The depression begins

The fourth quarter of 2009 marks the beginning of the Great Slide, as the US sinks into depression. This will be the second leg of the “W shaped recession, except it will not be a W, because the US will not recover from this dip until 2015 at the earliest.

Yes, folks. I am predicting the beginning of the end of the US domination of the world economic stage, starting this quarter. By the time the US recovers, Europe will have found its economic feet, and China will be standing astride the world.

I will outline some of the known economic influences that will continue this recessionary slide.

It may be possible to change some of the outcomes by huge changes in Government intervention, but there is an ideological element of the populace that is so rabidly opposed to Government participation in the business process, this potential help is unlikely. In fact, it may not help. The Government is so accustomed to pandering to lobbyists and big business, the real engines that could pull the US out of this spin, innovative small business and new start-ups, would be pointedly ignored.

I would like to make an important point here. This is an economic analysis, not an emotional statement of strange political beliefs. If you take umbrage at anything I have to say, then the anger is all yours. J

The State of the Union

Over the past few months, the stock markets have recovered. The Dow's dive from 14,000 down to 6,000 has been reversed, and it is now temporarily above 10,000 again as I write.

This share price recovery has resulted from cost-cutting, not business expansion. Employers are paring their costs in both capital expenditure, and cutting their workforces.

For the fourth quarter 2009, I am predicting

* increasing unemployment and underemployment

* the tide goes out on credit markets (home equity loans, credit cards)

* a substantial drop in consumer spending

* Governments at all levels (City, County, State, Federal) will see worse-than-expected tax receipts and start to trim their spending

* continued reduction in US manufacturing capacity

* continuing erosion of the US manufacturing technology base

* growing reliance on high tech manufacturing imports

* continuing low levels of venture capital and angel capital investment

* the commercial real estate fiasco starts to get under way

* the housing mortgage market takes a turn for the worse

* the dollar continues and accelerates its slide against other world currencies

* the Dow will fall again (measured against a basket of global currencies)

Employment, underemployment, and unemployment

First, a handy little graph of the unemployment statistics.

http://www.bloomberg.com/apps/quote?ticker=INJCJC:IND

These statistics only include those who have recently lost their jobs, and whose job loss complies with very tight conditions. From that link above:

"Weekly initial jobless claims is the actual number of people who have filed for Unemployment benefits for the first time. Following five (5) eligibility criteria must be met in order to file for unemployment benefits: 1. Meet the requirements of time worked during a 1 year period (full time or not). 2. Become unemployed through no fault of your own (cannot be fired). 3. Must be able to work; no physical or mental holdbacks. 4. Must be available for work. 5. Must be actively seeking work."

When an employer can fire an employee for cause, they do not have to pay their unemployment costs. In many cases, employers are firing people for trivial issues, because it will save them unemployment expense.

As well, there are tax accelerators kicking in which are making it more expensive for employers to keep their employees. Massachusetts will raise the tax per employee from $594 to $832 per employee in January to try to cover the shortfall in the State Unemployment Fund. http://www.boston.com/news/local/massachusetts/articles/2009/10/16/unemployment_at_33_year_high_insurance_fund_running_dry

Every incentive measure works towards fewer jobs, and more productivity from the people who are still employed.

At the same time, Government employees and company employees are being furloughed, cutting their work hours and income.

The issues of underemployment are not being measured. In this category we have people whose career skill set is no longer marketable in the existing employment market, for reasons that range from their jobs have been sent overseas to the technology has been obsoleted. For example, television repair men are an almost dead breed, and computer repair technicians are following fast. It is cheaper to throw away an imported electronic device than attempt to repair it, and there is no commitment on the part of overseas consumer electronics manufacturers to try to build a maintenance force in the US.

The tide goes out on consumer credit markets (home equity loans, credit cards)

Banks are tightening up their lines of credit to their customers. This is accelerating the drop in consumer spending, as consumers run out of expandable credit lines.

