Monday, July 5, 2010
“Economic Tsunami” Headed Our Way?
I believe that an “Economic Tsunami” may be heading to the United States from Euro Land. Clearly there was a conflict at the most recent meeting of the G20 in Toronto over cutting budgets (austerity) vs. expanding governmental budgets (stimulus). Many of the socialist countries in the European Union have found themselves in a very difficult position of breaking promises because they are running out of money.
In Greece, for example, the unions must give back 20% of their income in order to make the country more competitive in the global markets. What is so surprising to me is that the union leadership so quickly agreed to the givebacks. While the rank and file may not agree to these concessions they were necessary to have a chance for the country to survive. The labor union members are not the only people in Greece, or any other country, that will have to make concessions. The rest of both the private and public sectors will also have to make givebacks. By reducing the costs the Greeks hope that they can be more competitive in the global markets and sell more.
The rest of the PIIGS countries and even the United Kingdom are considering making serious budget cuts and increasing taxes in order to reduce debt and get the budgets under control. At the G20 meeting our president seemed to be the lone wolf preaching that “it’s too soon to stop spending” and he encouraged the union and Britain to expand budgets not cut them.
In the United States we are finally beginning to understand the magnitude of the debt we have already issued and the staggering amount of unfunded liabilities. The Congress this past week did not extend unemployment benefits to 1.3 million Americans. There seems to be a real debate as to the role of the Federal Government in the funding of state and local budgets. Many in Congress do not want a repeat of what was done in the previous stimulus package to bail out the states. If Congress doesn’t pass the funding to the states then many states may well go into default. Some people have a misconception about states going bankrupt. It is my understanding that local governments and agencies like school boards can file for bankruptcy however states can only declare that they are in default of their debts. When a state government defaults they stop paying interest on their borrowings and may stop making payments on other types of liabilities in order to conserve cash revenue.
American labor unions may well be faced with some serious decisions much like their counter parts in Europe as the “Economic Tsunami” hits the American shores perhaps as soon as late this year. Will the teachers, state workers, teamsters and other union members be willing to take less in order to keep jobs? Can the public sector employees expect to continue to receive the level of compensation and benefits they have received in the past? I do not think so.
With the economy predicted to slip in the third and fourth quarters of 2010 and with reduced economic outlook for 2011, the outcome of the general election in November is in doubt. The European countries are reducing leverage to try to strengthen their balance sheets. Many Americans are working to get their personal balance sheets in better shape. I expect interest rates to continue to fall and a substantial flattening of the yield spread between 30-Day T-Bills and 30 year T-bonds.
I have said to all of you many times, “get paid while you wait.” I think the best opportunity in the second half of 2010 and all of 2011 is to own assets that pay income. The things I like are the things that you, as clients, and I already own and I will be adding to our positions things like preferred stocks, Master Limited Partnerships and Royalty Trusts. These pay us returns greater than cash and better returns even than 30 year T-Bonds. We are in for an extended period of deflation therefore income producing investments will protect you.
Just cash the checks.
As was indicated in my last Flash, Merrill Lynch thinks that the Fed will stay at zero until at least the first quarter 2012 and readers of this Blog know that I think it will be at least 2013. Perhaps Merrill will make an adjustment in the future and extend the on-hold period. If Merrill is correct then many money market mutual funds will have paid zero or close to zero for almost 4 years to their shareholders.