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Thursday, June 23, 2011

Transcript 448: Forecast, at least here, for accuracy, Main Street beats Wall Street

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A recent post from Calculated Risk begins
Just thinking out loud ...

Fed Chairman Ben Bernanke argued that the recent slowdown was mostly due to temporary factors. From the FOMC statement: "The slower pace of the recovery reflects in part factors that are likely to be temporary, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan."

I also think we will see some pickup in the 2nd half of 2011, although I think the recovery will remain sluggish and choppy.

There has been some progress on the supply chain issues, and oil and gasoline prices have fallen sharply since late April.

So when will we see some better economic news?"
Demand Side wonders why? Why will we see better economic news? Corporations will begin to hire again? Debt will be lifted? Yes, oil and gasoline are coming down, but because they triggered the next slump, as we said they would at the start of the year. The flock of black swans explanation for this so-called soft patch is not convincing. From the Demand Side there is no reason to expect better news. Those in power have chosen the madness of austerity. Those at home have to save as much as possible against uncertainty. Where is the demand that is the driver of the economy going to come from? Unless you can identify that, you cannot tell me why things are going to get better. It is just a languid hope.

Today on the podcast we will continue our gloating about predicting negative growth in the second half of 2011 and not last week, but at the outset of 2011. No, we won’t. True, we did predict that, and we’ll get back to the I told you so series as soon as we can muster up the interest. But there are two reasons not to be so … actually, there are three reasons … to be so full of our self.

One, nobody listens to the forecasts that are outside a conventional range, so there is the case of “If a tree falls in a forest and nobody hears it.”

Two, while Demand Side was right and the great swath of conventional economists were wrong, the usual suspects were also right – Roubini, Stiglitz, Keen, AND a good part of the educated American public. Yes, we have not done much better than the consumer confidence surveys of the broad population, which have hovered in recession territory stubbornly unconvinced by the happy talk from Wall Street and inside the Beltway.

Three, gloating about being right is not appropriate when you haven’t been right enough or effective enough in communication to affect policy. Policy has followed the blue chip consensus. Disaster has followed the policy.

Imagine what would have been done had policy-makers realized that the waning of the public works and revenue-sharing portions of the stimulus package would set the economy back into recession. They might have done what needed to be done to fix the problems.

The great John Kenneth Galbraith once said, “Politics is not the art of the possible. It consists of choosing between the disastrous and the unpalatable.”

In our case, politicians have chosen the disastrous because they did not realize it was disastrous because the forecasts they follow – from the IMF, to the Federal Reserve, to the orthodox blue chip consensus – told them things were going to get better.

The great irony of Baffled Ben Bernanke is that he championed the Monetarist line that monetary policy mistakes created the Great Depression. He has chosen to aggressively pursue another course. That course is turning out to be many times more dangerous.

Is it too late? Yes.

Politically the debate is over the non-issue of the deficit. Again, average Americans realize that the economy and jobs ought to be priority one, two, and three. But there is no jobs program in sight, there is no infrastructure or other public works program, there is no revenue sharing with our states and localities. There is only Mediscare and debt ceiling brinkmanship. Oh, and we almost forgot because it is such nonsense, hyper-inflation hysteria.

In terms of resources, while it is possible for the Federal Reserve to transfer trillions in support of banks, it is not possible for them to transfer a couple hundred billion to solve the unemployment problem.

In terms of institutions, the big banks are bigger, the regulations that might have helped have been mugged in the back rooms at the Capitol. There is no voice for the American people.

In terms of economics, the same stupid schemes that got us into the mess are the same stupid schemes that are being proposed now.

This last is the greatest failure of economics. It is not the housing bubble or even the Great Financial Crisis, it is the inability of economics to learn and change and come up with a workable plan. In spite of evidence and history, we are back in the same soup of 1932. And the debate is the same damned debate we had back then.

Why? A big part of it is that economic forecasts were taken as fait accompli, and non-solutions were thus taken as solutions. The ship ran aground, it was refloated, but the course was not changed, so it hit the same rocks. This is disgusting. It is scary. And it is about time somebody firgured out how to change the course.


The commodities bubble is again on the downward slope, as we noted on Monday.

Risk aversion trades are back on the market. Much was made of the major indexes breaking their six-week losing streak, but as David Rosenberg pointed out, two year Treasuries are still going higher. These are near cash. This is where the liquidity trap can be most clearly seen.

And here come the downgrades for Q2 2011 growth. Yes. I know. Q2 ends in ten days, but blue chippers are still forecasting it. Forecasting the past, we call it at Demand Side. Macroeconomic Advisers, the highly respected forecasting firm, lowered its Q2 forecast to 1.9 percent. It started the quarter out at 3.5. In February, it was 4.4. Goldman Sachs cut its Q2 forecast to 2 from 3.

Equally frightening, Ben Bernanke expressed optimism and Olivier Blanchard of the IMF called the downturn a bump in the road. Both raised their estimation of downside risks, however. This is so they can have it both ways. If growth rebounds, they can point to their growth numbers. If it collapses, they can point to their risk warnings. They have no clue.

