Greenspan Had a Real Economy. That's the Difference With Powell
The technical definition of recession is two consecutive quarters of negative GDP. At least that’s what everyone says. If that was the case, what was the dot-com recession? According to the Bureau of Economic Analysis (BEA), the government agency which measures GDP, economic output in the US dipped in Q1 2001, rebounded in Q2, and then fell again in Q3. There were never two straight quarters of contraction.
In fact, if you go back a little further what you find is a more prolonged period where output was, shall we say, unstable. In GDP’s terms, we can find it already in the third quarter of 2000 – when the S&P 500 was still reaching for its then-record top. In that quarter, GDP shockingly declined to just +0.5%. It then rebounded in Q4 2000, but “only” to +2.5%.
What the dot-com recession really had been was nearly two years of down/up, down/up, down/up.
It was truly noticeable more in comparison to what was going on just before. The reason Q3 2000 was so shocking was that in Q2 2000 GDP had expanded by 7.3%. And, though it seems completely foreign nowadays, that wasn’t out of line with how the economy had been unfolding.
In fact, the unstable cycling began half a year before Q3; in Q1 2000, the same when the NASDAQ was hitting its top, GDP growth had dipped to 1.4% from 6.7% in the final quarter of 1999. So, it had really gone: down/up, down/up, down/up, down/up.
In Q3 2019, the BEA’s preliminary estimate for growth was 1.9%. It was universally hailed as a measure of strength and resilience.
That doesn’t mean there aren’t serious questions about the state of the economy. Even the most optimistic group of optimists have been forced to reckon with substantial and for them unexpected uncertainty. That’s why 1.9% is being characterized as strong; the optimists are trying to say, hey, at least it wasn’t worse!
We are taught to think of the business cycle as an all-or-nothing proposition; the economy booms and then it tanks. Black and white. The mythical “V” shape.
There’s much more nuance and granularity. In one respect, that’s just what current Federal Reserve Chairman Jay Powell is hoping to capitalize upon. In cutting rates now three times over the past few months, Powell has characterized this effort as a “mid-cycle adjustment.” Some negative pressures have materialized, the substantial negatives he reluctantly has been forced to consider, and the Federal Reserve is responding to them in a way that it had done before.
The term “mid-cycle adjustment” refers to specifically Alan Greenspan at the very height of his celebrity. What convention assigns as Alan Greenspan’s greatest achievement was his handling of the middle of the 1990’s boom cycle. In both 1995 as well as 1998-99, the Greenspan Fed reduced the level of its federal funds target by not coincidentally 75 bps each time.
Powell isn’t shy about it, either. Having arrived at three totaling 75 bps this time, he’s pretty open about the comparison. At his September 2019 press conference announcing the second cut in what is now a series, the cut which was overshadowed by the repo market, the Fed Chairman leaned on 1995 and 1998 pretty hard to try and drive home his point.
Which was characteristically quite optimistic:
“So, as you can see from our policy statement and from the SEP, we see a favorable economic outlook, with continued moderate growth, a strong labor market, and inflation near our 2 percent objective. And, by the way, that view is consistent with those of many other forecasters. As you can see, FOMC participants generally think that these positive economic outcomes will be achieved with modest adjustments to the federal funds rate. At the last press conference, I pointed to two episodes in, I guess, 1995 and 1998 as examples of such an approach, which was successful in both of those instances.”
Maybe it was a sign of the time, repo and all, but I don’t know what’s worse; that he actually is trying to claim 2019 can be at all like 1998 or that he thinks you will be so foolish to accept the attempt.
That’s the reason I recalled the dot-com bust’s history at the outset. What were inarguably the bad quarters during the first half of it, those that came before the declared recession in early 2001, today wouldn’t be at all out of line. If GDP dropped to 1.4% in Q4 2019, as it had in Q1 2000, what would Powell say about it? We know what he’d say because he’s already said as much about how things stand right now under 1.9%.
Good thing it’s not worse, a sign of strength that it hasn’t.
In Q4 1998 when Alan Greenspan began undertaking his second “mid-cycle adjustment”, the BEA says that real GDP had expanded by 6.4%. Six point four, and Greenspan still was a little nervous about it.
And he was right to be concerned. The Asian flu, or Asian Financial Crisis, if you prefer, was a very real drag on global growth. Perhaps the first systemic eurodollar system setback, it ravaged foreign economies across Asia in the same way as the “overseas turmoil” we find again today.
Likewise, its effects didn’t remain overseas. The US economy felt them, too. By the second quarter of 1999, real GDP had shed more than 3 percentage points from when it began two quarters earlier. Yes, Greenspan was cutting the federal funds rate in order to keep growth running at a minimum of 3%.
And that was considered a minor dip.
If GDP were to be stripped of around three percentage points in late 2019, it would be equivalent to the worst negative quarter of the non-consecutive two of the dot-com recession. We just don’t see anything like 6 or 7% anymore. Furthermore, a 3% quarter, which was the downside bottom of the US Asian flu experience, today is classified as the greatest boom in history (as was said about Q2 2018, which, while the highest in years, was all of 3.5%).
There is nothing about today which could remind anyone of 1995 or 1998 (or 2000 for that matter). The good quarters now were really bad and alarming quarters back then. If Mr. Powell is trying to use them as a guide for his current policies, he’s in much bigger trouble than he wants to let on.