Consumer spending tends to resist pattern change. Most consumers tend to keep their old spending patterns until they are no longer viable, using the excuse that they are already being as frugal as they can. When there are economic reversals, consumers tend to bridge the gap with borrowing, either on a home equity loan or with credit cards.

Governments at all levels (City, County, State, Federal) will see worse-than-expected tax receipts and start to trim their spending

First up, a straight prediction. I predict that every State, County, and City in the US is currently working on inflated expected tax revenues, and that, in every case, over the next 15 months, they will get a lot less in tax revenues than they budgeted.

To compound the problem, the consumption patterns for consumers extends to Government spending. At City, County, and State government levels, we have already seen extended borrowing. Currently, the Federal Government is providing the States with a chunk of the extra cash they need, and the States are making up the difference by borrowing more. Governments are not addressing the systemic reorganization that they needs to make at all levels, and their resulting dithering will continue to burden the productive corporate sector with inefficient overheads, worsening the economic situation.

The Federal Government is able to print money, and the Federal Reserve printed around $4,700 billion during 2008. They are remarkably silent about their current activities, or maybe I am not paying attention. As well, the Federal Government can borrow money against the international creditworthiness of the US dollar.

But all good things come to an end. The party for the money-printers is just about over, and as the world economy contracts, and other currencies gain in credibility, the world will be increasingly afloat in US dollars.

For the past 40 years, the US has been able to print money, and spend it for goods internationally, simply because continually expanding world trade needed more dollars every year. This allowed the Treasury to print around $600 billion a year, and the Government to spend that money, knowing it would continue to be needed to oil the wheels of global industry.

Now, we have the rest of the world looking at alternative currencies. During the past decade, the US has behaved in an astonishingly irresponsible and dangerous manner, from military misadventures to fiscal oversight irresponsibility.

So the double whammy is, while there will be a reduction in world demand for US dollars for world trade, which will depress the value of the dollar, the US will no longer be able to print $600 billion a year for free. Print that $600 billion, and the dollar goes further into free fall.

I close this section with a scary prediction:

http://www.businessinsider.com/mitsui-strategist-elliot-wave-theory-says-dollar-will-halve-2009-10

The Sumitomo Mitsui bank, the third-largest bank in Japan, has an analyst of considerable forecasting ability predicting the US dollar will halve against the Japanese Yen next year.

'According to Daisuke Uno from Sumitomo Mitsui, from Japan’s third largest bank, “The U.S. economy will deteriorate into 2011 as the effects of excess consumption and the financial bubble linger. The dollar’s fall won’t stop until there is a change to the global currency system.” '

In the next year, US Government spending will have to be cut dramatically. But it will also not go as far. So the contraction in the economy measured by other world currencies, will be even more stark.

Continued reduction in US manufacturing capacity

Offshore manufacturing was substantial by 1990, but at that time, there were few high tech products manufactured off-shore.

Since 1990, off-shore manufacturing has really taken off. Today, much of the manufacturing that has moved off-shore cannot return, because the overseas manufacturers are now up to four generations of manufacturing technology beyond what is available on American shores.

One of the assumptions that Government economists continue to make is that a weaker dollar would make American exports cheaper. Problem is, the rest of the world is accelerating away from American manufacturing in both technology and cost reduction. Even if the dollar drops to half its current value against the Euro, manufacturing in the US has been hanging on by its fingernails for years, and the current recession/depression has gutted the ability of manufacturers to spend on R&D or new equipment.