Here is a cute finesse from Goldman economist Sven Jari, quote,

"At this point, we still expect a bounceback in Q3 and beyond, but will need to see significant improvement in the data over the next few weeks to maintain that view," he said.

Another cute way of finessing incompetence is to couch it in precise numbers. 2.3 percent growth. 1.9. 3.3. Then there is a flurry around the release date of the preliminary data. And a month or two later, when that data is marked up or more likely down by 30 or 40 percent, no notice. We're on to the next quarter's growth to two decimal points. The number of importance is jobs. That number needs to be in the 500,000 range. It is in the 50,000 range and dropping. Of course other numbers are carbon in the atmosphere, average temperature increase.

There’s more to be said, but we can't be heard over the babbling buffoons at the IMF, Fed, on Wall Street, inside the Beltway, at the EU and ECB. Will they be shut up by the next downturn? Who knows?

Check out our post of William K. Black’s short form of the dance of death being performed in the Eurozone right now, as the core countries demand bailouts of their banks by way of austerity from the periphery that will lead inevitably to non-payment on the debts the banks need for solvency.


  1. I do not think that we are back in 1932, but earlier still because all the mal investments are still standing because of the efforts of the Fed to protect the foolish, and stop assets reaching their natural floor, considerably lower than they are now. At least in 1932 much of the bad investment had been wiped out. Now it still stands as a millstone around the tax payers neck.

    In fact I am beginning to wonder if people are also misjudging the start of the bear market as 2000, which would mean that we are quite a way through a conventional bear market. Though with a stagnant stockmarket for most of this century, and it did not really collapse until the financial crisis, I suspect that the experts have got this wrong as well. We might be at the beginning and it could well be dragged out for decades as governments screw up attempts to rebuild the economy.

    Deflation is the big risk but that is ignored by most. Assets are overvalued considerably and somehow are being held up by QE. Even though this is weakening the real economy it will not be allowed to find its true value. So much for letting markets decide.

    I personally expect world trade to slow down but not stop unless the are many more losses in the banking system. That is going to happen but just what triggers it wll be a mystery.

  2. Your points are well taken, as usual. I do not fully understand the importance of the start of a bear market, nor the impact on markets of the rising debt levels. It seems like some of that debt could be embedded in market prices. Or may be very susceptible to selloff if debt problems get too severe. That is, the increase in debt being sponsored by the Fed may be increasing volatility. A little muddy there. If you get a chance, I'd appreciate your thoughts.

  3. If this is a bear market then as some investors are concerned then we are looking at 16 years of falling asset prices. Which if started in 2000 means we are most of the way through. If it started in 2008 then we have a lot further to go. Personally I do not follow such theories. If a market is overpriced then it will have to fall or stagnate until it is fair value again. That can be quick or slow. Minsky is my influence here. Though I do think that such falls can be sticky as sellers try and hold on for better prices only selling when they have given up hope. This is very true in real estate markets. As for the importance it is probably all psychological. Bull markets get a head of steam that keeps them going for a while. The same probably applies to the negative impact in a bear market. The best way to judge this is Japan. It had its ups and downs yet continued its slow and relentless fall for 20 years. My point about bear markets was more about the fact that the stock markets were no higher than they were in 1999. So a decade going nowhere. I would not consider that a bear market. I do think that we are about to enter a period of falling prices especially in assets. QE might be able to falsify the real values for quite some time. Eventually things will crack and prices will adjust.

    Actually you may have a point about debt being embedded in stock prices. Low interest rates mean that a business can support higher debts and so its stock prices can be higher. If however interest rates look too low and will climb fast then this will impact on the ability of stocks to hold that value. This could be enhanced when so much stock is purchased on margin, as is now the case. Also if interest rates had been constant would companies have been able to boost their earnings so much? There has been much made of how strong corporate balance sheets are, but that hides the problems in smaller businesses unable to borrow for trading or to grow.

  4. There have been lots of comments this week about 1937. I do not see that either. Things are different this time. Yes there are debates about austerity and trying to balance the budget, but yet the economy is still holding onto huge piles of debt that had been cleared out by 1932, so things are not like 1937.

    Yes you are right about the susceptibility of markets if debt is seen to be a burden. Banks have probably found that they are finding it hard to find backers willing to buy their capital at a price that is not too onerous. Sovereign funds may be cash rich but if there are problems back home that money will be wanted fast. So yes the debt is adding to volatility. I suspect that those first out of the markets will realise this and everyone else will be nursing huge losses and large debts to settle. I also think that driving everyone into a risk investment with zero interest rates is a recipe for disaster.

