April 13, 2010
The Health Care Bill will Tank Any Recovery

Let me start with a primer – if you don’t want to hear the bad news, don’t read any further.

Introduction:  While there is some good news to report, such as retail sales are up and some business activity increasing slightly for select businesses, the jobs report demonstrates that the economy is stuck in low gear with the jobless claims [unexpectedly!] up last month.  I can also report that there a number of announced layoffs in the hundreds each here in Wisconsin that are forth coming this summer.
 
In contrast, our own leasing activity is up considerably over last year; a chunk of the activity is government or government supported, a chunk is growth in the tech sector or new start ups, and a chunk is attributable to musical chairs – tenants downsizing and relocating without any net absorption in the market.
 
Bouncing Along:  We’ve talked about how the economy will bounce along the bottom for some time, and that’s exactly what we are experiencing now – some larger businesses seeing a slight uptick and Wall Street rebounding (based upon excess liquidity, I believe), but with Main Street continuing to struggle.  We’ll continue to see mixed messages in the economy for at least a couple of years, and as a result, we won’t be able to characterize the economy “on the whole” or across the board.  (This also means that these reports won’t be as cohesive as in the past.)
 
In the last Wall Report, I mentioned the uncertainty of where the economy is going based upon the uncertainty of where Washington is going.  Yes, politics is having a greater impact on the economy than any other single issue, period.
 
The election of Scott Brown in Massachusetts led many to believe that Washington was stopped in its tracks and prevented from heading down the path of increased government and taxation.  The reason I worded the March Report as having two possible paths to take is because many would not have believed me if I had said that the current Administration and Congress would find a way to pass its legislative agenda even if they had to break the rules to do so.
 
Well, they did, and now we know what’s in store for us – so let’s examine what’s coming to the economy next.  And yes, many of you may be surprised to learn about what’s in store; I certainly was even in spite of trying to stay informed.
 
Forecast:  So here’s my forecast for 2010.  This year will continue to be a muddle through it year, with slightly positive GDP numbers (because global corporations are seeing a global pick up and because a large percentage of the GDP is government – and since government is going to increase exponentially, the GDP will artificially reflect that).  Meanwhile, on Main Street and in the rest of America outside of Washington D.C. and Wall Street, the economy will worsen as small businesses that have been just hanging on by their teeth start to go under.
 
Then next year, in 2011, I believe we’ll see a contraction; yes, a second dip; a follow on recession, which could be quite severe.  Why?  Because of a whole host of negative factors.  Basically, my worst fears are coming true.

What’s Coming:  Here are a few primers for 2011 with more detail below.  Higher income tax rate, higher capital gains tax rate, higher estate tax rate, and now, even higher tax rates due to the health care bill – yes, higher than the increases that were coming anyway.  Add on top of this, 15% more state income tax (you can thank you Governor Doyle), plus combined reporting.  Accountants are telling me that Wisconsin’s combined reporting (again, thank Doyle and the legislature) is having a mega size negative impact on C corporations in Wisconsin.  Multiple corporations have told me that they are analyzing leaving Wisconsin because of the multi-million tax hike they will experience from this bill.  Likewise, an accountant told me that companies with warehouse operations in Wisconsin are thinking of closing those and relocating them to a state without combined reporting taxation.  Why pay tens of millions more in taxes just because you have a small “footprint” in Wisconsin?!  This law, if allowed to stand, will devastate Wisconsin’s economy and further isolate this state from the rest of the country.  Yes, it’s really that bad.

And wait until the senior citizens and others who live off of the dividend income get hit with the new 44% tax rate on their dividend income.  That’s right; hidden inside the health care bill is a provision that triples the tax rate on dividends from 15% to almost 44%.  The devastation this bill will reek on Americans is only just now beginning to be discovered.  Think about it; seniors who lost a big chunk of their savings in the stock market are now going to see their incomes further reduced by one-third more.  They can’t survive this kind of a hit against their fixed incomes.  Plus, this will translate later into lower spending.

