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Is 2011 worse than 2008?

By Brett Danko, CFP^®

We have been getting this question from our clients. The answer is simple – no one really knows!

The biggest difference in my view is that in 2008, there was real concern that the entire worldwide capitalistic system would end with immediate depression, rampant crime and an overall catastrophic breakdown of society – essentially the end of the world as we knew it.

This was averted through the strong actions of governments worldwide and the Federal Reserve. While disaster was averted (please understand I am NOT defending all the policy moves during that time), I feel 2011 could be different because the current worldwide economic malaise could last, perhaps 3-5 years or longer. Also, we were wooed into thinking the economy was getting better in 2009 and 2010 and that happy times were right around the corner. Unfortunately, this was NOT the case.

While capitalism may not be threatened as directly or immediately as it was in 2008, here are my reasons for adopting a cautious outlook regarding the prospects for economic growth worldwide for of the next few years:

1. The US government is in poorer fiscal shape than they were in 2008 with deficits and the national debt ballooning to record levels.
   
   
2. Europe is a total mess – The “euro” zone currency is grappling with the nearly bankrupt economies of the “PIIGS” countries (Portugal, Ireland, Italy, Greece and Spain) which, without German financial backing, may NOT survive fiscally and may be forced to exit the “Euro”
   
   
3. Governments worldwide do NOT have the tools available to help the economy break free of low growth or recession. Simply put, there is little or no appetite for another round of government stimulus spending in the US or around the world as budget deficits (noted above) are exploding.
   
   
4. The Federal Reserve has fewer options to help grow the economy. For example, the Federal Reserve uses its power over interest rates and US Treasury purchases to keep interest rates low. However, rates are near zero and the Fed has been buying hundreds of billions of Treasuries (called Quantitative Easing or QE) with little impact of the broader economy. To use a simple metaphor, the Fed has no more bullets left in the revolver.
   
   
5. US and European consumers are still overburdened by debt from all sources, be it credit card, mortgage, student loan, etc. and will need to continue to deleverage over the next 3-5 years or longer. This will lead to continued weak demand (typically consumer spending accounts for 70% of spending in the US).
   
   
6. State governments no longer have the federal government to help bail them out as the federal government tries to get its own fiscal house in order. The states will have to live within their means despite lower revenues (fewer people working/paying taxes) and huge legacy costs from pension and medical guarantees.

Now that I have laid out that depressing analysis, the question is: Where does that leave us and how should people deal with this pessimistic outlook?

First, while we averted immediate economic disaster in 2008, huge challenges still remain as discussed above. The silver lining is that US banks and corporations are seemingly better prepared financially than they were in 2008 with stronger balance sheets and cash reserves.

Also, the Federal Reserve, led by Ben Bernanke has made it clear that will keep interest rates low for as long as needed to get people and especially small businesses borrowing again (hopefully) to invest and create private sector jobs. These factors should alleviate the threat of total collapse which is good.

However, it appears it will take a longer period than normal to break free and grow the economy. In addition, this punishes savers and retirees as they may take MORE risk in order to obtain higher yields on bonds.

Taking more risk at a time of huge uncertainty, especially when you can NOT really afford to do so or if you do not have a high risk tolerance, is a recipe for disaster if things get worse.

Please understand that just because times are tough, no one knows when the economy will turn around. They say it is always “darkest before the dawn” so never panic and keep to the plan your investment advisor has laid out for you.

My suggestion during these difficult times is to stick to your financial plan, live within your means and keep saving if possible. We realize returns on your investments/savings may or may not be high over the next few years, but putting money away is always a good idea.

The goal during times of economic turmoil is to simply “tread water” and NOT fall behind financially (or not fall behind too much). When the economy turns around and I believe it will, then maximize your saving and investment opportunities.

If retired, try to cut back on expenses if able and have your assets allocated appropriately. If working, try to live within your budget and diversify your investment holdings. For those unemployed or underemployed (nearly 20% of workers), there are no easy answers as paying bills and putting food on the table become increasingly difficult. Try to stay positive and know that things will get better financially. Again, stick with your financial plan and make changes only if necessary.

Studies show that difficult economic times tend to make people realize what is really important in their lives – their family, friendships and faith (I call them the “3Fs”). In the long run, these 3Fs are much more important than big screen TVs, fancy cars or a vacation house in Tuscany.

America has seen tough economic times before and emerged stronger each time. Some pundits say this time is different, that we will never recover and the USA is in permanent decline. However, I disagree.

Despite all our problems, I believe the American capitalistic system will prevail through the willingness of Americans to innovate, work hard and persevere through difficult situations.

It just may take a few years for that scenario to start to take shape.

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