Local and Regional Sustainability Events Offer Entrepreneurs Powerful Information and Exchange (published in October of 2010 in the SB News Press)

Santa Barbara is truly one of the most amazing places on the planet.  I don’t think there is another city of this size that offers such a diverse array of activities for virtually every interest under the California sun.  For entrepreneurs and business owners, this is certainly the case.

The Santa Barbara Tech Brew, “The Premier Networking Event for High Technology Professionals, Cutting Edge Innovators, Business and Community Leaders, and Related Non-Profits,” offers a fantastic opportunity on a regular basis for those interested in all things technology and innovation to congregate, communicate, mix, mingle, and connect. 

A key driver of these events is the focus on sustainability, which underscores a sizable part of the regional innovation taking place along the coast.  In my role as a business consultant and business plan writer, I see a substantial percentage of deals coming from green innovation.  The Tech Brews offer a compelling combination of information, insight, and linking of ideas, all in an atmosphere of innovation and sustainability.

This month’s Tech Brew will be held at the Fess Parker Double Tree, from 4:30 to 9, on Monday, October 18^th.  Taylor Reaume of The Search Engine Pros. will kick off the event with a one hour seminar: "WHY IS SEO AN IMPORTANT PART OF THE MARKETING ARSENAL?" from 4:30 to 5:30.  The Tech Brew networking Mega Mixer then begins at 5:30, and will feature industry-related exhibits, complimentary snacks, and a cash bar. On display will be the 3^rd prototype of Life Cube, which was recently endorsed by the American Red Cross, and which I wrote about recently for my column. In addition, there will be a special presentation by the California Space Authority on the latest developments of the California Space Center, including how professionals can have their part in this $220,000,000 project.

SBCC Center for Sustainability will have a booth where guests can learn about upcoming programs, including the Last Paradise film event at the Arlington Theater on October 20^th at 7p.m. (a fundraiser, $10, tickets at the door); and the “Cities as the Solution” speakers series, scheduled to begin February 2011, with Richard Register from EcoCity Builders, San Francisco, ecological city planner and organizer for EcoCity World Summits.

Tech Brew attendance is free either by registration at: www.smallbizentrepcntr.org or you can just show-up.  Enterprise and non-profit exhibits, sponsorships and advertising in the program are available. Contact Alan Tratner at 805.879.1729 or alan@smallbizentrepcntr.org for more information. 

Another amazing event that local entrepreneurs should attend is The Global Summit II (TGS), which will showcase “Twenty-First Century Sustainable Cities” in their Sustainable Technology Exposition (STE).  The Global Summit biennial meeting in San Francisco brings together citizens, businesses and non-profits for three days of education and planning to make global-scale vision, engagement and leadership a reality.  The Global Summit will be held in 

San Francisco on November 8th-10^th.  The TGS was launched as a planning symposium in 2008, and focuses on a new framework for tackling global sustainability by linking the ideological, social, economic, and technological divides that often keep various constituents from working together in meaningful ways.  The Sustainable Technology Exposition is a core part of this event, with this year’s topic being “Twenty-First Century Sustainable Cities.”

The Summit will be held att the Fort Mason Center Herbst Pavilion and will include “Solution Councils,” mini think tanks intended to generate achievable solutions to address pressing world issues of our day: climate change, poverty and economic security. Additionally, the Summit will include educational seminars, the Sustainable Technology Exposition, multimedia demonstrations, interactive workshops, daily musical performances and art installations, all designed to ignite the imagination and move people to identifiable action that will have a positive impact on our world.

Over the course of the three days, local and international representatives from communities, governments, businesses, and non-profits will discuss the following eight industry sectors:

• Agriculture
• Renewable Energy
• Waste and Recycle Management
• Green Construction
• Smart micro grid
• Information & Communications Technologies
• Air Purification
• Water Purification

The representatives will be working on action items to address pressing planet wide issues in a collaborative format.  The STE will feature cutting edge, deployable ideas in renewable energy, materials, pollution control, and design that can be adopted by nations around the globe.  The STE is a cooperative project of the Green2Gold series of incubators/workshops and Empowerment WORKS, the fiscal sponsor of The Global Summit.  Inventors, environmental entrepreneurs, non-profits, and many more will display a wide variety of achievable initiatives that can help drive efficient economic development and address environmental cancerns.

In addition to The Sustainable Technology Exposition, which is open to all TGS conference attendees, the Summit will offer evening programs.  These programs will be held on Monday, Nov 8th and Tuesday, Nov 9th from 6-10p.m. and are available to the public for a fee of $10-$20.  Evening programs include cultural performances, music series, artist installations, and a fashion show. 

A featured portion of The Global Summit is The Funding Round Table—a workshop being held on Tuesday, November 9th.  The Funding Round Table will feature international experts in enterprise financing, funding for non-profits, angel investors, venture financing, debt/lending capital, and unconventional sources, many of which will have exhibits in the STE. Among the organizations presenting will be: Maverick Angels, the Clean Business Investment Summit, the California Coast Venture Forum, and the SBA.