Lending:  Lastly on the summary, the feds are now forcing banks to further curtail lending to commercial real estate.  The federal regulators have imposed a 300% of capital limit on commercial real estate lending in banks, and two banks have told me that this will mean they will have to reduce their lending by not renewing loans and by also not accepting new customers (and by not expanding lending to existing customers) in order to comply.  This will further tighten an already bad credit situation nationwide, and it’s simply insane that the government is doing this with no direct evidence of specific loan problems.
 
In fact, they’re taking this action just at a time when banks should be doing more lending, because the conduit market for lending has dried up.  (Funny thing though, New York reports that a few investment banks on Wall Street are now gearing up to provide securitized lending [again] on commercial real estate – hmm, anyone see a pattern here?  The feds tighten bank credit forcing borrowers to look elsewhere and “elsewhere” just happens to be the Wall Street banks that got us into this mess in the first place!)  Unfortunately, small borrowers are not going to be able to tap into Wall Street to save themselves.
  
On the good news front, however, leasing is up in Madison.  T. Wall Properties has leased more square footage in the last month than in all of last year.  Some of it is musical chairs with tenants, some is government leasing (which is clearly increasing), and some is true growth, but that growth is limited to entrepreneurial growth, not a broad-base growth of businesses.

Interest Rates:  First, in March at a Treasury auction, interest rates rose as the Treasury department couldn’t attract enough buyers for their debt offering at the price (interest rate) that investors wanted.  Also, the Fed stopped its subsidy of home mortgage interest rates, which means rising rates.  But worse, the Fed also has to unload over $1 trillion dollars in mortgages that the Fed owns, which will also drive up rates.  And as the Treasury department just learned in March, the government is going to start to offer higher interest rates in order to attract enough buyers for its bonds, given the massive and historically unprecedented borrowing that the Federal government is conducting.
 
Tax Increases:  the Administration and Congress have seen fit to not repeal the Bush tax cuts, which means that the income tax, the capital gains tax, and the estate tax all increase in 2011.  But wait, there’s more.  Surprise!  The Administration and Congress doubled-down on the tax increases inside the health care bill.  That’s right, hidden in the bill are significant tax increases across the board.  For example, there’s a combined new health care tax of over 6% (3.8% plus 2.3%) now applies without a cap on income and applies to capital gains, dividends, etc.  This means that not only will capital gains tax go up by 33% next year, but with this tax, capital gains taxes will eventually increase by about 58%.  The estate tax will increase to 55% from zero.  Likewise, income taxes will increase significantly for small business owners and middle class America.  All in all, in 2011 Americans will be paying between double to more than triple the taxes that they paid during the Reagan years.  Then there is the hidden insurance company “fees” that small businesses will pay through increased premiums, which add up to over $14 billion per year! 

In particular, however, I must highlight the real problem – a problem that will hit small businesses and small business owners across America like a two-by-four across the head; all these new taxes are designed specifically by the Administration and Congress to kick in at $250,000 of income, which means that they specifically target small businesses.  I predict that these taxes will rob America of its small business growth capital and limit economic growth.

Think about it; if and when small businesses get back up on their feet, they’re going to be knocked down again by a government bent on targeting them and punishing them for their success in growing, adding jobs and creating profits.  So while in the short term these businesses don’t have as much income due to the rough economy and therefore may not be immediately impacted, almost every single small business owner is going to question making investments in growth and hiring if their profits are going to be taxed away at usury rates.

In other words, the automatic tax increases that were coming next year were bad enough, but now we all have to deal with a whole set of new taxes, found in a highly complicated 2,800 page health care bill that the bureaucracy won’t have figured out for at least a couple of years.  So we’ll all sit here in limbo [again] until all this is settled out, which is just what the economy doesn’t need. 

Decision Making:  All this will cause business decision makers to put their investment and business decisions on hold, again.  Recall that business owners and decision makers put their decisions on hold until the Presidential election; then they waited until the new administration was installed.  There was a brief decision making period that occurred in and around June 2009, but then again, decision makers got spooked in the latter half of 2009.  And now, given that we know where Washington wants to take America, I have no doubt that most business owners and decision makers will put their investment decisions and hiring on hold again.  What choice do they have?

