Over the last several years my outlook for the domestic economy has been generally steady – we’re in a balance sheet recession and the government is running large enough budget deficits to offset the effects of de-leveraging to a large degree. This means the economy won’t fully recover and feel healthy again until the balance sheet recession is over and the private sector can run with the baton without the aid of the government’s massive deficits. Based on my estimates, we likely won’t be at that point until 2013 or perhaps later.
The primary reason why the government response has failed to generate a sustainable recovery is due to several factors. First, our leaders misinterpret the actual way in which our monetary system operates. This has resulted in a persistent dissemination of neoclassical economics over the last 30 years which has contributed to a misguided policy response on both sides of the aisle. This contributed to an excessively financialized global economy and helps to fuel the misguided policy response in the current environment in which monetary policy and the Fed is largely impotent. In short, we’ve focused too much on helping the banks when in fact, this was never a banking crisis. It was always a household crisis. Unfortunately, Main Street has been overlooked for the most part.
In terms of the outlook going forward – not much has changed. These broader macro trends are all still in place. The balance sheet recession continues, large deficits continue, the inept government response continues and therefore the malaise (but not a collapse) continues. This all means the economy is likely to remain in a growth phase, but domestic demand will remain stagnant to the point where it feels like a recession (although the NBER won’t classify it as such) and results in a high rate of unemployment and below trend growth. But make not mistake, this is most certainly one long recession – a balance sheet recession.
To my surprise, the corporate profits picture has remained very strong over the years. This has created an even more confusing environment for many. As companies cut costs and Asia recovered, the global diversity of the the American corporate sector led to a robust profit recovery. Contrary to popular opinion, America’s corporations remain the best in the world. But as domestic demand has remained low they’ve been given little incentive to leverage up and hire new workers en masse. Meanwhile, fat profit margins, below trend domestic growth and strong Asian growth has led to a healthy bottom line. This has all been good news for the stock market since the 2008 crisis occurred.
In my opinion, the government’s deficit remains large enough to support below trend growth in the coming year. That is likely to come under pressure as we head into 2012, but the deficit should remain large enough that we can sustain growth and not fall into a technical recession. The major risk to this forecast is international markets. In particular, I believe China holds the keys to the kingdom. If the Chinese economy can thwart a hard landing in H2 then much of the worrying will subside and the domestic economy will get back to business as usual, which, in this environment, means inadequate growth, but top line growth ultimately translating to bottom line growth as margins remain strong (read, no hiring).
The other major risk is Europe. Europe is clearly on the precipice of a potentially serious crisis. It is eerily reminiscent of 2008 and the EMU leaders are woefully behind the curve. The bad news is that there is no structural fix in place yet and that means the turmoil will likely continue. The good news is that every time Europe has been pushed to the brink their leaders have been responsive (and yes, they built this flawed currency system so it is their duty to fix it once and for all). I think there is a fairly high probability of a 2008 type event in the coming year. If Italy is pushed to the brink (and I do think bond vigilantes will continue to push them) then we are likely to see a much broader response which is likely to involve ECB rate targeting or Eurobonds. This is the bazooka and would put an end to this silly crisis for the most part. Then the EMU just needs to fill in the holes with the final pieces of a fiscal union. Easier said than done – I know, but if there is one thing we know, it is that wealthy politicians don’t like to see their wealth collapse due to their own lack of action. And I am confident they will act when forced to. I guess we can call this the Trimerkel Put. It’s there, it just needs to be dusted off once every few months.
All in all, I think it’s unwarranted to panic excessively over the domestic U.S. economy, however, the risks to the global economy are substantial.
Thanks for these macro minutes. they’re always excellent. Can you update us when you get a sell signal on your algo? Thanks.
When was the buy signal?
Will disagree again (again at the margin only!). Eurobonds won’t happen because that is just Germany/North subsidizing the South/periphery. ECB rate targeting is hocus pocus (targeting a lower yield doesn’t do anything to stimulate demand, this is an old whip that you are whipping up again, it won’t do anything in the US and it won’t do anything there!).
What will happen is ECB will buy up sovereign debt when pushed to the brink. It will make a lot of noise, governments will try and promise some austerity (and like Italy back out of it in just a few days or weeks just like it has done in tghe past 2 days) and sovereign spreads will widen. ECB will step in again (the past few times they ahven’t even bothered sterilizing).