A companion partner to TGS is Where's the Money?—a workshop being held at the Hyatt Hotel, Saturday, November 6^th, prior to TGS.  This regional conference is being presented by banking institutions and offers resources for small business.  (Visit www.vedc.org for more information).

A special workshop during TGS will present Entry into the "green economy"--on Sustainability, Inventing, Innovation and Entrepreneurship; by Green2Gold, with speaker Alan Tratner, who has appeared on Oprah, CNN, CNBC, NPR, Good Morning America, and in the Wall Street Journal, Business Week, Time, Fortune Small Business, INC, Entrepreneur, and USA Today.

A special youth program will also be presented for the three days of TGS for parents, educators and kids, including a presentation on sustainable college/university campuses by Green Tower Sustainability.

Both the Tech Brew and the Global Summit II offer exciting and valuable opportunities for local entrepreneurs to connect with experts and funding sources, to help drive success for their businesses.  For those in the sustainability sector, there are many additional opportunities to gain a better understanding of the current state of the green space, and to collaborate with other business leaders and investors to drive innovation and profitability.  I will be in attendance at both events, and hope to see you there!

The Global Summit II evolved out of its producing organization, Empowerment WORKS, which is a non-profit organization founded in 2001 with a mandate to advance interdisciplinary, collaborative, multi-sector, local asset-based approaches to global community development issues.  For additional information on The Global Summit II, sessions and speakers, please visit: www.theglobalsummit.org.

Quantitative Easing: It’s effect on the dollar, the economy, and inflation (published in October of 2010 in the SB News Press)

The Fed met this week to discuss their options in terms of helping the economy.  Federal Reserve Chairman Bernanke stated that there was a strong “case for further action” on the part of the Fed, on the monetary policy front, although he did not specific what or when they might take this further action. 

Given the current level of short-term interest rates, and the tepid response we have witnessed from the economy thus far to the actions the Fed has taken, including lowering rates basically to zero, there appears to be few remaining options the Fed could take that would have any real impact.  In fact, I am not certain that there is anything they can do to help (although there are a lot of things they could do that could very well hurt the economy, and things they have already done that may hurt it).

In this week’s column, I will explore the options remaining for the Fed—namely quantitative easing—and the possible results and consequences of this action.  I will also discuss some of the current problems we face that already exist, that have resulted from past actions of the Fed, and as a result of the recent recession.

Quantitative easing (QE) is a fancy way of saying that the Fed will buy securities, such as treasuries and mortgage-backed securities.  As they buy these securities, they pump cash into the economy.  The hope is that, by pushing cash into the hands of people, companies, and institutions; that economic activity will increase.  Further, they hope that banks will lend.  Japan recently began using quantitative easing, but for a slightly different reason, which is to weaken their currency (more on this below).  Their desire to weaken their currency, however, is because they want to stimulate their economy.

Bernanke, in his statement released after the Fed meeting this week, said that the current high unemployment/low inflation environment would exist well into 2011.  He was not clear about the specific intentions of the Fed, and backed a cautious approach, only adding that the Fed expects keep interest rates “low for longer than the market expects.”

Normally the Fed will use lowering interest rates as their primary tool for stimulating the economy, to help us lessen the severity of a recession, and to pull us out of recession into recovery.  Unfortunately, because the recent recession was so intense, even with the Fed dropping rates to zero, it has not been enough.  Short of paying institutions to borrow money, the Fed is out of room to lower rates, which means that their strongest tool is now off the workbench.

The problem with quantitative easing is that it is a blunt instrument at best.  It is difficult to accurately predict what impact (if any) pumping even as much as $1 trillion would have on the economy.  For this reason some Fed officials are opposed to QE.  The Fed will meet in early November to discuss the economy and what, if anything they will do.  My guess is that they will employ some QE; possibly as much as $250 billion to $500 billion (to start).

Consequences

Probably the most dangerous possible consequence of QE is inflation.  By pumping more money into the economy, demand for goods and services should increase.  Higher demand is good for economic growth, and right now, it is what we need.  But too much demand will create steady price increases that can get out of control very quickly. 

One other aspect of QE and of inflation is a weakening dollar.  As mentioned above, Japan is trying to purposefully weaken their currency.  The problem with a weak currency strategy is that currencies are only weak or strong as compared with other currencies.  For example, the Japanese yen is strong against the dollar and euro right now, or you could say the dollar and euro are weak against the yen.  This is bad for Japan because it means that the good and services they produce are more expensive in dollars and euros—it takes more dollars and euros to buy things in yen, so it is basically like Japan’s prices have been raised for U.S. and European buyers.  Higher prices mean less sales, and less sales means a weaker economy. 

The problem with trying to bring the value of a currency down, as Japan is trying to do right now, is that the other countries don’t like it.  The last thing the United State of Europe want is for their currencies to become more expensive.  Our economy is weak already, so we do not want to make our goods and services more expensive right now. 

From this perspective, QE here in the U.S. would make some sense, because it will weaken the dollar.  To the extent that we want to keep the dollar weak right now, QE appears to be a good strategy, and is certainly part of the reason the Fed is considering using QE.  The problem again is that weakening the dollar can lead to out of control inflation.