Forgive me for saying this, but it doesn’t take a lot of intelligence to understand that massive tax increases and massive new regulation during a Great Recession is not a recipe for recovery.  So why would the Administration and Congress do this, in spite of their rhetoric about focusing on jobs?  You have to draw your own conclusion. 
 
And what’s worse, I fear, is that the health care bill will energize Washington to continue down this same path of behavior.  Count on the cap and trade (tax) bill coming back up for a vote, and then card check, and then who knows what else.  (And don’t forget, in case you missed it, the health care bill included a complete government takeover of the student loan industry.)  The evidence is clear:  now Washington is talking about a massive Value Added Tax (VAT), which in other countries comes to 22% to 30%.
 
I know, I know, many of you think I’m probably nuts, but hey, you’re talking to the guy who predicted the August 1998 credit market crisis, the March 2000 technology market crash, and in May and again in August of 2007 I went on record warning us of the present economic hurricane that hit.  It’s simply math.  All these new taxes will hit the economy like a ton of bricks next year.
 

Ironically, the only way to avoid more taxes is to increase your debt and interest so that you lower your income.

The government can’t take that much capital out of the private sector and not expect any consequences.  There are too many business owners like me who are honestly afraid of what is coming; afraid of our futures, and as a result, we’re not going to invest in risk taking ventures, or new hiring, or new spending.  In fact, the health care bill has resolved me to stay focused on cost control and maintain the present staffing levels with no new hiring.  Sure, leasing activity has picked up, but most of the increase is just musical chairs; i.e. tenants are just trading places.  Just don’t be the developer left standing without a chair when the music stops!
 
And remember, under the health care bill the government is going to tax us for three years before the first year’s “benefits” kick in.
 
New Regulations:  And we are forgetting that Washington has added a massive regulatory burden to the equation as well.
 
Specifically, the health care industry in Wisconsin is the third largest industry (after government[!] and manufacturing) and the bill is designed to allow the federal government to control every single aspect of the health care industry.  So while I believe the health insurance carriers will benefit from rising premiums caused by piling federal mandates on top of state mandates, health care providers will slowly erode under a mountain of regulation and uncertainty, especially over the next few years.

For example, the bill bans development of for-profit hospitals; that’s right, the federal government just outlawed profit!  Companies like Aurora are now stopped in their tracks.  While they can remain in existence, their existence will become more like a living coma than a real business, because all the decisions will be made for them, in Washington.

And thousands of IRS agents will be hired to police us – coming into our homes and businesses to force us to buy health insurance or levy massive fines ($2,000 a head) if we don’t.
 
I could go on and on, but you get the idea.  This isn’t a health care bill; it’s an Orwellian takeover of nearly 20% of the U.S. economy.  Cap and trade will follow with a takeover of the energy industry, and card check is designed to allow the government to control smaller and medium sized businesses by expanding the unions.  If the government controls our personal health care and it controls energy, which we all need to survive, then the government controls us.
 
Our only hope now is for a massive turn over in this November’s elections so as to give the House and the Senate to the opposing party in order to do a few things – first, put the brakes on Obama, and second, to remove Nancy Pelosi and Harry Reid from power.  Then we have to cut spending and cut taxes and regulation and restore confidence so that private sector hiring, investing and spending can begin again.
 
Of course, repealing the health care bill will be critical in order to prevent the U.S. from defaulting on an unsustainable debt load in the next few years.  I realize some naysayers say that can’t be done, because even if the Republicans control the Senate, they won’t have a veto proof majority, and that’s true.  But hey, even Bill Clinton signed onto welfare reform after two prior rejections.  He realized that his election was coming up – and so too will Obama as 2012 approaches.  Yes, he is an ideologue, but I suspect that his own thirst for power will override his ideology and if he sees a massive turn over in the Congressional election in November, he’ll start to rethink his future.  Plus, throw in the lawsuits against the bill, tea party rallies, and a new Congress that he can’t control, and he may surprise us.  So, keep the faith.
 
