power and energy from that single source, an overall economic slowdown will more than offset that issue. Furthermore, demand for all economy-related commodities will be down significantly as well.

Third, the rebuilding process in Japan will take many years. Since the scope of the nuclear problem is still not completely defined, it is likely that Japan will face extremely difficult times ahead and things will be worse than what anyone can now predict.

Fourth and most importantly, as Japan goes….so goes the world. The fallout from the multiple Japanese problems will have many repercussions all over the world. Here in the US we should be concerned about the impact on our own economy for a myriad of reasons. Japan is one of the biggest buyers of our debt and what will happen to that situation going forward? The US trade deficit with Japan is about $50 billion and what will happen to that situation going forward? And what will happen to all of the US based multi-national companies that have huge exposure in Japan? The answers are far from certain, but the downside for the US economy, as well as the rest of the world, is very real and we must be careful not to underestimate that downside.

We are in the business of selling coins. We are supposed to be bullish on Gold and Silver and we are supposed to tell the Everyman that he must have some of each in his portfolio. But let’s forget the “supposed to” for the moment and focus on both sides of the issue.

Truth be told, this is a moment in time when certainty is far from certain. There are strong arguments for owning precious metals, but there are negatives as well. We will try to lay out the picture for you and the rest is up to the Everyman.

We have been bullish for quite some time on precious metals. In fact, we believed in the upward trajectory of Gold and Silver since the earliest days of the bull market, nearly 10 years ago. But the cycle has matured and it’s prudent to take a fresh look, so let’s begin with the positives. Gold has become the world’s global currency. Once upon a time the US dollar was king, but no more. Geopolitical forces, economic forces and the health of the US financial system have all brought pressures to bear on the US dollar. And let’s not forget the US budget deficit. At more than $1.2 trillion, it does not argue strongly for the former king. But the alternatives are just as problematic. Asia is far from stable, Europe is fracturing, with financial crises hitting Ireland, Portugal, Spain and Italy, to name a few. Wherever you look, national currencies are under fire. As a result, Gold is the de facto global currency and it is not debatable. It may not always be the case in the future, but for now we’re stuck with it. That alone is a very bullish argument for Gold at a time when the entire world’s problems are percolating. And Silver is not much different. With Gold near $1400 and Silver near $30, it’s no surprise that more interest would suddenly be brewing in the cheaper metal. Exchange Traded Funds (ETF’s) have been gobbling up Silver and pushing prices higher and higher. It may have taken many years for Silver to advance from $10 to $20, but it has taken only months to get to $30. As alternative investments, Gold and Silver have brought their owners higher returns than virtually all other options. While the party goes on, and while the bigger picture stays muddy and treacherous, why give up on metals now?

Which brings us to the negative side of the issue. Some of the world’s largest investors in precious metals have have recognized the bubble environment. While they hold vast positions, they also fear that the bubble could burst at any time. Markets tend to get overdone and who knows when that situation will play itself out. The US economy is showing signs of life and interest rates are already aching to go higher. Congress has recently provided new stimulus by maintaining the Bush tax cuts and with any positive movement on the deficit front, there will be several important factors in place that will provide continued strength to the US dollar, which would mean weakness for precious metals. We are in the early days of this scenario, but it all bears watching. So what should the Everyman do? It’s still prudent to hold Gold and Silver in his portfolio. The momentum is still in place, but it’s also time to be nimble. Pay close attention to new developments and be ready to pull the trigger as life unfolds. We live in uncertain times, so it’s better to remain uncertain right now than to buy into the Bulls or the Bears.

