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, October 25, 2011

Roubini Week: Summary of Perth Address

50 Percent Chance of Another Recession
by Nouriel Roubini

From Perth Now:

THE economist known as “Dr Doom” has tipped a more than 50 per cent chance of another global recession that could force the break-up of the eurozone.

Professor Nouriel Roubini spelled out for delegates at the Commonwealth Business Forum in Perth today there were potential positive and negative impacts stemming from the current global financial turbulence and uncertainty surrounding the Eurozone.

Specifically, he suggested there was a “significant probability” of a double dip recession engulfing most advanced economies around the world, stemming from unresolved issues in Europe.

“In my view, there’s a significant probability – more than 50 per cent – that over the next 12 months, there’s going to be another recession in most advanced economies,” the New York University professor said.

“If we look at the situation in the United States, in the Eurozone and in the United Kingdom, the chances of another recession are significant.

“Whether you call it a double dip recession, or a cultivation of the first recession or a second recession it doesn’t matter – it’s semantic.”

Professor Roubini also suggested there could be disorderly defaults and, in turn, a disorderly break up of the Eurozone

“If we’re asking ourselves whether the recession in advanced economies is going to be mild or whether it will be severe…the answer very much depends on what happens in the Eurozone,” he explained.

“If the Eurozone is able to control its own crisis, the recession will be relatively mild.

“But if the situation in the Eurozone becomes disorderly, with defaults by a number of countries, and [there is ] a disorderly exit of a number of members of the Eurozone, and eventually a break up, that shock could be as large, if not larger, than the disorderly collapse of Lehmann [Brothers] in the fall of 2008.”

He also mooted a “hard landing” for China’s economy in the not too distant future because of its “unsustainable model” based on significant over investment, which he said now makes up almost 50 per cent of the nation’s GDP.

“Over investment booms during the last 60 years have resulted in a hard landing for that economy,” he said.

He added that China’s massive growth will stall by 2013-14, increasing the chances of a hard landing.

Two rounds of thunderous applause greeted Professor Roubini at the close of his 45 minute presentation to the diverse corporate audience on the first day of the Commonwealth Business Forum.

Mining magnate Gina Rinehart and well-regarded deal-maker and Commonwealth Business Council member, Mark Barnaba were among the throng of business-minded attendees listening attentively to the speech from the man who predicted the global financial crisis two years prior to the fallout.

Even Dr Mohan Kaul, the boss of the Commonwealth Business Council which oversees the Forum, was impressed by the quality of Professor Roubini’s interpretation and forecast of global economic factors.

“Wow,” Dr Kaul said.

“What a speech!”

One member of the audience who wished to remain unidentified said he was blown away by the pace at which the economist delivered his dire predictions.

“He hardly even took a breath,” he said.

Wednesday, October 19, 2011

Net Real GDP Historical Charts

A long-time listener asked about historical charts for Net Real GDP. Here are some 1947 through 2006.

(click on the charts for a larger image in a new window)

Transcript 463: Forecast Interest Rates

Today on the podcast, interest rates. And the return of Idiot of the Week. Plus some audio from Robert Shiller, advocating direct employment of people in public works, the true Keynesian prescription.
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First, Shiller. We like this audio because it uses the best metaphor for the economy and government – the family farm. We’ve used it before, and welcome its introduction to polite society. Here from Weekend Business with Jeff Sommer.

Well, part of the jobs bill was infrastructure investment. And another part of the bill was raising taxes to pay for it. There were other parts, too, but let's focus on those.

On a farm, there are times when unemployment becomes a problem. Notably, in the winter, right? There's no crops to plant. There's no fertilizer to use. There's no harvesting to do. So, what do you think a farm does? Well, people don't want to sit around doing nothing, so they fix the barn, or they build a bridge over the creek. Or whatever. And I think that's what this part of the Obama American Jobs Act was doing. It was putting people to work on sensible projects that are not being done.