One other tricky aspect of everything the Fed does is the lag time between when they make a decision or take an action, such as QE, and the actual impact that action will have on the economy.  It normally takes from two to four quarters for Fed actions to take effect.  This means that the Fed is constantly guessing where the economy will be in six to twelve months, and then is making policy decisions, like using QE, based on those guesses.  Obviously this is not an exact science, and the process is, therefore, rife with heavy risks. 

The most prominent downside risk to QE is that inflation gets out of control, and the Fed is forced to raise interest rates aggressively, as Paul Volcker did in the early 1980s.  Inflation peaked at 13.5% in 1981, and was brought under control through very aggressive interest rate increases, to a peak of 20% by June of 1981.  By 1983, inflation had falling to 3.2%.  The problem was that, as a direct result of these interest rate increases, Volcker crushed the economy, and we had one of the worst recessions in U.S. history, including double-dip recessions, (which I have already written about). 

With the time lag between the decision to use QE and the actual impact of it, coupled with the fact that interest rates are already at zero percent and have been there for a long time, the risk of inflation, in my opinion, is probably at its highest in the history of this country.

What concerns me most is that we have just been through the worst recession since the Great Depression, and if we are pushed back into recession because the Fed is too aggressive about using QE and keeps rates too low for too long, we will have an extremely long, painful, slow process of working out of the recession, which could take a decade or longer. 

Admittedly this is a worst case scenario.  The Fed officials making these decisions are some of the smartest economists on the planet, and have done their homework.  My hope is that they make the right decisions and achieve the economic growth we all wish to see without blowing things up in the process.  It would be great if there was an historic precedent for the current economic situation, but there is not.  With uncertainly comes risk, and unfortunately that risk is significant, and impacts every one of us.

Housing Affordability: Has the real estate market bottomed? (published in October of 2010 in the SB News Press)

Economists have developed a number of indexes and other indicators that can be used to evaluate whether homes in a given area are fairly valued. By comparing current levels for the index or indicator to previous levels for the same index or indicator during period of time surrounding bubbles and the resulting crash we can make an educated guess as to whether a given real estate market is experiencing a bubble. You may be saying to yourself; A lot of good this will do us… the housing market has already crashed.  True enough, but we can also compare the current data to previous periods to see if homes are affordable on a historical basis, or if we should expect more price declines.

There are two important components of a housing bubble that we can analyze: a valuation component; and a debt (or leverage) component. The valuation component measures how expensive houses are relative to what most people can afford, and the debt component measures how indebted households become when they buy them as a home or for investment.  

The price to income ratio is the basic affordability measure for housing in a given area. It is generally the ratio of median house prices to median family disposable incomes, shown as a percentage or as years of income. It is sometimes compiled separately for first time buyers and termed attainability.

The National Association of Realtors has a housing affordability index series, as does the California Association of Realtors (CAR).  I will use the CAR index, since the national median home price is so far below our local median home price ($179,300 for the national median price versus $487,500 for Santa Barbara County.  The media price in the city of Santa Barbara, as of September 2010, was $834,750, which is down 34% from the peak price in October of 2007). 

Going back to 1988, as the last real estate bubble was starting to form, the California single-family home affordability index (from CAR) was 34.  As the bubble hit its peak, the index fell to a low of 18 in May and June of 1989 (Higher numbers indicate more affordability, while lower numbers for the index indicate less affordability). This same index rose to a high of 44 in February of 1997.  If we look at the timing of these highs and lows, they very closely match the top of the bubble (1989) and the bottom of the collapse (1997).  Prices actually started bottoming around 1993, and took about 3 to 4 years to form a bottom and start to recover. (I expect the bottoming process for the current real estate collapse to take at least this long and very likely a lot longer.)

The CAR Housing Affordability Index for California got as low as 11 during the second quarter and third quarters of 2007 (right when prices peaked), and has now rebounded strongly to the high 40’s. 

Does this mean that houses are “affordable?”  The median home price for all of California fell to around $175,000 in 1996 and is about $320,000 at present.  Household incomes, according to the California Department of Finance, averaged $39,000 in 1997, and are now around $56,000.  If we do a very simple calculation, and divide the median home price by household income, we get a ratio of about 4.5 times for 1997 (the median home price was about 4.5 times household income); and 5.7 times today.  While these two ratios are relatively close, the current value is still almost twice the “rule of thumb” I have always heard for buying a home, which is that you should not pay more than 3 times your annual income for a house.

Shifting gears to the local market, CAR only shows data going back to 1990 for their Santa Barbara County Housing Affordability Index.  In January of 1990, the index was at an incredible 12.  In June of 1997, the index has risen to 37 (it was 33 in February of 1997, at the time when the California index hit its peak).  By May of 2005, the Santa Barbara Index was as low as 6, and stayed around that level through March of 2007.  The most recent reading was a 29.

For an explanation of how CAR calculates their Housing Affordability Index, visit this link: http://www.car.org/marketdata/data/haimethodology/

Using data supplied by Mark Schniepp of the California Economic Forecast, our same simple ratio calculation of price to income, and with median household income of $49,300 in 1997, and the median home price in Santa Barbara County of $242,445, our ratio is 4.9 times.  The current median home price in the county is about $431,000 and household income is $71,400, so our ratio is 6 times.  Again, this is about twice the rule of thumb level of 3 times annual income for a home purchase.

