Economy

Labor Market Outlook

Look at the pictures below.  The picture on the left is a lettuce robot.  It travels down the rows and picks heads of lettuce.  The picture in the middle is a strawberry robot.  The robot travels around the strawberry plants and gently picks ripe strawberries with it foam fingers.  The picture on the right is a GPS in a combine harvester.  This is used to drive the combine down the rows to maximize the harvest in the most efficient manner.

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So what is in common with these three items?  They all do work and reduce the number of workers needed to complete tasks that used to be completed by people.  Today in agriculture and business, more and more tasks are being accomplished using technology, which requires fewer workers.  The architect may have ¼ of the staff he had in the past, as he relies on CAD equipment instead of a large group of draftsmen.  Factories are now staffed with robots, where they used to be filled with people to complete tasks.  Credit Unions operate with less tellers and staff, as more people use other ways like online banking and ATMs to access their money. 

This is both a blessing and a curse on the US Economy.  The blessing is that we are the most productive country in the world.  The curse is that it will continue to take fewer workers to create the same economic output.  Note the chart below of industrial production and employment.

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Note in 2009, the US had $600B of labor costs for $2.4T of industrial output.  This is by far the most productive economy in the world.  This trend has been continuing for years, as is shown in the next chart.

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More and more GDP goes to capital and less and less to labor.  So when you hear about manufacturing returning to the US, which it is, that may not translate into the same increase in labor as it did in 1970 or even a decade ago.  In the 1950s, a young man could get a job in Detroit, attaching the rear wheel to cars as they go down the assembly line.  He could make a career with that job and make a nice living for his family by just doing that one task.  Now, that same job is handled by robots, which do not require all the costs of benefits and salary the worker does.  The economy has changed.

We now live in a world economy where globalization and high technology will leverage top talent.  The talented can now be seen and demanded by a world audience instead of a smaller local or regional one. Areas that were completely closed to capitalism in 1980, like the old Soviet Bloc, China and India, have now embraced it.  This has created a larger supply of labor around the world and has also created many more customers. Highly demanded processes can reproduce at a breakneck rate like Amazon, Starbucks, Wal-Mart and Apple apps.  Top CEOs and professionals will use the world market to bid up their income.  This equates into a growing gap between those in demand and the ordinary worker. 

Today, it is important to grow and acquire skills that are in high demand.  This could make the difference between financial struggle and success.  I would encourage everyone to study the chart below.  Note the difference in wages between changes in wages among the highly educated and those with the least.

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We all know a graduate degree will not guarantee success, and there are those dropouts that occasionally end up on top; nevertheless, it is still important to gain as much training and skill sharpening as you can to develop talents that will be in high demand in the coming years.

The US Economy: A Good Future?

Despite all the problems with the US Economy after the crash in 2008, we are still the only developed economy to have a higher GDP than what it had prior to the crash.  In some ways, we are the best house in a bad neighborhood.  Here are some positives and negatives in the US:

+ We have an energy bonanza fueled by hydraulic shale fracturing (“fracking”) which will continue for decades.  This has provided an abundant low-cost energy resource.  There is a wide gap between the price of natural gas compared to the price of oil.  Gas prices are 4xs more expensive in Europe and 5xs more expensive in China than they are in the US.  This provides low cost energy to fuel our economy.  Natural gas provides some cleaner environmental benefits compared to other hydrocarbons.  Fracking is also friendlier to the environment than traditional drilling as there are less holes drilled in the ground.  An interesting aside is the only place in the world where there is not the presence of shale gas is in the Middle East. 

+  The US has the world’s most innovative and productive economy.  We have the highest gap between what industrial workers are paid ($600B) and industrial production ($2.4T) of any country in the world.  We are still the place of great innovation and new ideas that fuel new industries.

The US banking and credit union system has been largely repaired and is well-capitalized.  There is a slow renewed growth in lending. 

There is a slowly accelerating business formation and job growth, but this is primarily in several areas or regions of the economy, as opposed to being all across the country.

