He that goes a-borrowing
goes a-sorrowing.
Benjamin Franklin

In the fall of 2010 we stated the following:
It is our contention that 2007 to some yet to be determined future date marks the third period since World War II of abnormal deviation from the country’s usual cycle of lengthy, steady prosperity marred by short-lived modest economic and profit contraction.

We went on to say that:
In our opinion the stock market will be primarily ruled by the macroeconomics of the next few years and an expansion in price/earnings ratios from current levels is not warranted under the emergency financial measures still being undertaken by many governments.

Since the fall of 2010 corporate profit growth of major public corporations has been very strong, but, as we anticipated, price/earnings ratios for the stock market have continued to decline in the face of the poor macroeconomic environment confronting the western world.

Everyone is very familiar now with the debt crisis in the United States and western Europe. It is imperative that it be solved in a rational, equitable and uniform fashion for failure to create a credible long term plan threatens the social fabric of the U.S. and presents the danger of a major weakening in American economic and military power. The explosion of debt to finance growth often presages the decline of a country’s stature.

Contrary to the beliefs of many investors, investment success over a long period of time does not come from individual investment selection. Instead about 85% of investment returns are a result of correct asset class allocations and only about 15% come from actual investment selection within a specific asset class. In other words, getting the big picture right is critical to investment success.

We have stated for the last two years that economic growth after the federal and monetary stimulus of 2009 and 2010 is completed will be disappointingly slow for the next five to ten years and may be marked by reoccurring recessions and financial crises. The cornerstone for our concerns is debt accompanied by the, to date, lack of political will to fashion a long term agenda to gradually separate the country from its current debt crisis.

Any agenda to rein in the debt explosion will cause hardship. It will cause slow economic growth for years to come. Quite possibly it will cause stagnation or decline in our standard of living for the general populace. It will involve sacrifice among the populace which has been raised on the myths of “plenty” and “more” while in the absence of sound financial practices. More than any time in memory the future of the country’s economic prosperity lies in the hands of its politicians, principally Congress and the White House. Confidence in skilled, equitable leadership is not high and we share this concern. As the three to four month debt ceiling debate revealed, the political ideological divisions are great but neither side is willing to take decisive action to resolve the debt crisis beyond self-serving rhetoric. The last minute debt ceiling increase was accompanied by modest spending cuts. However, even these limited cuts were delayed until 2014/2015. In other words, both political parties were happy to postpone for a few more years any real solutions to our debt crisis. In Wall Street’s parlance, Washington continued to kick the can further down the road in pursuit of a strategy of buying time. The government hopes there will be a strong recovery in economic conditions which will solve all of our problems without requiring structural change through legislation. We are strong believers in the efficacy of the free market place as a corrective mechanism, but government policies, especially deficit financing, have muted the effectiveness of the market place.

The issues which need to be addressed by Congress and the new super committee of twelve are well known and have been debated for years but now need constructive action. Briefly they are:

a. a steady reduction in the government’s annual deficit towards a balance fiscal budget
b. an overhaul of the federal income tax code
c. changes in government and military employees retirement and health care benefits
d. changes in Social Security and Medicare to make both systems solvent
e. reductions in state, municipal and local government employee pension and health care programs to make them solvent
f. changes in union labor laws to enhance U.S. competitiveness
g. a restructuring of the national real estate mortgage market.

These are the main issues as we see them. Provide immutable, concrete long-term solutions to these problems and we will become wildly bullish about the prospects for U.S. economic growth and the stock market. However, the magnitude of these problems is large. We believe they are solvable by leaders truly acting in the interests of all the people. This probably means no one gets everything they want and it also means everyone will have to make sacrifices. To illustrate the magnitude and difficulty of these problems, unfunded entitlement programs in the U.S. exceed $115 trillion as of today. These are future obligations of the government, which the government owes and has agreed to pay. This amount is at least 10 times the size of our annual Gross Domestic Product. These unfunded obligations of the government increase daily just like the deficit. Simply stated we were all promised more than any government can pay.