Of course, there are a few people out there that quite innocently don’t believe my prediction for a double dip recession, so let me point out the choice that Washington just made in clearer terms.  The States of Michigan, Massachusetts and California have been headed down the same path (for years) that Washington just set this country on with the health care bill, and all three are in serious financial jeopardy.  The end result of this policy has been well documented in those states.
 
Massachusetts is experiencing demands on its “free” health care system that will bankrupt the state eventually.  The cost of the program is exponentially higher than original forecasts.  There is no mathematical way that the taxpayers of the state can keep paying more.
 
Likewise, Michigan is the perfect example of what kind of mess the government can get us into when the government and the unions work together to maintain control over the economy – putting themselves first and the taxpayers of the state last.  Michigan is broke, California is broke, Wisconsin is broke (with a deficit four times higher than California per capita I might add.)
 
What more evidence do we need to be able to predict where the U.S. economy will end up in a few years after similar programs are in effect at the national level?
 
Enough said.  Sorry for the “downer,” but I can’t just beat around the bush any longer.   We must all stay vigilant and work to turn this situation around.  If we do, we can get our America back; but if we don’t, we know what the economic consequences will be.
 
And therefore, I am optimistic – I am optimistic that the massive grassroots effort that I see the American people taking out there across the state and the nation will manifest itself in taking back our government this November.  And then we can begin to turn this great ship around and get it headed in the right direction in 2011.  If we then see new legislation in early 2011, I think we could see an economic turnaround by mid-2011 based upon past historical events.

Tax and Demographic Supplement:  Ironically, due to demographic changes in the U.S. economy, the federal government as well as all local and state governments should be cutting back spending.  Why can I say this?

Because Generation X is just now entering its peak household income earning years.  (For easy reference, I’m at the beginning of Gen X, age 45.)  There are about 11% fewer people in this X generation than in the Baby Boomer generation, but more importantly, there is a 25% decline in population from peak to trough, which means that the government is increasing spending and taxing precisely at the time when the next generation won’t have the capacity to “carry” the extra tax burden let alone carry the old tax burden.
 
Demographically speaking, the U.S. is looking at a twenty year period during which Gen X will be moving through their peak earning years – now aged 26 to 45 – which translates to a deficit of earning power, which in turn will translate to an inability to pay the same total sum of taxes that various governments have been used to receiving.
 
Besides, governments should also realize that they don’t need to provide the same aggregate level of services to a numerically smaller generation, and therefore, should be reducing costs, even though governments may provide the same per capita level of service.  Unfortunately, we all know that the governments are not going to cut back on spending, even though they should.  Think about it; twenty years during which time there will be fewer people moving through the system. Having the government spend just as much as in the past would be like a business trying to sell the same amount of product to 25% fewer customers.
 
Some people out there may counter this and say that spending less is not possible.  I counter that by pointing out that school districts across the nation were closing excess schools and reducing classroom capacity when I was growing up; so too can other forms of government.
 
If local, state and the federal government continue to spend at the levels they could during the peak earning period of the Baby Boomers, there’s going to emerge a huge clash – because Gen X simply cannot support the same level of government spending and taxation as a generation that is 11% larger on the whole and 25% larger at the peak.
 
Supporting my thoughts, the Fed Chair just said the following in the Wall Street Journal:  “In a speech in Dallas, Mr. Bernanke bluntly noted that two giant fiscal waves were headed for the federal government, one atop the other. First comes the big deficit caused by the economic downturn.  That will be followed immediately by ballooning costs for baby-boom retirees drawing Social Security and Medicare funds.  ‘To avoid large and unsustainable budget deficits, the nation will ultimately have to choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above,’ Mr. Bernanke said.”