Going back to the Nineteenth Century, this idea seems obvious to many people. Unemployed people doing nothing is a huge waste of human talent. And so they came up with all kinds of infrastructure ideas. You know, building canals, or dams, or railroads, or improving harbors. And some of those were done, but they had a bit of a problem. I think it's the same problem we are facing right now.

It's not "the Republicans." It's a long-standing attitude in this country that we don't tax some people to bail out others. Taxing the rich to bail out the poor, unemployed, has never been that popular in this country. There is a lot of opposition to tax increases.

You see, the thing that I am emphasizing is that if you take the part of the bill, the infrastructure and tax increase part of the bill, it was more than balanced budget. Those parts together would have helped cure the deficit as well. People are really opposed to tax increases and deficit spending. But I think in the new political environment, this could change. Because these demonstrations are having an effect.

You know, this crisis might last for years. We might have unemployment over nine percent three years from now. People are tired of this. It's been already four years since the recession began. And I think the political winds could change. I am not going to take it as a given that we can never do sensible things like raise taxes on higher-income people and put unemployed people back to work. That's sensible, and I think the American people may well support that.
Indeed, you hear people say, “Why can’t the government be more like me and my household? I don’t spend more than I make.” Well, if you have a mortgage, you are spending more than you make. Your indebtedness is right on par with many of the most profligate of national governments. You could sell your house, you say. Well, the government could sell Yellowstone Park or the Interstate Highway System, or a host of natural monopolies.

The point is, like a farm family, we have old people, young people, infrastructure needs, a future to plan for, and a complex of activities that are simplified out of existence in the household metaphor. We are not just going to work, collecting a paycheck, and coming home to pay the bills. We don’t have to worry about protecting ourselves from the neighbors, building roads to work, educating our children in-house, providing for the old people’s health and retirement, and so on, all of which – and more – you need to include in your calculations if you are going to do away with the support of public goods in your self-righteousness.


And now, Howard Davidowitz, Idiot of the Week. Appearing with Tom Keene and a doorpost,
DAVIDOWITZ: The single most important thing I did say is that receipts on American ports for retail merchandise were lighter than last year. That's important. That means that retailers are not optimistic about holiday. They're receiving less merchandise.

PRUITT: Well, we were talking with Dana Telsey earlier about how the inventory is pretty much already here, and any retailer who wants more is going to have to scramble. It will have to be air freighted in. It's going to cost more.

DAVIDOWITZ: I don't agree that it's already here. I thinks that's a little loony. It's certifiably mad. But the point is that it's not nearly all here. No retailer in his right mind would have it all here. A lot of it is here. But you can chart what's been received up to now, and that's what I'm talking ... If you chart it up to now, Retailers are planning on a conservative season, which I think is smart. I think it's a function of what American industry has done in this recession. They've been magnificent. They've fixed their balance sheet. They've been conservative. They've loaded with cash. Contrast with that with our deranged and dysfunctional, bought and paid for federal government, and look at their performance versus the performance of American industry. It's day and night.

I don’t know if you followed that. Davidowitz started out with how receipts are down in ports, and then laid into fellow analyst Telsey for saying retailers have their stock on hand already, before admitting that retailers have a lot of their stock on hand already. That petulance is not, of course, what got him featured on today’s Idiot of the Week. He is featured for his nonsense on how government should be like business.

We’re not going to repeat the analysis from last week, or the week before, that demonstrates that the profits Davidowitz so proudly claims for business come directly from the government deficits he cites as spawn of the blind bureaucrat

Instead, we are going to affirm that it is a good idea, on the eve of another government bailout of the financial sector, to review what government might do if it were truly run like a business.
  • It might charge fair market value for its roads and education and use of airwaves. 
  • It might exploit its power to tax in order to balance its budget, and likely it would go where the money is, to the wealthy. 
  • It might position its advocates on the boards of private companies like private companies position theirs in the legislatures of governments, particularly in the U.S., where such offices are up for sale through campaign donations.