Re: China – they are set for a hard landing according to Patrick Chovanec although Pettis seems to think they will avoid it. My take – it’s hard to say what comes out of there but such a crazy stimulus fueled by printing yuan in late 2008/2009 is more likely than not to lead to a hard landing than a managed soft landing. In any case, they certainly don’t have the room to push through another huge stimulus.
And let’s not forget Bernanke, he won’t settle for the muddle through, so it is highly likely that he will continue to do stupid things and one of them eventually will backfire.
The risks are skewed (significantly) to the down side. I admire your optimistic outlook (optimistic nowadays is for a muddle through for a few years!), but I project that things WILL END BADLY.
Eurobonds and bailouts are the same thing in effect.
Of course one is actually a plan while the other is ad hoc.
The rate targeting wouldn’t be primarily to encourage growth but more to bring down the rates of the PIIGS to ‘manageable’ levels and stop the panic. I do think at the end Europe will let the ECB to do some sort of Quantitative easing or rate targeting. A fiscal union is too hard to create at this moment and the cost of letting the PIIGS fail are too great.
That said, European QE is also a stretch at this point in time.
If US government starts discretionary cutting following the bipartisan congressinal prescriptions (or the lack of such prescription), and if unemployment benefits are not extended anymore (with the high long term unemployment rate we have already) this could be another danger for eventual downturn.
Cullen, My own view has been very similar. Which begs the question – why is Benny pursuing policies that have NOT and will not help. My only answer is that 1) He thinks a lower dollar helps on the margin. And QE reflates Asia and thus raises their real exchange rate and that is what Ben and Obama admin want to see – if the Renminbi is not revalued on a nominal basis, Ben will just raise inflation in China. 2) Keep rates and thus, debt service, low for the government. Rates are already low so I dont know how much he gains on this.
Cullen,
Why do you think the deficit is enough to sustain slow growth?
“It was always a household crisis. Unfortunately, Main Street has been overlooked for the most part.”
This all started with Ronald Reagan and the middle class has been hanging themselves ever since.
Furthermore, people really need to stop worrying about Europe.
Trichet and the ECB is well funded and has more ammunition then people realize. He continues to thumb his nose at the ratings agencies. Which is exactly what he should do.
KP, hmmmm. Let’s revisit this one in exactly one month (which should be just after the Bundestag votes to withdraw monetary support for the bailouts on Sep 29th). I don’t share you optimism…..
rhp
Cullen- Everytime I get a little tilted you bring me back to center. I let you because it’s worked.. when I get too, “this is going to happen” speak my biases are taking over. Thanks for bringing me back to center it has increased my income and clients wealth.
Cullen, I generally agree with your take on this environment but I’m a little puzzled but your belief that this was never “a banking crisis” per se. I see your point for the larger banks but the community banks that got squeezed in to predominantly real estate lending do not appear to have recovered to any significant degree?
Agree that the US is now on a muddle through trajectory. I think that 2013 is optimistic. The problem is twofold and interrelated "” 1) a global housing crisis must be unwound before any real recovery can begin and 2) the precarious condition of major banks, not only in the US.
The present muddle through trajectory is contingent on absence of shock. The US economy and the global economy are both teetering on the edge of a cliff, and a shock anywhere could easily push us all over. There are several known unknowns and we have no way of knowing the unknown unknowns "” another significant terrorists attack, significant natural disaster, etc. Perhaps the most significant complication is that the global leadership and their advisers seem to be clueless. There is nothing substantial being done to address the problems, and, in fact, the push politically is in the opposite direction, aided and abetted by neoliberal and Austrian economists in the US, UK, EZ, and now it seems Japan, too. Expansionary fiscal contraction? Concern with government debt in the face of demand deficiency? Really?
This uncertainty in the face of contingencies is reflected, for example, in the demand for gold and US tys at negative real yield.
Cullen,
I was wondering whether you read Michael Pettis’ latest piece about Chinese growth slowing to 3% by 2013 and if we could get your thoughts.
I highly doubt a Chinese ‘hard landing’ will happen this year. And the Chinese government has very strong incentives to avoid a hard landing. A hard landing in the US means Obama can say good bye to a second term. A hard landing in China means that all the problems that are high growth hides will be uncovered or intensified and massive riots leading to tons of officials in China getting the chop.
