Analysis of America’s Economy – Part 1 of 2; Sound or Sand?

The world is now focused on the state of the American economy and more specifically, on Wall Street. America’s current crisis is the ultimate trickle down, economic theory. The housing meltdown created solvency issues, within the banking industry, when borrowers defaulted on mortgages. The construction industry continued to borrow to build more housing, leaving a glut in unsold properties and a further insolvency issue in the construction side. Many of these mortgages were underwritten by insurers who bet (and lost) that the mortgages would go to term and not enter bankruptcy proceedings. Wall Street firms bet on bundled packages of mortgages that were traded as if they were commodities, hoping for exorbitant profits on ARM (Adjustable Rate Mortgages) and Sub Prime Loans. Mutual funds bought into firms that touted profit margins that simply weren’t there or sometimes, allegedly, were fraudulently promoted. Investors, fearing the aforementioned insolvencies, withdrew millions from affected firms reducing working capital and liquidity and thereby hastened the downfall.

The issue at hand is what is the true condition of the American economy and where will it stand by the end of 2009. The current market price sag is providing a buyers market but will investors take the risks in stride? The betting is going against the theory that the average Joe will commit life savings while the Mutual Fund markets depend on those citizens even more than institutional investors. Many investors have a wait and see attitude and are looking to the retail sector for any signs of consumer spending. Initial indications are that consumer confidence remains relatively high despite the turmoil and that bodes well for the retailer. Should same store sales show an up-tick over the next two months (traditional beginning of the holiday shopping season) then one can expect an upturn in the overall economy.

The underlying economy in fact is sound, with stock valuations increasing in well-managed companies and solvent financial institutions gobbling up their former, now insolvent competitors. One can expect liquidity problems in the near future as banks overhaul their lending principles. One can expect an overall decline in the market indexes with occasional dips below the Dow 10,000 level. One should also anticipate further bank seizures and mergers as the wheat separates from the chaff. However the consumer will continue to be the economic engine even if their purchases are more focused and utilitarian. To be sure, this is a major market correction brought about by unchecked greed and market manipulation but it is not a heart attack. Simply some clogged arteries that need a cleansing and then specific, periodic checkups to prevent another buildup of plaque. We have a healthy patient but just one in need of medical care.

America’s Median income is at $24,000 plus, while the Mean exceeds $35,000. This is sufficient to foster growth unless the indebtedness exceeds income capabilities.

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The economic downturn, along with soaring fuel prices, have caused Americans to reassess their spending habits and will thus allow for debt reduction. The average consumer debt is $35,000 (excluding mortgage) and includes such things as credit cards, auto, even student loans. A change in buying patterns will foster debt reduction and thereby provide capital infusion into the financial sector. The eight hundred pound gorilla in the room is the inflation rate (August – 5.37%) and the unemployment rate (August – 6.1%). There has been some moderation in inflation from 5.6% in July but it has otherwise been increasing. A continued moderation, coupled with lowered jobless filings, will spur the market and rejuvenate the economy rather than investors sheltering money in Treasury notes.

Yes the economy is sound but its recovery will be tenuous and slower to fully recover than any time in our history. The combination of global competition and the costs of military operations limit our ability to rebound. In prior, post-war periods, where fiscal difficulties rivaled the current situation, we were still the major industrial power on the planet. The current weakness in the dollar will also factor into the equation however, with exports on an upswing and consumers becoming more fiscally responsible the economy will recover from its granite base an