The Newest Abnormal:
October 31, 2009
The eighties brought us Japan’s “miracle economy”. The ’88 Dukakis presidential campaign delivered the “Massachusetts miracle” – not many years later renamed “Massachusetts miserable.” The Asian Tiger “miracle economies” (and markets!) were all the rage in the mid-90s – until their systems blew apart. Here at home, there was all the “New Paradigm” and the “New Era” hoopla. And until the recent crisis and double-digit GDP downdraft, many bravely trumpeted Ireland’s Celtic Tiger miracle.
It’s as if there’s a contest to coin a catchy phrase that will gain popular acceptance. There was “muddle through” to describe the expected course of the post-tech Bubble economy. The “Great Moderation” lauded newfound policymaker success in moderating economic (and inflation) variability. And who can forget the vaunted “stable and desirable” global monetary “system” - “Bretton Woods II” - analysis that rationalized Credit Bubble excesses. Then there was the pride and joy of coining “the shadow banking system.” Now it’s “The New Normal.”
I must be a grump, as I’m rarely fond of popular economic catchphrases. The “miracles” were – without exception - belatedly recognized as Bubbles. Bullish visions of new eras and paradigms were similarly Bubble delusions. I never bought into the post-technology bust notion of a “muddle through” economy. It was just inconsistent with Bubble analysis – and the dynamic of a more powerful Bubble throughout mortgage finance emerging from the tech wreck. Bubbles tend to not muddle.
I scoffed at “The Great Moderation.” The framework from which it originated was flawed. An optimistic view held that astute central banking had become quite adept at tinkering with interest rates. Students of economic history found this disconcertingly reminiscent of the fateful view from the “Roaring Twenties” that central banking had conquered the business cycle. Central banking has repeatedly been given way too much Credit, while the expansive influence of speculative finance is always easily ignored.
There was no disputing the impressive potency central bank rate cuts had attained (over the past 20 years) for reigniting and sustaining economic growth. Yet rigorous analysis of the Credit system would have illuminated the newfound role of the Wall Street firms, Fannie Mae, Freddie Mac, the FHLB, the massive securitization marketplace, derivatives, and the hedge funds. Central bankers hadn’t become smarter or even more sophisticated. But never had they enjoyed such a powerful monetary policy tool – an expanse of aggressive players keen to stimulate Credit expansion, the markets and the economy at a moment’s (or 25bps) notice. Over a period of many years the Credit system – and the Fed’s transmission mechanism to the real economy - had been completely transformed. It should have appeared shadowy only to those that had clung to a narrow focus on banking system Credit.
“Bretton Woods II” propaganda really rubbed me the wrong way. “How can intelligent analysts not see that the U.S. has exported its Credit Bubble to the rest of the world,” I would mumble to myself at the time. There was certainly nothing stable or desirable about the arrangement of the U.S. massively inflating Credit - using these IOUs to feed asset Bubbles and over-consumption. Especially with foreign central banks content to monetize these dollar flows, in the process dangerously inflating their asset markets and economies. Again, the key to sound analysis was rigorous analysis of underlying Credit structures and financial flows.
Which brings me to the latest and greatest: “The New Normal.” It’s not that I have huge issues with the analysis – it’s certainly not “miracle,” “New Era,” or “Bretton Woods II” silliness. I just sense it’s incomplete and misses some important aspects of the unfolding backdrop. From Bill Gross: “We’re transitioning due to popped bubbles and de-risking of portfolios and balance sheets... A simple way to look at it is that private market capitalism simply went too far over the last 10-20 years, and now we’re in the process of pulling back and accommodating deleverging, regulating and de-globalization.”
From my perspective, the “New Normal” appears more like the old than something new: I'm thinking more “The Newest Abnormal”. To be sure, there have been some popped Bubbles. But we remain trapped in the same old Bubble-inciting paradigm of activist central banking and government intervention. I have expounded the view that a “government finance Bubble” emerged with the bursting of the Wall Street/mortgage finance Bubble. I would argue that Bubble dynamics have taken firm hold in China, throughout Asia, and in the “developing” economies more generally. New Normal reminds me too much of “muddle through.”
“Deleveraging” is at this point overrated. Our federal government issued about $1.9 TN of additional debt over the past year. In my book, that’s “leveraging.” The Fed’s balance sheet has become much more leveraged. The mortgage businesses of Fannie, Freddie, Ginnie and the FHA have become much more “leveraged.” The Newest Abnormal is about massive synchronized global government Credit expansion and extreme monetary looseness. The Newest Abnormal sees massive “private” Credit expansions in China, India, Brazil, and the “developing” markets. The Newest Abnormal is fueling historic Credit and economic Bubbles in China.
The Newest Abnormal has seen a major resurgence in the global leveraged speculating community. The Newest Abnormal is acting with great speed to impair the dollar as the world’s reserve currency - taking unfettered financial “globalization” to a whole new level. The Newest Abnormal has animal spirits that could give the old ones a run for their “money”.
Mr. Gross’s New Normal – constrained by “deleveraging and reregulation” - seems to imply a more subdued and therefore stable Credit landscape. Such a backdrop would be consistent with lower average economic growth and lower investment returns. The Newest Abnormal – with varieties of newfangled Bubbles, excesses and uncertainties – would point to ongoing financial and economic volatility. The “averages” may indeed be lower going forward - but it may be the divergences that prove most noteworthy (hard asset returns vs. securities; non-dollar vs. dollar; China GDP vs. U.S., for example).
The New Normal implies more monetary order, while the Newest Abnormal suggests unrelenting Monetary Disorder. The proponents of the New Normal would tend to view extreme government intervention as a stabilizing force appropriate for a (deflationary) post-Bubble landscape. From the Newest Abnormal perspective, massive government deficits and market interventions inaugurate a dangerous new stage of global inflationism. Newest Abnormal analysis posits that a more stable New Normal backdrop would, at this point, likely arise only after a major government debt crisis.
It was a Newest Abnormal kind of week. For months now, unprecedented global government intervention has spurred a stampede back into risk assets. Buoyant risk markets then sparked a run of bullish optimism. Not surprisingly, everyone ended up on the same crowded side of the reflation trade. This week, global equities, emerging market bonds, commodities, and most currencies were rocked by heavy selling pressure. Those borrowing in yen to leverage higher-yielding currencies in, for example, New Zealand or Sweden, had their heads handed to them. The reflation bet definitely had some air kicked out of it. And many believing, with two months to go, that they had great years in the bag are now recalling that sick 2008 feeling. It’s a reasonable bet that heightened uncertainty and market volatility have returned and will be sticking around a while.