A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Tuesday, November 3, 2009

Transcript: Demand Side 320 - Recession Over? No. Bubbles Brewing? Yes. China? Maybe.

The Recession is not over. The Recovery has not begun.
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Last time we had the jobless recovery. This time we're going to have the invesment-less recovery. Pretty soon, we'll have the recovery-less recovery. Actually jobless and investment-less is pretty much recovery-less.

Tim Duy is one of the typical commentators
Sustainable Growth?, by Tim Duy: [We can] see the light at the end of the tunnel after this long recession, with a GDP report that confirms what everyone thought - the economy turned the corner in the third quarter of this year. Policymakers undoubtedly breathed a sigh of relief, and rightly so. That said, it is far too early for complacency; I found the underlying details less than comforting, especially in comparison to Wall Street's ebullient reaction to the data.

That the recession would end was never in doubt. Indeed, the timing is almost exactly what one would expected given the steep declines in spending in the first half of 2008 that triggered the flood of job losses later in the year. Spending, consumer spending most importantly, would not fall indefinitely, especially with the benefit of significantly lower energy costs beginning in the second half of last year. Moreover, as the Wall Street Journal notes, rebuilding household balance sheets is not accomplished by just increased savings; a default can do the job much more quickly, quickly adding to household cash flow. Indeed, I admit to being surprised that strategic defaults are not much higher.

Demand Side will remind you that we were among the five percent of economists who had the U.S. in recession in December 2007. Actually we had them in recession in November, and we're still right. Now it seems that the same 95 percent say we're coming out of the recession into recovery.

On the basis of positive GDP growth in the 3rd quarter. You can look it up and see our positive GDP growth predicted for ... I don't know. Quite a while. We'll get all the charts up. But it's been at least July. We were gloomy from the start and positive only on account of an apparently misplaced confidence in the new administrations progressiveness and pragmatism. In any event, positive GDP is not a recovery.

The recession is over, but the depression has just begun, someone said. Cute.

But the recession is not over. Actually, it's like Carl Weinberg of High Frequency Economics said. The economy fell off a cliff and is bouncing along in the canyon. This is not a business cycle event. This is depression. Recovery and recession are terms used for the business cycle. The business cycle is buried.

If it were a business cycle event, it would need investment and employment to come along as part of the, well cycle. The business cycle, as Minsky correctly points out, is inseparable from investment. That there is no investment taking place or on the horizon means there is no end to the recession on the horizon. Government spending may generate increased activity, but it is activity, not investment, not recovery, not even in the technical sense.

And even I, who count government spending on infrastructure and public goods as investment, do not think the government is going invest in the scale that is required. It doesn't have to. But those who say the recovery is underway are really saying only that there is positive growth. Government spending came into the economy as output. Demand equals supply. Surprise.

Others have said that the problem is credit flows. Businesses are not borrowing. Consumers are not borrowing. But what is really required in a capital-intensive production process, such as the kind we want to develop for economic recovery, is a sturdy and stable demand that can support the prices necessary to validate the investment and financing. These were available for yearsfrom a citizenry that was employed or could borrow and was willing to. No longer.

The second problem is overcapacity. But overcapacity in housing and consumer products, not in the public goods that we could produce.

That is, there is another stable and sturdy source of demand. The production of public goods. Rosa DeLauro identified in the infrastructure bank in her speech we put up on Saturday. Just so. The Europeans have been doing it for decades. Productive investment that can generate the cash flow needed for its financing and for investment.

But beneath the contracting for particular infrastructure or services is also a need for private business to tool up and invest. You don't build a bridge with a shovel. This investment is readily forthcoming when the scale and scope of infrastructure is broad enough.

The Blue Ribbon Commission on Transportation Infrastructure, I believe at the turn of 2007, put up a proposal for over two hundred billion dollars per year for fifty years in essential infrastructure, to be financed by a gradually escalating gasoline tax. Why we are not doing that today is a testament to the obtuseness of the country, its leaders and its citizens.

That is to say, capacity exists in certain areas, but in other areas, needed areas, there is no overcapacity. Which is further to say that the route to an investment-led growth is open, it just doesn't lead down the familiar consumer product lanes that have been so long dominated by the corporate oligarchy.

Absent investment, and most of them don't see government spending as anything other than consumption, I cannot see how any self-respecting business cycle analyst can call this a recovery.

As I've written on the forecast recently, the recovery will be weaker by the same dimension that policy diverges from one focused on the massive production of public goods.


Plus I have a problem with those who want to reduce the private savings rate. First of all, How would you do it? Second, Why? Third, It's going to go down anyway as the economy folds as people are forced to tap savings for normal expenses.

