Between a Rock and a Hard Place

Every day in every way as I twist and squirm to see good news, all I see is the walls closing in around us squeezing out what little wiggle room is left in the most important issues facing our nation.

The economy: I see intractable problems on two fronts. While the credit/financial crisis has clearly eased/ended, the economy still has quite a long way to go to prove it is healthy again and on a steady road of growth. But worse yet, if the economy needs more stimulus [not at all clear at the moment], our ability to supply it runs head on into our fiscal pinch which includes real political headwinds. And to make matters worse our unemployment rate has reached 10.2% and while it may be peaking, it will be slow to recede and may be a long, long time away from getting back anywhere near its historical base of 4 to 5%. The bubble of the past generation saw consumption as a % of GDP move from a long held base in the low 60% range to about 70%. That was a huge and very rapid change in the makeup of the largest part of our economy brought about by cheap money which fueled massive increases in home, auto and other big ticket sales to non-sustainable levels which post the crisis cannot be reached again for a very long time. And that strongly suggests that unemployment will be stuck at very high levels with all the inevitable political baggage which accompanies that fact. Translate all that into a simple conclusion that says watch out: while the financial system may be out of the woods, the crisis has left behind a partially crippled economy at a time when we really do not have any significant tools available to overcome the disability.

Foreign Matters: The angst over Afghanistan [and Pakistan] and what to do, not to mention Iran and the rest of the Middle East, also betrays frightening limits on our options. It grows clearer daily that we are stuck half in/out, straining our fiscal deficit in dangerous ways, when we desperately need relief to afford an essential health care reform. History is against us. For 150 plus years England and the USSR [now Russia] could never succeed in Afghanistan as occupying powers, which we now have become. How can we even hope to succeed? We need to radically alter the game plan but ‘real politick’ seems to make that almost impossible. Add to that conundrum Iran, Pakistan and the rest of the Middle [muddle] East and go see your shrink fast.

Domestic Policy: Our brilliant new, young President early on staked out health care reform and the environment for his first and major issues. Health care has slowly, slowly been winding its way through our byzantine political system and finally [historically?] passed in the House by 2 votes with nearly 40 democrats standing aside over their reelection concerns. And now the Senate version has made it to the floor for debate without a single vote to spare and several Democrat Senators saying they cannot vote for a bill with several key provisions currently in it. That would NEVER have happened under Franklin Roosevelt, who would have given those Senators and Congresspersons other even more serious concerns for their reelect ability. But even Roosevelt probably could not have done that today because the process of Congress has been changed radically since the 1970’s with earmarks and giant campaign finance contributions and the virtual end of seniority. All that said health care now seems to be stuck in the muck of special interests in the Senate and may never emerge with anywhere nearly enough cost containment in either version. The silver lining to that is that both bills have far too little that addresses the real cost culprits [defensive medicine and a culture of pay for procedures] so maybe a next try might do better?

On the environment the President has solid ideas about ‘cap and trade’ but the special interests have already signaled what may be the death knell of those crucial global issues.

Inflation fears: The appropriate conventional wisdom today says “do not worry about inflation because deflation makes it impossible”. That is, of course, correct as far as it goes based on history’s experience. But, what is worrisome is that while inflation remains under the protective umbrella of deflation, there will be a lot of inflationary forces building up. When deflationary concerns finally begin to rise with the morning mist, out there emerging from the fog we will see an armada of inflationary battleships ready and beginning to fire their big guns. Those “battleships” simply put are our gigantic deficit accounts, domestic and foreign, which will put big downward pressure on the dollar, raise the cost of all our imports, including foreign capital, and inevitably trigger a weak dollar inflation bubble which will be the flip side of our recent consumption and finance bubbles. And, if we think our recent encounter with deflation was a big problem, we may have an even bigger challenge ahead. So once again we have to recognize that we are being squeezed between the powerful forces of deflation and inflation with very little wiggle room to maneuver.

What to do? Tough question. On the political front my suggestion is that the President go back to his mandate for change which was the central strength in his campaign and tackle head on the biggest obstacle of all. That obstacle is an unworkable Congress made more so by the money of special interests, to which far too many members are beholden, through which they seek to distort the national interest into their need for self preservation. Simply put, we must move toward a much larger role for public finance for elections to our House and Senate. That is unlikely to happen, if it has to go through those bodies. Therefore, it will need to be led by our popular President over and around Congress by arousing a lot of public support. About 75% of polled Americans already support this concept. And, the way it is proposed it should not cause any constitutional issues with abridgement of free speech.

On the foreign front I think we need to be very discriminating about what we take on. We cannot effectively project a strength, which sadly is already compromised and which is continually being eroded by our endless overextension of our precious resources: people and credit.

On the economic and investment front as a Nation we have to hunker down, roll up our sleeves and slog through the tough times of our recovering economy, out of which we will surely emerge stronger and smarter than ever.[So Buffett’s long term bet on S&P options should work out fine.] As investors we cannot/should not turn our backs on risk, indeed we must confront those dual risks by dividing our investments between those that protect us from deflation and those that can shelter us from inflation. That won’t be easy, because the easy options of mostly bonds and cash cannot be a safe haven much longer, due to the specter of inflation. Those who can should explore some special investments in innovations, commodities and possibly agricultural real estate. And, while investments in good businesses will continue to be essential, they may also be vulnerable to some extent as we go through the inflation/deflation squeeze.

So – onwards, onwards with hope and determination.