Looking Forward - The Economy

Yesterday, I made predictions for our next Presidential election. I may or may not be right, but it's my prediction and I'm sticking to it (for now). Today I'm going to talk about the economy.

Unless you've been deployed to Antarctica for the last year or so, you've heard about the housing bust and the credit crunch. The government, the Federal Reserve and the banks have been scrambling to tell us everything's going to be okay, while simultaneously warning us that things are going to get worse. I think this is truly the beginning of the end of American dominance in our global economy. The end of our dominance isn't necessarily a bad thing in the long term -- especially on a global level, but it's going to suck for us for the next two to ten years.

I'm not going to spend a lot of time explaining how we got here; that's what the professional economists are for. Besides, this post isn't about the past, it's about the future. If you are interested in what the pundits have to say though, I'm a big fan of Jim Jubak. He does a great job of analyzing what's going on with the economy as a whole, yet he puts the information out in plain English. Here's an index of his published articles. If you haven't checked him out, it's definitely worth a read. Now... on with the predictions.

First things first. I think we're in for a serious round of stagflation. The feds say that core inflation is under control, but that's not giving us an accurate picture. You see, "core inflation" doesn't factor in the costs we pay for food and energy because they're considered "too volatile" to provide an accurate measurement of inflation. There's an inherent problem with this measurement. The items being excluded from the core inflation formula are the same things that are skyrocketing in price, pinching the average consumer. Eventually, I believe that the inflation in food and energy prices will bleed into the rest of the economy, leaving the fed no choice but to acknowledge that we're experiencing inflation. But for now, they're perfectly content to sing their Pollyanna song and say there's a low risk of inflation. Mark my words though... inflation's here, and it's going to be here a while.

That covers the "flation" part of stagflation, but what about the stag? That's around the corner too, and it's being driven by the housing market and credit crunch. People are defaulting on their home loans left and right, which has the added impact of dragging down home values for all homeowners. The markets that saw the insane appreciation of home values are now seeing an equally crazy drop in value. This means that many homeowners owe more than their home is worth.

Psychologically, this means that homeowners see themselves as having less net worth, which means they're going to be less inclined to spend. Additionally, many homeowners would spend by borrowing, not by spending truly discretionary income. The problem is, banks are less willing to give out loans right now, so even those still inclined to spend may find themselves unable to do so. This is going to slow consumption, which will cause job loss, specifically in the housing sector and the automotive sector, which will have a ripple effect across the economy, making things worse.

The worst part is that these items are happening at the same time, and the fed can only address one of the problems. They can allow inflation to fight recession, or they can allow a recession to fight inflation. Based on historic trends, I expect the fed to fight a recession.

Another factor in our inflationary problem is the weakening dollar. Essentially, a weaker dollar means that it costs more to purchase goods from overseas. This includes oil, electronics and a plethora of other goods that help our economy go. The weak dollar will fuel inflation in the short term, but it will have a positive spin as well. American goods will cost less to our overseas buyers, which means that American exports will increase as imports decrease. It will take a while for this to play out though.

The final step in the shifting of our global economy will be a return to equilibrium. With a weak dollar and cheap American goods, there will be an increased demand for labor. And since other economies have expanded while ours has contracted, it will be relatively cheap for American labor. For example, the Chinese economy will grow, as will the wages of the average Chinese worker. This will allow them to buy more American products, which will create a demand for American labor. Some jobs that are currently overseas will return home because American work will be relatively cheap due to the weakened dollar. Our next round of expansion will begin from overseas consumption, but will take off because of new jobs and the relatively low cost of American goods vs. foreign goods.

When this all plays out though, don't expect us to be the economic powerhouse that we've been for the last century or so. Instead of being the dominant economic power, we will be one of many equals in the global economy. Over the short term, this will be painful for us, but in the long haul, this will benefit everyone globally.

As I said, this will play out over the next two to ten years. I think the worst of the pain will occur in the two-to-five year timeline, and the recovery period will be five to ten years out. The big question is how to minimize your own exposure during this time. Unless you're independently wealthy, you're likely to experience some pain from this, but there are some things you can do now.

Pay off any outstanding debts that you have, specifically credit cards and car loans. This will free up discretionary income, which you'll need during a credit crunch.

If you invest, I recommend looking overseas, and do it now. Our stock market is already running on borrowed time. I was relatively fortunate. I saw the inevitable housing bubble, but was a little off in my timing. I was exposed when the bubble popped, but moved a large portion of my money when things temporarily recovered after the fed 1/2 point rate cut. That move has helped preserve my long-term investments.

I am not recommending that you move everything overseas, because that's just as risky as keeping the money in your mattress. But I am predicting that the overseas market will do just fine while we flounder. I plan to remain heavily invested in overseas markets for a year or so, and re-evaluate from there. This, of course, is subject to change. I watch consistently for trends, but don't actually change my allocation more than once or twice per year.

After a year or so, I suspect that our domestic stocks will have hit bottom, which means it will be time to bring the money home. Furthermore, I suspect that foreign stocks will start lagging around this time, because the pain of our recession will start being felt in the overseas markets because we are purchasing fewer of their goods.

I see a rise in domestic commercial property values -- specifically apartment buildings. As people lose their homes, they're going to need somewhere to live. This will cause a demand increase in apartments, which will cause rent to rise, increasing profit for the companies that own apartment complexes or their associated property.

In summary... I think that in the short term, we are going to experience something new to Americans... an actual reduction in our standard of living for the next two to five years. In the next five to ten years, our standard of living will once again increase, but at a slower rate as the rest of the world catches up.


Note: These predictions are not to be taken as financial advice. I'm telling you what I've done, and you can choose to do the same or not... it's your money, so it's your risk.

What would you like me to talk about next? Iraq?