In the fourth quarter of 2008, I wrote about the risks of social unrest during the economic downturn. One of my major concerns was that the pressures caused by economic pain might lead to social unrest and political instability or conflicts. I focused on risks to despotic Middle East regimes, risks of rising expectations in China, the potential of Russia to behave badly externally to distract from internal stress, and finally, risks of unrest and rising populism in the U.S. and the European Union (EU).

 

Unfortunately, while some of these issues have already begun, we may not have seen the worst of it yet. I fear that the effects of rising social unrest will have a negative feedback loop into already faltering economic growth, a risk that I do not believe to be broadly contemplated by most market observers. While the Arab Spring did come to the Middle East (with significant momentum for continued tumult), and concerns remain about unrest in China and Russia, today I am particularly focused on risks in the EU and the U.S. The societal debt problems facing the developed West will require very significant changes in taxation and government benefits in order to avoid insolvency and economic collapse. I fear that these changes will be so wrenching to the expectations of an entitled citizenry, that many will feel that a basic social contract with their society has been broken. The consequences of that rift between large segments of the population and their country will be significant and unpredictable.

 

The average U.S. (and even more so, EU) citizen has developed high expectations of what their government will provide to their families when it comes to retirement, education, healthcare benefits and even basic services such as law enforcement. These expectations are going to increasingly run into the financial reality of their unaffordability. “Defaulting” on the expectations for wide swaths of the population as it relates to their retirements, the education of their children and the quality of their basic services and infrastructure will have consequences. We already stand at a time when the wealth gap between the “haves” and “have nots” is stretched to multi-generational highs, with the forces of globalism continuing to weigh on the future prospects of society’s disadvantaged. I believe that the rioting we saw recently in London may be only the tip of the iceberg as it comes to how a large segment of our citizenry will react to a perception of a rending of the basic social contract.

 

Beyond the weight that examples of violent un-rest put on consumer and business confidence, I fear the political reaction to this unrest in the democratic developed world. As I said at the end of 2008, these are the times in history that seed the Huey Long breed of populism, a vein of political opportunism which is insidious and dangerously seductive with its hollow promises. Lest I lean only in one political direction, I would note that these times also breed opportunists on the other end of the political spectrum, who preach nationalism and a “return to traditional values”, often in hateful term to villanize the “other guys.”

 

I fear that our fragmented political process may go from bad to worse as increasingly polarized factions face off over how to respond to a fraying of the Western social contract. Inefficiency in developing effective policy in that environment is likely to be a further drag on economic growth, potentially creating a negative feedback loop. Without a prompt, assertive and dramatic change in direction from the political leaders of the developed world, we run the serious risk of crossing a dangerous tipping point where economic pain fuels dramatic social unrest, which in turn makes a path to recovery more difficult.

I do not see equity risk premiums sustainably falling until there is evidence we begin to witness that change in direction.

 

 

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the fore-casts are accurate.

 

Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.

 

Securities products offered through Columbia Management Investment Distributors, Inc., member FINRA. Advisory services provided by Columbia Management Investment Advisers, LLC.

 

© 2011 Columbia Management Investment Advisers, LLC. All rights reserved.

225 Franklin St., Boston, MA 02110

columbiamanagement.com

9/11

 

 

 

(c) Columbia Management

www.columbiamanagement.com