It has taken the US Government years of neglect to get us to where we are today. Here is a little feature you will enjoy. The screen for the Amazon Kindle uses American patented technology for their screens. Sure, the technology is American-owned. But the kicker is, the product can’t be manufactured in the US. The manufacturing know-how isn’t here to assemble the invention.

http://blogs.harvardbusiness.org/hbr/restoring-american-competitiveness/2009/10/the-us-cant-manufacture-the-ki.html

This is a repeating paradigm. US inventors may be able to produce a result in a lab, but they cannot take the product through manufacturing. And as the manufacturing sector declines, the ‘commons’, or the support and administrative structures (infrastructure) that need to be in place in a business community to support a manufacturing environment, all disappear

Meanwhile, all the States are looking at new ways to tax business to try to make up the shortfall in their tax revenues, putting further pressure on manufacturing industry both politically (through union response) as well as financially. With the social unrest that results from this disruptive environment, we will see an acceleration in offshore manufacturing, and a resulting acceleration in US unemployment.

Continuing erosion of the US manufacturing technology base

This is simply a conclusion from the previous section. If new manufacturing technology is not being evolved to compete with the rest of the world, and the manufacturing infrastructure has severely eroded, it will be more and more difficult for start-up technologies to find companies that can turn their inventions into a saleable product.

New products will have to go overseas to find manufacturers.

Consider the story of Boston-Power. They have been a success story, building laptop batteries with superior charging and lifetime characteristics. Buy an HP laptop, you now get a Boston-Power battery.

This is a US technology, and a US company. Dr. Christina Lampe-Onnerud, CEO, tried to get her technology manufactured in the US. The cheapest quote she got from any US manufacturer involved a $700,000 start-up cost, and a fairly high price per unit. Wrestling with her loyalty to US industry, she reluctantly researched China as an alternative. She was amazed at the courteous and professional treatment she received, and to her amazement, she got a lit of some 400 manufacturers who would take on the task, with no up-front expenditures, and much lower per-unit costs, with guarantees of quality.

Her company has raised around $65 million in venture capital, and is successfully manufacturing in China.

Now the kicker. She has proposed building a factory in the US, and is looking at the Government incentives for energy companies. Looks like the US Government would rather she took all her business to China, and just sold products back to the US. http://www.xconomy.com/boston/2009/08/05/up-to-2600-jobs-that-won’t-be-coming-to-ma-boston-power-ceo-“incredibly-disappointed”-to-miss-out-on-doe-funds/

Growing reliance on high tech manufacturing import

A manufacturing environment is a complex synergy between the manufacturer of a product, and all the goods and services it has to buy to get their products manufactured. Since 1990, manufacturing has increasingly moved off-shore, and the expertise of off-shore manufacturers has become much more sophisticated. With the erosion of US manufacturing capacity, there has been a parallel erosion of the 'commons', or manufacturing infrastructure that is essential for their efficient operation. The 'commons are all those companies that provide specialized subcontract manufacturing or services to manufacturing industry. A new manufacturing company is attracted to this manufacturing environment, because this 'commons' infrastructure reduces their costs, reduces their risk, accelerates their delivery, improves their quality, and gives them flexibility for rapid expansion.

When manufacturing capacity is sufficiently eroded, the 'commons' infrastructure collapses from lack of business. Without the 'commons', a new manufacturer must do everything for themselves, and it is very difficult for a new company to develop mature expertise in every aspect of their operations quickly.

For this reason, once manufacturing environments close, they do re-open.

Continuing low levels of US venture capital and angel capital investment

Angel investors are the guys who put up the first $50,000 to $5,000,000 in funding for new ventures. Venture capitalists typically kick in at a minimum of $5 million and up.

In 2008, US angel investment was around 16% of what it was in 2006. Venture capital has also contracted dramatically.

In Asian countries, money is being spent on research and development and new venture formation as though there has been no recession. These countries do not have the condemnation of Government participation in business, because they are already a tad socialist. J China is leading the way here.

I expect to see a jump in new ventures in China, and generally in the rest of the world.

This is already ahead of where it would have been if George W. Bush had not clamped down on educational visas, and work visas, for the world’s best and brightest. For decades, the US has brain-drained the world of its smartest young people. These innovators have been one of the major reasons that the US has stayed buoyantly at the forefront of innovation.