And given that the health care bill will add two trillion dollars in spending the first year alone.  (And every government entitlement program has ballooned to nine times original estimates, so that means $18 trillion in new spending within ten years, which is unsustainable.)
 
Business Supplement:  So, what does this economic mess mean for my own company and how will I change my behavior?  I already prepared my company for this new operating environment by reducing costs and rightsizing the staffing level to meet the lower development needs.  We’ll just keep plugging away at leasing, leasing, and more leasing, while avoiding new development unless any new building is leased past breakeven with a credit tenant.  The bigger trick will be for me to avoid being enticed into other investment opportunities that look good on a micro level, but which may be negatively impacted on a macro level.  One thing is for sure, we now know that this new operating environment is here to stay with us for a few years – the hope that the economy would turn around this year is out the window with the health care bill and more new taxes and regulation coming on-line, so stop hoping and start preparing your company for this new environment.

March 11, 2010
The Economy Hangs in a Precarious Balance

For the last six months I’ve been warning about the coming rise in interest rates.  Well, the Fed just fired its warning shot across the bow, raising the rate on funds that banks borrow from the Fed.  Get ready for a new operating paradigm. 

The Fed’s New Paradigm
What I can’t understand is the Fed has been saying for months that it will not raise interest rates, and, in fact, is still saying so.  The Fed also made this rate move outside its normal FOMC (Federal Open Market Committee) meeting to try to emphasize that this is not part of a greater scheme to raise overall rates.
 
I’d like to highlight the problem with this new Fed. Under Greenspan the Fed’s coming actions were telegraphed far in advance so businesses could prepare, but this Bernanke Fed, like a good magician, seems determined to convince Americans to watch their right hand while their left pulls a rabbit out of the hat.  My advice is to watch the Fed’s actual behavior rather than listen to its words.  For those of you who don’t read the Federal Open Market Committee summary, the Committee made esoteric and confusing statements about raising rates, so watch out.  

Sure, the Fed may not raise rates more in the short-term (who knows with their current desire to say one thing and do the opposite), but one thing is certain, we all need to prepare for the coming higher interest rate environment within the next couple of years.  Fortunately (or unfortunately), businesses have been cutting back on debt, so that may help ease the transition to a high interest rate environment. 

Present Environment
So, where are we today?  The economy is a mixed bag with economic statistics showing some minor export driven growth, but with domestic sales, companies are lagging behind.  Sure, GDP is up last quarter, but when you take out the government sector and consider the coming revisions along with government "adjustments", the number is lower than the face rate.
 
Then take out inflation factors in the GDP and you begin to see that real growth is anemic or non-existent.  One manufacturer I know (I think I may have said this before) achieved apparent top line revenue growth last year (and was proud to state so), but when you subtract the company’s price increases, the real inflation-adjusted growth rate was negative.  His top line actually fell in real terms.

GDP:  The other factor to remember on the GDP ratio is that 26% of the GDP is government, which means the GDP ratio is skewed – government can’t create national output and every dollar of government expenditure must come out of the hide of the private sector and is therefore, a negative.  This bias in the GDP is one reason I believe we are seeing a positive GDP number when the reality on the street is that there is no recovery. 

Inflation:  One interesting sidebar theme is companies are starting to see some prices increase.  The CPI in December was up 1.8% (annualized), demonstrating that we’re starting to see some inflation in spite of the recession.  Some businesses can no longer eat the material and labor price increases they’re experiencing in spite of fierce competition and are passing those price increases along to their customers.

You’ll note that inflation rose to an annualized rate of 5.6% before the recession knocked it down, but just in the last month it’s started to head up again.  Certainly in the short term with the recession still active, inflation will be kept at bay, but long-term with the expansion of the money supply, there’s no way of getting around high inflation.

Risks
Let’s talk risks, because that’s what the next twelve months is all about – managing risks, keeping overhead and expenses low, and trying to survive on lower overall sales until the economy starts to improve. 