For South Santa Barbara County, household income in 1997 was $59,600 and the median home price in the South County was $360,000, so our ratio is 6 times for 1997.  Currently, household income for the South County is $87,800 and the median home price is $905,000, so our current ratio is 10.3 times. 

Another commonly used ratio that can be very useful in terms of identifying bubbles and also understanding the affordability of homes is the House Price to Rent Ratio.  Rents are generally tied closely to supply and demand fundamentals, so we rarely see an unsustainable rent bubble.  Therefore, a rapid increase in home prices combined with a flat renting market can signal the onset of a bubble.  We can use the ratio of home prices to rents to track home affordability over time as well.

The ratio of median home price to annual rent back in 1997 for Santa Barbara County  was $7150 (apartment rent) per month; annual rent was $8,580.  The ratio of median home price to annual rent is therefore is 28.25 times.  Currently, rents are approximately $1,160 per month, or $13,920 annually.  Using the current median home price, our ratio is 31 times.  Based on this ratio, housing in Santa Barbara County is very close to the same affordability level as it was coming out of the last major real estate debacle.

The ratio of median home price to annual rent for South Santa Barbara County (Goleta and Santa Barbara only) was $1,010 (apartment rent) per month; annual rent was $12,120 in 1997.  The ratio of median home price to annual rent is therefore is 29.7 times.  Currently, rents are approximately $1,600 per month, or $19,200 annually.  Using the current median home price, our ratio is 47 times.  Clearly prices in the South County are still inflated, at least in comparison to where they were as we emerged from the last real estate collapse, and based on the ratio of price to annual rent. 

What does all this mean?  I think in a broader sense, and in a broader geographic area, prices have come pretty close to bottoming.  However, it appears that we may still experience some further downside in prices locally, at least to get us back to affordability levels witnessed at the bottom of the last real estate cycle.  We certainly don’t have to get back to the levels of the late 1990’s, so it is quite possible that we have already seen the lows.  However, my feeling is that the bull market we experienced in real estate, which lasted from 1997 through 2007, was probably the strongest in history.  Therefore, I believe the depth and breadth of the decline and the duration of the bottoming process will be more significant than was the case for the previous cycle, so I would anticipate more price declines and more time to get prices moving back up again.  With that stated, I do believe that we are close to a bottom, at least from a price standpoint, although I think we will see prices linger for several years before they begin to move back up.

Gold Matters (published in October of 2010 in the SB News Press)

We have witnessed one of the strongest rallies in gold (and commodities in general), in history.  Gold is currently trading around $1,325 per ounce, off about 4.5% from its recent all-time high of $1,388 per ounce, which it hit earlier this month.  The rally from the most recent significant low of $1,036, which was set in July of 2009, represents a 34% gain in a little more than a year.

Gold has historically been a store of value and a hedge against inflation.  While this still holds true, more recently we have seen gold rally on fears of deflation as well (although the pull-back over the past few weeks shows a break in this trend).  What is the significance of the rally in gold and what lessons can we learn from it?

Many point to President Nixon’s decision to take the U.S. off of the gold standard in 1971 as the beginning of the modern Federal Reserve.  One the gold standard was abandoned, the Fed could influence the economy much more directly through open market operations and rate changes. 

The Bretton Woods Agreements established the system under which countries fixed their exchange rates relative to the U.S. dollar. The U.S. promised to fix the price of gold at $35 per ounce, which in essence pegged these countries’ currencies to the dollar, which meant that their currencies also had a fixed value in terms of gold. Under the regime of the French President Charles de Gaulle up to 1970, France reduced its dollar reserves, trading them for gold from the U.S. government, thereby reducing U.S. economic influence abroad. This, along with the fiscal strain of federal expenditures for the Vietnam War, led President Nixon to end the direct convertibility of the dollar to gold in 1971, resulting in the system's breakdown, commonly known as the Nixon Shock.

Debate still rages as to whether Nixon made the right decision.  I would say that one could argue about the timing, but the reality is that, sooner or later, we were going to be forced to drop the gold standard.  The U.S. economy is far too large and complex, and the world economy even more so, to rely on the value of gold or any other single store of value.

Over the past five years, gold has basically doubled in value.  If we think back over all of the different economic changes we have experienced, from boom and busts in real estate and stocks, the financial market implosion and partial rebound, and the world economic recession, it is interesting that gold has made such an impressive run.  We did have a significant pull-back from around $1,050 in mid-2008 (remember when oil collapsed), down to about $750, but gold quickly recaptured the $1,000 mark about six months later.

So why should we care about gold?  Gold is not only an investment option, and many strategists would argue that is should be a part of every portfolio, but it is also the best hedge against inflation.  But, like any investment vehicle, the price can make gold unattractive and risky to purchase.  We have seen a huge run-up in the price of gold, as stated above, so is this the time to buy it—will it continue to rally, or should investors wait for lower prices before adding gold to portfolios? 