Short and sweet. The economy is coming back. The Everyman is coming back. In due course, employment will be coming back. So what should we expect in the near term? The US securities markets are expecting the FED to embark on a new course of QE or quantitative easing and interest rates have been falling in anticipation. What does this mean? Since the FED’s benchmark Fed Funds rate is already at zero, the FED does not have that tool at its disposal to influence rates and the economy. As an alternative, the FED can buy large volumes of securities in the open market, thereby driving down rates on these securities and forcing all related rates to go down as well, particularly mortgage rates. This is known as Quantitative Easing (QE) and since the FED has done this once already, you are now hearing about QE2. That’s not a cruise ship, it’s the second round of QE. So will the FED actually do QE2? Frankly, it doesn’t matter much at this point. It’s already built into market rates, so if they do QE2, interest rates will likely rise afterwards because QE is never as much as the markets anticipate and they will be disappointed. If the FED does not do QE2, interest rates will rise as well because the markets will be left holding securities at unreasonably lofty prices. In either case, it doesn’t matter because interest rates will be going higher over the next 12 months no matter what. Why? Because the economy is much healthier than anyone believes right now and we don’t need any additional stimulus…..FED, political or otherwise. Clothing retailers were expecting soft September sales figures and instead they just released numbers that show the consumer was buying strongly. And that will continue. We said it before and we’ll say it again….the Everyman is coming out of hiding and the US economy is in a slow and steady recovery. You will see more signs during the holiday season and things will fall into place more and more. Unfortunately, housing will remain subdued for an extended period, so that’s not what the Everyman will depend on in the future. Instead, he is more flush than at anytime in the last 10 years and he will exercise his buying power when opportunities are right. That means subdued prices, not runaway oil, gold, etc. In fact, the dollar will reverse course soon, as the QE2 issue disappears. Europe has its own problems and the Euro at 1.40 to the dollar is an absurdity. So now is the time to get positive on things and sell ALL of your US securities. You will have lots of better opportunities to reload way down the line, but not when 10 year notes are 2 3/8%, which is sheer lunacy……..

The Everyman has been in hiding. All things negative have been thrown at him for almost 2 years now and the time has come to see the light. After paying down debt in record numbers, after saving in record numbers and after withholding spending in record numbers, the Everyman is now at a point where the government wishes it could be. There are still some clouds lingering and the stench of the last 2 years is hard to overcome, but the future is brighter and there is reason for hope. The financial system is healthier, there is more money available than ever before, and the Everyman is in a better place. Almost 2/3 of the US economy is driven by the Everyman. As the Everyman goes, so goes the economy and the Everyman is now ready to re-emerge. All else will follow from there. Jobs and hiring are lagging indicators, so you won’t see improvement until companies are convinced that the economy is moving forward. And the economy WILL move forward as the Everyman leads the way. Forget the talking heads who make good TV by predicting another recession. In an environment filled with uncertainty, these so-called pundits create more anxiety and simply delay the inevitable. But reality is in place and even the pundits will be pushed aside. Time is always necessary to cure wounds and we’ve had plenty of time to get the ball rolling. Record low interest rates, government spending and incentive programs and a better regulatory environment will ensure that the Everyman has a fair following wind. The upcoming holiday season will be stronger than anyone is now predicting and just watch all the naysayers rush to make amends. It’s interesting how major market turns are often accompanied by bubbles and this time around is no exception. There is a bubble of negativity and it will soon be popping as the Everyman comes out of hiding. It’s meant to be and it’s going to be, so start your engines now….

What is it with politicians? I know they’re human, just like the Everyman, but I thought we elected these folks for their judgment and wisdom. It’s not the sexual meanderings that bothers me. What they do in private, should stay in private. But the total hypocrisy of these guys is pitiful. The Spitzers of the world crusade for justice, all the while frequenting the same madams and prostitutes they’re arresting. The Sanfords of the world preach family values, all the while breaking marriage vows and skipping out on their kids. And we have to ask “should they resign?” Of course they should resign! We did not elect these people to be our role models, but we certainly didn’t vote for them to be our hypocrites either. If a politician wants to visit a prostitute, fine. But he better not be banging down the door of every brothel in New York, looking for criminals. Because when someone bangs down his door, he’s the next criminal they’ll find. If a politician wants to visit his gal pal in Buenos Aires, fine. But he better not be preaching about the sanctity of marriage and family responsibilities. Need I say more?          

In case the Everyman hasn’t noticed, medium term and long term interest rates have been skyrocketing for the last few weeks. Ever since the day the Fed announced that they would enter the market to buy securities and rates dipped briefly, they have reversed course. The rate on 10 year US government securities is nearly 4%, which is up from 2.25% earlier in the year and even 5 year securities which were as low as 1.38% earlier in the year, have now climbed to almost 3%. These are massive moves, especially without any real changes in the economy, so why has it happened? And will the impact on mortgage rates, which have also risen by about 1%, hurt an economic recovery?