Government Crowding Out the Private Sector:  Presently the government is crowding out the private sector in quite a number of industries – insurance (through AIG), banking, home mortgages, student loans, auto manufacturing, etc.  I had one insurance agent relate to me how AIG (government) agents are trying to undercut private insurance agents by offering insurance below cost. 

Right now the U.S. is fortunate because, ironically, there is now increased risk in the overseas markets of multiple sovereign defaults (Ireland, Iceland, Italy, Portugal, Spain, Greece…).  International investors are placing their money where they believe it will be safest – in U.S. Treasury bonds.  However, this is a temporary and fleeting condition.  As soon as investors see other safe investments overseas, those capital funds will quickly leave U.S. Treasuries, leaving the Treasury department with no alternative but to raise rates to attract enough capital to finance the government’s enormous debt.  I believe this will occur once a recovery begins and the risk of those sovereign defaults has subsided.

Presently the U.S. national debt is $14 trillion and quickly on its way to $20 trillion.  That’s more than can be financed (in my opinion).  More importantly, since we last talked, Moody’s Rating Service has issued its own warning shot, threatening to downgrade U.S. debt if the United States doesn’t get its finance house in order.  Amazingly, this warning has been down played or ignored by the media and the government. 

China:  The bigger threat is China.  Little fanfare occurred when Japan recently became the largest buyer of U.S. debt.  Make no mistake about it, Japan didn’t suddenly increase its debt holdings – rather the previous largest buyer, China, didn’t buy enough to maintain their leadership position!  You may recall that I pointed out previously that if China didn’t step up its purchases to the same percentage of total U.S. debt offered, which would mean buying more total dollars of debt, then the U.S. would not be able to finance or sell all its bonds.  That is exactly what just happened; China did not step up.  Fortunately, other nations like Japan and other investors have stepped in to take up the slack, but how long can this go on?  There’s only so much capital in the world (especially during a recession).  Think about it; Dubai just went belly up, and there are at least six nations or more in Europe close to default and in need of bailouts.  Even if the European Union bails out those countries, the EU has to then finance the bailout, which means competing in the world debt markets with the ever increasing U.S. appetite for borrowing.

30-Year Treasury Auction – February 11, 2010

Auction Overview:

• The February 30 year bond Auction results showed that the government had to pay a higher interest rate to sell the bonds.
• The 30-year bond came in at a yield of 4.720%, above the 4.681% before the auction.
  • Demand was low at the government’s offered interest rate.
    The bid-to-cover ratio was a low 2.36 (it was 2.68 in January)
• The lower the number, the less aggressive that bidders are being. 
  • This low ratio meant that the auction was oversubscribed, i.e. there were more buyers (domestic buyers), but only at a higher interest rate.
• Indirect Bidders are the key foreign buyers including central banks.
  • This most important category defines the success/failure of an auction.
  • Foreign buyers only bought 28.5% of the bonds compared to 36% to 40% levels seen in most of 2009.
  • This signals that foreign investors may be moving away from U.S. Treasuries and reducing their holdings in U.S. debt.
• Direct Bidders (domestic buyers) – non-primary dealers, banks, money managers, and depository institutions with direct accounts to submit bids to the treasury: 
  • Were a record 24.07% in this auction.
  • Well above the 4.9% in January and 6.9% in December.
  • May indicate the lack of other alternative investments that will pay as high a yield. 
• The public tendered to purchase $37.7 billion while the government only accepted $16 billion of their bids, because the interest rates tendered to the Treasury were higher than the Treasury wanted to pay.
• Conclusion:
  • 1.  Foreign buyers are cutting back on their purchases of U.S. Treasuries.
  • 2.  Interest rates will be forced to rise to attract the number of buyers that the Treasury will need to finance its debt, although presently, at higher rates, there appears to be enough buyers given the lack of alternative investments and the risk in foreign debt, i.e. the problem in Greece.

The U.S. is also quickly reaching what is considered the tipping point in national debt to GDP ratio.  Consider the real level of total unfunded liabilities compared to the real level of (lower) GDP and you begin to see the U.S. is in a real pickle. 