The answer is not a simple one—there are many economic and political factors that affect the price of gold.  Also, the reality is that gold is not so much driven by economics and politics, as by those speculating and investing in it, and those making a living from the trading in gold.  Since the financial market collapse in late 2008, commodities brokers have had a compelling story to tell about the importance of owning gold, and they have taken full advantage of it.  One could argue, based on the fact that these brokers all over the world have been pounding the table on gold for so long, that we are in a bubble, which could burst at any time.

While it is my feeling that gold is in a bubble, and as a result there is significant downside risk in owning gold, I feel there are powerful reasons to expect gold to continue to rally for some time.  With this stated, the higher the price goes, the more likely there will be corrections of increasing magnitudes, making buying and owning gold increasingly more risky.

What the rally in gold is telling us is that we should expect inflation in the near future.  This makes complete sense, because the Fed has dropped rates to zero, and the government has been pumping hundreds of billions of dollars into the economy through borrowing.  Our national debt is the highest in history, and is around $13 trillion.  We have a massive annual budget deficit, so we are forced to sell new bonds to finance the interest on the national debt and the shortfall on the budget.  Luckily at present, rates are historically low (the 10-year treasury is yielding just 2.57%), which means that the cost of servicing the national debt is relatively low.  However, at some point in the near future, when the economy starts to heat up, the Fed will be forced to raise rates to combat inflation, and the cost of servicing our debt will rise dramatically. 

The implication for an inflated price of gold in a rising interest rate environment is that gold would get hit quite hard, especially if the price continues to rise from current levels.  Increasing interest rates not only cool inflation, but they strengthen the value of the dollar over time, which is also negative for the price of gold. 

For local investors who own real estate, owning gold is a more complicated still.  Real estate historically has been a decent hedge against inflation as well, although the current real estate market is suffering from much more powerful and direct influences than inflation.  While I do not expect real estate prices to increase (due to inflation or for any other reason) for many years, a long-term investor with a significant portion of their total net worth invested in real estate would want to consider a gold investment in the context of the total portfolio, and the possible, long-term impact of inflation on their real estate holdings, (even if that real estate “investment” is the family home). 

My personal feeling on gold is that it will likely rally some more from current levels, possibly after a short-term correction of $100 per ounce or so.  Each investor should consider their personal risk tolerance and investment objectives before considering an investment in gold, and for most investors gold (if included in portfolios at all), should be a small percentage of the total value of the portfolio.  While it is not a bad idea in a very general sense, for gold to be in portfolios, one must be aware of the current and relative value of gold in the big picture context of the sustained rally it has experienced and the risk inherent in it at these levels.

If those who continue to recommend buying gold are correct, and if the current price of gold is an indication of inflation to come, we should all be prepared for the impact of significant inflation on interest rates, the economy, employment, and businesses.  Higher rates make it more difficult for companies that need to refinance existing debts or to borrow new money to afford the cost of the interest.  Higher costs for businesses mean that they have less money to hire people, develop new products, advertise, expand into new markets, etc.  Local companies should plan ahead, locking in financing at today’s attractive rates, if possible, with longer-term maturities, so that enough funding is available for their long-term strategic plans. 

Hopefully the Fed will be able to raise rates enough to combat inflation without crushing the economy.  Personally, I think the coming few years will be the most challenging for the Fed in its entire history.  I just hope they are up to the challenge.

The more things change… (published in September of 2010 in the SB News Press)

We have all heard the old adage: The more things change, the more they stay the same.  Nowhere is this more applicable than with some of the latest and greatest gadgets most of us love to purchase.  I am certainly guilty of wanting the newest technology, no matter what that technology applies to; from televisions, to phones, to the latest software.

I recently bought some new shirts, and was debating on where to take them to get them laundered.  I have had bad luck with some dry cleaners, so I am reluctant to take my clothes in for laundry service.  Several of my friends have recently bought garment steamers, so I thought I would try one to see if I could use it instead of having to take clothes to the cleaners, or, my worst case possibility, iron them myself.  I was very excited to receive my steamer this week, and to try it out.  It works great!  The problem is that it takes just as long to steam a shirt as it does to iron one.

This experience got me to thinking about all of the new gadgets that hit the market with so much hoopla, only to quickly fade from public consciousness, either because they don’t deliver on the hype, or simply because another, newer, supposedly even better gadget trumps it.  Just as there is no real substitute for a hot iron and can of spray starch, many of the old, tried and true tools that have been around for years often work just as good, if not better than the newest gadgets, even if we have convinced ourselves otherwise.

In the entertainment category, I will freely admit to wanting the latest and greatest.  I watch a lot of television, and there is nothing better than having a giant flat panel, HD television with surround sound to watch sports or a good movie.  But how much added enjoyment do we really get from watching something on the big screen versus a somewhat smaller, non-HD television?  This is an interesting and highly subjective question, but it underscores the importance of constantly evolving technologies as a key driver for the U.S. economy.