It's not just the “overseas turmoil”, though that is where it begins even for Jay Powell in September 2019. After he talked about the mid-nineties comparisons, he also admitted:
“As our statement also highlights, though, there are risks to this positive outlook due particularly to weak global growth and trade developments. And if the economy does turn down, then a more extensive sequence of rate cuts could be appropriate. We don’t see that—it’s not what we expect—but we would certainly follow that path if it became appropriate. In other words, as we say in our statement, we will continue to monitor these developments closely, and we will act as appropriate to help ensure that the expansion remains on track.”
They don’t expect more weakness because they never expect any. The Fed, remember, was supposed to be raising rates all throughout 2019. At one point in 2018, Powell’s hawkishness had led many “experts” and commentators to conclude inflation was going to become such a huge problem this year there would have to be several more rate hikes than even the FOMC was planning at the time.
It was the bond market and the curves which showed that this wasn’t ever realistic.
I wrote all the way back in August 2018:
“Underneath it all, policymakers are nervous. They project confidence according to personalities not rational analysis. I personally preferred Janet Yellen to either Bernanke or Powell. Not because she was any more competent, rather her skills didn’t dictate the single setting of false confidence. There was more honesty in her often comedy level blank stare.
“Powell much like Bernanke betrays only arrogance. They know what they are doing, except what they know is only within ferbus, edo, and sigma. They can tell you a lot about complex equations, but almost nothing about economy and especially its relationship to…bonds.”
That’s why the ridiculous attempt to link 2019’s rate cuts to 1998’s. Desperate for any semblance of credibility, Jay Powell is trying to make himself appear more like Alan Greenspan because he believes, all his models say, you are a successful Fed Chairman when you play one on TV. By creating the false impression that the economy of today is even a little like it was in the late nineties, people might actually draw some comfort from the attempt.
What a world.
And when we turn to “particularly weak global growth” we see exactly why, and also why the bond market even backing up rates keeps saying there will be more than just the three. Powell can call it a mid-cycle adjustment all he wants, the chances of his actions surpassing Greenspan’s two three’s in the latter nineties is a near certainty.
There is no better proxy for “global growth” than Germany’s enviable industrial powerhouse. According to estimates released by the German government this week, Industrial Production in September 2019 was 4.4% less than it had been in September 2018. Four percent to the downside doesn’t sound like much, but for IP in this one country it amounts to an enormous contraction.
During Europe’s 2012 recession, for example, Euro$ #2, the most German IP declined was the -2.8% that November. During the worst of Germany’s recession in 2001 concurrent with the US dot-com bust, the largest contraction was -4.9%.
And in that particular cycle trough, the IP decline was severe (meaning around -4% or worse) for just a single four-month period toward the end of 2001. In 2019, German industry has slumped to that same level in each of the last five including September. And there’s no sign it is about to turnaround (particularly when examining forward-looking indicators like factory orders and ZEW sentiment)
That’s not even the most remarkable part. This one statistic suggests the contraction started all the way back around August 2018, just when I was writing about Jerome Powell’s false confidence. Before that, IP had peaked all the way back in December 2017.
In other words, that’s nearing two years of constant, persistent slowing and contraction right at the heart of the German machine. It hardly fits the traditional definitions of anything, though as 2019 draws to a close there’s a very good chance that negative German GDP will end up meeting at least the threshold for the “technical definition” of a recession.
Though this stubborn downturn hasn’t conformed to the black and white conceptions about boom or bust, it keeps coming anyway. At every opportunity, at every minor (often statistical noise) positive deviation officials tell us how they’ve got the situation under control.
Instead, month after month after month, a slow grind lower.
Turning back to examine Germany from the perspective of just GDP, surprise, obvious instability which begins to explain the grind. According to the latest revised estimates from Eurostat, German growth was solid (though unspectacular in historical comparison) in Q4 2017 at +0.73% (quarterly rate). It then decelerated to just +0.13% in Q1 2018, shocking everyone around the world, rebounded to just about +0.40% in Q2, was negative in Q3, -0.10%, rebounded in Q4 and Q1 2019, and was negative again in Q2 (-0.08%).
Down/up, down/up, up/down…down? The forecast for Q3 GDP, which will be released next week, is for -0.2%. Thus, the technical definition is finally in play only at this late date.
The real problem for Powell, as well as officials in Germany, those like Christine Lagarde who failed her way into the ECB’s top position, is they can’t read, interpret, or understand that instability let alone incorporate it into some coherent policy responses (Lagarde’s predecessor Mario Draghi opted to just throw another QE into the mix, because…reasons).
It just doesn’t follow along with their worldview. Even though it’s a little more nuanced than the black and white “V” shape of conventional wisdom, it isn’t yet nearly nuanced enough.
Neither is the mainstream conception of time. Two years from the last peak and only now is Germany, which has unfortunately been positioned at the forefront, getting into a position where it is more recognizable as an inarguable downturn if not worse. If the US economy is following the German one lagging behind it by about a year, what does next year look like in the US?
As Powell said, particularly overseas weakness. That pesky dollar thing again. As I wrote last August while the words “hawkishness” and “boom” were still being taken seriously:
"Strong economy, or false dawn #3?
"We are so far off from realizing what’s wrong that even when the yield curve comes into focus it does so for the wrong reasons. That’s the legacy of Economics, a backwards mentality that studies everything but the economy, and still it has permeated all levels of education. Economic illiteracy is rampant especially among the econometric models."
No longer much doubt, even as the bond market sells off the last couple of months, false dawn #3 it was. But what does that mean for the end of 2019 and the first part of 2020? Two things are for sure already: it’s not 1998 and the only difference between Powell and Greenspan is how the latter had a real economy and rapidly growing eurodollar system to cover for him.