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

Friday, October 14, 2011

Transcript 462: Forecast Real GDP and Net Real GDP

You’ll see in today’s forecast of Real GDP and Net Real GDP the same chart we presented in January. It bounces, but it’s bouncing along the bottom, a bottom sloped downward, with craters from easily predictable crises.

We also have audio from Justin Rowlatt of Business Daily and Brian Lucey of Trinity College Dublin, nicely laying out the true dynamics of the European mess .
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First, a note on how the economics profession has given up its claim to be a science. Being blind to the great financial crisis of 2008 until it was on top of us was bad, but not fatal to the pretences of economists. But then failing to revise our thinking, not giving credibility to the few who got it right and the relevance of debt and financing structures, and simply clinging to the old schemes … that was fatal. We had evidence disproving the long-held hypotheses and evidence supporting the Minsky view. But as a profession, we have ignored the evidence and have continued with the failed paradigms.

Nothing more clearly illustrates this than the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, sometimes known as the Nobel Prize in Economics. Thomas Sargent of NYU and Christopher Sims of Princeton shared the prize. One of these guys did how to forecast economic outcomes without economic theory (basically regression and extrapolation), the other did how to make your predictions robust (by which he meant survive bad assumptions). Neither one came close to predicting the biggest economic event in recent history. I think both, if they were honest, and they are, would say their work is not particularly relevant to today. Depressing.

Now a somewhat scattered exchange lifted from Business Daily, with Justin Rowlatt interviewing Brian Lucey of Trinity College Dublin.
ROWLATT: The latest dramatic installment of the soap opera that is the Eurozone crisis came on Sunday, when the Belgian government stepped in to buy the Belgian division of Dexia, the struggling Franco-Belgian bank. The $5.4 billion nationalization makes Dexia the biggest victim of the crisis to date. And there was another dramatic plot twist on the weekend. France and Germany said they had reached agreement on how to recapitalize Europe’s other crisis-hit banks. But, as in all good soap operas, this was left as a cliff-hanger, with no details of the agreement available. But there is no question that it will be an expensive process. Some estimates put the total cost at 200 billion Euros. I am joined by Brian Lucey, professor of economics at Trinity College, Dublin. Brian, Where is the cash going to come from?

LUCEY: The cash is going to come from the taxpayer, and in fact, Dexia at $5.4 billion seems like a complete bargain –

ROWLATT: -- You mean a bargain for taxpayers. They’re going to make a profit, are they?

LUCEY: No. God, no. Absolutely not. The reality is that these things cost more, take longer and are more difficult to get out of than governments think. The U.K. and Ireland have been three years down the road of dealing with banks, broken banks, partially nationalizing them, you know, doing that which is deemed necessary. Now, to put it in context. $5.4 billion is really nothing to Belgian and French governments. In terms of their GDP, it’s, it’s, I think it’s a percent. Anglo-Irish Bank, the world’s worst bank, close quote, has cost the Irish state, the Irish taxpayer, something of the order of $27 billion at the moment, and is likely to cost in excess, hold your breath, $90 billion.

ROWLATT: $90 billion. But, Where… You say the money comes from taxpayers. Where does the money come from?

LUCEY: Well, it’s going to basically come from future taxpayers. From your children and your children’s children. The same way as the U.K. government when it recapitalized the banks in ’07-’08 basically borrowed that money. That’s exactly what’s going to have to happen …

ROWLATT: But How far, how far are we mortgaging the future?

LUCEY: We’re mortgaging the future for these banks for decades, generations, literally, two generations ahead.

ROWLATT: You know, the estimates of the recapitalization… You know, we’re talking about sort of $200 billion, I mean just absolutely --

LUCEY: -- The Irish bank, the Irish bank crisis will have cost us, by the time it’s all wound down --

ROWLATT: -- You mean, “us” the Irish people.

