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

Wednesday, June 8, 2011

Transcript 442: Demand Side Forecast is proving out

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Today's podcast was prepared not this week, not last week, but in January. You might call it the first of the "I told you so," series. In January happy days were here again. Q4 2010 GDP had come in at over 5.5. The dawn was breaking, life was going to be good according to the consensus. What happened? Another flock of black swans! GDP was revised down to under 4 for Q4 2010. Forecasters initially ignored it, but when Q1 2011 came in low, they reestablished their practice of forecasting the past. Now, with last week's confirmation in the form of a crippling unemployment number, the stagnation camp has popped up in the middle of them. But again, that is the past. Our practice at Demand Side is to forecast the future. In January we led off with audio from David Rosenberg. Today we'll jump right in. Link to the January podcast online.

The blue chip forecasters are in the stratosphere compared to our assessment of the probable experience of the economy in 2011 and beyond.

Over the next three weeks, we will be updating our bi-annual, once every two years, view of GDP, net real GDP, employment, inflation and investment. Subsequently we hope to begin looking back at our calls and how they worked out, compared to our rivals.

Our short form for 2010 was the economy would continue to bounce along the bottom, with significant downside risks from European debt and banking problems and from domestic weakness in commercial real estate. We saw only modest manifistation of those risks in 2010.

The short form for our 2011 outlook is that those risks will be put in play in 2011, triggered by the traditional trigger, rising oil and commodity prices. 2011 will witness significant new disruption to the American and global economies, likely within the first eight months of the year. The potential for bubbles in emerging economies to burst is growing. And since the structural dilapidation of mega-banks and investment houses has not been repaired, only papered over, and the paper has all been used up, a new and severe crisis in the financial sector is a non-trivial possibility.

The key to the call is the trigger, rising oil prices.

In our view, we have returned to 2008, when political constraints and economic ignorance resulted in over-reliance on the Fed and a very poorly designed stimulus package under George W. Bush. The stimulus design had its advocates in the Democratic camp too, and might be most correctly laid at the feet of Larry Summers, who descended from Harvard with a mantra: Timely, Targeted and Temporary. Public infrastructure spending was deemed too slow a mechanism. The tax cut package cobbled together was weighted toward business, and although everyone appreciated the $400 or $800 bonus from the government, the economy did not respond.

Meanwhile a huge commodity bubble rose out of the ashes of the housing bust, as investors scrambled for returns and a hedge against the inflation that was assumed to be inevitable from aggressive Fed action. This commodity bubble has largely been ignored to this day. Yes, everyone remembers the $147 dollar oil, but do they associate it with a financial bubble? Mostly not.

Rising oil prices, combined with higher interest rates, have been the surest early warnings of impending recessions. This same trigger was operative in 2000. Oil prices and interest rates rose together in 1999, when then Maestro, now buffoon, Alan Greenspan raised short-term rates right into the explosion of oil prices. Demand Side listened to Warwick University's Andrew Oswald, and joined him in predicting the recession of 2000. This was the collapse of the New Economy.

And the same two factors triggered the 2007 recession.

Interest rates are low in the current environment, but credit terms are tight and dropping real estate values means collateral is not as handy as it is in normal times.

Oil and broader commodity prices are the match that will start a new conflagration in 2011. In our view, the American economy is fundamentally weak and burdened with debt, public policy has chosen the madness of austerity, and the corruption of the financial sector is structural. That is, the economy will not be able to bear the shock. This is not your father's economy.

Oil prices are the trigger for two reasons. One, a rise in oil and gasoline acts as a tax on consumers, constraining their purchases of other goods and services and weakening their confidence. Two, resource extraction industries, particularly oil production and distribution, are by far the worst producers of jobs. A dollar spent on gasoline or heating oil employs fewer workers than a dollar spent on any other activity. Thus, returns to oil up, returns to labor down, and labor produces demand when oil does not.


