Monday, August 25, 2008

The Reign of Uncertainty

The most dominant factor operating in markets at this time, domestic and international, is uncertainty. Yes, the price of oil is down. The price of gold and other commodities is down. The dollar is stronger. And, question have been raised…like has the dollar reached a bottom in value and now will recover (“Historical Trends Suggest That the Buck Is Back”, Is inflation going to drop as the economy weakens so that interest rates don’t need to be raised? And so on, and so on.

What I see in world markets these days is not a “trend” here or a “trend” there. What I see is uncertainty. I see volatility with no clear direction, one way or the other. And, the uncertainty that exists is not connected to events, but to fundamental issues.

Three international issues immediately come to mind. The first of these has to do with Russia, the more active role it now seems to be playing, and the response of the rest of the world to the new feeling of power being exerted by Russia. The United States has expended a lot of its good will over the past seven years or so and is, at present, in no position to lead others against this exertion of will.

The second has to do with the other BRIC countries and the role they are going to play in the world economy in the future. China, of course, coming off the successful execution of the Olympic Games, is gaining in confidence every day. India, although it has its problems, is going to play a major role in the world economy going forward. And, Brazil seems to be growing stronger every day. The United States has little or no influence over the direction these nations move since it forfeited it’s ability to work with them when they were, economically, just emerging countries.

And, of course, there is the uncertainty related to world energy sources and the role that the Middle East plays within these markets. Although the demand for oil seems to have dropped off in the United States due to Americans driving less, the overall demand for energy in the world continues to climb. And, there is always the uncertainty relating to supply…we just don’t know what might happen here in terms of leaders and in terms of cultures. Of course, the militant forces of terrorism play a role in how this issue works itself out.

This just represents a start. We can remain at the world level and talk about the unraveling of the global consensus on trade. ( Current economic relationships have been built upon the efforts of many people and nations to build a more global economy. This consensus is showing signs of weakness now and is in danger of collapsing. A world with more restricted trade and greater emphasis upon nationalism would certainty have major economic and financial ramifications for the world at this time.

There are other factors causing uncertainty internationally, but let’s take this discussion into the national level and focus on the United States. First, there is great uncertainty concerning the health of the financial system. The number one concern at this time is what is going to happen to Fannie Mae and Freddie Mac. Is the Federal Government going to have to step in and do something about them and if so what is going to be the resultant structure of the companies and what is such a bailout going to cost the American people? But, there is still concern about the health of investment banks and how large the additional write offs are going to be. There is concern about the commercial banking industry, whether or not there will be more bank failures and whether or not there will be a failure of one or more “major” banks. The fact that the FDIC is pulling back former employees that worked in bank examination and bank closures and workouts to augment its current staff is a source of some concern. Furthermore, there is no good estimate of the amount of charge offs that financial institutions will face…first in terms of mortgages, then credit cards, then…

Then there is the housing industry. How much further down will it go and how long will it take before the industry bottoms out and construction really begins again?

What about unemployment? The unemployment rate hit 5.7% last month and the projection is for this number to go higher and higher. But, how much higher? It seems as if layoffs and firings are just beginning. Many industries are going through major restructurings and we don’t know, as yet, what the final effect will be in terms of the employment numbers. Companies are going into bankruptcy. Other companies are reducing the number of retail outlets they have retrenching for the growth at any cost efforts of the past. The auto companies are asking the government for major dollars to help them make adjustments to the changing nature of the industry. And, in this environment, would you be terribly aggressive in expanding output or hiring new employees?

Higher unemployment means higher payments for unemployment compensation. The government will almost certainly give the auto companies financial help. The government is promising relief to people facing foreclosure on their homes. The bailout of “Fannie” and “Freddie” could run up to $200 billion. And, what if commercial bank failures, let alone the possible failure of another investment banking firm, put pressure on the FDIC’s insurance fund requiring the government to set aside more funds, how would that add to the deficit? And, these potentials demands for government monies are just a few of the possibilities along with the worldwide problems that could cause the Federal deficit to become even larger. What price will the United States Government pay to finance all the debt that could be amassed in the near future to handle the multitude of potential crises that could unfold?

Then there is the leadership concern. The Bush Administration is history…yet, it still is in office for almost five months. There are still members of the administration trying to leave some positive legacy behind them. There have been several recent articles discussing the efforts of Condoleezza Rice and Henry Paulson to do something positive before they leave office. The “big one” for Paulson is, of course, the Fannie Mae/Freddie Mac bailout. Everyone else seems to have just disappeared into the woodwork.

And, there is the case of the presidential candidates. I won’t go into that again…you can read my thoughts written in my blog for August 18, 2008 ( All I will say right now is that I don’t believe that either of the two candidates have given us a clear idea of what we can expect from them in the economics or financial arena if they are elected President.

The world is a highly uncertain place today. Given the nature of many of the factors contributing to this uncertainty, I don’t see how the uncertainty can be resolved in the short run. Because of this uncertainty, the risk associated with any business or investment decision will be higher than it has been for quite some time. Over the past several months we have seen this risk being built into market relationships, especially into the interest rate spreads that exist on financial markets. However, we are also seeing changes in relative pricing in the “real” economy as businesses adjust for the changing assessment of risk that exists within these markets. These re-evaluations, obviously, are not very encouraging for the stock market.

The prognosis for the future, therefore, is for volatility. Markets are going to go up and markets are going to go down, but it is going to be very difficult to determine longer term trends in such markets. There is just too much noise.

What will get us out of this mess? The answer to this dilemma is time, information, and leadership. Nationally, as well as internationally, we don’t have a vision of where we need to go. There is still much “pain” to be felt in the United States. Someone is going to have to “own up” to this pain and provide a map for getting through it, helping those hurt where possible. Until we get some idea of what is going to be done…uncertainty will reign in financial and economic markets.

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