Murky, Scary and Uncharted Waters
Ho! Ho! Ho! and Happy New Year! And, now that we’ve said cheers to a more than merry Holiday season and put the cork back on the bubbly, it’s time for yours truly to bring things back down to earth. For starters, I will flip to the sunny side of things, as best I can, and even spice it up with a dash of conviction.
A week before Christmas, with the malls and stores teeming with giddy shoppers clutching fistfuls of coupons, drawn to one sale sign after another beckoning to give the best deal, we knew this was going to be a better selling season than last year. In fact, several experts were raising their forecasts at the eleventh hour. Certainly it would be representative of the recovering economy we have all come to believe in. Even the thawing political freeze was giving way to compromise to ‘get things done’, not the least of which were personal and business tax breaks, along with the Bush tax cut and unemployment check extensions. All perfectly timed to kick in alongside the “QE 2” stimulus efforts of the Fed, the combination of which would put extra money in consumers’ pockets and continue to provide almost “free” credit if they wanted even more spending money (if being the operative word and contingent of course, on the banks’ willingness to lend.)
On top of these stimulants, the marketplace will continue to do its part to juice spending. It will figure out how to maintain its excess capacity (with a little help from its government and the Fed), so “on sale” ubiquity will continue as a way of life, including real estate. Wow! And, whatever the price on the tag, John or Jane Doe can check his or her smart device, or hundreds of other stores or websites, to find exactly the same thing or even something better for a lower price, with free shipping to boot. And, everything will probably be even cheaper tomorrow. Whoops! What does this sound like?
So, here we are. And, do we feel sunnier? Frankly, I don’t.
As the MBA student in this month’s “Quotes to Remember” (page 20) said to Fed Chairman Ben Bernanke: “If you inflate the economy without doing anything about growth, you’re just printing money.” And, of course, the bright young man does know that Mr. Bernanke is, in fact, trying to stimulate growth. So, what he was really saying is that Bernanke’s stimulus is not going to stimulate growth, so it’s just printing money for no purpose.
The young man makes a good point. Simply throwing money at consumers will not force enough demand or spending to unleash the $2 trillion in capital sitting on corporate sidelines for investment in new capacity, including opening new stores, which would require more workers, which in turn would begin to reduce unemployment. Furthermore, the small business beneficiaries of the tax break extension are more likely to use it just to keep their doors open for another day vs. hiring another body.
TEETERING ON THE EDGE OF A NEW DEFLATION
Whether you prefer the “Checkmate,” “chicken or egg”, or “who’ll blink first” metaphor, the question of which side will spend first, business or consumers, is still unanswered. This is the “wheel” of our economy stuck in the mud, slipping and sliding to get out. And, what’s worse, in my opinion, is the fact that it’s teetering on the edge of outright deflation.
Last month the government announced that overall consumer price inflation was 1.1 percent for the 12 months ending November, down from 1.2 percent the prior month, and many months of much higher increases earlier in the year. Just to put the recent drop into perspective, the previous low point for overall CPI for a twelve-month period was .7 percent, which occurred during the recession of 1961. Since the Fed has set an annual inflation target of 2 percent, the economy isn’t even close, and in fact has been tracking a similar direction to Japan’s slide into deflation, which the Fed has made its top priority to avoid.
So, the Fed and our government are trying to stop any further dis-inflation, or declining inflation, and God forbid, outright deflation, by inflating the economy.
Well, here’s a jaw dropper for you. Back in early 2003, when then-Fed Chairman Sir Alan Greenspan was faced with a similar situation, of six straight months of an inflation rate of about 1.5 percent and an economy flirting with deflation, here’s what The Economist magazine had to say about deflationary dangers and the world’s central bankers’ roles in managing it: “Central bankers are popularly portrayed like ships’ captains carefully steering their economies. In reality, they often don’t know where they are, let alone where they are heading; their maps and compasses are unreliable and their steering is wonky. Worst of all, their recent policy dilemmas are the equivalent of not knowing whether the earth is round or flat. Today’s central bankers learned their trade in a world where the main danger was inflation. But, in recent years, the biggest hazards have instead been asset-price bubbles and now, perhaps, deflation. They still do not grasp that this recession was quite different from all previous post-war cycles. It followed the bursting of the biggest financial bubble in American history. Share prices have seen their biggest fall since the Great Depression.”
I ask you, couldn’t exactly the same thing be written today? This is incredible. Here we are seven years later, in the same predicament and for the same reasons. However, and a big however, this time it is even worse.
Fortunately, Sir Alan and friends, particularly the new wizards on Wall Street, were at least able to find a new bubble to inflate to get the economy growing again: housing. And, as we now know, ‘growing’ was an understatement. It was more like a legal ‘Ponzi’ scheme on steroids. And, now we’re still feeling the effects of that apocalyptic collapse. Need I say more?