The combination of low economic growth and questions regarding political determination will put pressures on valuations in the capital markets. Although corporate profit growth among the nation’s 500 largest companies has been excellent in the past year, the stock market is basically unchanged despite significant volatility. The price/earnings ratio of the S&P 500 index has fallen from about 13x-14x in 2010 to about 11x to 12x now. Because a financial cure for the issues listed above will require belt tightening, we do not see real U.S. economic growth returning to a sustained level of 3 to 4 percent for many years. The country’s growth since 1990 has been steadily borrowed from the future. As once said by a very lucid 95 year old woman to her equally old husband, “the future is now.” Macroeconomics for the past year has won the battle versus seemingly low price/earnings ratios. If the stock market turns into a bear market, then price/earnings ratios on average will fall well below 10x before reaching a bottom and creating a time to buy.

We do not forecast an economic collapse, and we do not forecast market levels. We find it difficult enough to correctly allocate assets. For the past couple of years caution and conservation have been the primary pillars of our asset management. We believe high frequency trading right now is the most likely way to make money in the stock market, but we do not espouse taking the risks of this approach. Even with quantitative models and high speed computer trading risks are high. Instead we have maintained very low levels of investment in common stocks during various time periods since November 2007 and consistently below our average historical levels during the last four years. There are many good companies selling at attractive prices if Congress and the White House will initiate a long term cure to our debt and unfunded liability problems. However, until we see this occurring exposure to the general stock market is to be limited.

Although we believe economic theory is correct that increased government spending is a major tool for ending recessions and hastening economic recovery, this form of economic stimulus is no longer available to the country. It has been overused in good times and bad times and its corollary of withdrawing the temporary excess stimulus when conditions improve has always been ignored. Consequently, more federal stimulus at this juncture may produce adverse effects in the financial markets and the Federal Reserve has exhausted most of its primary stimulative tools. Government fiscal retrenchment has begun albeit slowly and it will accelerate during the next few years. This retrenchment along with corrective action in other areas of excess liability are major reasons for our expectation of slow U.S. economic growth for at least the next several years.

We also believe corporate profit margins will begin to slip in 2012 and beyond. With all the changes being advocated as necessary to bring government spending under control, the effect on corporate profits is unknown, but we do not believe it will be net positive. Major revisions to the federal income tax code will affect public companies. Again the impact is unknown, but a reduction in corporate tax breaks is to be expected. The “super committee” of twelve has been selected but it is going to be the recipient of super lobbying, especially by corporate America. The success or failure of their lobbying efforts from their narrow perspective will have an effect on their profit-margins. Typically, companies during a period of recession, such as in 2008 and 2009, reduce investment both in capital expenditure and in labor. As a result company expense structures become very lean and profits and profit margins improve. Going forward there is little room for further margin growth. Corporate profits will have to be driven by revenue growth which may be increasingly difficult in this post recession anemic recovery.

Psychology is a very important influence of stock prices. There is always mentioned the axiom that profits run the stock market. A true statement but overstated. Investor psychology dictates stock market valuation. If the investor is happy, the stock market is happy. If confidence wanes or deteriorates sharply, the stock market in time will follow the same trajectory. Often the relationship between market performance and sentiment becomes self-referencing, negative sentiment driving prices lower which reinforces negative sentiment. It is like a run on a bank. The repeated sharp decline in equity prices during the past 11 years has significantly undermined investor psychology. If you add to this questioning of confidence the daunting, long-term macroeconomic problems facing the developed nations in the world, a sustained improvement in confidence indicators heralding the advent of a new secular bull market will not be forthcoming soon. Suspicion, disapproval and fear are the paramount factors shaping investor psychology now. Worry, if not fear, is also a prevalent concern among the public regarding job creation, employment and wage growth. Huge quantities of debt at all levels, e.g. municipal, state, federal and household, were assumed under the auspices of future growth. Remove the prospect of growth, and fear becomes the major characteristic affecting decision-making, especially in the area of debt reduction. The specter of debt accompanied by psychology of fear in a no growth society will negatively impact asset valuations. If you do not believe suspicion, disapproval and fear have gained traction in our western society, look at the prices of silver, gold and short-term treasury yields.

