Reading the news these days, one might get the impression that the economy is struggling to restart, and that government fixes made by the Congress and the various agencies have played a part in keeping the sputtering engine from conking out completely.
There's another way to look at it: The little good news we have is, in fact, the result of government meddling, but that their actions have instead worked against a recovery, adding to our problems rather than allowing the economy to resolve its own issues in due course.
Let's review. As many of you know, various agencies of the U.S. government have implemented plans over the past 12 months to prevent the U.S. economy from falling into a recession. For example, the Federal Reserve has significantly increased the money supply and lowered short-term interest rates, while the Treasury Department has set aside approximately $152 billion to be sent to U.S. citizens this year in the form of tax rebates.
In addition, the Fed has implemented numerous actions over the past year to alleviate the biggest U.S. credit crunch since the 1985 to 1990 savings & loan crisis. The Fed also helped to bail out investment banking firm Bear Stearns this past March by allowing JPMorgan to temporarily borrow funds from the Fed to acquire the beleaguered banker.
Meanwhile, the Fed approved measures last month to lend funds to mortgage providers Fannie Mae and Freddie Mac in the event that such lending would be required to assure the solvency of those government-sponsored agencies. In addition to the Fed’s actions, the Treasury Department has sought approval from Congress to increase its credit lines with both of those agencies, as well as approval to buy an equity stake in each company if necessary.
Yet the economy has continued to grow at a modest rate over the past two quarters, expanding at a 2.5 percent year-over-year rate during the first quarter and 2.2 percent in the second quarter.
Meanwhile, home mortgage rates have trended higher over the past six months, with the 30-year conventional mortgage rate rising to 6.43 percent in July from 5.76 percent in January, and commercial banks have significantly tightened their lending standards.
In essence, the only thing that the government has accomplished in its monetary and fiscal actions over the past year has been to fuel inflationary pressures by devaluing the U.S. dollar and to significantly increase the federal budget deficit.
As a result of those actions, my research indicates that long-term interest rates will likely trend substantially higher over the next 12 months.
Even worse, the government’s actions have led to an increasing degree of uncertainty about future economic conditions, as both leading and coincident economic indicators now give mixed signals about the future course of the economy.
More specifically, several leading economic indicators suggest that the worse may already be over for the U.S. economy. These indicators appear to have either bottomed or to be very close to bottoming, including new, privately owned housing starts, consumer-confidence indices, and non-defense capital goods orders.
Yet several other leading indicators suggest that the economy will continue to weaken during the months ahead, including first-time claims for unemployment benefits, the Institute for Supply Management Purchasing Managers’ Index, and the spread between long-term interest rates and short-term rates.
More specifically, unemployment claims have been rising, manufacturing activity has been slowing, and long-term interest rates have been rising.
Historically, the indicators mentioned above have tended to move in the same direction. For example, whenever inflation rose at fast rates, the Federal Reserve would generally decrease the money supply (and raise interest rates) in an effort to contain inflationary pressures.
Shortly thereafter, economic growth would tend to slow as consumers decreased their spending and business enterprises reduced their capital investments. However, once the employment situation began to deteriorate, the Fed would usually increase the money supply (and lower interest rates), and the U.S. government would increase its spending and investments, lower tax rates, or both.
As a result of those actions, businesses would tend to hire more workers and to take advantage of low interest rates by borrowing money to invest in capital assets. Meanwhile, as the employment situation improved and mortgage rates declined, consumer’s expectations regarding future economic conditions would tend to improve and they would increase their spending on both discretionary and non-discretionary goods. An increasing number of consumers would also tend to purchase new homes whenever their employment prospects improved and interest rates were falling.
In other words, new housing starts, consumer confidence, and capital investments would tend to rise at the same time that manufacturing activity and the employment situation was improving.
Unfortunately, the socialistic actions taken by certain government officials, such as Fed Chairman Ben Bernanke, Treasury Secretary Henry Paulson, and numerous members of the U.S. Congress, have broken the normal chain of events. As a result of those actions, my research indicates that the housing market will remain in a slump for at least another 12 months and that the employment situation will continue to deteriorate and that inflation rates will remain near historically high levels.
So, rather than getting caught up in the current political hoopla regarding all of the economic promises being made by Barack Obama and John McCain, I urge you to turn off the TV and to ignore those self-promoting politicians.
Regardless of who’s elected as the next U.S. President, my research suggests that taxes will likely increase significantly over the next couple of years and that long term interest rates will trend higher.
Don’t get discouraged, because there’s always a way to make money in the financial markets. The key is in knowing how to properly position your portfolio for a given economic environment.