US Takes a Tumble

The following is the final part in a three part series about the US downgrade and the effects it will have on the consumer, investor, and economy.

Organic Recovery

Let me start by saying that when talking about economic recovery, there are many methods people believe work best. They range the gambit from A laissez faire type of involvement, or none, all the way to a complete government takeover of some social services. What I’ll be talking about today will lean more toward the earlier, in that markets will correct themselves, or “organically” grow into their own.

Where will it come from?

As stated earlier organic growth will come from the businesses rather than the government. Conditions are ripe for this because of a few factors.

-Companies are running lean: If we do see another recession, and decrease in consumer buying, this could be a bad thing. However, most consumers and companies are already running lean, and don’t have much room to cut spending to show their dissatisfaction with the market. Because companies are running as efficient as possible we are likely to see little movement in the job sector in response to the crisis. Thus, jobs will continue to grow as demand for them rises. Unlike with the previous recession, where the government injected capital to create projects and jobs.

Running Lean also means that companies are less likely to be affected by another credit crunch. With trillions of dollars in cash reserves, companies are more than capable to make payrolls, pay debts, and make purchases. We’ll continue to see the strong companies stay strong even during a credit drought, if it were to happen.

-Market is on the up and up: Well, sort of…The market is healing, albeit slowly, and is on a positive trend. This is good news for growth of the economy. In order to have growth, there actually have to be positive signs.

-Government is out of tricks: This may sound like a flawed statement, but it’s been said that nine of the worst words you can hear are: “I’m from the government and I’m here to help.” The FED and Treasury has run out of ways to give more “help” to the market. While the FED can still keep rates low (as it has done, and has recently stated, it will keep doing; there is really no way the government can intervene. It is essential to an organic, natural, recovery that the government have little help as possible. That is not to say that their help is not needed at all…they just need to take a smaller role for the time being.

Why it’s good?

Inflation in the job market is very easy to create. Government spending often creates inflation. For instance, if the government gives more money to build roads, at the time the roads are built there will be a higher demand for workers, but after the projects are complete, there will be a severe deflation of workers needed.

However, an organic growth in the market creates “real” and “permanent” jobs. If a company grows out of actual demand and not government driven demand, these jobs are much more likely to stay on the payroll for years to come.

Also, gains made in the stock market because of actual and real inspired consumer confidence, are much more easy to hold on to.

Finally

So while an organic economic recovery is a long way off, it will happen baring another catastrophic event. (Think the European debt crisis getting even more out of hand). If the US government tapers of spending and lets the market correct itself, it will do so. As stated earlier the foundation is good and set for a nice, although slow, organic recovery.

US Takes a Tumble

The following is the second part in a three part series about the US downgrade and the effects it will have on the consumer, investor, and economy.

2008 Part Deux?

Many economists have compared the fallout from the S & P downgrade to the collapse of Lehman Brothers. While there are some similarities, there are some key differences that make this a different type of crisis.

As the crisis worsened in 2007 and then in early 2008, the investment bank teetered on the brink of crashing just as it had done time and time again, only to rebound back even stronger. Lehman, its balance sheet full of sub-prime mortgages saw its trouble come make headway when, on September 8^th, the government announced the assumption of Fannie Mae and Freddie Mac. By week end, the government had made it clear that no bailout would be coming for Lehman, but it encouraged others to purchase Lehman.

When Lehman finally filed for bankruptcy on September 15^th, the markets were in a spiral. Investors and companies alike saw that “To Big To Fail” was indeed a mantra deserved for those the treasury saw fit to give it to. To the investor, the government was no longer backing their investments. Lehman’s downfall set off massive tremors throughout the market. The uncertainty surrounding the financial world and hedge funds exacerbated the “Crisis of Confidence.”

Essentially, what we’re seeing now is a continuation of this “Crisis of Confidence.” However, while confidence is the key issue, it’s not any longer a question of confidence in the corporate world; it is one of a federal nature.

An American Always Pays His Debts.

When we speak of a “Crisis of Confidence” what we’re really saying is: “A mechanic in the game has changed, we’re not sure what to exactly believe now.” What we’ve seen with the United States downgrade is exactly this. The, previously, unthinkable has happened. The United States has been downgraded, and doubt has entered the market place. Investors call doubt, Risk. And when risk is found in places where it normally was absent a correction in price occurs.

In 2008, we saw the exact same thing happen. The Treasury, under the direction of Henry Paulson, had bailed out numerous American corporations in their time of need. What set the precedent, really, was Bear Stearns. “If the United States bailed out Bear, surely they would bail out Lehman.” And why not? Lehman was a banker’s bank. If Bear had a big market share, then Lehman’s would have been gargantuan. But something happened, the treasury decided to change the game, and reset the rules. It wasn’t going to be in the business of bailing out everyone. It was just “untimely bad luck” that it was Lehman.

