ROBERT BROOKE ZEVIN ASSOCIATES, INC
Pioneers in Socially Responsible Investing
IS THIS THE BEGINNING OF AMERICA’S “LOST DECADE”?
IF SO WHAT CAN WE LEARN FROM EUROPE AND JAPAN ABOUT HOW TO COPE WITH IT?
Are we in America’s Lost Decade? I will answer the question right away. Most definitely yes …. sort of. The “sort of” qualifier is because there is more than one definition of a lost decade. If a lost decade means ten years (or more) during which the growth of a nation’s economy and the incomes of its inhabitants drops to a much slower pace than before, while unemployment is much higher than usual and prices go up very little or even decline, then the answer definitely is definitely yes. This is not rocket science. Kenneth Rogoff, former chief economist of the International Monetary Fund, and his collaborator, Carmen Reinhart, have compiled massive data about banking crises triggered by excessive debt leverage in multiple countries over two hundred years. Absent major wars or massive natural disasters, there are no exceptions. When excessive debt leads to a major financial crisis such as we have experienced, the consequences are debt defaults, foreclosures on property that is collateral for the debt, declines in property prices, equity prices, and employment. The aftermath has always been a dramatic reduction in the growth of the economy.
Note that growth declines; but it rarely stays negative for very long, certainly not a decade. The precipitous declines in America and Europe from 1929 to roughly 1932 or 1933 stand out from the historical record for their severity and duration.
We have had an interesting experiment over the past two years as government interventions to limit or reverse the effects of a financial crisis have been sooner and bigger and more internationally coordinated than ever before. Nevertheless, it now appears that the end result still will be stuck within the range of previous experience. The interventions were not big enough, which was well known at the time. The money and banking interventions were not efficient, being designed almost entirely to benefit bank owners, managers and creditors rather than bank customers. Predictably the stimulative policies, which had to overcome a sclerotic political system, especially in the US and UK, are now in danger of being dropped on the false but superficially plausible argument that they did not work. And the unprecedented bipartisan and international cooperation that marked 2008 has quite disappeared in the last six months.
At the same time we know that virtually all of the modest economic growth that has occurred in the United States and most of the world has been a direct result of the government programs that are about to be reduced or reversed. Meanwhile, housing prices are in their fifth straight year of decline and inventories of unsold homes are at record highs relative to sales. Over eleven million homes, nearly a quarter of the total, are worth less than their owners’ mortgages, and for over five million the value of the mortgage is 20% or more greater than the value of the house. In the likely event that economic growth slows over the next six months these houses could add to the supply of houses and accelerate the decline in housing prices. Stock prices are no higher than eleven years ago, and most investors in IRAs, 401(k) s and 529 Plans have done much worse, not to mention the employees who thought they had a company guaranteed retirement plan which has now been terminated.
So we are still very early in the process of reducing personal debts (mortgages, car loans and credit card loans). If the rate of reduction for the past 16 months were to continue until the end of this decade, the consumer debt to income ratio would still be higher than it was for most of the 1990s or almost any time previous. And of course the income part of this ratio would grow slowly as consumers used their earnings to pay down debts or add to savings rather than buying something that would create jobs and incomes for others.
A surge in exports could be another source of growth, but this seems unlikely with US imports still far greater than exports and the entire world trying to export more to everybody else’s country and to import less. Major exports from the US are dominated by very large aircraft, weapons systems, very large computers, and (forgive the expression): financial services, legal services, health services and entertainment products, notably movies, TV shows, music and computer games, plus highly subsidized agricultural exports which are the bone of contention that has brought new World Trade agreements to a halt. A little reflection reveals that the great majority of these exports are highly dependent on a vigorous if not giddy expansion of the global economy, which is unlikely for the same reasons that a vigorous expansion of the US economy is unlikely. Another possible source of economic growth might be investment by corporations. This too seems s unlikely, first because there is now very substantial excess capacity in the United States and in the world. Second because slow economic growth will take a long time to put enough pressure on that capacity to inspire more investment; and third, because American corporations have shown their strong preference for making whatever investments they do decide to undertake in faster growing foreign economies. Even when growth was much more rapid than now and capacity more fully utilized, American businesses kept new investment projects to a minimum and used their growing hoard of cash to buy back their own shares or to acquire other companies. These trends were temporarily interrupted by the need during the financial crisis to sell more stock instead of buying it back and to cut dividends; but now the trend seems already to be re-established. In a world where managers are rewarded for the immediate increase in their stock prices and investors celebrate that increase over any prospect of increased profits in future years, it is hard to imagine that corporations will redirect much of their cash toward domestic investment.
The remaining possible “engines of economic growth”, as the saying goes, are state or local governments and the federal government. All have been backed into a corner by the tax revolt that started in the Regan years with caps on property taxes that have sharply reduced their contribution to state and local budgets. The states have responded by regularly exhausting their rainy day funds when it was only a bit cloudy, by spending all of their windfall revenues from capital gains during stock market booms, by initiating lotteries and casinos and by borrowing against or selling future revenues as in the sale of bonds backed by future returns under the mammoth tobacco settlement or privatizing turnpikes and other state activities that generate revenue. In effect, what would have been today’s revenues and future revenues have been spent already. State and local revenues are down and these governments have neither the capacity nor often the legal ablity to borrow money in order just to maintain spending. So schools and libraries are closed, and public employees are laid off.
That leaves the Federal government as the only borrower and spender left standing. But, our national government has already borrowed about $3 trillion in the last couple of years in addition to guaranteeing $5 trillion or more of debt owed by Fannie Mae, Freddie Mac, AIG, Bear Stearns, every commercial bank in the United States and assorted smaller players. Counted properly, this means the national debt has already doubled in two years. And it was a pretty big number to begin with, having increased relentlessly since the end of World War II except for a handful of years under Presidents Truman and Clinton. Even so, the right thing to do would be to borrow more and spend more, and that will certainly happen if things get worse again; but it appears unlikely to be done more effectively than has been the case so far. If anything, increasing political deadlock, partisan and international divisions and a diffuse, seething anger apparent in many countries are likely to impede very seriously any further effective action especially in the U.S.
So we are left with the seeming certainty that this time will not be different from all the previous aftermaths of financial implosions. Actually as you can see from this chart, we have already had a lost decade in the immediate past ten years. Less than 2%. So my point is that, like the Japanese, we are now likely to have a second consecutive lost decade.
I’ll get to coping with it in a minute; but, let me pause to consider an alternative definition of a lost decade, one familiar to roughly half the people in this room who are in the investment business. Namely a decade in which stock market investors make nothing. As already noted that too was true of the last ten years and Japan, US 1929-39. But not always, the old Main Street/Wall Street dichotomy thrives even in severe downturns. As we have seen in the markets stupendous rally over the last year or so. WHY? Profit margins, advantage of low cost or new technologies in squeeze, slow growth=low interest rates= higher stock prices even with no growth in earnings.
What can we learn? Not to do assume market forces can be quickly restored and will carry the day; stimulate too little; fail to punish criminals and to correct lax regulations; bail out zombie corporations, etc.
What to do? Quality of life chart. Focus on what we can do without economic growth. Recondition ourselves to accept that further aggregate economic growth is not necessarily desirable and is quite possibly unobtainable on anything like the previous scale.
EUROPE UNE MPLOYED, US WPA. NON PROFIT SECTOR? SUBSIDIZED ARTS AND RECREATION?