So, poor Ben Bernanke is left with a worse mess than his mentor had faced. And, do you see any new growth bubbles lying around that he can shove this mess into, and have Wall Street work its alchemy to spread the risk and outsized profits around the world? I don’t think so.
A NEW DEFLATION
I believe what we might be dealing with now is a “new” deflation, one which flies in the face of traditional thinking about demand-side stimulants being the road to recovery. As you will read, I believe that no amount of stimulus on the demand side will return us to robust growth and may, in fact, act as an accelerant for further disinflation, potentially tipping the economy into the feared deflationary spiral.
Now, if I’m thinking of this dire possibility, Ben Bernanke has certainly given it consideration along with many more potential scenarios. Yet, having examined all possible options, he decided the Keynesian theory of the printing and spreading of dollars to goose the demand side was our great best hope. Why, I wonder? Even our best and brightest economists and financiers would all agree, according to the hundreds of books and articles chronicling the mayhem during the most recent financial collapse, that we are in uncharted waters.
So, given the even remote possibility that my theory swims in the same uncharted waters as Ben’s, it’s probably worth paying attention to.
A NEW AND FLAWED FREE MARKET SYSTEM?
As opposed to focusing on the demand side for consumption growth (where we have been since WWII), I posit we are, and have been for some time, facing a supply side problem that reveals a major flaw in our now somewhat ‘managed’ free market system.
I believe we have overcapacity that is perpetuated through new business entrants adding to the supply side at a faster rate than those leaving, and all of it compounded by slow and slower growth on the demand side. If so, is it possible that no amount of stimulus to increase consumption will stop deflating prices, simply because a new paradigm now exists, with an eternal disequilibrium of too much supply driving an unrelenting downward pricing spiral?
Impossible, you say? Did you see any fewer stores or less stuff in them this Holiday season compared to last? Most likely you even saw some new stores and stuff. At last count there were over 40 square feet of US retail space per person, compared to the runner-up UK, with only 6. The square footage figures don’t even include the vast and exploding space that is e-commerce. What’s more, if you wait for two seconds, your smart phone will beep with an ad or a friend telling you where you can get whatever it is you’re thinking of buying, cheaper.
Everything is on sale all the time and shipped for free. Retailers have shifted their pricing structures (good, better, best), down. Outlet stores are growing faster than full price stores, even in the luxury sector. ‘Flash sales’ and ‘Groupon’ and all other kinds of on-sale online models are proliferating at the speed of light.
Across the entire marketplace, value is being recalibrated – down.
What happens next? The hope is that the demand-side stimulants will elevate demand in tandem with some ration-alization on the supply side, a shedding of the excess, so to speak. The result: a relative equilibrium of supply and demand, poised for a new round of healthy growth.
IT’S A SUPPLY SIDE ISSUE, STUPID
However, I maintain that even if demand increases, excess on the supply side will continue to proliferate, because marginal players are not disappearing from the supply side quickly enough. The immutable theories from “Economics 101,” or Joseph Schumpeter’s theory of “creative destruction” are being reversed and we have no tracking or measuring devices to see such a fundamental transformation. And, Schumpeter’s theory and the free market forces that have historically eliminated excess are impeded by:
- The liberal and “strategic” use (or misuse) of bankruptcy during which businesses shed debt, renegotiate contracts and emerge as new low cost competitors. Overcapacity is preserved and the new company drives another round of price decreases.
- An endless pool of investment capital willing to “prop up” the losers or ostensibly to turn them around. In many cases they act as “vultures” whose ultimate goals are purely financial.
- An immeasurable and increasing global flow of new businesses adding to the supply side while consumption demand is either slowing or at least not balanced against supply, exacerbated by the two previous points.
- Finally, of course, the unrelenting acceleration of e-commerce, with virtually no barriers to entry, including financial. This is an unprecedented phenomenon, and there are no measures that indicate these enormous additions to the supply side are being offset by corresponding declines in the ‘brick and mortar ‘ or any other retail sector.
Since WWII, all of the economic focus has been on the demand side. Stimulate demand and everything else would fall into place and we would be on the yellow brick road to growth and prosperity.
But maybe the Emerald City has gotten overstuffed, to the point at which there is no room in the closet for one more frock and no room in the driveway for one more car, regardless of how low the price.
Can lower interest rates or extra dollars in the pocketbook stimulate consumer purchases in such an environment? I think not, at least not enough to absorb the relentlessly growing and excessive amounts of stuff being tossed into the marketplace, which has many markdowns built into it before it even hits the shelves, and tomorrow, and the next day, and the next, even lower.
And today’s consumer knows it, and doesn’t need it, and eventually will wait for tomorrow and the next day and the next. The potential for deflation exists. However, it will be driven by infinitely growing over-capacity on the supply side.
Oh, and I’ll say it again with even greater feeling: Happy New Year!