So, in the Lehman case, we see the federal government’s lack of will to do anything. Skip ahead three years, and we see yet another “game changer” but this time, the government does not lack the will; it lacks the way. As much as the government may want to, it can’t spend its way back into a AAA rating. In fact, Standard and Poor’s has said that this is the exact opposite of how the government should go about regaining their rating.

Depending upon which side of the fence you may be, this may be a gift or a curse. While the government cannot boost investor confidence by injecting capital into the markets, it also gives the economy time to heal naturally. However, on the other side of the coin, in a slowly mending economy this may take quite a bit of time.

I need more Ammo!

In 2008, the government had quite a few weapons left in its arsenal to keep the economy afloat and stave off a deeper recession. Right now we’re seeing that arsenal as severely diminished. Rates are at historical lows, and there’s nothing the treasury can throw money at to regain investor confidence. The only thing that could regain confidence is something that the government hasn’t been able to do in a long time; balance the budget.

Right now what we’re looking at is the markets giving themselves help, which we’ll talk about in our next installment of this series.

High stakes Chicken

A similarity between the two “Crises of Confidence”, is this sort of betting game. In 2008, we saw it played out between the federal government and solvent banks. Where the government was essentially not giving its guarantee to help with the purchase of Lehman, to see how it played out, hoping that a buyer would surface. They lost that game, and that’s where the crisis came in.

Here again, we see another high stakes chicken game, but this time it’s the federal government on its own (Republican Vs. Democrat). Standard & Poor’s has stated in its report that it is not an issue of the amount of debt, nor is it the financial stability of the United States. It is the issue of the inability of lawmakers to come to a compromise on how the debt should be handled.

The Economy

In 2008, GDP was negative, we were losing jobs, and credit markets were completely frozen. We find ourselves in a, albeit bad but, better climate. GDP is on the positive trend along with Jobs (again, not great). With Quantitative Easing just complete, we may see some tightening, but nowhere near recession levels. Also, companies are at record highs as far as liquidity is concerned, so the need for commercial paper is not there.

Essentially, what we’re seeing that the American economy is in a much better place to heal itself than it was a few years ago. 2008, saw companies highly leveraged with little in the way of meeting payrolls without some sort of outside financing.

In our next section we will look at the ways the United States can set itself up for an Organic Recovery.

US Takes a Tumble

The following is the first in a three part series about the US downgrade and the effects it will have on the consumer, investor, and economy.

What does the downgrade mean to me?

Friday evening after markets closed, the S & P (Standard and Poor’s) downgraded the US Credit Rating from AAA to AA+. Everywhere you look it seems that this is spelling catastrophe for the investor and consumer alike. However, let’s take a deeper look into the downgrade and what actual effects it has on the average American.

The Risk of Risklessness.

For a long time, the United States’s debt has been seen as an instrument of riskless investment. In fact, the US treasuries have set the precedent for the risk free rate. For the S & P to downgrade the US Debt rating, it would appear that investors are recognizing that the US potentially contains some default risk.

While any investment inherently contains some risk, it is generally accepted that US debt is a safe haven for money. This downgrade, however, has put that general assumption into question. With that said, nothing has really changed. The debt ceiling is still raised, politicians will still philander, and the US will continue to mint dollars to pay its debt. The downgrade hasn’t changed the balance sheets of the American Consumer or the government for that matter. It has no “physical” effect on the United States ability to pay its debts or sell debt instruments. Think of this downgrade as a bruise. The damage to the body has already been done, and what we’re seeing are just the cosmetic effects.

What we may see is that interest rates eventually will inch higher because a credit downgrade, which essentially increases the United State’s cost of borrowing. However, because the US is still widely seen as a “safe haven” it is doubtful we will see any real increase in cost of borrowing to the consumer:

• Mortgage rates are typically tied to Treasury yields which are at historic lows.

• Credit card rates tend to follow the prime rate, which the federal reserve has given no indication of raising any time soon.

Then why the stock market crash?

On the word of a downgrade, we saw the stock market loose significant points. With that said, any real cost to consumers will take months to be felt.

The stock market is a generally good indicator of investor confidence and overall market/economic health. What we saw today was a reaction of investors to the overall health of the economy. A good example would be the decline in oil to just over $81 a barrel. The price of oil went down on the speculation of a decrease in demand, not an actual demand decrease. The same thing happened with the majority of declining stocks on Monday.

If not this, then what?

Until we can see the actual effects of increase cost in borrowing, the pressure investors and consumers will feel will come from the slowly growing economy. The job markets will not take a change for the worse solely because of the downgrade. What we will see is a decrease in consumer uncertainty which could decrease spending and lead to cuts in the job market. With the economy already reeling from the last recession, if we were to see a “double-dip,” the impact would be very dramatic. Businesses and consumers alike are already running lean. Another wave of spending woes would leave them with next to nothing to trim down.

Thus, as a consumer and investor you have little to feel directly from the downgrade. What we’re feeling right now is the market’s reaction to the possibility of another recession.

In the next part of our three part series we will examine whether or not there will be a double dip recession. And, if there is a recession how will it compare with the last.