Update to the Outlook

This piece was written for a customer who deemed it too long for his use. So, since I hate to waste 2000 words–enjoy! Regular readers will note that there is some repetition here for you, but that’s because you’ve already learned this stuff while new clients haven’t.

It’s a hard cruel world out there with much economic turmoil and concern. Since August 9, 2007, the day that the huge French bank BNP Paribas (one of the 10 largest in the world with assets in excess of $1.3 trillion) told owners of shares in three of its mutual funds they could not redeem them “because we own bonds based on U.S. subprime mortgages that we can’t put a value on right now,” financial panic has spread around the world.

Nothing makes an investor madder or more scared than being unable to cash out his or her investment from a fund. This problem has recurred many times throughout history. A comprehensive documentation that is also a most delightful and interesting book to read is Manias, Panics, and Crashes: A History of Financial Crises (5th Edition) by Charles P. Kindleberger and Robert Aliber (ISBN 978-0-471-46714-4). This wonderful book, which has always been a huge hit with my MBA students in the several second-year elective courses when I’ve used it, covers the history of financial panics around the world from Kipper-und-Wipperzeit of 1619-1622 and the Dutch tulip bulb episode in 1636-1637 through the Asian collapse in 1997 as well as the Russian default and the collapse of Long Term Capital Management in 1998 and the corporate scandals of 2001-2003 (Enron, Worldcom and so on).

The Wall Street Journal had a lead editorial on September 16, 2008 (“Surviving the Panic”) referring to the usefulness of this book in understanding the current situation. You’ll feel better if you get a copy of the book and peruse it carefully.

Few people were sorry to see 2008 pass into history at the stroke of midnight on December 31. Many will be happy to see the end of 2009 as well because it has seen the largest decline in global economic output and international trade since the end of World War II.

The International Monetary Fund (IMF) in its October World Economic Outlook expects world output to shrink by 1.1 percent in 2009 after having grown 3.0 percent in 2008. They expect global growth of 3.1 percent in 2010 and for growth to average 4.4 percent a year in the 2011-2014 period. Click here to read the full post and comment (Insights subscribers) »

Why Economists Are Confused

As you know, the crystal ball of all economists remains murky these days. This results in a wide range of opinions about the economy for the next year or two. The biggest issue is whether PCE will stay around 70.0 percent of GDP or decline as consumers return their debt-to-income ratios to the 90.0 percent or so that was ” normal” in the 1990s or if they’ll return to more recent spending patterns with debt ratios around 110.0 percent. If the former develops (Ian Shephardson is quite articulate in this camp), then consumers will save much more than in the last 3 decades and the US economy will be on a permanently lower growth path. Variations on this theme fuel the predictions of Nouriel Roubini, who is not in any forecasting panels, and Rajeev Dhawan, who is.

If consumers find a way to keep spending (drawing down assets or finding new ways to raise their incomes) then the recovery will be robust. No one knows how this will turn out, so the arguments are endless and occasionally, even interesting.

Perhaps more harrowing than the prospect of slow growth is the oncoming bankrupcty of the US. The Pete Peterson- and Rudy Penner- or Larry Kotlikoff-types keep talking about the $55-75 trillion net present value of the deficit. Click here to read the full post and comment (Insights subscribers) »