The real problem, however, is that the government has entered a "wealth destruction" era, where the wealth creators, the job creators, and various industries are continually demonized.  The U.S. can’t get itself out of this hole without doing two things – first, cutting back on the massive increases in spending to prior levels or lower, and second, allowing wealth to be created in the private sector so that the government can finance its debt needs by attracting that wealth in the debt market.

One good quote from the Ludwig von Mises Institute is  “Over time a situation can emerge where, as a result of persistent loose monetary and fiscal policies, there are not enough wealth generators left.  Consequently, generated real savings are not large enough to support an increase in economic activity.”  I would add this; if there is not enough wealth created, there won’t be enough capital to finance all the government debt, thereby either driving up interest rates substantially (in order to attract the capital competing for it from the private sector) or there will be a failed Treasury bond offering of U.S. government debt. 

In addition to all that federal debt is the issue of state debt.  State government budget shortfalls are projected to be $193 billion for 2009, $180 billion for 2011, and another $120 billion for 2012.  Those figures compare to $110 billion (in total) for 2009.  And you thought the states were in trouble in 2009!  State governments are looking at budget deficits that are about 85% higher than last year.  Repeat that scenario for two more years and you get the picture.  States are headed for a disaster over these next three years. 

Government Spending:  There was a good chart in the Wall Street Journal recently that showed federal government spending has reached 221% more than 1970’s levels as compared to household income, which grew only 32%.  In other words, when government employees and politicians complain that the government doesn’t have enough funds to spend, don’t believe them.  Government spending has skyrocketed to unsustainable levels.  The amount of taxpayer household income cannot support this level of government spending, which is why the government is incurring massive deficits.  I believe we have now reached the point that federal deficits combined with state and local deficits have reached the breaking point.  The U.S., given the size of its national debt, may very well result in a Greece like crisis in this country within the next few years. 

I’m not the only one who is afraid of this happening.  Business owners around the state are telling me that they too have the same fear, and this is what is driving them to be so cautious in their spending, investing, borrowing and hiring.  As long as these conditions persist, any recovery will be a job-less recovery, as businesses learn to live with the lower level of overhead.  If sales do pick up, they’re not going to rush out and start hiring – instead, they’re going to harvest those profits to continue to pay down debt and cover losses from the recession. 

One reason for the growth in government spending is the old covenant that government workers were paid less than the private sector, but received better benefits and a pension has been broken.  Today, federal government workers’ compensation (wages and benefits) has grown to almost $120,000 vs. slightly under $60,000 in the private sector (Cato Institute).  Today, a government worker not only receives significantly higher pay verses the private sector, but they also get significantly higher benefits and an extremely generous pension as well; all at no risk.  Why would anyone work in the private sector under these circumstances? 

Lending:  One sign that wealth is not increasing is the lower overall lending and borrowing activity.  Commercial bank lending at the four largest banks was down 12%, and likewise, loans at the top ten regional banks was down 8.2%.  Overall lending was down 8.8% in January and down 7.9% in December, according to the Ludwig von Mises Institute.  A lower overall lending rate translates into lower economic activity.  Bankers tell me that even if businesses wanted to borrow, with demands for increased capital ratios and the like, regulators are making it difficult to lend. 

Ironically, while lending is down, there are still three-quarters of a trillion dollars of commercial real estate loans that need to come out of the conduit market and into the traditional bank lending market within the next three years.  And yet, in spite of the lack of credit, the Fed is holding over $1 trillion of U.S. bank reserves that instead could be loaned out.  If the government really wanted to get the economy started again, the Fed would push those funds back out to the banks to be loaned out. 

Another example of the lending problem that is out there is this – a home builder just showed me two federal guarantee and financing programs that the federal government has discontinued for construction of new homes (but continued for existing home sales).  I realize that the government wants to unwind the existing inventory of homes, but new construction is what creates jobs. 