America’s problems, in our opinion, are fixable. Clean, honest communication with its citizens is essential and political leadership needs to emerge. America’s bull market in stocks since March 2009 has lived on borrowed time and perhaps is a rally within the context of a secular bear market which began in 2000. We have no opinion on determining historical landmarks. They cloud an assessment of the present and future. The U.S. cannot grow its way out of its debt morass. Only spending cuts, revenue increases via taxes or a combination of both can achieve the return to financial strength necessary to push the country onto a new growth cycle. This cleansing process will take a decade in our judgment. During this time the stock market will be punctuated by brief rallies and declines which may offer opportunities for the quick, but in our judgment the environment for this decade will be one of high volatility and low returns on stock investments as measured by the major stock market indexes just like the first decade of this century. We have not changed our view since November 2007 that macroeconomics will continue to dictate the direction of the stock market, not Wall Street’s conventional valuation metrics, which we characterize in this environment as propagating the inevitable proposition that stocks are cheap. We will continue to structure portfolios with under representation in the stock market until the catalysts of debt reduction, employment increases, wage growth, entitlement program reductions, tax code simplification all coalesce into a mixture cementing the new foundation for future growth. Until then our asset allocation will minimize common stocks.

Is the stock market cheap or overpriced? We hear conflicting pronouncements daily on CNBC and other media outlets. The pessimistic camp believes the broad domestic and international economic scene is weak and weakening and therefore, almost all common stocks are overpriced. Historical price/earnings valuation criteria in this negative environment for this group are mostly irrelevant.

The optimists believe things are difficult in the world economies, but not as bad as the pessimists contend and, therefore, every piece of bad news that is not as bad as feared is looked upon favorably as another small bud of improvement which is slowly beginning to blossom. The optimistic prognosticators think that emphasis on current macro economic data is yesterday’s market and that stock prices and their price/earnings ratios are cheap as we advance slowly toward an era of general prosperity bolstered by strong corporate profit growth.

The price/earnings ratio is a relative valuation measurement. It allows an investor to imprecisely measure the relative attractiveness of one stock, industry or general stock market against another. As the name price/earnings ratio implies, the ratio is derived by simply dividing a stock’s current market price by its earnings. The resulting ratio can then be used to compare the relative attractiveness of one stock to another stock usually within the same industry. With all other variables being equal, the common stock with the lower price/earnings ratio is more attractive to the investor than the common stock with the higher price/earnings ratio. All other variables are never equal.

In the price/earnings ratio calculation, price is always the known variable. It is the earnings denominator which causes the problem. Earnings can be and are reported by companies in many different ways. Companies can and do derive net income using many different accounting principles and rules making it difficult to consistently compare just one type of reported income. Sometimes the same company will use different formulas to derive net income from one year to the next. So, earnings, the denominator in the ratio, is an imprecise number, and different investors determine it differently. The result is investors derive different price/earnings ratios for a company, industry or stock market because they are using a different earnings denominator. There is always a debate as to which reported or projected earnings number is the best to use for the purpose of establishing relative attractiveness.

To complicate the issue a little further, the stock market is a forward looking mechanism, but investors like to use past historical data in determining future valuations. Is it more accurate in determining relative attractiveness to use past reported earnings or future projected earnings? The former allows the investor to derive a price/earnings ratio based on historical fact while the latter is an imaginary best guess number of the future, which often changes significantly, especially the further it is projected beyond the present. There is no correct answer to the question. Analysts use both methods generally favoring one methodology over the other depending on their assessment of the current investment environment.

Allowing for some variation in earnings determination, most Wall Street analysts believe the stock market is now selling for about 13 to 14 times past twelve month earnings and about 12 to 13 times future 2011 earnings. Historically since 1970 the stock market has sold between 7 times earnings and 28 times earnings. In the severe recession of 1973/1974 it sold close to a price/earnings ratio of 7. At the end of the dot com boom in 1999 it sold at about a price/earnings ratio of 28. Usually at some point in time stock prices revert to a historical medium price/earnings ratio of about 15 to 17.

If you believe the economy is on a recovery path, it is reasonable to project an improvement in earnings in 2011 versus 2010. The larger the earnings denominator the lower the price/earnings ratio and, therefore, the more attractive the general stock market, especially when compared to historical data with a smaller earnings denominator. Consequently the optimist says the stock market is under priced at about 12 times forward earnings as the economic recovery unfolds compared to a norm of 15-16 times.

