Current Economy Spells Trouble

Several economic signs of the 1970s are back, spelling distress for the United States in the global marketplace, said Jay Feuerstein, ’80, chief investment officer and managing partner of 2100 Xenon, a division of 2100 Capital Group, LLC.

From a change in Federal Reserve leadership style to deficits from an unpopular war to commodity rallies to the weak dollar, he said the current economy parallels that of the 1970s.  Coupled with the subprime lending crisis and credit crunch, it makes for an “extraordinarily challenging” road ahead, Feuerstein said in a keynote to the Asia Deep Dive 2007 conference November 17 at the Charles Harper Center. The conference was organized by the student-led Chicago Asia Pacific Business Group.

One difference between today’s economy and the 1970s’ economy is the growth of China. Some say China may be at a bubble stage. Feuerstein doesn’t think so. “I’m still very bullish on China and Asia,” he said.

Asia is doing “extraordinarily well,” with a growing middle class and huge demand for goods and commodities that drive up prices and make it a giant competitor with the rest of the world.

This puts the United States and the rest of the world in a difficult situation because “the subprime problem has weakened the banking system and consumer, and the ability to grow the economy becomes a little bit suspect,” Feuerstein said.

The U.S. economy is 18 percent manufacturing and 82 percent consumer services.

“As the consumer begins to slow down, it will have a tremendous impact,” Feuerstein said, particularly because U.S. currency is weak compared to emerging market currency.

“I believe we’re in a situation where the economy of the United States is going to begin to slow” and then continue slowing at an accelerating rate, he said. 

The downturn could be stopped by a Fed that is “tight and aggressive,” one that “risks doing something harmful to an economy, to a stock market that is just starting to come back, to a tech market, which is still 20 percent below its highs,” Feuerstein said.

He questioned what Federal Reserve Chairman Ben Bernanke would do next. “Does he dare stop the easing cycle, such that, oh my gosh, the banks will feel some pain? Will he stop the easing cycle so that investment funds, fixed-income funds, take the hit? I mean, he should, right?”

Fed leadership has changed from Alan Greenspan, with his “pragmatic, hands-on” style, to Bernanke, with his “purely academic” style and no crisis experience. This mirrors the change in the 1970s when a less experienced William Miller replaced a disciplined and “battle-weary” William Machesney Martin, Feuerstein said.

Feuerstein said Bernanke “is living true to his writings” about managing public expectations, which Bernanke believes can keep a severe downturn from turning into a recession.

Feuerstein predicts “a Fed that tries to talk tough but does nothing but make things easy.” He thinks over the next couple of years, the Fed will continue with easing policies in an increasingly inflationary environment.

“But the facts are the facts, and the result will be an enormously cheaper dollar,” Feuerstein said. Commodities will continue to rally, standard of living will decline, and because of consumer problems, unemployment will rise, he said.

With the core price index hovering at 2 percent, “today there doesn’t appear to be any inflation,” Feuerstein said. But he questions that appearance. “Can you have the kinds of global liquidity that have been forced into the system - especially in the wake of the subprime [crisis] - and still not have inflation?” he asked.

Feuerstein said Bernanke in his book says food and energy costs should be excluded when considering inflation levels because of their cost volatility and because people have to buy them no matter what.

“I give him some of that, but not completely all of it,” Feuerstein said. “We are spending more. Things cost more. There is higher inflation, I think.”

Feuerstein recalled working as a grocery store clerk in 1972. He carried a price eradicator/stamper because “inflation was so rampant,” he said. Feuerstein said he’d have to wipe out old prices on all the goods and affix new ones as frequently as once a week.

The economy became “runaway with inflation for fear of a breakdown, for fear of a recession,” Feuerstein said.

Deficit financing also prevailed in the 1970s, when expenses had run up for an unpopular war, “similar to today,” Feuerstein said. With the Iraq war, “we’re pumping money into something; we’re very expansionary.”

Also in the 1970s, commodities started to rally. Oil hit $40 a barrel, “which seemed like a lot at the time,” Feuerstein said. Gold became “very expensive.” Other such commodities as wheat, beans, cattle, cocoa, and sugar “began to really bubble and explode in the 1970s,” Feuerstein said.

Similarly, in the last 12 months, wheat, corn, and beans commodities have gone up 70 percent, Feuerstein said. Gold prices are up 28 percent, crude oil prices are up 45 percent in the same period. “In general, we’re seeing producer prices begin runs we haven’t seen for 30 years,” he said.

Second-year student Marcus Axthelm said he was interested in Feuerstein’s remarks about the credit crunch and also the “macro-economic remarks about the 1970s.”

“We just covered [Fed-fighting inflation] in our macro-economic class,” he said.

– Mary Sue Penn