Thursday, August 25, 2011

Stirred, not shaken

A 5.8 earthquake hit the East Coast this week. Buildings were evacuated, companies shut down and there was wall-to-wall television coverage. Most Californians don’t get worked up over smaller quakes. Last year a friend was visiting and during lunch by the ocean a 5.3 shaker hit and she was the only one who noticed. No tsunami fears here as there were in Times Square. I suppose if a snowstorm hit LA then we’d have wall-to-wall coverage and people would be marveling at the event while our East Coast brethren would be curious as to what the big deal was. The upside to the shaker? The Stock Market ended the day up 322 points.

The Dow Jones Industrial Average is an average of 30 company stock prices on a given day. The companies are all large, multinational corporations in a range of business sectors.  The focus on the daily iteration of whether it’s up or down is a pedestrian way of reporting complex business news. Dow Jones has over 130,000 indexes. There’s also many other stock markets to track. The Dow is an important indicator to part of the economy, but they are not the whole story.

The financial crisis of 2008 resulted in lots of damage to the economy. The Dow and other stock markets nearly halved in value, tens of millions lost jobs, the credit markets froze and consumer spending reverted to necessity based purchases. Housing woes included the essential nationalization of the mortgage industry, record foreclosures and a virtual collapse of new construction. The American banking, insurance and automotive industries received over $1 trillion in government guarantees and bailouts.

The Dow Jones hit its historic high on October 9, 2007 at 14,164.53. By March 9, 2009 it had lost 53.78% of its value and closed at 6,547.05. The Dow rose to over 12,000 by February 2011. By August 2011 the roller coaster dropped the average to under 10,000 with daily swings of 400 points in each direction becoming the norm.

That the Dow increased 45% from its low in 2 short years is the important statistic. Conventional thinking is that a strong stock market reflects a strong economy. This is where the economic recovery of the past few years is fundamentally different than any other in American history. A resurgence in investments is not reflective of the day-to-day economy.

Everybody’s playing it safe. In 2008 companies relied on credit to operate their businesses. When the credit markets froze and businesses lost their ability to borrow to fund operations – something had to change. Today companies are holding on to a record amount of cash – nearly $2 trillion.  President Obama has implored these companies to use the cash to hire people and reduce the nearly 20% who are unemployed or underemployed. This reasonable request ignores the fact that the cash hoarding is a protection against an unreliable credit market. The stock market may have restored, but confidence hasn’t.

What corporate America is doing is mirrored in the personal savings rate of Americans. By the end of Quarter 1 2008 the savings rate hit an all time low of 1.5%. Americans were living beyond their means, spending virtually everything that came in and carrying lots of debt. Today the rate has increased to 4.6% . From a structural financial point of view – this is good news. For an economy that for 30 yeas has relied on consumer spending for growth – this is not so good news.

Confidence is ethereal. To make it concrete requires political leadership. While politicians cannot impact the economy as directly as they wish they could or claim they can, they do establish the climate where confidence is measured.

In 2008 the government opted to bail out banks that were “too big to fail.” The merit of President Bush’s actions is a whole other blog – the point here is that there wasn’t a consistent metric to determine who was saved and who wasn’t. As a result the government's actions bred fear and destroyed confidence. Why was CitiBank saved but not Bear Stearns? If the State was going to nationalize the banks, it should have done all of them consistently. There would have been a legitimate constitutional and economic philosophy debate – but there wouldn’t have been this reality show to find out who was in and who was out.  Even today it's unclear the result.

Today’s economic indicators remain all over the map with few metrics showing promise. Politicians bicker and policies change. Just over a year ago the Dodd-Frank Financial Reform Act was signed into law. Today virtually none of the Act has been implemented. It’s the see-saw that is hurting the economy, not a particular policy – since no policy has had the chance to be unequivocably implemented for at least 6 years.

My hope for 2012 is that there is a landslide. Maybe that's what it will take for one policy to actually be implemented and seen through to completion.  Then we can measure its effectiveness. That would stir things up much more than the constant shaking that happens now.

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