LUCEY: “Us” the Irish people, probably 150 billion euro. Now anybody who thinks that’s going to be approximately the same size as recapitalizing and restructuring the entirety of the Eurozone banks frankly needs their head examined. There are literally hundreds more billions -- possibly a trillion euro will be required. Gone are the days when we used to worry about tens or hundreds or thousands of Euros. We’re now talking trillions, blasé. But the reality is that most of Europe’s banks are very heavily over-levered. In other words, they’ve borrowed from each other, from private individuals, from sovereign wealth funds. They have lent that out, in many cases very foolishly, to either Irish property speculators or to the Greek government. Greece, for example, cannot repay its debts. And yet, it’s buying 400 main battle tanks.

ROWLATT: Well, this is the absurdity that people struggle to understand, that we’re taking on yet more debt to get out of a debt crisis.

LUCEY: You cannot – exactly – do that. You cannot do that.

ROWLATT: That’s necessarily what we’re on to, isn’t it?

LUCEY: Governments will do the right thing when all possible alternatives are done. And that’s what’s happening, is that the European governments are going down the line of austerity and debt. It’s not going to work. What we need are a realization that some of these debts are not going to be repaid. A writing down of those debts, a realization that – that may leave banks bankrupt, but that’s the problem we have to deal with.

ROWLATT: But that’s what the recapitalization is about, filling the holes left by sovereign debt.

LUCEY: Unfortunately, it’s not. At the moment the recapitalization is about – in the most part – bailing out the bond holders of the banks that have lent the money to the banks, the banks have lent that money foolishly. Capitalism in its normal workings would say, “If you lend me money and I can’t repay that, well, then you’re at loss.”

ROWLATT: So what you’re saying, in a sense, is a kind of nationalization of the debt, from private institutions , the banks that lent the money …

LUCEY: It’s a socialization of the debt.

ROWLATT: … being taken on by sovereign governments.

LUCEY: And you have the unique situation that the Left and the Right, politically and economically, are at one on this – that that is not how Capitalism is supposed to work. Everybody agrees that we need to have banks. Everybody agrees we can’t have banks closing up and ATMs stopping. However, how you insure that that happens, how you insure the credit transmission mechanism, the liquidity transmission mechanism of banks, is another way. It may well be that you need think about separating – going back to very old-fashioned approaches – and separating out the utility element of banks from the more –

ROWLATT: -- which is what Britain’s talking about at the moment. Why aren’t they talking about this across Europe. Because that would be a way of hiving off the risky bits …

LUCEY: As I said at the start of the program, Britain and Ireland are about three years ahead of the rest of Europe on this. This, too, shall come to pass.

You heard much the same here six months ago, and more, not in the crisp and gory detail, but the bullet points were the same. European banking meltdown with contagion to US banks. Rumor has it Morgan Stanley may be the first, with its exposure to French banks

So it comes around again. A debt bubble promoted, sponsored, funded and enabled by a runaway financial sector culminated in the 2008 banking bust. Private debt was socialized by the sovereigns, including the U.S., who also absorbed what Richard Koo calls a balance sheet recession and a burden that came in the form of increased demand for services and decreased revenues. The creditors and bond holders of the banks were bailed out and immediately moved to the sidelines to demand austerity – the madness of austerity – the pound of flesh – from citizens and governments so as to further encourage their “confidence.” That austerity continues to weaken economies, starve future productive growth, and in the end sap the ability of taxpayers to fund the bailouts, and ultimately frustrate even the bond vigilantes.

Now, as the European banks melt down, we hear the cries come up that “something needs to be done for the banks.” Hundreds of billions of euros. The true number is in the trillions of euros, just as the true number in the US was in the trillions of dollars. Nouriel Roubini has called for a two trillion euro “bazooka.” He has also opined that such a remedy is beyond the established public policy structure to provide.

We have the experiment of 2008 to guide us. We tried the Bernanke hypothesis. It failed. Yet we are in denial. That denial is, of course, sponsored by the bond vigilantes. But in the U.S. we also have a political mob intent on torching the economy for the purposes of taking control of the blackened fields. All of it is enabled by an economics profession that is tied to its own professional capital, an economics profession that is at sea with its analysis and/or is engaged in advocacy economics for Wall Street or market fundamentalism.

