Bad Times are on the Horizon

July 16, 2010, 12:26 pm ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

I am becoming increasingly concerned about the Austerity measures in the world economy.  From Greece to the United States, and virtually everywhere in between, countries are talking about prudent fiscal policies.  However, when those discussions are being had, the resolutions always fall short of what we know as responsible.

As responsible citizens, we all realize that we cannot live with high levels of debt.  Those that do struggle every day.  Those who do not have debt are freer.  Then there are those who have recently come out of debt, and they are breathing a sigh of relief.  Those persons know what it takes to overcome debt burdens, but the government does not, not yet.

Paying down debt does not mean assuming less debt.  Paying down debt means reducing debt, and that means creating a surplus first.  In order for normal people to pay down debt, they must have free cash flow after expenditures.  The same holds true for Government.   This is a simple economic law, and a preliminary proof in any economic theory course.  Debt cannot be reduced without first having positive free cash flow.  The Global Economy does not have positive free cash flow.

The reasons are numerous, and they all are political.  I realize that Religion and Politics should never go together, but maybe Politics and the Economy should not either.  Requiring Politicians to not only have a great speaking presence, but also a background in economics and business would make the world a better place.   Imagine, for example, all of the assistance we could provide to the needy if we were not burdened by debt.

Therein lays the issue, and the problems the World is facing.  The debt is so massive that the world cannot pile on more.  That is the reason for the austerity measures already being discussed.  However, if stimulus packages are cut, and if measures that are more prudent are being taken to reduce the rate of increase of the existing levels of debt, the net result will compound the problems the world is already facing.  That causes many leaders to dissent. 

With Global unemployment at extremely high levels, and no new hiring in sight, things may only get worse.  As the Governments of the world cut programs, and that means jobs, the unemployment rate will only increase.  An alternative exists in raising taxes, which will surely be part of the equation as well, but that has the same effect.  Higher taxes are a headwind to economic recovery. 

More specifically, if the US were taking on debt to fund programs that would add jobs, debt may be considered a good thing, and an offset to the inevitable weakness illustrated by the Investment Rate and the third major down period in US History that the Investment Rate identified well in advance.  Instead, the new debt that is being assumed now is being assumed to repay other debt obligations, and only a fraction is being applied to programs and jobs.

Spending our way out of a recession can last until the money runs out.  The problem in the world today is that the money has all but run out.  The conversations amongst global economists have shifted from stimulus to austerity, largely due to the problems in Europe, but there does not need to be contagion in the traditional sense to have repercussions around the Globe.  At the G-20, the discussions were everywhere, and the demands were obvious.  Investors want prudent fiscal policies, and they no longer consider increasing debt levels to be acceptable.

Not only is the United States facing pressure from the world, but also the objective of the Government seems to be to ride out the storm as long as it takes, until of course the economy regains strength.  What they do not realize is that the net new investment dollars in the United States declines steadily for the next 14 years.  The Investment Rate proves this, and it tells us that planning for the worst is the only prudent way to plan going forward.  I tell you this every day, for application in your personal investment strategy, but the same applies to the Government.

In 2006, I attempted to share the Investment Rate with the Government.  I called, sent it by mail, and I made every effort to help the Government understand what was coming.  My efforts were aimed at encouraging the Government to back off the debt pedal for a while.  Not knowing that trillions would soon be spent to prevent a catastrophe, I was hopeful in 2006.

Recently, I emailed the President’s National Commission on Fiscal Responsibility and Reform, but I do not expect an answer.  Sometimes, I believe, Congress listens, but not without a little help.  One of our Members handed Senator Dodd my work on overdraft fees, and I like to believe that I played a slight role in helping promote the bill that is effectively taking hold right now.  I will talk more about this in future correspondence soon, but the simple takeaway is that banks will begin earning substantially less on overdraft fees in the months ahead.  The rules take effect in July and August, and that means billions in lost revenues for each major bank.

If you have read The Investment Rate, and you appreciate its ability to accurately predict longer-term trends, maybe you can also play a role in helping me help the Government.  They need to realize that ‘hope’ is a four-letter word.  They cannot hope for an economic recovery, and a sudden windfall of tax revenues.  It is not coming.  Instead, the opposite will happen.  The Investment Rate proves this.

In recent months, money has flocked from the Euro to the Dollar because the dollar was ‘less bad’ than the Euro.  Nothing looked good, but there was a less bad option.  This is the state the Government is in as well.  We had the ability to take prudent steps in 2006, but we did not.  We still have the ability to make the third major down period in US History less worse, but we need to act now. 

The choices the United States Government makes now will affect the future and reshape history.  This is a very important time.  The decision is not easy when political pressures are factored in, so maybe everyone needs to reconcile something to make it work.  Without a prudent fiscal policy today, the Greater Depression I have been warning of will come exactly as I have illustrated.  If we do not accept the less worse route now, and make tough decisions and take the blows today, we will be forced to our knees in the future.

Neither is a positive scenario.  There is no way to win.  Both choices mean sacrifices need to be made.  However, it still can be a lot worse, but no one seems serious about austerity.  That is what concerns me about the Global Economy today.  The talk is Political, it is not meaningful.  There needs to be a change.

Instead of making headlines, important decisions need to be made, and they need to be made quickly.  No matter what, bad days lie ahead, and the risk of a Global Depression is high.  The only way we can protect ourselves is to remain focused on what is important, and we cannot stray from our disciplines.

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