Wouldn’t it be fun to see Bernie Sanders on the board of Exxon? In any event, with the power of taxation – universal (in theory) coercive revenue collection – government has no reason to be in arrears relative to private companies. A simple 50% profits tax, for example …

You might argue that the shareholders of government are the citizens and each one gets a vote – again ignoring the one dollar one vote policy in place in the U.S. – so maximizing shareholder value would mean the opposite of trickle down, which is a theory that helping the few will somehow … Well, you get the point. Run the government like a business? We say, go for it, but remember who the shareholders are and remember to wring the corruption out of the boardroom.



The failure to control credit and the decision to leave financing to the markets and their manipulators is the great failure. It is the genesis of the great financial crisis, and its legacy is the huge burden of debt that now crushes prospects for an orthodox recovery. The invisibility of financing and financing structures – as we’ve noted before – is what made the orthodox forecasters blind to the biggest economic event of the generation. And the unwillingness to deal with the misallocation of credit in a ruthless and rational way is what prevents policy-makers from putting the crisis behind us and real recovery in front. Instead we limp from crisis to crisis, always choosing to burden the future with more debt, always choosing to socialize the losses of the powerful and privatize the suffering of the powerless.

(click on the chart for a larger image in a new window)

Source: New York Times, Analysis of Current Population Survey data by Gordon W. Green, Jr., and John F. Coder, Sentier Research.(click on the chart for a larger image in a new window)

Today on the Forecast, we look at interest rates. We are forecasting interest rates to continue to trend downward. But we do not put much stock in the importance of interest rates to the real economy or see monetary policy as playing a positive role in recovery.

For several reasons:

1. Credit availability is not described by how low interest rates are. Particularly in the mortgage market, where banks once so happily lent to anyone and were even willing to lend the down payment. Banks will not now finance anyone who needs financing. They resist refinancing even the best risks, in fact, so as to keep the old higher interest mortgages paying. Not too different from squeezing credit card holders. But the point is, mortgages may be at four percent, but you can’t get one if you need it.

2. Low rates delight the market players who can finance their stacks of chips cheaply. This means speculation, and it means higher prices in commodities like oil and food and basic materials. This means higher and volatile prices for consumers than would be the case in a supply-demand market. Which means decreased consumer confidence and reduced private demand.

3. It is not ultimately the supply of credit that is the problem, it is the demand for credit.

4. Real interest rates for assets may actually be high when nominal rates are low. Deflation in the prices for investment goods means a zero nominal rate is actually positive. Two bullets on this:
  • It doesn’t seem that long ago that markets were efficient, by the accounts of the fundamentalists, and incorporated new information with seamless efficiency. Outguessing the market was futile according to Eugene Fama and the Chicago School, and better to be passive. Now it seems that investors are stupid and their information is deluded when they take the two percent ten-year Treasuries. They need to be coaxed by the enlightened fund managers. Well, maybe investors are not so stupid. Housing as a surrogate for investment goods? Prices are dropping. A hundred dollars in a ten-year at two percent yields five percent versus a house that drops three percent in value….
  • Consumer price inflation is not relevant to calculating real interest rates. As we’ve said, if it were any more than commodity speculation, inflation in wages and incomes would be rising, too.
5. It is a lot easier to stall an economy with hikes in interest rates than it is to restart it by lowering rates. This is, again, because demand comes first. It is the demand for products and thus investment goods driven by the prospect of profit that causes people to invest. It is not the supply price of inputs.
You can see this on today’s chart. We’ve mapped GDP on the right axis with an inverted scale. So it should be going in the same direction as interest rates. And it does in many of the negative cases. The well-worn plot has been: The Fed sees inflation in its tea leaves, myopically searches for its only button, the big red EASY button, and punches it. The economy stalls. Our chart goes back only to 1991, but the pattern is similar since the Fed became the independent authority over monetary policy in 1951.

