In a recent two-part discussion with Banphot on The Money Channel, my business partner, Paul Gambles, discussed their own particular assessments of the state of the America, turning to the political risks and issues.
They both saw the annual State of the Union speech on TV for the American people, but we actually read an alternative State of the Union by Nouriel Roubini, the economics professor, who put something together that, for me, is a much better description of the State of the Union of the United States at the moment. He described what he thought were seven major problem areas whereby American economic performance is really just papering over the cracks, and what we are seeing is just hiding all the problems that are underneath, and it is actually a lot of things that we have been saying for some time now.
He was talking about the fact that there is a USD15 trillion debt that is just not going away, and what is more, there is a deficit every single year as well, so that debt is just increasing. Like us, he does not really believe that American economic performance is picking up even though we saw some better numbers coming through for some of the Q3 and provisional Q4 results.
However, please remember we had Operation Twist in the second half of last year, and that really forced a lot of stimulus and put impetus into the economy. It came with a very large cost as well with all this long-term debt being swapped for short-term debt, but it did have an impact on the economy. To us that is not real growth; it is a one time benefit.
Unlike QE, I think the benefit of Operation Twist was that it had an impact on the real economy rather than just on financial assets. It is better than QE but it still has the same fundamental problem, which is that the first time you do it, you get quite a big impact, but after that, you always get diminishing returns, so they might do a second Twist, a third Twist, etc. They are still talking about QE3. They mention buying residential mortgage-backed securities, and commercial mortgage-backed securities. They are considering all these alternative forms of stimulus but the problem with all of them is that even if they do have a positive impact, it is inevitably decreasing.
There is no doubt that QE1 had a positive impact on the financial markets. However, it did not have the same impact on the economy that it did on the stock markets. QE2, though, had a much more limited impact over a shorter period of time, and we think that QE3, therefore, would not be so great, and then QE4, QE5 even less so. Eventually you end up having no real impact at all. We might get a second and a third Twist, but each time the impact will be smaller and smaller. We do not really think that these things are in any way a fix, and again we agree with Nouriel Roubini in that the real problem is still there.
Roubini describes all of this as two kinds of deficit problem. One is that there is a stock problem, i.e. there is USD15 trillion of debt already on the US federal balance sheet, and you have to do something about that because the cost of servicing that debt does not go away – no matter how much you want it to.
The second problem is what is called a flow problem, i.e. are you actually paying off that capital every year or are you really increasing it? Well America has both problems; it has a huge amount of debt, approximately 100% of GDP, and it is getting worse every single year, and no-one really seems to have come up with a solution to that.
In America, a lot of the State of the Union was political posturing; it was Obama putting himself in front of the American population as a great advert for a re-election campaign as voters have to go to the polls at the end of the year.
We have got a choice in the States with a Democrat party that believes in raising taxes for the very rich, which we agree with – it needs to happen. Income in the States is so badly distributed that it is all sticking in the top echelons. It is not circulating into the economy. This also applies to companies as well. The money is just stuck on corporate balance sheets, and corporates are not employing people, so again it is not circulating; it is not having any economic utility.
As reported by Deloittes, this is confirmed by the fact that big companies have built up substantial cash reserves in recent years. The pace of the economic recovery depends on what companies do with these cash piles. The numbers are striking – US corporates collectively hold USD1.73 trillion in cash. As a share of total assets held by non-financial companies, cash holdings are at the highest level in more than half a century. This is not just a US phenomenon. UK non-financial companies’ cash holdings stood at GBP731.4 billion in the third quarter of 2011, the highest level on record.
High levels of corporate cash reflect the success of big corporates in controlling costs and rebuilding profits in the last three years. In the US the share of profits in GDP stands at a 50 year high. While big corporates are profitable and cash-rich, governments and consumers in Western economies are, by and large, short of money. If Western economies are to grow over the coming years businesses will need to do a lot of the spending. Corporates have proved more willing to pay out cash to shareholders, through dividends and by buying back their shares. Now is the time they should start spending on growth but they will not when there is no clear guidance from the top.
To be continued…
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