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What's the Next Chapter in the Economic Saga?

by on July 17, 2011 6:00 AM

The past several years in the economy and investment markets have been extraordinary. We have had the deepest recession since the Great Depression of the 1930s. Banks, brokerage firms and AIG went bust, or almost failed before the great bailout. The venerable firm of Lehman Bros. actually failed, while others were merged and/or propped up by massive politician-backed infusions of cash. The predictions were dire, and the politicians flinched and bailed out the financial industry, not to mention General Motors and Chrysler.

The Federal Reserve moved to make money widely available at a nearly 0 percent interest rate. When that was not enough, they bought hundreds of billions of dollars of Treasury debt as the federal government ballooned its expenditures in the face of falling tax receipts. The sharp expansion of credit fired up the stock and commodity markets, but it did little to spur everyday economic activity.

When it seemed that commodity prices would skyrocket, the government moved to quash speculation by raising margin requirements for silver futures and unleaded gasoline futures, among others. The government then moved to release 30 million barrels of crude oil from the Strategic Petroleum Reserve in conjunction with 30 more million barrels from the strategic petroleum reserves of other countries. Commodity speculators were getting pummeled by official actions designed to offset the effects of QE I and QE II. Amid all this activity, the dollar has slipped against stronger foreign currencies and gold has relentlessly climbed to new all-time highs.

If you haven't followed the events in the financial news arena, you probably haven't connected the dots yet. The administration's economic plans are a shambles as all the major players except Bernanke have resigned or are planning to resign, many retreating to the safe havens of academia. Unemployment is stubbornly high at 9.2 percent (more than 16 percent if you read the data the way they did 20 years ago) and the outlook is not getting any better. Housing activity is flirting with multi-decade lows. Growth in the economy is sputtering, rising in the first quarter just 1.9 percent on an annualized basis. Consumer buying is propped up by massive federal support (18 percent of all consumer spending is federal transfer payments) and the Gross Domestic Product is barely back to numbers realized four years ago. Meanwhile, oil prices have stayed high and our trade deficit is running $50 billion a month at the most recent reporting.

Now we are debating the debt ceiling at the federal level. State and local governments are raising taxes, cutting expenditures and employees. Even venerable Penn State is feeling the cutbacks. In the private sector, new hiring is agonizingly slow.

For investors, the choices are difficult. The banks' savings accounts, certificates of deposit and money market funds offer nearly nothing. Investors are being pushed to longer-term maturities in bonds and into stocks in order to earn decent returns. While bond yields are historically low, the stock market really has made no appreciable progress in the past 11 years.

We have a presidential election coming up in 15 months. Historically, the party in power pulls out all the stops to make the markets and the economy look great just in time for voters to make their selections. Ours is not a perfect system. Yet what stops are left to pull out to make the economy improve in the next 15 months? Indeed, what is next?

The financial world may read like a Russian novel (that is, long-suffering), but we hope to avoid it becoming a Greek tragedy.



Dan Nestlerode was previously the Director of Research and Portfolio Management at Nestlerode & Loy Investment Advisors in State College. He retired in 2015 after 50 years in the investment business. A graduate of Penn State University, Nestlerode became an investment advisor in 1965. He can be reached at [email protected]
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