Seventy percent of our economy each year results from consumer spending.  Part of that spending is on durable goods—items we buy that last at least three years.  The rest is spent on consumer non-durables, or things that don’t last as long.  The combination of these two segments of consumer spending is the key to whether we have a good or bad economy.  So far, although consumer spending has been very weak, government spending, and to a limited degree corporate spending (a significant amount of which has been spent to build inventories back up from extremely low levels), has substituted for consumer spending, keeping the economy from falling into a deeper, longer-lasting recession (or from falling back into recession—a double dip recession).  The problem is that, at some point (and we may already be at this point) the government will no longer be able to borrow more money to spend in the economy, and if consumer spending has not rebounded by the time the government cries uncle, we will slide back into recession (if we haven’t already).

We will get our next installment on U.S. GDP (Gross Domestic Product)—the total value of all goods and services produced in the country within one year, around the end of October.  Our GDP growth was 3.7% (annualized) in the first quarter of this year, but declined to 1.6% during the second quarter.  It is anyone’s guess, but we could very easily see GDP growth drop into the negative this quarter.  If this occurs, consumer confidence will decline dramatically, causing a further decline in consumer spending. 

The noted economist John Maynard Keynes developed a theory of consumption that focused primarily on the level of people’s disposable income in determining their spending. The rate at which consumers increase demand as income rises is called the marginal propensity to consume. For example if someone receives an increase in income of $2,000 and they spend $1,500 of this, the marginal propensity to spend is $1,500/$2,000 = 75%. The remainder is saved—so the propensity to save would be 25%.

Many banks and economists have economic models that seek to predict what will happen to consumer spending after various shocks. In the long-term, the thing that matters most is real individual incomes. Changes in the amount we earn are by far the most important feature determining how much we spend. Other features, such as the value of our homes or our financial savings, matter a bit but their effect is dwarfed by changes in our earnings. 

The key factors that determine consumer spending in the economy can be summarized as follows:

• The level of real disposable household income
• Interest rates and the availability of credit
• Consumer confidence
• Changes in household financial wealth
• Changes in employment and unemployment

The willingness of people to make major spending commitments depends on how confident they are about both their own financial circumstances, and also the general state of the economy. Consumer confidence is quite volatile from month to month. Some of the fluctuations are seasonal, but the underlying trend is what really matters.

The main factors affecting consumer confidence are:

• Expectations of future income and employment
• The current level of interest rates and expectations of future interest rate movements
• Trends in unemployment and changes in perceived job security
• Anticipated changes in government taxation
• Changes in household wealth including movements in house and share prices

Getting back to our discussion of the American obsession with the latest gadgets, we have seen a substantial decline in consumer spending due to the recession, and thus a significant decline in spending on these gadgets.  An interesting question one might ask is; Have we seen a permanent shift in consumer behavior, or will be see the American public revert right back to their high rates of consumption, as soon as unemployment improves?  One of the positives of the recession has been that consumer debt levels are coming down as individuals tighten their belts and pay-down their credit card balances.  This is good for two reasons: 1) because we owe far too much in this country; and 2) when the economy does improve, and consumer confidence rises, we will have buying power, which could drive a much faster pace to the recovery.

I have no doubt that I, along with most people, will continue to want and to buy the latest gadgets, whether for the kitchen, computer, garage, or for entertainment.  I just can’t help thinking about my old iron and spray starch though…they do work pretty well.

Outsourcing: Why American companies do it, and why they shouldn’t (published in September of 2010 in the SB News Press)

Last weekend I decided to “upgrade” to Windows 7.  I had finished my work for the week by mid-day Sunday, so I thought I would be able to complete the upgrade Sunday night and be ready for work again by Monday morning.  I had actually upgraded to Windows 7 several months prior, but had compatibility issues with my printer, so I reversed back to Windows Vista.  Needless to say, things did not go smoothly or to plan, and I ended up spending the next few days sorting out the vast web of complications that so often seem to plague PC users these days.

I attempted to call Microsoft’s support team late Sunday night, realizing that they outsource their support to India, so I thought someone would be available.  They weren’t.  After fighting with the software all night and into Monday morning, I was finally able to get a support person (from India, of course) on the phone, after spending about fifteen minutes on hold.  This person was clueless, so I after several minutes of explaining my problems and what I had already tried, I could see that I knew more than they did.  I asked for their supervisor. 

After another ten minutes on hold, the “supervisor” got on the line.  I again explained the issues, only to have “Lea” (they have “Microsoft aliases” because their names are too complicated for most of us to pronounce) state that she could do nothing to help me, other than mail me a disc.  When I stated that I had my previous Windows discs, and asked if we couldn’t use those to get my computer working again, and then download a fresh copy of Windows 7, she stated that my product key that I had received when I downloaded the first version of Windows 7 would not work with a second download.  I asked: couldn’t we just get another product key?  She said that was “impossible.”  I said; what do you mean impossible; you work for Microsoft… can’t you just call someone and get a product key?  She said that was impossible because she could not get me a product key for software that I had not purchased.

After a few well-chosen words, “Lea” hung-up on me.

I went to OfficeMax, purchased another copy of Windows 7, reloaded it, and solved my problems myself.  I tried calling again several times to get help with Outlook, my (Microsoft) email program, but they stated that I did not have a support contract for that program.  When I countered with the fact that Windows 7 was causing the problem (it was working fine before I upgraded), they said that my case number was for Windows 7 and not for Outlook, so there was nothing they could do.