The housing market appears to have bottomed in many areas and is moving up.

+  The US has decent private-sector growth and has some government shrinkage, especially at the state and local level.

-   There is a lot of uncertainty in a “fiscal cliff” deal and how that will actually impact the economy.  We need a strong and stable plan to work through the issues now and not just push this into the future.  If a decent deal is done, the economy could surprise to the upside.

The US has a large growth of entitlement spending with a record number of people on food stamps, unemployment compensation, Social Security Disability, and now healthcare.  We simply can’t afford this.

 There is an uncertainty in the private sector, with a tsunami of government rules and regulations.  This is increasing the cost of doing business and will lessen productivity.  It will also force some companies to cut back or close altogether.

 By far, the largest threat to the US economy is the large amount of domestic debt we have in our country.  This is at a level that we have never been at in the history of our country.  Highly encumbered households do not spend.  Governments at all levels will cut back.  Companies lack the top line growth and don’t expand capacity, and political games will paralyze decision making.  This will hamper growth for years to come.

Take a look at the chart below.  This measures total debt in our economy as a percent of GDP.

Total Domestic Non-financial Debt as a % of GDP

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Source:  Ned Davis Research, March 2012

Note the drop that shows up around 2009.  This is not from retiring debt.  It is from mortgage defaults and the reduction of debt that came from foreclosures.  One thing to note is that we have had huge debt bubbles in the past.  Note the following chart that has tracked Federal Debt since 1791.

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Source:  Blanco Research

Note that the federal debt from WWII was higher than it is today.  One difference today is that a greater percentage of Federal Debt is not held by the public.  How did we drop from the high after WWII to a low of 28.9% in 1975?  Did the government pay off that debt?  The next chart shows the key.

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See, there is no way to pay down the debt without inflating the currency and retiring a fixed amount of debt with inflated dollars.  Note this happened after WWII with an inflation rate that reached 20%.  It is possible, but I don’t think that we will have that high of inflation.  If the inflation rate rises to 4-5% per year over a 10 year period, you will get rid of the majority of the debt if you are not incurring new trillion dollar deficits each year.  So the take away here is to expect higher inflation in the future. 

The Eurozone: What Impact Will It Have on the US?

In spite of how slow or bad our economy seems, we are still the only developed economy in the world that has a higher GDP now than it did before the 2008 crash.  The largest industrialized economy, in terms of population, is the Eurozone.  As interconnected as the world economies are now, it is important to see what is happening in other places to see how this may impact our lives.

The Eurozone was created at the end of the 1990s.  Seventeen of the 27 European countries are in the European Union (EU).  The original structure seemed great for all these countries to ban together with a common currency, common contracts and a common economy.  But, the set-up is deeply flawed, and fixing this, if it happens, will take decades. 

The first problem is that the EU joined together good credit risk countries like Germany with poor credit risk countries like Greece.  At the time of the start of the EU, Germany could borrow around 3.5% while it was nearly 14.5% for Greece.  The Greeks have gone bankrupt every 25 years or so after they won their independence from the Ottoman Empire.  In the old days before the Euro, when a country went bankrupt, they could devalue their currency to a point that made sense and still continue doing business.  With the EU, all countries, from the Germans to the Greeks and all those in between, can now borrow at the former German rate.  Prudent financial management would dictate that countries with higher interest debt could refinance this for lower rates.  Foolish financial management means countries that could not borrow in the past, can now borrow to do anything they want.  In the case of several of the EU countries, this is like lining the table with vodka shots in front of an alcoholic.

The creation of the Euro led to a larger bubble than we had in the US.  Spain’s real estate bubble was 2.5xs as large as we had here.  The Netherlands had the 2nd largest housing boom in the EU.  The Euro also led to rampant borrowing for social welfare benefits, pensions and private borrowing in most EU countries.  This happened, as many ignored the need to increase productivity.  As such, the cost of production shot up.  Germany has some of the highest paid workers in the world, but they are also some of the most productive.  In France, the employment taxes a company pays is 50% of the salaries they pay their workers.  So even though it is higher to pay German workers, it is still cheaper to make stuff in Germany than it is in France.  This has led to uncompetitive cost of production relative to Germany and the rest of the EU.