In our chart, the dot.com bust as well as the latest greatest recession both were triggered in part by the inability to lay off the interest rate button. Parenthetically, in both cases, rising energy prices were accomplices, and in fact, it was the real … ah … short-sightedness of the Fed in not seeing that its inflation fears were rooted in the price of oil that compounded the blunder of raising rates.

There is more in our chart. First, we see that one recovery was actually helped by lower interest rates. That was the recovery of 1992. The Budget Deal raised taxes and the Three Amigos – Greenspan, Summers and Rubin – brought rates down. Millions of homeowners refinanced, producing billions in new demand. Interest rates went back up in 1994, but GDP stayed strong – Plus Four was the norm through the 90’s.

And – yes – low oil prices. Don’t forget the Gulf War oil prices helped trigger the 1991 recession and then, not exclusively through the brilliance of Bill Clinton, oil prices came down to the $15 per barrel range throughout most of his presidency. That’s one-five. Fifteen. Dollars a barrel.

And further on. yes, in 2009 GDP bounced back up – or down in our inverted scale – as an apparent response to interest rates. But was it the rate of interest? No. It was the federal stimulus and the massive give-aways to the financial sector.

What else do you see?

Interest rates in the boom of the 1990s were substantially higher – five to eight percent for Treasury ten-years, seven to nine percent for triple A bonds and 30-year mortgages. They are now stretching toward two for ten-year notes and four for mortgages and triple A paper.

But you see the pogo stick at the Fed. Six percent effective federal funds rate PLUS in ’91. Three percent in ’92. Six percent in ’94, followed by a little bit of stability in the five to six range, before going up to six point five in 1999 to trigger the recession of 2001 and then diving from six and a half to one and three-quarters in 2001, finally settling in at one percent on into 2004 as a way of throwing gasoline on the housing bubble. Then? Bernanke to five plus in 2006 and Wile E. Coyote down to the zero of today.

And you see the bars for QE I and QE II. These quantitative easings were happy news for stock markets, but for the real economy, not so much. Yes, the intended interest rates did come down, though not really in sync with the QE’s, but no, the push on housing and other investment has not been observed.

Below is a chart from the Federal Reserve describing the QE’s in terms of the Fed’s balance sheet. You see the pig of direct loans to banks that was gulped in September ’08, subsequently passed in favor of the cow that is the mortgage backed securities. Which at one point were intended to be resold, but which now are apparently a permanent feature of the balance sheet, since the only buyer of MBS’s is the government. And while retaining the cow, the Fed added the long-term treasuries beginning in the fall of ’10, to no great effect on anything except financial markets.

And you see our forecast at the end, an extension of the trends because there is no reason for optimism on either the recovery front or the monetary policy front.

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.

Monday, October 3, 2011

Transcript 461: Forecast Commodities

Long-time listeners will appreciate that our call for negative growth in the second half of 2011 was made in the first days of 2011, not at the end of Q3.

Now, just as last month the turning in the sky was from recovery to no recovery, it is now from recovery to recession. This was epitomized by Laksman Achutan of Economic Cycle Research Institute when he rushed to press in the last days of September to announce, yes, recession, either now or in the 4th quarter. But Demand Side listeners had the same information back when it would have made a difference to planning. That was a forecast. Saying it is happening now is not a forecast.
Listen to this episode
And we can’t go very far without a comment on Europe. As the same January forecast made clear, and even into last year, we said – following Nouriel Roubini and others – that there was no option but default for Greece. We added that this was essentially a cost of the financial crisis and would not be a problem except that it exposed the banks. That is, policy makers would be willing for Greece to undergo whatever austerity they could impose, but asking the banks to take a hit on the other side of the contract for bonds? There would be hysteria. Now there is hysteria.

And we’re going to cut it there.

We are in 1932, 2008 was 1929. Now as then, we didn’t fix the problem but kicked the can down the road. Now we’ve run out of road. The kicking of the can has let us imagine we are going somewhere. But we needed to fix the road and the bridge, not comfort ourselves or our elites.