Occasionally there occurs a time period in the history of our economy since World War II which is considered abnormal, atypical. This has been a rare event. Perhaps 1973/1974 and the subsequent six years of very high inflation and extraordinary interest rates is one such time period. The last several euphoric years of the 1990s, and the concomitant faith in high technology was perhaps a second atypical period when economic and or psychological behavior changed dramatically from the nation’s usual experience. It is our contention that 2007 to some yet to be determined future date marks the third period since World War II of abnormal deviation from the country’s usual cycle of lengthy, steady prosperity marred by short-lived modest economic and profit contraction. In “abnormal” periods a comparison of earnings and therefore price/earnings ratios to “normal” historical periods loses its validity. Atypical periods are marked by greater than usual changes in psychological behavior toward investments and a major shift in economic assumptions from the historical experience. Optimistic stock market prognosticators believe we have just gone through another typical cycle of expansion-contraction-expansion. They will concede the contraction was much sharper than usual but they believe that with typical fiscal and monetary intervention by the government the normal cycle of recovery remains intact. We contend we are in an abnormal time zone where the reemergence of expansion will be delayed and erratic during the next five to ten years. In assessing the stock market it is important to differentiate between these “normal” and “abnormal” periods. The current stock market rally is saying that price/earnings ratios in general are attractive in a “normal” expansionary phase of the economic cycle. Bullish investors contend that earnings in 2011 have a high degree of predictability along with investor psychology and, therefore, price earnings ratios should expand to reflect this return to a more predictable and stable environment. Thus, the stock market is cheap.

We think earnings predictability will be much less than expected by many on Wall Street for the next several years – our “abnormal” economic period. In our opinion the stock market will be primarily ruled by the macroeconomics of the next few years and an expansion in price/earnings ratios from current levels is not warranted under the emergency financial measures still being undertaken by many governments. The general historical norm, or greater than historical norm, price/earnings ratios will be delayed by the difficult macroeconomic environment.

A normal price/earnings environment envisions a normal stable period of prosperity in the country and world. We believe we are many years from reestablishing this environment. It is important to stress that such a lingering, difficult economic environment does not mean another collapse in stock prices or another immediate contraction in the economy such as occurred in 2008 and early 2009, but it does portend a stock market where current price/earnings ratios already very adequately reflect the past twelve month surge in corporate profits and the small improvement in U.S. and European economic data.

We are currently in a world environment where every country wants to export its way out of a sluggish economic environment. This simultaneous global objective puts pressure on currencies, raises the prices of commodities and could lead to trade wars. Most industrialized countries, including the U.S., are devaluing their currencies to make their products more competitive in the world market place. Manipulating or debasing of currencies also leads to trade wars and international financial uncertainty. They are policies of beggaring thy neighbor. Since the 1970’s the dollar has been the stabilizing currency in the world but with the United States’ huge federal deficit, stimulative monetary policy and weak economic recovery from the Great Recession its value vis-à-vis other currencies is being questioned. In other words, there is little prospect for currency stability in the near future as countries worldwide pursue their easier monetary policies.

Corporate profit margins are poised to begin a multiyear decline starting with the third quarter of 2010. Near historic earnings have been forced from declining revenues. This trend cannot continue and is near an end. We anticipate that the earnings estimates for 2011 and 2012 in the price/earnings ratio may be too high as we move into the next two years. A slow growth economy cannot sustain high growth in corporate profits. This dichotomy is not being reflected in future optimistic expectations for price/earnings ratios.

At some point, the gargantuan federal stimulus will need to be withdrawn from the U.S. economy. Instead of being a major factor in stimulating growth and support of the U.S. economy it will become a contracting force. The threat of unbridled federal deficits and monetary stimulus to the American economy is real and growing.

Improvement in the U.S. economy since June 2009 has mostly originated from major companies. These companies had and still have access to the capital markets. Small companies and small, but important regional banks, have been and remain shut out from the major flow of funds being created by the U.S. government. Outside of the few giant banks saved by the taxpayer bailouts, regional banks continue to fail at a high rate.

Housing will remain depressed for at least several more years and will not contribute to U.S. growth any time soon. Commercial real estate will not provide the stimulus to the U.S. economy that it has in past recoveries. The commercial real estate landscape is littered with over building.

The uncertainty regarding U.S. income tax policy after 2010 is not being adequately reflected in today’s stock market prices. Higher income taxes as expressed by the Obama administration regardless of their merits will likely inhibit economic growth in 2011/2012.