Business Environment:  Small businesses around Wisconsin are telling me that they’re on their last leg.  Many owners have reduced or suspended their own compensation just to survive.  Moderate sized businesses are seeing enough business to get by, and many, to their credit, have elected to retain employees on their payroll even when they don’t have enough work for them.  That says one thing about family and small businesses in America – many have told me how they have sacrificed profits in order to maintain employment.  Talk about patriotic!

Larger companies are seeing some revenue growth, again, from exports and overseas orders.  Most are saying that they’ll try to live within their new lower-cost structure paradigm, which also means that once a recovery does come, employment will not pick up as fast as in past recoveries.  But I’ve noticed one thing in common with the hundreds and hundreds of business owners I have spoken with in the last few months; they are terrified of what Washington wants to do to them next. 

Is it any wonder businesses aren’t hiring or investing or spending or borrowing?  In 2011 the income tax is going up, the capital gains tax is going up, the estate tax will soar, and then add in the possibility of a health care tax, soaring energy costs under cap and tax, and increasing wage costs under card check.  And of course, now we know that interest rates will be rising on already tight credit.  The combination of all this is too much for most people to process let alone plan for, which is why they are holding onto what little capital they have left just to survive and wait for things to settle down. 

Other Statistics:  Pending home sales were down 7.6%, signaling an upcoming period of slow
closings (or sales) over the next couple of months.  In the Midwest, contracts were down even further by 8.9%.  The Mortgage Bankers’ Association reported that mortgage activity was down to its lowest level in 13 years.  Home prices were down again by 2.5%, but given this small decline, I would guess that home prices are bottoming out.  Continuing jobless claims increased to 4.6 million, and even if initial claims were down, those claims seem to be stuck at a level above 450,000, which is way too high.  And while the media likes to point to the positive that job cuts were only 42,000 last month, just the fact that there are still jobs being cut should be a concern.  By now we should have seen job creation starting to occur.  I am beginning to worry that the U.S. will experience a period of malaise in which there may be positive GDP growth, but no one on Main Street feels it, because no new jobs are created.

The good news is that there are clear signs that some inventory replenishing is occurring, with January durable goods orders up 3%, factory orders overall up 1.7%; although, taking out the aircraft industry leaves only a meager increase of 0.1%.  Other good news includes a rise in retail sales, and a rise in FedEx and UPS shipments. 

Quite a few other statistics and data points indicate a small jump in overall economic activity, but with certain sectors still hurting.  Business owners’ confidence levels also seem to be not as bad as they have been for their own businesses, but still are registering lower than a recovery would dictate.  So, there are some good news points out there, but still many bad ones as well, which is what you would expect to find during a true bottoming out period.  Now the question becomes, how long will the economy bump along the bottom? 

Conclusion:  If Washington were to announce today that all those tax increases are hereby repealed and that the proposed health care bill, cap and tax, and card check will not be passed, and instead focus on a few common sense solutions to the issues at hand, such as creating health care competition, then we would see an immediate positive impact on the economy as confidence levels soared.

The next step would be to focus on cutting back all the spending increases nationwide to levels prior to the crisis.  Then follow that up with getting all those government owned companies back into private hands, and using the repaid capital to pay down the national debt.  Then, and only then, would we see a strong recovery taking hold this year and gaining strength in 2011.  And no, that isn’t a political statement; that’s an economic statement coming from someone who holds degrees both in business and economics. 

I believe that we’ll see a sea of change in the political environment come November, which will mean new legislation come February through May 2011.  However, that means the effects of these coming changes won’t take effect until the latter half of 2011, unfortunately. 

But they are coming.  Unfortunately, the structural damage has been done.  It will take many years to undo that damage and for the credit markets under the present regulatory environment to loosen up.  Following the 1980 election that process took about three years, but in the third year (1983), the economy did experience strong growth.  And leading up to 1983, business owners and people in general felt better because they knew better days were coming, so they started to act upon those feelings. 

I sincerely hope that will be the case starting in 2011, which means we could see the light at the end of the tunnel by 2012, but of course, that depends on a lot of factors. 

Stay tuned…