First, a little background information. We’ve probably seen the worst of the downturn in the economy, so it’s no surprise that most markets are in the process of consolidating their huge declines. Stocks are up, oil is up, commodities are up and the dollar is down. This is all part of the normal process that markets should go through after the recent global financial meltdown. But make no mistake about it, many markets are now in the process of believing their own baloney. After the Dow bottomed at about 6500 and now has climbed to 8500, there are lofty predictions of a new bull market. The same is true of oil, metals, and many other markets. Unfortunately, the big picture scenario does not support this thinking. The economy is just too far from health and is very susceptible to aftershocks from every direction. Whether it’s the auto industry, consumer debt, private and commercial real estate or interest rates, the economy needs a lot of good things to fall into place and they are just not happening yet. The markets may wish it to be, but wishing and hoping does not make for sound investing.

And that brings us to interest rates. The securities markets are about to be overrun by new supply. All of the government spending that we’ve seen over the last several months will get paid for by issuing securities. With a deficit the size of the Grand Canyon, that means there are a lot of securities in the pipeline. The more securities, the more upward pressure on interest rates, as they seek a price level where the supply can be absorbed by investors, traders and foreign governments. You can throw in predictions of runaway inflation and a collapsing dollar, and interest rates have a steady stream of bad news to deal with. In all likelihood, rates will top out for the short term near their current levels. Any more climbing and whatever plans the Obama administration has for an economic victory celebration will have to be put on hold. So the environment will take care of itself and rates should settle down soon. They will not likely fall too far, however, and they will continue to be plagued by supply and demand issues, but the economy will be the big determining factor. Choke off a recovery and we will see lower rates again and quickly. The recovery is not yet guaranteed and even if it was, it would be feeble at best, so don’t expect rates to soar much more.    

Just when the Everyman thought that the financial system had learned its lesson, here we go again. The traders are at their old games and the markets are acting like we’re back in the chips. We’ve just come through the worst scenario since the Great Depression and nobody can seriously believe that we’re off to the races, or can they? Well apparently the pundits, the pros and the posers can. In their views, we’re either in a raging bear market or a raging bull market, and nothing in between. Stocks can go from 14,000 to 6,500 and back to 14,000 again…oil can go from $147 to $33 and back to $147 again…and so on and so on and so on. Of course when you can leverage yourself 10, 20, 30 times or more, you can force things your way for a time and that’s where we are once again. The same people that did it to us before are at it again, but this time we have to put a stop to it. The global economy isn’t suddenly growing by leaps and bounds, yet oil is nearly double in price in a few short weeks. If we don’t regulate these guys soon, we’ll be back to $4 a gallon, but this time we won’t have the jobs and income to pay for it. Enough is enough. It’s going to take a number of years to get through these dire times and we don’t need the same old overzealous risk mongers running loose in the markets. It’s time to grab them by their necks and slow them down before they take us all down with them. Where is the regulation we were promised and when will it begin? It better be soon or we’ll have an even steeper price to pay than we’ve paid already. Call your Congressperson, your Senator and anyone else who will listen and demand the regulation the markets need NOW!   

Back in the 1940s, the Everyman could buy a house in the USA for $5,000 to $10,000. Even at those prices, however, there were naysayers who suggested that a house was a bad investment. In 1947, Time magazine wrote “the prices of houses seem to have reached a plateau, and there is reasonable expectancy that prices will decline.” In 1948, House Beautiful magazine further opined that ”the days when you couldn’t lose on a house purchase are no longer with us.” As if those thoughts weren’t enough, the view of Science Digest magazine in 1948 was that “houses cost too much for the mass market…..with the average price around $8,000, it is out of the reach for two-thirds of all buyers.”

So much for the naysayers of the 1940s. But the doom and gloomers continued to shout from their rooftops during the 50s, 60s, 70s, 80s and 90s, consistently warning the Everyman that the value of their homes would collapse.

At just about the turn of the 21st century they all stopped shouting. Instead, they were buying. They bought houses to live in, houses to vacation in, and houses to invest in. Credit flowed like tap water and it was easy to buy a house in any price range with virtually no money necessary. Suddenly, there was no doom and gloom, only blue skies and a warm sun.

And then it happened - the greatest housing collapse in US history and all the pain that went with it. And where were the naysayers? Right alongside the Everyman, in deep financial distress and with very little hope.

There are only a few examples of major market collapses throughout our nation’s history, but they all share one thing in common. A recovery followed each collapse, but it took many years to unfold. And so is the likley scenario with our current housing situation. There are already signs that prices in the lower end of the market may be bottoming out, but don’t expect too much more than that for quite some time. You will definitely not see those lofty prices of 3 years past and you might NEVER see them again. And here’s why.