U.S. public sentiment has turned against free trade agreements. Politically the building of a global economy versus national interests will be much harder to sell. In such an emotional and politically charged environment greater global trade may be restricted and world economic growth stunted. Major and medium size companies have achieved a significant portion of their earnings growth by outsourcing their jobs and work to foreign countries while shuttering facilities here. Even during our current period of very high unemployment companies continue to outsource their work to overseas locations. Consequently, unemployment in the U.S. remains stubbornly high. Commerce department data show that employment at foreign subsidiaries of U.S. multinational companies grew by 729,000 from 2006 to 2008 while U.S. employment for the same companies over the same time period fell by 500,000 jobs.

The American consumer maintained his life style from 1990 to 2005 by increasing his debt. It did not come from wage growth. Increases in the American consumer’s net worth will be very slow during the next 10 years versus the 1990/2005 period. The U.S. standard of living will show little improvement in this new decade. The American middle class is under extreme financial pressure. The worst since World War II. 2009 showed the steepest one year drop in spending by the middle class since record keeping began in 1984.

State and municipal finances in the U.S. are in serious difficulty. Without financial aid the threat of bankruptcy for some states and municipalities is real. Because of their budget constraints these entities will be firing people not increasing their hiring. State and local governments in general for the next several years will be a restraining force on economic growth in the U.S.

The unemployment picture in the U.S., as detailed in our earlier position paper “Slow Growth, No Growth and Unemployment”, will not improve much into 2012. To reduce unemployment, corporations will have to create millions of jobs in the next two years which will at least initially hurt productivity and profit margins and earnings. It is our contention that growth in wage income will be very slow and will be a major factor in retarding U.S. economic growth.

The U.S. has operated at close to zero percent interest rates for the last several years. This has seriously hurt the income of retirees but it has helped major corporations borrow trillions of dollars at very low cost. It has not helped small businesses. The money so far is not available to them. It was hoped that very low borrowing costs would stimulate investing and spur the economy back to its old normal levels of growth. This has not happened. In time it should, but corporations are nervous about the instability and lack of predictability in the present world financial and economic environment. U.S. corporations have accumulated huge amounts of cash but most of it is overseas and will not be repatriated to U.S. shores to stimulate U.S. growth and job creation under current U.S. tax policies. Corporations in the U.S. continue to focus on overseas countries for their expansion.

Politically the mid-term elections may produce grid-lock in Washington. Many view this as good. In fact some investment funds restrict their investments to periods of political stalemate. Ordinarily we would not disagree with the thesis that political gridlock has its economic benefits, but in this turbulent time strong political leadership would be better. Instead we have serious political polarization.

The government and the Federal Reserve frequently like to point out that inflation in the U.S. economy is almost non-existent. This is not true. Inflation appears to be running at about a 2% annual rate. The government’s inflation numbers are lower than 2% because of the decline in housing prices which accounts for about 40% of the inflation index. With the expected new round of monetary stimulus by the Federal Reserve it is very possible that both inflation and interest rates will rise and a defacto devaluation of the dollar will occur. All are destabilizing events. The government’s weak dollar policy has encouraged currency and commodity speculation. Broad commodities indexes have gained in price about 30% in the past year. These increases in commodity prices have not occurred solely because of increased demand. These increases will be seen soon in the price of finished goods if current monetary policies continue for another year or more.

The U.S., its states and its municipalities and many corporations are facing severe problems regarding their entitlement programs. The American worker has been promised over 60 years incredible health and retirement benefits. Their cost today is staggering. Retirement pensions and health care costs are perhaps the major problem causing are nationwide budget crises. The unfunded liability of these future obligations equals trillions of dollars and will affect our prosperity and future. No one has solved how to place entitlement programs on a solid financial platform without bankrupting the system. Many entities (countries, corporations, states etc.) are probably bankrupt once you account properly for their future entitlement obligations. Resolving the entitlement problem or continuing it in its present form will result in significantly altering and slowing future economic growth. Because no one wants to come to grips with the major dilemma, its negative impact on the stock market, future earnings and price/earnings ratios is out there somewhere in the future, but someday it will register a severe negative jolt to our way of life. The day is approaching and at perhaps a faster rate than we think.

