These are interesting times. While the stock market has been notching new highs, market bulls have had little reason to hold back. In parallel, a lot of investors are fretting about what to buy because many solid stocks are at or near all-time highs.
Amidst all this excitement, former Federal Reserve Chairman Alan Greenspan thinks our economy “stinks,” won’t kick into high gear any time soon and has no simple fix. Greenspan presented his views at a recent KPMG Insurance Industry Conference and his speech was nicely captured by Bill Coffin, Editor-in-Chief of National Underwriter Life & Health, in an article on PropertyCasualty360.com.
Greenspan’s speech caught my attention because to most economists and pundits on Wall Street, our economy is doing just fine and appears to be solidly recovering from the Great Recession. This seems so to me too, but Greenspan doesn’t agree. Here’s why:
1Lack of Confidence
According to Greenspan, the current economic recovery isn’t being led by construction. That’s a problem because all major economic recoveries since World War II were essentially driven by construction. As he sees it, this recovery is sluggish because construction is “dead in the water” due, in part, to excess capacity build-up before the economy crashed in 2008. This means that there was an overbuilding of homes and office buildings before the big downturn and it takes some time for this new real estate to absorb the growing need. This causes businesses and households to be skeptical of the future and unwilling to invest in it. Until folks don’t invest in longer-lived assets, the economy won’t really return to form, says Greenspan.
2Renting Instead of Buying
Greenspan says economic malaise and future income uncertainty was also reflected in an increasing trend towards renting rather than buying. Many more houses are being built for rental, not for sale. Home ownership is way below where it was years ago and there’s no sign that this will change any time soon.
3It’s Gone Global
He notes that this was not just a U.S. problem but a global one. Construction is down across the globe from the UK to Germany, the Eurozone, Japan and elsewhere. Construction-related uncertainty is causing corporations to hold-off on making major investments because they aren’t sure about future returns.
4Chinese Debt Bubble Is Going To Burst
He also sees an inevitable slowdown in China’s economy as a problem that could lead to a serious collapse. Over the past few years, China has been on an unprecedented building rampage. It now has empty apartment blocks and ghost towns across the country. Many have been built from virtually unchecked government-funded borrowing just to keep the economy going. As a result, China’s debt has rocketed from 140% of GDP to 230%. This bubble could burst with serious ripple effects across the globe.
Greenspan believes global instability, such as Russia flexing its muscle in Ukraine and the Islamic State running roughshod over Syria and Iraq, will have wider economic consequences that an over-stretched U.S. government will no longer be able to effectively address. We simply do not have the money to support a bigger military. This expanded budget is complicated by the rise in domestic Medicare and Social Security costs due to aging Baby Boomers and their parents living longer. Greenspan thinks Global hot spots that had been kept calm before by our strong military dominance are now likely to explode. This will create further economic uncertainty across the world.
Greenspan also warns on inflation, essentially saying that interest rates have been artificially held down by the Federal Reserve but cannot stay near-zero forever. Once banks resume lending, interest rates will have to rise, along with inflation. When inflation rises, it will surprise us with how quickly it moves. He cautions us to be prepared for a spike in inflation that could have a chilling effect on the economy.
Greenspan also cites other issues that are holding back the economy such as regulatory over-reach in the financial services industry. It is doing more harm than good because it was poorly conceived in the first place. His core message is one of caution. Our economic recovery isn’t all hunky-dory. Deep structural problems still exist within the U.S and across the globe. Inflation could spike and catch us by surprise and the recovery will likely take much longer than most of us currently expect.
Greenspan has some valid points and he’s an important person to listen to, but his comments are his best learned guesses, and as such, should not be taken as gospel. He’s been wrong before, but it’s important to wrap your head around the whole range of ideas form positive to negative and watch carefully as things pan out.
While I think our economic recovery is pretty solid and not all doom-and-gloom as Greenspan sees it, I do know that interest rates are poised to go higher and we should all be cautious and prepare ourselves for a spike in inflation that could have severe undesirable effects. The going has been pretty good over the last few years but now IS a good time to talk to your advisor and protect your portfolio against a possible spike in inflation. Be mentally prepared for unforeseeable shocks just in case Greenspan turns out to be right.