The U.S. recession is not over yet

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In recent months the U.S. stock market has recovered much of the earlier losses from the financial crisis. What is more, GDP growth has been observed for the first time in a year. According to a survey this month the majority of macroeconomic forecasters believe the “Great Recession is over“!

But is the recession over? Looking beneath the two headline measures of stock market moves and GDP, the fundamentals of the U.S. economy would indicate that the recession is not over yet; with high unemployment, under-regulated and over-leveraged financial markets, uncontrolled government debt levels, a deflating U.S. dollar, and costly demographic shifts. This clearly implies bearish conditions in the US for many years to come. Many alternative commentators (see previous post) are indicating that the recession is not over yet.. indeed the worst may be yet to come!

Market capitalisation: Over the past 6 months organisations have exceeded analyst expectations for profitability and recover much of the losses in market capitalisation earlier in the year. For foreign investors any value gain in share price will be reduced to almost nothing after USD depreciation is considered. For domestic investors profitability has been achieved largely through either government stimulus or cost cutting (e.g. mass layoffs, reduced travel and favourable short term oil and raw material prices). There is little further which can be done using this approach to improving profitability without compromising future quality and capability. And as outlined below, the broader economic fundamentals remain bearish.

Financial system: Global financial system has deep flaws including an unregulated derivatives market which have not been adequately addressed. Corruption may still be a big part of U.S. Federal Reserve together with other banks and financial institutions which are “too big to fail“. Financial reforms in these areas are compromised by powerful business loby groups.

Deflation and Inflation: The U.S. is currently experiencing deflation due primarily to a massive drop in oil prices. However in years to come the U.S. now faces risk of high inflation or even hyperinflation from “printing money” to finance the massive economic stimulus and bailout programs. Further contributing to hyperinflation are skyrocketing oil and food prices. With continued global reliance on oil, with peak oil fast approaching and with carbon taxed, the oil price is likely to trend above and beyond USD100 per barrel in coming years. Food price to be effected by inter-related global issues of overpopulation, carbon taxing, global water shortages and global warming (as per causes of other recent food crisis).

Public Debt and Currency Devaluation: The Federal budget deficit for the fiscal year ending Sept 2009 was USD 1.9 trillion. The U.S. public debt is now close to USD 12 trillion and heading towards 100% of GDP. The U.S. will find difficulty fulfilling interest payments obligations of their U.S. Government Bonds with the value of the USD progressively eroding and foreign debt levels rising astronomically. Compounding this problem, the USD is likely to fall further as China diversifies out of USD (into commodities and other assets) and as other currencies (e.g. Euro and Yen) including potential new currencies strengthen (e.g. SUCRE, EAC and a unifed Gulf currency).

Householders and consumers: Where once the breakdown in the financial system was associated with a sub-prime mortgage crisis now two years later, with persistent high unemployment levels, it can be associated with record foreclosures in the prime mortgage market. Whilst there has been some improvements in housing prices in recent months they still have a long way to go before they recover the losses of the past three years. Whilst consumer confidence has also made ground it remains at low levels rarely seen in the past ten years. The bottom line is unemployment is heading towards double digit figures. It is only when this trend is curtailed that housing prices and consumer confidence can be properly be restored.

Demographics: With the baby-boomer population retiring there is increased government welfare cost burden, bearish force on the stock market due to pension fund shares being cashed out, and less income tax revenue. With a deterioration in the U.S. education system and associated poor academic performance there won’t be the competitive young adults to fill the globalised jobs of the future.

Geopolitical Influence: The combined cost of U.S. acting as global superpower in Iraq and Afghanistan accumulates (see ‘CostofWar‘). The U.S.’s financial capacity to wage wars and determine the terms of trade in other countries is significantly diminished. China has turned the financial disaster into a strategic econopolitical advantage by buying up cheap assets. Now with not only massive domestic savings and the power to influence US terms of trade (though being the biggest holder of U.S. government bonds), China now has massive energy and resource investments in the Middle East, Africa, Australia and throughout the world. China has replaced U.S. as a world empire.

In conclusion, the present fundamentals of high public debt and unemployment combined with the future high probability of high inflation, high welfare/social security cost burden and reduced geopolitical influence mean that it may be many years before the U.S. returns to sustained growth.