Should today’s stock market sell at a price/earnings ratio reflecting normal times? The Dow Jones Industrial Average first hit 10,000 in March 1999. It crossed 10,000 numerous times since then. Most recently last month. However, look at the deep differences between the U.S. economy and the American consumer then and now. The times and conditions of both the economy and American consumer in 1999 versus now look almost idyllic compared to today’s uncertainties, continuing emergency financial measures to bolster economies and fears. Is there a disconnect between reality and the stock market? The stock market operates on the principle that adversity equals opportunity. We concur with this thought. In March 2009 the stagnating U.S. economy presented opportunity if you believed a recovery would soon begin. We anticipated a stock market rising from the ashes of early 2009. However, after 18 months and 4000 points we believe the price/earnings ratio of the stock market is back to reasonable price levels in light of the serious complex problems facing the country and industrial world. We are probably still in a secular bear market which began in 2000 and has years to go before ending. But during any long term bull or bear market there will occur extensive contractions in stock prices or conversely extended periods of price increases. We are in such a rally now. An economic recovery slow and steady has become the belief and force de rigueur in the stock market propelling prices upward. Consequently, the optimists believe price/earnings ratios can still expand back to normal historical levels and the current rally has the potential to climb another 15%. We have pointed out in this position paper that we believe we are in an abnormal period in our financial history. A period filled with uncertainties in number and severity which we have not faced since World War II. We do not think the economy or stock market will collapse, but we do believe growth in either or both will be a fitful struggle over the next few years. The current pricing/earnings ratio of the stock market reflects its recovery from March 2009. Any higher price/earnings ratio will begin to increasingly ignore or deny the serious problems we have enumerated above confronting the nation between now and 2015. We are in atypical times which do not warrant, as yet, a return to historical average price/earnings ratios. The risks in the economy as outlined above are serious and normal price/earnings ratios must be discounted to reflect our current unusual times. With a new round of massive federal stimulus commencing soon, the stock market could continue its rally through year-end, but the new stimulus will only exasperate the imbalances in our economy and increase the difficulty of getting it back to normal. The return to normalcy will not be painless. Regardless of further federal stimulus we foresee continuing slow growth in the economy and longer term problems, which could flare up at any time. Stock market risk exceeds the potential for reward in our judgment at this time and we will continue to maintain a conservative asset allocation which we began last spring, marked by under representation in common stocks.

In August the government said unemployment in the United States increased to 9.6% of the total United States labor force. For the headline reading public, percentages, as bad as they might be; are more soothing in their impersonal nature than actual numbers. The U.S. labor force is estimated to approximate 154 million people. An unemployment rate of 9.6% equals 14,784,000 people. There are also the underemployed, part time workers who lost their former full time jobs. The underemployed equal about 7.1% of the labor force according to the government. Consequently, as of August, 2010 about 16.7% of the total U.S. working population is unemployed or underemployed. In human costs 16.7% equals 25,718,000 people in this country who are out of work or unable to find full time work. This very large number does not include those individuals who have dropped out of the labor force according to government statisticians.

There is an opaqueness or lack of clarity in government monthly unemployment numbers. Econometric models, based on assumptions, are used in compiling the monthly unemployment data. Although we believe there is an honest effort for accuracy, some of the assumptions used to generate the final headline numbers are questionably biased. For example, each month the Department of Labor estimates (guesses) how many unemployed people decided to start their own private businesses to generate income. It also guesses each month at the number of people who discontinued their personal business venture. During difficult economic times the government seems to assume that many more new businesses are started than are terminated each month. A very questionable and unquantifiable assumption. For example in August the Bureau of Labor statistics decided that a net balance of 115,000 jobs were created by individuals who could not find either work with existing entities or did not want to. This is a hypothetical number which can only be more accurately ascertained many months later. It is quite possible in August that more small private businesses closed their doors than started new ventures. In economically hard times this is not an unreasonable assumption. Credit and liquidity become scarce and undercapitalized small personal ventures fail. The government said in August there was a net loss of jobs in the country of 54,000. Wall Street and economists were happy the job loss was not bigger. If we remove this questionable creation of 115,000 jobs last month, then the job loss would be 169,000, a negative number which would have shocked Wall Street and further heighted fears on Main Street. Also, in the August report almost all of the gains in employment came from an increase in part time employment, an increase of 331,000 part time jobs. Full time employment declined last month on a net basis.

