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PRESIDENT OBAMA HAS QUITE UNINTENTIONALLY articulated the contradictions facing economic policy-makers around the globe.
In a town hall meeting in Racine, Wis., Wednesday, the president said the burgeoning national debt is a "real and legitimate concern," and that the federal government has to rein in spending.
But Obama also recently implored the Group of 20 not to tighten fiscal policies prematurely in order not to weaken further the already debilitated economies of Europe and the rest of the industrial world.
Or as St. Augustine was reputed to pray, "Lord, make me chaste, but not yet."
Dylan Grice, part of the provocative strategy team at Societe Generale, sees the world split between the cognitive dissonance expressed by President Obama. On one side is what Grice terms the "Keynesian/Krugmanist" faction decrying any withdrawal of fiscal stimulus while conditions remain parlous.
On the other are those worried about government debt, represented by Axel Weber, "the hard-money Bundesbank president who voted against the [European Central Bank's] bond purchase and has been most vocal on the need for fiscal prudence," Grice writes in his "Popular Delusions" letter.
The former contingent points to the disastrous 1937 tax increase by Franklin D. Roosevelt, which precipitated the second leg down in the Great Depression. (Remember that U.S. gross domestic product grew at more than 9% per annum from 1933 to 1936.) Also, Japan's 1997 consumption-tax hike snuffed out a nascent recovery.
Grice contends the one instance that the public accepted the pain of fiscal austerity during hard times was under Margaret Thatcher starting in 1979, which he attributes to the surge of popularity of her government after the victory in the Falklands War a few years later. Canada, Sweden and Finland were able to put their fiscal houses in order, but that was because they took advantage of the boom of the 1990s, which provided the revenues to pay down debt.
Now, we're in the opposite situation. Max Bublitz, chief market strategist of San Francisco-based SCM Advisors, says the outcome of what he calls The Great Reflation Experiment is anything but assured. A "fumbled handoff," in which the private sector is unable to pick up the ball from the public sector's efforts, he puts at a 20% probability, low but up from 10% previously.
The "turning Japanese" scenario, with extended feeble growth interrupted by serial bouts of mild deflation, he puts at 30%, up from Bublitz's odds of 20% earlier in the year.
What's left is the "successful handoff" outcome, with private-sector growth taking over from the government's stimulus, which Bublitz places at 50%--"hardly a slam dunk."
Recent market action points to the less felicitous 50%, with Wednesday's late slide in U.S. stocks extending into Asian morning trading. Adding to the downward pressure was a weaker-than-expected purchasing managers' report from China, a report that is superseding the U.S. PMI in market impact.
All of which helps reconcile the shockingly low level of Treasury yields. Yet even while the benchmark 10-year Treasury note yields remains solidly under 3%, at 2.91%, Gluskin-Sheff's David Rosenberg points to the extraordinarily wide gap of nearly 1% between the 10- and 30-year maturities. Even at a sticker-shock 3.87% yield, he sees scope for further declines in the long bond's yield.
Based on a new report from the Cleveland Fed, Rosenberg reckons the 10-year yield could "ultimately grind down" to 1.90% with inflation basically nil. Given its historical spread over inflation, the 30-year bond yield could get down to 2.30% --40% less than the current yield.
These are stunning numbers that dramatically illustrate the current economic conundrum.
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