    As to what will US policy do and achieve are very limited. Successful policy requires both fiscal and monetary measures. That will not happen with the Tea Party having any influence. The US will rely solely on monetary measures which have already reached their limit. Overall this ongoing crisis has been about regulatory failure everywhere it has impacted. In Ireland because of the failure of regulators to clamp down on what was clearly a bubble. Same in the UK, and its banks exposure to overseas markets. Same for France and Germany yet both have managed to survive some how though there have been bank failures in Germany. This will not end until there has been reform as the banks will take more risks as soon as they can, and wait to be bailed out by the tax payer yet again. With central banks exhausting all their weapons, and governments considering austerity measures as the only way to balance their books the overall prospect is bad. Central banks are trying to drag this out for so long that people clear their debts, though how people can clear a 25 year mortgage or get it down to a sustainable level in the time frame, is a mystery to me. US de-leveraging has appeared to have stopped which is probably a sign that those able to, have done so. The rest are unable to. A lot of that debt is vulnerable to default.

    Also what has not been considered by any economist that I am aware of, is the decline in vitality of the economy because the market has not being allowed to operate. Normally when a recession strikes business premises will have fallen in value so that new businesses can start up. I do not think that the cost of property has fallen far enough to allow new entrepreneurs to take that chance or that rents are still too high. This favours incumbent business though it is the small start up that is the greatest creator of jobs. They are being squeezed out this time, by central bankers trying to reduce bank losses.

    So my prognosis is that the the world economy will slow down. The US and Europe will fall into recessions, caused by bad policy. The rest of the world will slow down but still grow. Only a major financial crisis will cause it to reverse direction temporarily. That major financial crisis will come sooner or later and will be worse than 2007 because trust in central banks ability will not be there. Debt write offs will come sooner or later and the big question will be will the tax payer tolerate it again? We cant keep fixing the banks to save the economy if that never worked last time.

  5. Your point about the economy declining in vitality because the markets are not functioning as they ought is really important, at least at first blush. I have thought, for example, that the bond markets are not really pricing risk of any particular outcome, including inflation -- as Jamie Galbraith and Dean Baker and others suggest -- but are just serving as cash that gets a little bit of interest. That is not a completely formed thought.

  6. My comment about vitality was aimed at the cost base of small businesses being increased by property prices or rents. If they were stable then new businesses would not it a problem finding capital to start. If they rise significantly this increases the fixed costs for a new business to over come to become profitable and to create jobs. Hence reducing the potential for start ups and my comment about vitality. Another way of looking at it is that wages have been stable for years, as have prices, yet rents have rocketed. So where has all the productivity gone? It has been drained away to pay rents and mortgage interest. This has been exacerbated by tax policies on capital gains. With many countries having lower capital gains taxes than earned income it skews incentives with businesses. Banks have practically become hedge funds with a retail branch network.

    I also agree about bonds. There is something that is completely wrong in bond pricing right now. With rates so low, bond prices would be very high, especially long dated bonds that have many years to pay out. Though if rates rise this would mean large capital losses for bond holders even if they held them to maturity. That also ignores any risk. Though I am looking at the bonds via Bloomberg app on my iPad and they look very low, with the yields already priced in so that bond prices are not far from par. These also do not cover inflation so why buy them unless you expect everything else to tank. With bank solvency questionable the only reason to buy government bonds is to protect against financial collapse of the banking system.

    Though if I were that rich I would be in treasuries or gilts rather than banks. Even FDIC insurance only goes so far. Wealth retention is more important than wealth creation from an investors perspective right now. So yes you are right they are cash with a bit of interest thrown in. There is no discounting of future years interest priced in from first glance.

    If you were a tax payer or worse unemployed, you simply are not on the governments radar right now. All efforts are going to save the banks and the economy be damned. I do not sit in front of charts or piles of statistics. I simply look around, and see what is happening in the real world. I read the odd comment but do not know if the economy will slump 0.1% or 0.3% next year or quarter. I simply look at the fundamentals and see things as over priced so they must come down. That is why I am so bearish. Neoclassical economists and policy makers simply do not understand the fundamentals. In fact over the last thirty years the Fed has become very adept at manipulating the economy to keep it ticking along and not allow recessions. Though that has allowed economies to get completely out of step with the fundamentals. Using the forest fire analogy by stopping all the small fires, the tinder builds up till it is so significant that it burns the entire forest to the ground. That is where we are right now. I have never been happy with the concept of the great moderation or the goldilocks economy. I have always known that recessions clear bad investments and eliminating them was bound to store up trouble.

  7. Thank you very much. This thread has some interesting and important angles at the crisis and aftermath. Particularly the idea that markets are not functioning as they need to, and I would add, because they are being manipulated to produce some arbitrary data points.

    It is a long way from the sink or swim camp, however, because the alternative is not doing nothing, it is supporting the markets in real stuff from the demand side.

  8. One factor about market manipulation is that interest rates come down as soon as markets feel stress. That should not be happening. The central banks should not be interacting to rescue the economy. It needs to allow bad investments to punish their holders. Without such feedback even idiots can make profits. Moral hazard appears to be something that can never happen. Recessions are the natural feedback about bad investments. Yet bankers do not like them.