Last month the government reported that the nation’s unemployment rate increased from July’s 9.5% to August’s 9.6%. The explanation the government said is that more people, who were previously out of the labor force, sought work. The government’s unemployment report does not count those people who have been unable to find work, have exhausted their unemployment benefits and have statistically dropped out of the labor force. It is highly likely that the estimated 25,718,000 people who are unemployed and underemployed understate the total unemployment in the eligible labor force in this country. If we made an assumption that at least two other people are dependent on the income produced by these 25,718,000 people, then at least 77,000,000 in this country are struggling to provide for themselves the basic necessities of life.

The consensus among economists is that it will take many years to recover the jobs lost between the summer of 2007 and now. It took almost 4 years to recover the jobs lost in the mid 2001 recession. Now it is estimated that it will take 7 to 10 years to recover the job losses that began with the advent of the 2007 recession. Since 1970 it has taken longer to recover the job losses experienced by each succeeding recession. There could be many reasons for the increasingly slow recovery of job losses from each successive recession, but in our opinion the continuing hollowing out of our domestic manufacturing capability since the 1950s, the growth of our service sector and the long term mismanagement of government and personal finances has created an environment in which a strong, quick recovery in employment is not possible. In fact these factors have caused a steady, lengthening of each employment recovery cycle. Consequently, we foresee an economy in the U.S. which will struggle for the next 10 years between slow growth and no growth because of our inability to provide employment growth.

According to the Wall Street Journal, the city of Toledo, Ohio recently completed a modern glass paneled building honoring the city’s long heritage as the country’s center for glass manufacturing. However, all of the glass windows in the building were made in China because no company in the United States had the high technology manufacturing expertise and capability to make these glass panels. High technology industries in the U.S. use to be the engine driving employment growth in the country. Now many high technology companies have “farmed out” these jobs to foreign countries as their technological expertise has grown to match ours. During the recession of the last couple of years high technology companies like IBM laid off workers in the U.S. while expanding their work forces abroad. This phenomenon in the high technology industry indicates that the technology industry may not be the savior of the American job market as in the past. In the 1950s manufacturing equaled about 50% of our economy. Today it accounts for about 17%. If the defense and aerospace industries are excluded from the current 17%, the number falls closer to 12%. The U.S. manufacturing sector of the economy has been so weakened over the years that it is no longer able to generate jobs to manufacture goods that are in demand in growing foreign markets, like Germany has done. The economic principal of comparative advantage has greatly weakened our national ability to compete and thereby create jobs. Profit growth is essential for job creation, but Wall Street and the corporate mantra for high profit margins have crippled entire industries in this country.

The manufacturing sector lost 27,000 jobs in August. The government sector of the economy continues to shed jobs each month except for the hiring of temporary census workers, late last year and earlier this year. Because of the dire financial condition of many state and local governments, it is difficult to foresee any meaningful employment creation in this area. The service sector of the economy provided the entire increase in private payrolls in August with health care becoming the only sector of the economy which has been consistently adding jobs in the past year. It is difficult to envision the service sector providing consistent growth in employment of at least 150,000 jobs a month which is needed to start a protracted, slow descent in the unemployment rate. The retail industry is a major component of the service sector. With the over leveraged balance sheets of most American households, it is unlikely that retail sales will accelerate much above current levels in the near future especially since wage growth in the past five years has been mediocre. The construction industry will continue to be a poor performer in our economy for at least the next five years. All sectors of the construction industry are overbuilt. Only Wall Street has prospered handsomely in this decade. Employment in the Wall Street financial community accounts for less than 1% of the U.S. labor force but its compensation, including bonuses in 2009, equaled about 1.5% of the country’s entire gross domestic product for last year, exceeding $170 billion. There has arisen in the United States an enormous inequality of wealth distribution which is threatening the survival of the middle class. This severely skewed wealth distribution in the United States has an adverse impact on the rate of job creation in the country.

