2009 Observations

January 2 2009

Much (probably too much) has been and will be written about the many economic challenges currently facing our nation and the world, the probable responses of our government and the world to these challenges, and the possible effects both may have on investors.  I have nothing to add regarding the specifics of these challenges.  But, I do see several issues that are both likely to have a major influence on our financial fortunes in 2009 and beyond, and that have been at best under-acknowledged to date.

In the weeks and months ahead, I will be monitoring these and other issues and sharing my perspectives on them.  If you would like to follow these musings and possibly add your thoughts thereon, simply sign on below.  You can unsubscribe at any time, and we will not bother you with any solicitations, directly or indirectly.  I look forward to hearing from you.

    1. Investors, like parents, managers and military strategists, have a natural tendency to “refight the last war” – to do what they should have done in the immediately preceding challenging times.  Investors tend to invest as they should have invested in the previous market environment.  Today, that aspect of our nature is producing too much concern about inflation, not enough concern about a possible extended economic contraction, and inappropriate faith in a near-term recovery of investment markets worldwide.
    2. The recent spate of excesses and transgressions among pillars of our financial community is raising a hue and cry for increased regulation.  These problems, however, resulted primarily from simple fraud, and were allowed to continue only by inadequate oversight and ineffective enforcement of existing laws and regulations.  The likely piling on of new regulations and their inherent costs will at the least extend the current economic difficulties and may well amplify them.
    3. Financial bubbles and busts are a natural aspect of human economic activity.  Their frequency and severity, however, are increased by anything that impedes the corrective actions of natural market forces or that facilitates “herding” responses by market participants.  We now have an over-abundance of both in the form of financial bailouts and the explosion of Internet “information” and trading.  Recurring extreme cycles should be expected within the various investment markets.
    4. Few investors and even fewer politicians appropriately appreciate the concept of a “tipping point” and its implications in periods of financial distress.  They fail to acknowledge the impracticality of rating agencies, regulators or even company managements being “honest” with their investors and the public during financial crises.  The difference between a company’s or public entity’s failure and its survival and eventual recovery is often merely whether or not the faith of investors is maintained.  Negative statements by a company’s or nation’s leaders or “insiders” could make the difference and tip an otherwise viable entity into insolvency.
    5. Increasing segments of our nation’s and the world’s populations are redefining “fair” as “equal,” and “equal” as “same.”  Although one such instance, the intended narrowing of wage gaps, is a worthy goal, the resulting dilution of incentives to produce will, to some extent, have its unintended but obvious and unavoidable affect on productivity.  It is only a question of degree.
    6. A critical aspect of a healthy, long-lasting market economy is the occasional cleansing of excesses that can be achieved only by a significant correction.  Without this, rewards are disconnected from risks, resource allocations become suboptimal, and inefficiencies are perpetuated.  The current spate of bailouts and loan restructurings preclude or at least defer the necessary, beneficial correction, and are certain to reduce our nation’s competitiveness and ultimately our standard of living.  It will, however, achieve the intended objective of sharing the pain among the general population (and probably future generations) as opposed to potentially devastating the specific areas where the reductions in economic values actually occurred.  (Side note: Some form of financial services industry rescue was admittedly necessary to avoid a worldwide financial meltdown.  Not so, however, with the auto industry.  With the politically required responses to the auto industry problems appropriately pronounced and promulgated, perhaps the new administration can focus on the economically appropriate responses.)
    7. The biggest weight on our economy and national psyche in the months immediately ahead may well be nothing more than the irrational expectations of the American and international communities regarding our new administration’s ability to deal with the multitude of challenges facing the world today.  Disappointment is a certainty; only the degree is yet to be determined.
    8. The greatest concern for our economy over the next few years is our nation’s unwillingness to address the very real problems caused by financing with borrowed funds nearly two decades of economic growth and rising living standards.  Even with our crumbling economy, the necessary deleveraging has barely begun.  One needs to look no further than the government’s actions and its pronouncements that borrowing more and resuming our high level of spending will get us through this.  Although such actions may defer the day of reckoning, possibly to the next generation, it is simply unreasonable to expect to be able to borrow and spend our way to prosperity.  Only after several years of saving, investing and increasing our national productivity can we expect our growth of living standards to resume, and our role as the world’s leading economic power to be retained . . . or regained.