I do think they got room for one more big stimulus package if they come close to a hard landing. Then a few years of more growth and then hell breaks loose. Inflation will shoot through the roof and the common Chinese citizen will suffer -again.
Funny thing, China has had this massive growth in its money supply year in year out and massive food inflation and yet I hardly see someone who believes in Chinese hyperinflation in the West. Yet you see every expert (Western and Chinese) and their dog saying The USA will suffer hyperinflation regardless the rather ‘meh’ growth in its money supply.
“Trimerkel Put”
I hope that catches on, its fun to say.
Notify me of follow-up comments via e-mail
© 2009 pragcap.com · Register for PC
Over the last several years my outlook for the domestic economy has been generally steady – we’re in a balance sheet recession and the government is running large enough budget deficits to offset the effects of de-leveraging to a large degree. This means the economy won’t fully recover and feel healthy again until the balance sheet recession is over and the private sector can run with the baton without the aid of the government’s massive deficits. Based on my estimates, we likely won’t be at that point until 2013 or perhaps later.
The primary reason why the government response has failed to generate a sustainable recovery is due to several factors. First, our leaders misinterpret the actual way in which our monetary system operates. This has resulted in a persistent dissemination of neoclassical economics over the last 30 years which has contributed to a misguided policy response on both sides of the aisle. This contributed to an excessively financialized global economy and helps to fuel the misguided policy response in the current environment in which monetary policy and the Fed is largely impotent. In short, we’ve focused too much on helping the banks when in fact, this was never a banking crisis. It was always a household crisis. Unfortunately, Main Street has been overlooked for the most part.
In terms of the outlook going forward – not much has changed. These broader macro trends are all still in place. The balance sheet recession continues, large deficits continue, the inept government response continues and therefore the malaise (but not a collapse) continues. This all means the economy is likely to remain in a growth phase, but domestic demand will remain stagnant to the point where it feels like a recession (although the NBER won’t classify it as such) and results in a high rate of unemployment and below trend growth. But make not mistake, this is most certainly one long recession – a balance sheet recession.
To my surprise, the corporate profits picture has remained very strong over the years. This has created an even more confusing environment for many. As companies cut costs and Asia recovered, the global diversity of the the American corporate sector led to a robust profit recovery. Contrary to popular opinion, America’s corporations remain the best in the world. But as domestic demand has remained low they’ve been given little incentive to leverage up and hire new workers en masse. Meanwhile, fat profit margins, below trend domestic growth and strong Asian growth has led to a healthy bottom line. This has all been good news for the stock market since the 2008 crisis occurred.
In my opinion, the government’s deficit remains large enough to support below trend growth in the coming year. That is likely to come under pressure as we head into 2012, but the deficit should remain large enough that we can sustain growth and not fall into a technical recession. The major risk to this forecast is international markets. In particular, I believe China holds the keys to the kingdom. If the Chinese economy can thwart a hard landing in H2 then much of the worrying will subside and the domestic economy will get back to business as usual, which, in this environment, means inadequate growth, but top line growth ultimately translating to bottom line growth as margins remain strong (read, no hiring).
The other major risk is Europe. Europe is clearly on the precipice of a potentially serious crisis. It is eerily reminiscent of 2008 and the EMU leaders are woefully behind the curve. The bad news is that there is no structural fix in place yet and that means the turmoil will likely continue. The good news is that every time Europe has been pushed to the brink their leaders have been responsive (and yes, they built this flawed currency system so it is their duty to fix it once and for all). I think there is a fairly high probability of a 2008 type event in the coming year. If Italy is pushed to the brink (and I do think bond vigilantes will continue to push them) then we are likely to see a much broader response which is likely to involve ECB rate targeting or Eurobonds. This is the bazooka and would put an end to this silly crisis for the most part. Then the EMU just needs to fill in the holes with the final pieces of a fiscal union. Easier said than done – I know, but if there is one thing we know, it is that wealthy politicians don’t like to see their wealth collapse due to their own lack of action. And I am confident they will act when forced to. I guess we can call this the Trimerkel Put. It’s there, it just needs to be dusted off once every few months.
Read Full Article »