After 9/11, these visas became much slower to process, and harder to get. It severely impacted high-tech brain-drainers like Microsoft. But it was a boon to the countries that have been losing their best and brightest to the US for many years. And this boon was given a dramatic lift when America exhaled all that imported talent in the dot com bust, sending home the people that had been imported to help, with an education in American techniques and business structure. In one month alone, 46,000 Indians returned to India from San Jose. These became the exploding factor in offshore services.

The end result of less money for innovation will be fewer US companies creating new products.

Oh, as an aside. Keep an eye on Chinese robotics technology. In the US, there is much play on the military applications. The Chinese have large universities with design and manufacturing facilities right next door, so the state of their art is easy for them to keep secret.

One giveaway is the number of articles published in China in this area.

Robots will be hugely important in the manufacturing environments of the future. The Chinese have a robust manufacturing industry in which to test and refine manufacturing robots of all kinds.

The commercial real estate fiasco starts to get under way

The current estimate for the losses in the commercial real estate loan/mortgage market is around $1,500 billion dollars. These are about to start hitting. With the end of summer, business slows. Some of those companies that have been hanging on by their fingernails, keeping the doors open for Summer to squeeze the last out of their business will now close for good, increasing the glut of commercial space available.

At the same time, expiring leases in a very depressed market will be renegotiated at rock-bottom rates, depressing property returns and making it far more difficult for commercial property owners to refinance their loans. (Commercial property mortgages are usually only written for fairly short terms, from 3 to 7 years.)

As well, in a very depressed market, some of the commercial property owners will simply declare bankruptcy.

So the next round of bank damage will start to emerge.

The housing mortgage market will take a turn for the worse

This is educated conjecture. It is very difficult to know the true situation, because the banks are not being forced to present a true and fair view of their mortgage exposure.

The mortgage market is cloaked by lack of information and good accounting. Banks are not writing their mortgages to market, because, they claim, most mortgage holders want to keep their homes even if they are underwater at this point in time.

But when a mortgage has become delinquent for over 60 days, the bank should have to make a provision for doubtful debt, because these are likely to be mortgages that will fail.

What muddies the picture further? Not only are banks not declaring their true asset/risk position, they continue to show the monthly profit on these unpaid mortgages, and their accompanying late fees, further overstating their revenues.

The banks are holding their breath on all this as long as possible, in the hope that property prices will recover in the near term.

Summer is the time when most house sales happen. We are now at the end of Summer. The banks have been holding off foreclosing on delinquent properties, hoping that a reduced inventory will support higher property prices.

Meanwhile, the Feds have written their 500,000 mortgage revisions, so that stage of support is over.

I have a hunch that we are about to see home prices wash out. If this happens, I predict that even people who have a mortgage situation that they can handle will walk, simply because it will be worth the hit to their credit rating to get out from under their old mortgage and into a much less expensive mortgage on an equivalent property. The incentive for people right at the limit is overwhelmingly tempting.

Along with this mortgage scenario there is also a glut of rental property, so this is an excellent time to rent a house or apartment.

My prediction is that property prices are going to start downwards again, and may bump down quite rapidly. The larger the loss per mortgage, the more money the banks are going to need.

The dollar continues and accelerates its slide against other world currencies

The US dollar has lost some 15% against the Euro in the past 6 months. As currency pressures mount, this figure may accelerate. I have previously mentioned the Mitsui Sumitomo bank estimate of a drop of 50%.

This will make consumer products much more expensive. It will also diminish the spending power of people on fixed incomes substantially. Those people who thought they were comfortably retired may find that their retirement fund does not cover their costs.

However, for people holding fixed assets, their asset values could double. Accordingly, the Dow may rise in US dollars, while still losing value against global currencies.

Of course, I could be completely wrong.

The banks may not have a bunch of bad mortgages they are sitting on. The commercial property market may not really be in as bad shape as people fear. The credit card market may not be a problem. Healthcare might magically fix itself. The States may suddenly discover the hundreds of billions they need for their projections of future losses in old shoeboxes under the bed.