U.S. spending its way to stagflation

Sectors that drove employment are not coming back. Industry expects higher taxes

Since late spring of this year, we have all heard about green shoots — yet on average more than 200,000 workers have lost their jobs every month since then and three to five new banks fail every week.

In spite of the new home buyer tax credits, historically low interest rates and very aggressive lending from Fannie Mae, Freddie Mac and the FHA, nationwide housing prices have declined by 7%.

The Cash for Clunkers program boosted car sales in Q3 to be followed by a drop thereafter.

The fact is in 2009, U.S. car ownership took the biggest dive since 1960 (minus 4 million vehicles in 2009) and this trend is expected to continue for the next few years.

Yet, the stock markets have made an amazing recovery, and the U.S. GDP for Q3 is anticipated to have returned into positive territory after four consecutive quarters of decline.

Are we really working our way out of the recession, or are we merely seeing the glint of a stimulus effort in excess of $1-trillion from the Treasury and a similar amount from the Fed that is finding its way into the economy?

Unfortunately, most of the excesses that have brought on this recession have not been dealt with.

While the U.S. financial system appears healthier than in 2008, that is largely the result of a change in FASB accounting rules, which has allowed banks to reverse write-offs from 2008 this year.

Even though banks do not recognize their mounting exposure to the real estate sector, bank failures have seen a rapid increase — from a couple per week earlier in the year, to four or five per week in the last three months.

U.S. consumers, whose spending used to drive 70% of U.S. GDP, are crumbling under their heavy debt burden and have lost access to home equity lines and generous credit card limits.

In fact, higher credit card fees and interest rates are squeezing many consumers, and banks are forcing them to reduce their loan balances.

This is why they did not spend a lot for the holidays and why they won’t spend much beyond, especially as we forecast unemployment to increase from the current 10% to 12% by the end of 2010. (And those are just the official, government-beautified numbers.)

The sectors that have driven employment over the past decades are not going to recover any time soon: construction, retail, financial, hospitality and other services are all expected to continue their decline over the next couple of years.

Furthermore, the private sector is going to be very reluctant to create new jobs as business owners feel threatened by the expectation of higher taxes and interest rates, increased regulations, and labour costs (healthcare and payroll taxes).

So, how can we forecast a 4% to 5% inflation rate for 2010?

If the recession is not over, shouldn’t we see deflation continue?

The answer is somewhat counterintuitive, but it is not a new phenomenon, it is called stagflation.

It was last seen during the 1970s, after the U.S. eliminated the gold standard and had to pay for the Vietnam War and the irresponsible spending programs of the late Sixties and Seventies.

Inflation ran into double-digit territory at the same time as we experienced recession and high unemployment.

While we anticipate the prices of several asset classes to decline in 2010, real estate (-7%) and stocks (-12% to -15%), most of it will not affect the cost of living.

The U.S. consumer will be much more affected by sharp increases in consumables as a result of the devaluation of the dollar (the dollar index has declined by 10% in the last 10 months, and we anticipate that it will go down another 8% to 10% in 2010).

Energy and many commodities will increase, as well as most of the manufacturing goods we import.

Services such as health care, education and financial services will continue to represent an increasing percentage of the budget of American families.

In spite of claims by politicians, local, state and federal taxes will also increase to stem a decline in tax receipt from a shrinking base.

The administration’s lack of fiscal restraint is going to result in unprecedented levels of printing by the Fed.

Under the current forecast, the U.S. Treasury needs to raise around $4-trillion to finance a $1.5-trillion deficit and to replace Treasury debt that is due to expire in 2010.

In the last five years, issues of new Treasury securities have already climbed from a couple hundred billion dollars to $1.5-trillion in 2009, to double that in 2010.

The debasement of the dollar that started in 2009 is certain to continue — and with it inflation will come, starting in 2010.

Unless the U.S. government reverses the current trend and cuts spending dramatically, inflation is soon going to accelerate to levels we have never experienced in this country.

Never before have we had such reckless monetary policies, not even in the Seventies.