The EU now has a banking system that is nearly insolvent.  Almost every EU bank would fail the capital requirements that are imposed on US banks.  This is from bad European house loans, bad purchases in US mortgage-backed securities and bad European sovereign debt.  In Europe, 80% of national debts are lent and held by the banks, as they do not have as sophisticated of a capital market system as the US.

The EU is also faced with governments having exploding debt obligations.  This is a lesson for the US.  As austerity measures of higher taxes and lower government spending will be forced on the countries of France, Spain, Portugal, Ireland, Italy and Greece, this will cause their economies to spiral further into recession and default, as these cures are being applied.  This will impact the world as the largest country that China exports to is the EU. 

Of all the countries, watch France.  The French government controls the banks and has forced banks to lend to insolvent and bankrupt companies.  There is lots of delusion in France with their leaders spending even more money for more social programs than before.  Their current administration immediately cut the retirement age to 60.  They have since raised it to 62 to try to salvage the pension system. 

The EU has a lot of lessons that the US can learn.  Explosive government spending, massive social programs and a lack of financial restraint lead to gigantic amounts of debt.  This debt can starve a country’s economy and prosperity for years.

The Fallout from the Fiscal Cliff

Well, Congress and the President finally got their act together to avoid the fiscal cliff, right? And since they did, this should not have any effect on working class Dakotans, right? If you believe that, I can show you some wonderful oceanfront property in Bismarck! You should understand how the new tax law changes will impact your business, farm clients, and yourself. 

Payroll Tax will increase. Last February, the payroll tax cut was extended through December 31, 2012. Payroll taxes include Social Security payments that were cut to 4.2% instead of 6.2% for several years. The new law reverts taxes back to the pre-recession levels of 6.2%. The impact here is a reduction of every paycheck of 2%. 

Capital Gains/Carried Interest rates will increase to 20% for individuals with adjusted gross incomes more than $400,000 and married couples with AGI more than $450,000. Individuals/couples below the AGI thresholds will still pay 15%. The effect here is a renewed emphasis on the IRS Section 1031 Exchange for higher income individuals to defer gains on property sales. 

Alternative Minimum Tax rates are finally adjusted for inflation. The AMT will be less burdensome on lower-income level s with more exemptions for credits and tax deductions; whereas, higher-income levels will receive fewer exemptions. 

Estate and Gift Taxes will be taxed at or above the $5 million per person level and the tax rate will increase from 35 to 40 percent in 2013. This will cause the need for more estate tax planning in order to pass on family farms and businesses without a substantial tax penalty. Vehicles such as life insurance and gifting become more important to shield more hard earned assets from Uncle Sam. A checkup with a trusted financial advisor knowledgeable in tax and estate planning is necessary for higher wealth clients. 

Depreciation bonus of up to 50% for property and equipment (not including real estate) is available for businesses during the 2013 tax year. 

Leasehold Improvements are now on a 15-year straight-line cost recovery for qualified leasehold improvements on commercial properties in 2013 and is retroactive for 2012. 

Income Tax Rates are going up for individuals with AGI over $400,000 and married couples with AGI over $450,000 at a new tax rate of 39.6%. For other income levels, the Bush-era tax rates are permanent. This is something to continue to watch as some Democrats in Congress have suggested going to the pre-Reagan tax rates on high income earners of 70% should be looked at! 

In spite of the vast majority of Americans seeing their tax rates increase with this new law, virtually no discipline in Federal spending was put in place. Perhaps that may come with the debt ceiling negotiations that will occur in the next few months. These changes do require your customers to review their strategies to keep their tax liability at the lowest legal level possible.