October 15, 2012

Wells Fargo’s Silvia Tells Tiger 21 Why He’s Bearish on the Long Term

Tough decisions face the next president—whoever is elected

While big business appears to be returning to normal operations, small businesses are considerably less optimistic about their prospects for a full recovery, John Silvia, Wells Fargo’s chief economist, told ultrahigh-net-worth investors during his Headliner talk to members of Tiger 21 in September.

“The biggest mistakes in business have very little to do with actually running the business,” Silvia said; “rather it has to do with not having a vision of where you are in the world and how things are happening.”

Silvia’s presentation was part of a series of talks by financial and investment experts to Tiger 21 members. Earlier this year, for example, George Soros was the featured speaker to the peer-to-peer group.

During his presentation, Silvia also set out economic statistics that had a decidedly on-the-one-hand, on-the-other-hand feel.

Signs point to moderate job growth, he said, but this is in the context of a much lower employment base to support growth and spending. Household debt service has returned to sustainable rates, but the sluggish recovery points to slower consumer spending resulting in lower states sales tax revenues.

Moreover, capital goods orders are slowing following their post-recession surge. And commercial property is recovering unevenly, with high-end office vacancies and apartment vacancies trending lower.

Below are highlights from the Q&A session that followed Silvia’s talk, summarized in the statement:

How will the wave of baby boomer retirements impact the economy?

Silvia presented statistics showing that the majority of baby boomers have an average retirement account balance between $60,000 and $80,000, which makes them totally unprepared for retirement.

“This creates political problems as well as economic problems,” Silvia said. “These people will be counting on certain entitlements that the country cannot afford to sustain.”

He noted that the labor force participation rate has actually increased among ages 55 and older in recent years, indicating that many baby boomers realize they are not prepared for retirement.

Is unemployment cyclical or structural?

As the unemployment rate has decreased during the past few years, year-over-year wage growth has also decreased. This indicates the existence of a huge structural problem, according to Silvia.

If the unemployment rate were just cyclical, its coming down would be associated with higher wages because companies would be chasing after skilled workers.

He said that in various localities across the country with high structural unemployment, many people have the wrong skills, and semi-skilled and low-skilled manufacturing jobs have disappeared. Furthermore, new manufacturing facilities that are being created today are fully automated and require a few workers who can navigate a laptop.

Because unemployment is structural, he said, printing more money to extend unemployment benefits will not solve the problem. Instead, he proposed a voucher program that would aid displaced workers in obtaining new skill sets.

Is the consumer truly deleveraged? And what happens when quantitative easing ends?

A Tiger 21 member asked Silvia: The household debt service ratio indicates that the American consumer has deleveraged, but taken in the context of the low interest rate environment, is the picture really so rosy?

Silvia said that while there is short-term stability with interest rates at 2%, this is largely an effect of quantitative easing. He scoffed at those who argued for the need to get interest rates back to the prerecession normal range.

If that happened, he said, the debt service ratio would go up.

He also cited a Congressional Budget Office study that said if average 5- and 10-year Treasury note rates should increase to their average in the prior 30 years, then net interest expense and entitlements would eat up the entire federal budget within 10 years.

What are the prospects of America going back into recession, especially if QE ends?

In the short run, Silvia said, there is just enough consumer spending, housing, commercial real estate and investment spending as well as federal, computer and software spending for 2% gross domestic product growth.

However, forecasting what happens five months hence is complicated by the prospect of the looming fiscal cliff. Absent a resolution, 2% to 3% will be knocked off the GDP, resulting in a recession.

What next?

A member asked Silvia whether he had ever been more bearish than he was at present. He said he had been more bearish in the short term, but not in the long term.

“In the short run, things will be fudged, but in the long run we have a real problem and it is coming at us a lot faster than many people expected,” he said. “We are in a position where we have not really faced up to our problems and they are not resolvable by current policies.

“We really have to make some changes, but we are not willing to talk about them.”

He concluded by saying tough decisions face the next president—whoever is elected in November. “We’ve sort of run out of time. The next president will have to come to grips with the economic situation. It will become clear as ever that there is no way to pay the bills.”

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