So, the Forecast: Real GDP and Net Real GDP

We always want to get to the “I told you so” part. But we’re preoccupied with what is in front of us as well. What we have told you, in time for you to do something about it, is we are bouncing along a bottom that is sloped downward, with risks of new financial crises arising from European bank leverage slash exposure to sovereigns (not exclusively Greece) and from commercial real estate and its importance to local and regional banks that are not too big to fail. (click on chart for larger image in new window)

GDP – gross domestic product – is economic activity. At present – looking at it from the demand side – that economic activity, GDP, in the US is underwritten by massive government activity.

We hear dissonant messages from the same mouths that (1) the economy is in recovery and (2) government spending is out of control. Both cannot be true. As we’ve shown in previous podcasts and posts, it takes only Algebra, Kalecki’s and Minsky’s Algebra, to demonstrate that the profits of corporations in the absence of investment are logically linked to these deficits.

So, GDP less government deficits should show us the underlying strength of a private economy. We call this metric Net Real GDP. Remarkably, or perhaps not, this calculation portrays an economy that looks very much like the economy portrayed by unemployment, real investment and median incomes.

And this has been true for decades. In the Bush II era of the early 2000s, and in spite of the immense private debt build-up, jobs languished and with them Net Real GDP. The supposed strength of the economy during the post 2001 recession was due in large part to very large budget deficits. Prior to that, the relative strength of the economy under Clinton is mirrored in the strength of Net Real GDP, and prior to that, in the Reagan-Bush I years, massive government borrowing supported the top line Real GDP number.

Of course, previous to Reagan, public borrowing was quite a bit more restrained. We paid for public services then. More under Democrats than Republicans, but more under both than under the Reagan trickle down policies. Since Reagan it has become the norm to demand services, but to be insulted when asked to pay for them.

And interesting here is to note that private debt has exploded in the past two decades, particularly since 2000, but this private deficit spending has not affected GDP to the same degree as public deficit spending. This is not visible in any of our charts, but

I suppose we should note here that the only metric that IS up is profits. Kind of sad for those who claimed – and still claim – that profitable companies spur wage growth and economic vitality. Seems to be one of the hypotheses that will survive all evidence to the contrary. Can it be called a hypothesis, if it is not vulnerable to being disproven by evidence? More of an article of faith, I would say.

This profits lead to prosperity seems to be one of the hypotheses that will survive all evidence to the contrary. Those profits, we find, were obtained by Draconian austerity by the corporations on their workforces, by Fed-sponsored interest rates that make corporate debt service as light as it could possibly be, and by demand supported not from the private sector BUT FROM FEDERAL DEFICIT SPENDING.

The charts are up, featuring our accounting for past forecasts in the We Told You So dotted lines. They look pretty good. Please note these are authentic forecasts, issued 9-12 months in advance at least. These are not adjusted for data at the end of the quarter they are forecasting. Compare us with anybody else.

Going forward we’re going to project another divot in the road. We’ve already made much of our call for negative Real GDP in the second half of this year. A call issued in January, not in the second half of the year. These are Depression numbers.

Parenthetically, we do think corporate profits will contract along with deficits.

Why would it be different? The demand side says that contracting government, households burdened with debt, and a corporate sector run for the benefit of its managers mean there is no upside.

There is no shortage of those who disagree. But insofar as I can detect, there is no explanation for an imminent recovery. There is the premise that the amazing austerity across the globe will starve returns out of the productive capacity of the economy – most notably labor – that are needed to ratify existing financial claims. But how that leads to economic recovery is not explained. Even that theory is wrong. Those claims can be ratified only to the extent that we employ that capacity.


  1. The sums being proposed to resolve the european banking crisis are a long way from reality. My only reasoning is that if they came out with the €2 trillion figure right away then the tax payers would reject it outright. They need to impale the tax payers on the liability hook first. Then periodically they will come up with a new reason for extra funding. First €490 million, then a few months later another €400 million, and so on.

    What is needed is the debt writeoffs to be taken by the creditors in full. Then the €490 billion be used to nationalise, break up and recapitalise new banks, which actually provide credit.

  2. Where are the old charts showing more historic net real GDP?