Long-time correspondent and frequent contributor to the Demand Side Economics dot net comments section, David Lazarus, commented again this week. Most of the time we don’t have much to say in response because we agree with him, and take more than a few notes on what he says. This time, however, he disagrees with us.

And as we look back to retrieve the comment, we see the blog ate it. For this we apologize to David. His comments are a very useful part of our blog. We have it up there now. I’m not following on how those disappear sometimes, but it is now there and it says, in part,
I think that there are serious problems with the definitions of investment as you portrayed them. An office building is often defined as an investment. The problem is that once the building is resold it is not an investment. It becomes a fixed cost for that next business. So if a building increases in value from $1 million to $10 million it is not an increase in total investment. That increase in value is inflation not investment. For a business that is starting out it is simply a tax on start ups. It is a capital gain for a business but not investment.

This is undoubtedly true, and I am sorry if I portrayed investment in a way that conflicts with this. In our simple two-good model, there are investment goods and consumption goods. Investment goods are those which require capital and which foresee a return over time to pay off the production of the good and add a profit. Once the good has been produced, it is an asset, as David goes on to discuss in the comment. Its value is bid up or down by the prospects for its return as an asset. It is a real asset, but often the claims on it go into the financial asset territory.

The thing about investment goods production is that they are what grows the productive capacity of the economy, and they are produced by workers not involved in the production of consumption goods. If all workers were involved in consumption goods production, there would be no inflation, in our simple model, because there would be no incomes that were not the result of consumption goods production. If some workers are involved in producing investment goods, there will be more incomes bidding for the same amount of consumption goods, thus inflation.

This could take off into a whole discussion, which we might have, but a point here is that Steve Keen has pointed out that the bidding up and down of asset prices is a playground for debt and Ponzi financing. We’ll leave it there.

And in doing this section, we apologize to Nathan Tankus, another frequent correspondent for having misfiled his contribution on Modern Monetary Theory. That was our bad, not bloggers. We’ll get that up soon.

In cleaning up the transition from DemandSideEconomics to DemandSideForecast dot nets, we’re going to change our mind. What we’re going to do is cast the Forecast site in more objective tones and make it a resource that can be mailed without the political tones. We see economics and politics as intimately entwined, particularly since policy can only be enacted through a political process and particularly because one political attitude has corrupted 90 percent of economics as it is practiced today. Market fundamentalism is a politically sponsored approach looking for any theoretical cover it can find. When supply side fails, it moves to rational expectations, monetarism, and down the line. Not by an experimental process to find out what works, but by a careful path to avoid the economics that does work, which is not particularly kind to the powerful or to entrenched interests.

So that should make it obvious. The Forecast section of the podcast will be scrubbed and set up on the Forecast dot net site. The full Monty will be as usual on the Economics dot net site.

That’s our plan. We take them seriously. Doesn’t mean you have to.

This week is forecast lite.


Demand Side is an economic forecaster, not a market predictor. In terms of investment advice, we don’t. The markets are a herd or behavioral field. They react to what they perceive the economy to be doing. That perception today is the perception of a herd of cattle in a lightning storm.

And today we are forecasting markets. We are not forecasting demand and supply for individual commodities based on global production. Because all that is washed out by the market dynamics. Commodities are trading in close correlation with other financial assets. Financial assets? Commodities are goods, right? Not when the traders need a profit. Your food and fuel is their bread and butter.

The market is being driven not by demand for the product, but by demand for financial returns. Speculation. There is immense liquidity sloshing around in the system. There is massive paper wealth looking for a place to be. Markets resist going down together. That money has to go somewhere. This is part of the dynamics of commodities. As the real economy failed over the past dozen years, that money has moved more and more into liquid financial assets and away from real productive assets. No investment in the private economy, particularly with the housing crash. As we noted a couple of weeks ago, there is a glut of productive capacity in any event, brought on by focus on the private consumer economy at the expense of the public goods economy.

