John Mauldin, one of the more astute observers, may have been the first to dub this the "Muddle Through Decade". Mauldin accepts many of the negative points made by his Austrian-school oriented friends but somehow counterbalances their arguments with a fundamental appreciation for the enormous expansionist momentum (our words, not his) of an American-led world economy.
For many of those (highly bearish) Austrian-school fundamentalists, we have already been moving headlong into a precipitous imbalance for more than a decade. They see a perilous world economy buoyed by one more dangerous gimmick than the prior.
Their great villain is, of course, Fed Governor Greenspan, who through the manipulation of one market after another, has been the chief priest of this cult of irresponsibility. It was Greenspan, after all, who blew into the pipe of the great Tech Bubble of the late 90's thereby allowing stock valuations to reach unmaintainable levels. For the critics, a wiser steward would have held back after the crash and allowed those same corporate equity values to wind down to levels in line with profits thereby laying the groundwork for a soundly based re-expansion. Greenspan's second deadly sin, in their eyes, is the great asset/debt bubble that was unleashed by the Fed after the Tech Bubble burst as the central bank yanked down interest rates to negative levels in real terms in order to stimulate widespread debt while encouraging the Administration to pursue a course of reckless deficit spending.
As frustrated Cassandras, the sound-money bears have stood on the sidelines pointing to the flight of US manufacturing capacity and jobs, the increasingly massive trade and current account debt, the impending shortages of basic commodities like petroleum, the grievously poor quality of the growing number of loans being issued by US lenders, the suspicion that huge pools of funds are under the trigger-finger management of largely unregulated, potentially irresponsible hedge funds, and any number of other risk factors, not least of which, the eventual impact of a costly and extended, and ultimately unpopular war.
The bulls and Administration cheerleaders, not surprisingly have seen these last couple of years in a positive light even if the stock markets have somehow not quite got the message, something that never fails to baffle them. The bulls have focused on positive, slightly above average GDP growth over the period, strong corporate profits, positive job growth, low unemployment numbers, the positive effect of the bump up in housing values and associated business and job activity, and the great growth stimulus being provided to the world economy by the emergence of India and China as economic powers. They see only the demonstration of the real economy's resiliency in the face of rising petroleum prices, the negative impact of the War, the recovery from 911 and the Tech Bubble, etc.
Mauldin's muddle-through scenario gets played out over and over again in the financial pages of the world's press. On any given day we can see the announcement of fairly positive job numbers on one page and pictures of over 10,000 people waiting in line to get 400 minimum wage jobs at a newly opening Wal-Mart, as we did last week, in Oakland, just across the bay from Silicon Valley to the south and San Francisco city where house prices are so high that nearly 70% of the population rents.
The disconnect is so extreme that it can get surreal. It may also be reflected, quite ironically given the way it shakes out, in the Blue-state Red-state line-up of the present political equation. Real wages in the US have been stagnant since the 1980's (especially in the red state heartland) while CEO salaries have grown a thousand fold. Corporations and the wealthy (based mainly on the blue-state left and right coasts) also have benefited from greatly reduced tax rates. The War and rising oil prices have also fattened the portfolios and wallets of plugged-in segments of the population, located mainly along the coasts. At the same time, outside the public sector, the labor unions have never been weaker since the Second World War.
The bulls await the kick-in of a second wave that takes the relatively narrow stimulus of low taxes, deficit spending and the housing "boom" and turns it into a broad recovery that will last for years boosted further as oil prices finally recede along with the financial and psychological costs of the War. The bears await the impending collapse of the housing bubble --signaled, once again ironically, by their boogey-man Greenspan in a speech this week-- the swooshing sound of foreign capital as it pulls out of the US financial markets unleashing the full weight of the accumulated foreign and domestic debt of the last few years and the death by a thousand blows of a moribund economy they'd liken to Terry Schiavo.
The muddle-through argument relies, despite the raft of acknowledged problems, on a belief in the positive momentum of an ungainly but nonetheless growing world economy, the basic strength and ingenuity of the American workforce and the bet that in times of real stress, it's more likely that capital will flow into the relatively safe haven of US capital markets rather than in even more perilous opposite directions. The US, they argue, is the engine of the world economy, it's in everybody's interest to keep it on life support even if the Fed walks away. In a muddle-through world, there is more productive capacity than customers, prices for many items remain down --see GM's move to (permanently, our words extend its employee discount-- as do interest rates as capital seeks but cannot find high return investments thereby forcing governments to fight deflation by issuing even more cash.
For the time being, the muddle through equation seems to be holding: markets go sideways, up and down almost in random patterns, and foreigners continue to cover our excesses by recycling their dollars back into US securities. Just this week, the Wall Street Journal pointed out that even as US mortgage loans get issued to riskier and riskier borrowers (40% percent of all new mortgages are in this category), the market for REITs --the securities that back these loans and make it possible for the banks to issue them while shedding the risk-- remains strong, even growing in popularity with the Asian bankers who seem to hold the key to the low interest-rate economy we now live in.
The Fed will continue to push up rates until as Greenspan said in Jackson Hole somewhat forkedtonguedly: "If we maintain an adequate degree of flexibility, some of America's economic imbalances, most notably the large current-account deficit and the housing boom, can be rectified by adjustments in prices, interest rates, and exchange rates rather than through more wrenching changes in output, incomes and employment."
In other words, Greenspan, now zigging to cover his backside, will have higher prices, higher interest rates and a lower dollar while avoiding a bust that's sure to follow. That's what we call hyper-flexibility here in Dymaxia.