The Obama administration has lately begun to concentrate its efforts on the economy and more specifically on job creation. Its federal stimulus programs in 2009 and 2010 have created jobs and probably have kept the unemployment rate from getting worse than it is. However, these stimulus programs at this juncture in the country’s financial history carry a very steep cost. Our unemployment benefits, future increases in business tax credits, new stimulus programs are all being financed by foreign governments, not the U.S. government through its collection of domestic tax revenues. Domestic tax revenues in fiscal 2009 equaled about $2 trillion and they will be about the same in 2010. Our government expenditures are about $3.5 trillion for both 2009 and 2010. Consequently our government shortfall or deficit is about $1.5 trillion for each of these years. Our government is able to spend about $1.5 trillion more than it makes by borrowing this money from domestic and foreign sources. Most of this money comes from foreign lenders, especially Japan and China. So, when Obama requests another $26 billion to extend unemployment benefits or $50 billion in new stimulus programs or $200 billion in business tax credits, the money to pay for these programs is primarily not coming from the American people but instead from foreign governments. The proposed programs are laudatory, but without going further into debt there is no way to pay for them. The financial condition of the U.S. government has been deteriorating during the past decade at an alarming rate. More government debt in the short term to hopefully generate more domestic economic expansion and concomitantly more jobs and, therefore, more wages followed by more tax revenues is a decent objective, but there exists a strong possibility that the level of debt by itself will defeat economic growth and thwart efforts to increase employment. High unemployment will impede economic growth. Slow or no economic growth will impair a reduction in the huge and constantly growing national debt. The level of the government’s indebtedness is reaching (and maybe has reached) a precarious point where the U.S. government is no longer able to finance its domestic and foreign debt without fostering inflation or a significant devaluation of our currency. Both events will eventually trigger severe economic repercussions for the U.S. economy and will have a profound negative effect on the rate of unemployment. The country’s sky-high deficits and sovereign debt makes the U.S. one of the most fiscally irresponsible countries in the world according to some prominent economists. The current profligate government spending to force-feed the U.S. economy to try to reduce unemployment will, if continued, only create soon more economic crises and a longer period of retrenchment.

The government stimulus programs have definitely helped to increase employment in the last two years. The stimulus helped keep the Great Recession from becoming the second Great Depression. However, according to the Commerce Department government presence in the economy is at a record high. $0.30 of every dollar earned by U.S. workers comes directly from the government. This figure includes all transfer payments plus compensation to public employees. Additional short term stimulus will further increase the government’s share of personal income. In previous economic recoveries federal stimulus policies were gradually replaced by a healing private sector. From the ashes of the Great Recession the private sector has not yet stepped-in to reduce and replace the government’s record high role in the economy. Many economists argue that more federal stimulus is needed to allow the private sector to regain its traditional role as the engine which drives our economy. But the corollary then comes into play: will the U.S. economy be able to show sufficiently high growth to sustain increasing employment numbers in the face of a significantly contracting government influence. The longer government remains the driving force behind economic growth, the longer it will take the private sector to regain its former footing. In our opinion, over the next 10 years the withdrawal of the government from its record high level of support to the economy will be another factor precipitating erratic and slow growth, and instead of systematically reducing high unemployment, it will be a factor in sustaining high unemployment.

In summary, the U.S. government’s very high and increasing level of debt will reach an inflection point which will severely limit further government support of the economy. We have perhaps reached that point. Rising interest rates would be a critical blow to the government’s financial structure and its ability to support the public labor force and transfer payments. Major industries such as construction, retail and real estate will not be making major net additions to their employment rolls in the next two years. Even the country’s high technology industry will be showing less rigor in its hiring of workers in the near future. State and local governments will continue to reduce their number of employees throughout 2010 and 2011. The absence of a strong national manufacturing base also hinders the country’s attempt to quickly reduce unemployment. The health care industry in the service sector of the economy is the one bright spot for full time employment growth. The very large number of people unemployed and underemployed, the absence of an effective national job training program, the mismatch of labor skills to job openings, the lack of wage growth in the private sector of the economy and the growth role of government in the national labor scene, which is susceptible to unpredictable national and international political forces, all portend an economy marked by stubborn high unemployment or underemployment and slow and erratic growth for at least the next five years. Before the 21st century the U.S. government had the financial resources to abbreviate economic downturns. These resources have been largely wasted and expended. Inflation, deflation and the devaluation of the U.S. currency are the monsters lurking in the background if Obama, Bernanke, Summers and company make future miscalculations about the U.S. economy. The margin for policy error is small and shrinking and none of the options will diminish unemployment or accelerate economic growth any time soon. The opposite is also true: frequently reoccurring recessions and persistent high unemployment might be with us for years to come.