Private savings is the difference between income and spending. A whole lot of that difference is going into paying down debt. The savings rate is not translating into new cash or equivalent nest eggs. It is translating into lower debt. We could do a lot more to stimulate spending by writing down debt for homeowners via the Home Owners Loan Corporation that should have been implemented a year and a half ago than by any form of credit easing, spending encouragement, or punishment of savings.

Savings and investment are supposed to be connected. That was the story before.

We can reduce the savings rate overall by government fiscal policy. Instead of overspending on consumer durables we can overspend on infrastructure or education. Same aggregate savings rate, no further damage to private household balance sheets.


The current financial situation is a bubble because it was meant to be a bubble. The Fed has done everything it can to keep up asset values. Keeping up asset values was seen as a way of keeping the banks and shadow banks from failing. Well, that and giving them big bailouts. Artificially high asset values and the absence of writedowns on a sufficient scale have left us carrying these bad debts on into the future, making interest payments that will never end on goods that have no use.


The housing stock is an example of a non-productive asset. It is built, it provides services over time, but it does not produce twice the services for twice the money. And truly it was not designed to generate cash flow that could be tapped later. Housing as an asset was supposed to go up because it had been going up.


We are warning you that noted economist and forecaster Nouriel Roubini last week echoed our bubble alert. Calling it "the mother of all carry trades," and saying, "Everybody's playing the same game and this game is becoming dangerous," Roubini stopped short of predicting a new crisis and another leg down, along with severe dollar weakening, as we have at Demand Side.

But the bubble is becoming more obvious, as Bernanke and the Fed have resisted discipline for the financial sector and instead force-fed it liquidity. The hopes were to keep asset prices up and avoid a calamity. But the assets that have been raised are not the mortgage-based securities that are at the heart of the financial sector debacle.

In 2001, Alan Greenspan cut rates to one percent in an attempt to reflate stock prices. Instead he created the culture from which a housing bubble grew. Now Ben Bernanke wants to reflate housing prices and is fueling a bubble in other assets. The last big bubble, in commodities from late 2007 into the middle of 2008, had a short lifespan. The next will likely be more broad-based, and more devastating as it collapses.

But that's our take. Here are some excerpts from the Bloomberg story on Roubini
Oct. 27 (Bloomberg) -- Investors worldwide are borrowing dollars to buy assets including equities and commodities, fueling “huge” bubbles that may spark another financial crisis, said New York University professor Nouriel Roubini.

“We have the mother of all carry trades,” Roubini, who predicted the banking crisis that spurred more than $1.6 trillion of asset writedowns and credit losses at financial companies worldwide since 2007, said via satellite to a conference in Cape Town, South Africa. “Everybody’s playing the same game and this game is becoming dangerous.”

The dollar has dropped 12 percent in the past year against a basket of six major currencies as the Federal Reserve, led by Chairman Ben S. Bernanke, cut interest rates to near zero in an effort to lift the U.S. economy out of its worst recession since the 1930s. Roubini said the dollar will eventually “bottom out” as the Fed raises borrowing costs and withdraws stimulus measures including purchases of government debt. That may force investors to reverse carry trades and “rush to the exit,” he said.

“The risk is that we are planting the seeds of the next financial crisis,” said Roubini, chairman of New York-based research and advisory service Roubini Global Economics. “This asset bubble is totally inconsistent with a weaker recovery of economic and financial fundamentals.”

‘Wall of Liquidity’

The MSCI World Index of advanced-nation equities has surged 65 percent from this year’s low on March 9, while the MSCI Emerging Markets Index has jumped 96 percent. The Reuters/Jefferies CRB Index of 19 commodities has added 33 percent.

Roubini said he sees a bubble in emerging-market equities and that gains in some developing-nation currencies are becoming “excessive.” The rally in oil “is not justified by the fundamentals,” he said.

An asset “bust” may not occur for another year or two as a “wall of liquidity” pushes prices higher, Roubini said. In a carry trade, investors borrow in countries with low interest rates to invest in higher-yielding assets.

Roubini said the U.S. recession seems to be over, though the economic recovery in advanced nations will be “anemic.” He’s “more optimistic” on the outlook for emerging-nation growth.


Now in our continuing series in which we stubbornly ask "China, Miracle or Mirage," we have David Smick from Bloomberg Surveillance last week. Smick is author of the new book The World is Curved focusing on world financial markets.


David Smick

Next Saturday we're going to reprise the Bill Moyers interview of James K. Galbraith of, well, more than a year ago. Galbraith, Stiglitz, Soros, Bill Black, Auerback, Roubini here ... there are those who can see beyond their own self interest into what is likely to happen. You will be surprised to hear how fresh is James K's voice and perspective, even after all this time. And how stale some of the Summers Geithner and even Jared Bernstein ideas are sounding. Remember pragmatism? What ever happened to trying things until something worked?

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