That was January. No wonder people get tired of us. Same thing this week. But with charts. These are the employment charts. Both courtesy of Calculated Risk. The employment to population ratio shows stabilization at a low level, below the era
of the early 1980s, the era of single-earner families. The second is the breathtaking comparison of jobs lost by percentage of the workforce, showing the current employment recession is an employment depression that will almost certainly end up bigger than all other such downturns in the post-war period combined.

Parenthetically, the headline unemployment number ticked up, while the all-in U-6 measure ticked down. Both are hanging out at a very high level. Both will go up.

The Big Picture relays the information that private employment today is 2% below where it stood ten years ago. Job loss over a 10-year period is unprecedented since the advent of something resembling reliable tallies began in 1890. This includes the Great Depression. The 2001 to 2011 period is the heyday of big tax cuts and deregulation, combined with huge deficit spending before the financial crash and two wars. Yet what is the prescription from the ascendent political party, more tax cuts, more deregulation, more privatization.

But we'll get to idiot of the week on Friday.

The NFIB -- National Federation of Independent Business -- reported small business hiring plans turned negative. Quelle surprise.

Elsewhere Paul Krugman continues to complain that we're making the mistake of 1937 when we cut back government spending.
The Mistake of 2010, by Paul Krugman, Commentary, NY Times: Earlier this week, the Federal Reserve Bank of New York published a blog post about the “mistake of 1937,” the premature fiscal and monetary pullback that ... prolonged the Great Depression. As Gauti Eggertsson ... points out, economic conditions today — with output growing, some prices rising, but unemployment still very high — bear a strong resemblance to those in 1936-37. So are modern policy makers going to make the same mistake?

Mr. Eggertsson says no, that economists now know better. But I disagree. In fact, in important ways we have already repeated the mistake of 1937. Call it the mistake of 2010: a “pivot” away from jobs to other concerns, whose wrongheadedness has been highlighted by recent economic data. ...

Back when the original 2009 Obama stimulus was enacted, some of us warned that it was both too small and too short-lived. ... By the beginning of 2010, it was already obvious that these concerns had been justified. Yet somehow ... it became conventional wisdom that the deficit, not unemployment , was Public Enemy No. 1...

This is all well and good. But Krugman is wrong. This is not the mistake of 1937, it is the mistake of 1932. And it is occurring three years after the crash. We have done nothing to fix the housing problem. By 1937 the Home Owners Loan Corporation had been in existence more than three years, negotiating loan agreements between borrower and lender, writing down principle and setting in place the 30-year fixed mortgage. We have done nothing of the sort. Consequently the housing market is continuing to tank. By 1937, we had installed Glass-Steagall and the SEC regulations. We have done an ole on bank regulation, and banks continue to be too big, too powerful, and too crooked. By 1937 we had installed unemployment insurance and social security. It is to our great benefit that these have yet to be rolled back by the austerity machine. By 1937 we had direct employment programs in the WPA and CCC in place. Us? We’re cutting government employment as fast as we can get the teachers to clean out their desks.

Demand Side continues to insist we are still in 1932. It is incredible to us that policy-makers in Washington cannot see over the ranks of lobbyists to what is plainly the second great depression in employment, nor marshal a message that reflects the understanding which is common on Main Street but absent in policy circles that something real has to be done.


  1. Meanwhile, our irrational media machine, failing to account or listen to history and unwilling to answer for its own past headlines and debt scaremongering, NOW wonders how Obama will win the next election with unemployment so high. And we wonder why we can't have a decent, INFORMED conversation regarding policy choices. Let's start with some real journalism and perspective from those organisations that are responsible to the public for information OR alternatively listen to the demandside. Thanks Alan keep bringing it.

  2. We could even be at 1930 as Stocks are still overvalued and I am waiting for them to collapse. As you say the banks have not been reformed and in many ways the they are still at the same state as in 1929 only saved from bankruptcy by the Fed, but the Fed may not get the opportunity to bail them out again. We are still at the edge of another depression but all that the policies have achieved is drag the problem out for 4 years without achieving anything. The banks could still collapse but they will also drag down many governments in the process.