Through the decades since World War II, the Everyman has seen continued increases in income. This consistent pattern has been the foundation of our economy and our spending. As long as we see our incomes growing, we buy. Unfortunately, we reached the heavens at least 15 years ago. Not every Everyman of course has achieved his greatest potential, but salaries overall have been bumping up against absolute ceilings for almost 2 decades. It was the housing bubble that gave the Everyman reason to buy well beyond his means, as he borrowed against the “implied” equity in his home. We know what happened next. Even with some future inflation, it’s impossible to envision an income explosion that would blast us back to and through the housing prices that we experienced a few short years ago.

And then there’s demographics. The baby boom population is huge and it’s aging fast. An overwhelming number of these boomers are owners of larger houses where they raised their kids and sent them off to college or work. Now they’re sloshing around in these big old houses and they want out. There are too many bedrooms, too much grass to mow and just too many expenses. But they can’t sell. Their neighbors are just like them and the youngins certainly can’t afford to pay the prices. So the prices of these larger homes have no place to go but down. The youngins are looking for starter homes and that market has already seen some large declines. With mortgage rates now below 5% and the government providing financial incentives, they are picking away at their first time home buying experience. They can finally afford to consider owning a house, even with a 25% downpayment. As a result, prices in the lower end of the housing market are beginning to bottom out and that’s good news. But that’s all the news. Everyone in between the top and the bottom is on hold. There are too many houses at the upper end that won’t sell and with the only buyers at the lower end, the mid-range housing market is a disaster. This is the harsh reality that won’t disappear any time soon and we have not seen the worst of it yet. Only after the economy goes into full recovery mode will the homeowners in the middle begin to see movement. Not so much in price, but at least some buying will return to the market and stabilize prices.

And that is the short to medium term outlook for housing in America. The highest end will always attract the rich and not many of us care what happens there. The high end for us normal folks will have a glut of baby boom houses for sale, with virtually no buyers in sight. The low end will continue to attract our kids, as they begin to make their way in life. And the middle range will be stuck in the mud. When the smoke clears, a house will be a place to live and anyone who is lucky enough to turn a profit will have icing on the cake. Otherwise, you can think of your home as you would think of your car. They are both necessities at some point, they are likely to be declining assets, and they both require a fair chunk of change to afford. Sorry, and I may be wrong, but the future of housing is no longer bright.         

The Everyman has been stirred up by the usual naysayers who are pointing the finger at the new Obama proposed budget. “Look at those 8,000 earmarks,” they’re saying. “What a travesty,” they’re saying. But here’s the truth. Earmarks are the only real expenditures in the budget that have a legitimate right to be there. “How can I make such a claim?” you ask. Let’s see.

There are 435 Representatives of the Everyman in the House and 100 Senators in the Senate. These politicians all represent only one constituency - us - that’s you and me. We elected these guys and we expect them to do our bidding in the sacred chambers so we get bang for our bucks. If we need a traffic light on the corner where we’ve seen kids get hit by speeding automobiles, we expect these politicos to get it for us. If we need a highway to help move traffic in our neighborhoods away from the busy streets, we expect these politicos to get it for us. If we need scientific research to help us learn about a disease that’s ravaging our families, we expect these politicos to get it for us. And yes, if we need a study to determine the effects of sewage on our local wildlife, we need these politicos to get that for us too. In short, the reason why these guys are all in Washington in the first place is to make sure that our local interests at the community, city and state levels are all looked after. And that’s why we have earmarks. Some may call them “pet projects” but I prefer to call them “necessities.” Now, among these earmarks you will find some that may not suit your appetite or interest, but without all the facts, you can’t possibly know why they’re there. And what’s more, it doesn’t matter because they have always been there and will always be there so we can all get what we pay for.

This may not all sound very appealing to Everyman, but you can be sure that without earmarks, the federal government will be spending our money on only those things that THEY think are best. Earmarks are a  miniscule piece of the budget and they help ALL of us have our voices heard. The politicos of both parties spend too much time demonizing what WE believe is necessary and riling up the Everyman for purely political purposes. Tell them all to Shut It! Get us our traffic lights first and then we can worry about some guy’s bonus at AIG.