Why am I torturing you with my wonderful experiences with Microsoft you may ask?  This experience got me to thinking about outsourcing, and how it is a trend that seemed to make a lot of sense on paper, but like a lot of things, in practice, it just doesn’t quite work. 

Luckily there has been a resent reversal in many aspects of outsourcing, especially when it comes to smaller-scale manufacturing.  Due to the recession, many companies in the U.S. have excess capacity, lower operating costs as a result of newer technologies and layoffs, and are hungry for business.  As a result, they are much more willing to manufacture products for less, meaning that they are much more competitive with places like China, especially when you throw-in the cost of shipping, customs, duties, foreign consultants, etc.

Also, as my experience with Microsoft clearly demonstrates, the quality of the service that many companies are offering to their customers, as a result of outsourcing, is quite simply, unacceptable, and more and more, customers are voting with their pocket books, and going elsewhere.  Microsoft’s stock price clearly reflects the fact that they are completely out of touch with their customer-base.  Their stock trades at a 70% discount to their peers, and Apple is absolutely crushing them.  Every day, more and more PC customers are leaving for greener pastures at Apple.  If Apple offered a decent word processor and spreadsheet program that was widely accepted, I would have left Microsoft long ago. 

On August 28^th, Paul Allen, Co-founder of Microsoft, launched a bunch of patent infringement lawsuits against Apple, Google, Facebook, and eBAY, among others, claiming that they built their businesses around “his” technology.  Ironic, considering that Bill Gates built Windows from technology he borrowed from Xerox, if I remember the story correctly, and a little more he borrowed from Apple.  If I could give Paul Allen and Bill Gates a little Advice, I would suggest that they worry a bit less about patents and a lot more about treating their customers well and provided half way decent tech support.

Outsourcing support is certainly not the only reason Microsoft is trailing far behind its competitors; especially Apple.  Apple has consistently introduced cutting edge products that are unmatched, by Microsoft or any other company.  When discussing Allen’s lawsuit, a Google spokesperson said it best; "This lawsuit against some of America's most innovative companies reflects an unfortunate trend of people trying to compete in the courtroom instead of the marketplace."  In fact, Microsoft’s revenues have been essentially flat over the past three fiscal years, while Apple’s revenues have nearly doubled.

So what is the future for outsourcing?  With many trends in business, it will take a long, painful time before most of the larger companies figure out that outsourcing, in a lot of instances, just doesn’t pay.  It might be cheaper from a direct expense perspective, but when you factor-in lost sales, irate customers, and unintended costs, such as higher returns, outsourcing makes less sense.

The positive side of these problems with outsourcing and the effects of the recession is that many U.S. companies may see growth in their businesses as more previously outsourced business comes back home.  This could help with unemployment as well, both directly in the form of new jobs created to meet demand for the work that comes back to the U.S., and indirectly, as companies that get the work demand more resources from other companies that in turn will need to hire more employees.

I think it is very early in this developing cycle, but I hope that companies will re-evaluate their outsourcing practices, especially when it comes to customer service and support, and especially in the case of Microsoft.  I have to say that, despite my horrid experience, I have been a lifelong customer of Microsoft, and I use their software every day, all day, and will continue to do so for the foreseeable future, at least until or unless Apple creates a viable alternative for Word and Excel.  Maybe Paul Allen and Bill Gates could take some of those tens of billions of dollars they have made from Microsoft and spend it on a little upgrading of their own, and upgrade their customer support, bringing it back home to the U.S.  I for one would certainly appreciate it, although “Lea” would have to find another U.S. company willing to frustrate their customers to save a few pennies.

Double Dip Recession: Possibility or Probability?

The threat of a double dip recession has been widely debated in the media and in the public, since we entered the recession back in 2008.  The most recent findings from the National Bureau of Economic Research, (NBER), show that we officially existed the recession back in June of 2009.  Many would debate that finding, since we still have almost 10% of Americans out of work, a national debt fast approaching $13 trillion, and the vast majority of small businesses unable to access credit to fund start-up, hiring, or expansion.  Nevertheless, the data show that the U.S. economy generated positive GDP growth in the third quarter of 2009, and has been showing positive growth since.

In this week’s column, I will review some of the key data-points that can provide some insights into the complex world of economics, to try and gauge the possibility of a double dip recession.  With the next reading on GDP growth coming on October 29^th, the debate will likely intensify as to whether or not we will slip back into recession, or reverse the decline in GDP growth we witnessed in the second quarter of this year.

First, let’s define a double dip recession.  Once the economy has shown at least two consecutive quarters of negative GDP growth, the economy is officially in a recession.  After the recession ends; meaning that GDP growth has turned positive, a double dip would occur if GDP growth turned negative again.  

A good way to visualize it is to think of the shape of a ‘W.’  If you were tracking the growth of the economy on a chart, and you had a double dip recession, the chart would resemble a ‘W,’ with the two bottom points of the ‘W’ representing the two dips.  We had a double dip recession in the early 1980’s, so there is a precedent for it. 