In any event, this massive amount of capital needs a home. It can go into cash. But at its base cash is just a government bond with no interest on it. “Federal Reserve Note.” It has gone into stocks, bonds and commodities and derivatives of these. Commodities are perceived to be a liquid asset that will maintain its value. This is in spite of all evidence to the contrary.

The commodities bubble of 2011, which is now collapsing, was a core predictor of the new leg down in the economy. We used it in January, saying it would be the trigger. And so it has proven out. So far, 2011 is a repeat of 2008, only on a weaker economy, with far less appetite for the stimulus of 2008-09, and thus much more likelihood of serious further suffering. We didn’t fix the banks the first time. All the old troubles are still with us. We kicked the can down the road instead of fixing the bridge.

Shall we do copper?

Shall we do Gold?

Gold is interesting as a commodity, because it has no real industrial use. Other precious metals do. Gold is simply a bet. Some see it as inflation hedge. Some see it as a hedge against instability. But it is a bet that people will continue to buy gold. The new ETF’s for gold have undoubtedly raised the price by allowing purchase of gold without holding it in your house. If you have one, look closely, it may be a virtual fund which operates on the “value” of gold, rather than actually owning gold.

So recently when commodity prices went south, gold should have gone north. it didn’t. We have a very loose understanding, but it came a little tighter when someone revealed that traders take positions in gold as a liquid value that can be tapped to cover other positions. This is what we think happened to gold. As stocks and bond yields came down, investors covered their losses by liquidating gold. Much to the consternation of the world. Or at least to the financial speculators. We understand the buying of gold to hold in India and China dried up when the price went over $1,700. They may be coming back now.

What about oil?

Here is the poster child for all commodities. You can see the up-to-the minute action on the right side panel on the transcript. The bubble is bursting, hopping down now to under $79 a barrel West Texas and under $103 in the much more relevant Brent Crude.

Oil and commodities are bouncing around in complete correlation with the rest of the markets. A correlation incidentally that is closer than at any time since the maps of correlation became detailed.

Last week we did L.Randall Wray on the commodities nuclear winter approaching.

But speculation as the cause. Senator Bernie Sanders let the cat out of the bag in August by leaking data from the CFTC, Commodities Futures Trading Commission, which clearly shows that financial traders have positions in oil futures which dwarf those of any legitimate hedger. And as we showed last year, it is the futures market – not the spot market – where real oil prices are set. Apologies to Paul Krugman. Here is Sanders, making his point.

This is information that I think our friends on Wall Street did not want to come out. It is supposed to be top secret information. And in fact, many of the folks on Wall Street were very disturbed that we made it public.

The reason that we made it public is we wanted to end this debate about whether or not excessive oil speculation is driving up gas and oil prices.

The answer is, when you have companies like Goldman Sachs and Morgan Stanley owning and buying and selling hundreds of millions of barrels of oil, dominating the oil futures market, there is no more debate. Excessive speculation is one of the reasons the price of oil is where it is today.

We have got to do what Congress passed legislation to do, and that is mandate that the Commodities Futures Trading Commission end excessive speculation, and have limits on how much these companies can own.

So, that’s commodities.

We were ahead on the bubble, and our only glitch is the bunny hops down, which are visible in the charts but which have yet to be explained in any terms that make sense. Our view is again, a trading strategy designed to limit losses in the Big Houses. Big house? Don’t you wish that’s where they were.

We’re leaving a lot on the cutting room floor.

Next week we’ll get to the GDP and Net Real GDP and point out the obvious. The so-called recovery was borne on the back of the much-maligned government deficits. Without government deficit spending, the private economy would be generating growth right down there with house prices and unemployment rates. Without government deficits, the corporate earnings that floated Wall Street would be negative, even with the brutal downsizing they have undergone to keep their bonuses up on the top floor. Government deficits have saved this economy. Those who work on Wall Street or in corporate America and play holier than thou with regard to government spending don’t know what they are talking about, or are being cynically malicious.