The economy fell into recession from January 1980 to July 1980, shrinking at an 8 percent annual rate from April to June of 1980. The economy then entered a quick period of growth, and in the first three months of 1981 grew at an 8.4 percent annual rate. As the Federal Reserve under Paul Volcker raised interest rates to fight inflation, the economy dipped back into recession (hence, the "double dip") from July 1981 to November 1982. The economy then entered a period of mostly robust growth for the rest of the decade.

We experienced the longest recession since the Great Depression, (affectionately referred to as the “Great Recession”), which officially started in December of 2007, and lasting 18 months.  The NBER panel was quick to point out, likely anticipating the negative reaction from the public, that their finding that the recession ended in June of last year did not mean that the economy had returned to robust growth. 

"The committee did not conclude that economic conditions since that month have been favorable or that the economy has returned to operating at normal capacity."

So, is there anything we can look at to try and judge whether or not we will double dip?  There are many economic indicators that we can watch that do impact the economy directly, and therefore can give us some sense of the direction of the economy. 

Unemployment is one of those indicators.  Unfortunately, unemployment is a lagging indicator, meaning that it tends to keep doing poorly, even after the economy starts to get better.  We have seen direct evidence of this during the latest recession, which again ended, according to NBER anyway, in June of last year, while unemployment didn’t peak until January of 2010 (if you believe we have seen the worst unemployment numbers already; I am not convinced).  This means that there was a 6-month lag between the end of the recession, and the peak in unemployment. Unemployment peaked at 10.6%, and is now at 9.6%, so we are still very close to the high.  What is concerning to me is that we dipped to 9.3% in May, but then the rate of unemployment increased to the 9.6% (August 2010) where it stands today.  Which direction will it go from here?  I do not think we have seen the peak for unemployment yet, and if it continues to rise, the impact on the economy could be significant and negative.  We will get the next reading for U.S. unemployment on October 8^th, which will be for September 2010.

Compared to the U.S. unemployment rate, California’s has shown a similar trend, although the rate is higher, with a peak of 13.2% in January of 2010, and a current rate of 12.4% (August 2010).  California also dipped lower to 11.9% in May, before rising to the current 12.4% level.  Santa Barbara County hit 10.4% in January of 2010, (close to the peak for the U.S. overall), and then dipped to 8.3% in May, before bouncing up to the current (August 2010) 8.9%.  The rising unemployment trend for the U.S., California, and Santa Barbara County are not encouraging, and could certainly contribute to a double dip recession.

The trend of GDP growth is also concerning.  After hitting bottom in the first quarter of 2009 with -4.9% annualized growth, we turned positive in the third quarter of last year, with 1.6% growth, peaking at 5% growth in the fourth quarter of 2009.  GDP growth has fallen, however, for the past two quarters, dipping to 3.7% in the first quarter, and again to a revised (just this week) 1.7% in the second quarter of this year.  Where will it go next?  We will find out on October 29^th, when third quarter GDP growth will be announced.  Until then, we can all debate the fate of the economy.  My personal view is that it will dip even further, possibly to below 1% annualized growth, and there is a distinct possibility that it could go negative.

With 70% of total U.S. economic activity attributable to consumer spending, consumer confidence—the gauge of consumer attitudes about the economy’s future—is extremely important, and can offer some insights into future economic growth.  On September 28^th, the Conference Board reported the September Consumer Confidence Index had dipped to its worst level since February of 2010, with a reading of 48.5.  This was a significant drop from the August reading of 53.2.  One interesting aside on this data series is the impact of the home buyer’s credit—$8,000 tax credit for first-time home buyers and $6,500 tax credit for repeat home buyers—that ended back on April 30^th.  Although April was a long time ago in economic terms, many of the data series that we track lag, (just like unemployment), so the impact of the home buyer’s credit is still showing up in the data.  The dip in consumer confidence may be the first sign of the end of the home buyer’s credit, and if this is the case, we could easily see consumer confidence and consumer spending sink further over the coming months.  If this happens, the negative impact on the economy could easily be enough to push us to negative growth, and by definition, into a double dip receission.

Lynn Franco, Director of The Conference Board Consumer Research Center stated: “September’s pull-back in confidence was due to less favorable business and labor market conditions, coupled with a more pessimistic short-term outlook. Overall, consumers’ confidence in the state of the economy remains quite grim. And, with so few expecting conditions to improve in the near term, the pace of economic growth is not likely to pick up in the coming months.”

Home prices are another indicator of economic activity.  The so-called wealth effect—the psychological impact that a person’s perceived wealth has on their spending habits—is directly and significantly impacted by home prices, because, for most of us, the value of a home is the single largest component of personal wealth.  When home prices decline, as they have during the recession, personal wealth is negatively affected; and people tend to spend less when they believe that their net worth has declined.  Although home prices have improved from the lows last year, they recently dipped slightly, very likely due to the home buyer’s credit ending.  If prices continue to decline, consumers may curtail their spending even further, weakening the economy, and possibly contributing to a double dip recession.

Any one of these economic indicators (and there are many others we could examine) could be dismissed.  We know that the measurement and methodology of calculation of each is questionable at best.  However, taken together, the conclusion I draw from the data is that the possibility of a double dip recession is real, and the chances of falling back into recession are, perhaps, more significant than most economists would have us believe.