Green Shoots Into Dead Weeds?
The popular consensus has become that the economy has “bottomed” and will most likely resume growth by the end of the year. Even a lot of bears like Paul Krugman and Nouriel Roubini are now more concerned about prolonged stagnation rather than continued economic collapse.
I’m just not buying it. Since learning about our problems back in 2006, I always anticipated that we would follow the Great Depression route and in real (i.e. inflation adjusted) terms I feel no differently today. The Great Depression played out as a major drop in late ’29 followed by a slowing and minor bounce in 1930, with a strong and prolonged collapse that reached its peak in 1932. Our system held together better from the initial strain (I thought it was going to go in Fall 2007) but seems to be doing a similar thing now.
When looking at assets over the three periods, the best way to describe the Great Depression is large drop in equities and bonds of poor companies, with little effect on bonds of good companies; a huge rally in equities and credit of poor companies, with a minor effect on credit of good companies; a massive collapse of credit for companies of all types, extinguishing credit and leading to a sustained downturn in equities. One of the stock quotes about the Depression is: “Just when we thought it was over, it was really only beginning.” That quote is referring specifically to the collapse in bonds that precipitated the worst of the Depression.
One of my greatest concerns was always that the amount of bad debt we had in the system was so large that it was unmanageable and would lead to massive defaults. I thought it was imperative that the government not take all that debt on its balance sheet or else it would threaten the ability for the government to function as it would be difficult to sell bonds and lead to a wildly fluctuating currency that would curb trade. When they started such purchases in the fall it was like a bad dream and I felt kind of insane, since the dangers were so obvious to me, but everyone else (even people whom I respected for seeing it come) felt like it was no big deal.
Well there is now increasing push back and the idea of hyperinflation is increasingly talked about (e.g. here and here). China is not happy to say the least.
And in that context, the last week has been worrying. I wouldn’t say that it’s cause for huge concern so far, but over the last four days yields on the 10 year have gone up 0.5%. The Fed said that it would start with purchases when it was at 3.0%, and now it is currently at 3.7%. As I wrote at the time, the Fed wasn’t doing enough to actually affect interest rates but was leaving open the option of “monetization” if its bluff didn’t work. Well the bluff isn’t working and that is what has China, etc. developing more concern.
I believe the chance of hyper inflation is remote. I think it is far more likely that creditors will realize that problems are far bigger than the US Government can handle, and fear that it will try to take them on will cause flight from bonds. This will lead to a large interest rate increase and choke off any prospect of growth*, leading to the second, larger wave of the crisis.
For example, mortgage rates exploded today. OK, so Denninger is a tad alarmist, but still, that data is real. It was such a large move that even the general-interest deal site SlickDeals.net had the topic on their front page. A 0.75%-1% jump in mortgage rates in a day is definitely cause for concern if it’s not unwound over the next few weeks.
Even while stocks have been rallying the last couple of months, the reality is that the underlying ability of the economy to service its debt has been steadily deteriorating. The bulk of defaults are yet to come in housing, and the number of foreclosures over the next year (or 18 months at least) will dwarf the number of foreclosures thus far! Meanwhile, commercial real estate and credit cards have imploded, and will lead to hundreds of billions in further write downs. It should be remembered that the IMF projected we are only 1/4 of the way through global writedowns and about 1/3 of the way through US writedowns. In addition, it should be remembered that higher interest rates lead to lower house prices, and a large increase in interest rates will push those down even further and cause more defaults…so the projected losses are most likely on the low side.
If government bonds are selling off strongly (or the dollar does if the Fed prints to buy bonds) then there will be no way that the government can continue to prop up the banks as these writedowns continue to grow, and will lead to an event larger than September 2008. Hopefully it’ll turn out that the last few days (and today’s mortgage action) was a blip due to trading, but we shall see.
* It should be noted that the official line is that the sell off is due to the prospects of economic recovery and thus people are chasing higher yields. This line is ludicrous because out of the other side of the mouth they are saying that we will need to keep 0% interest rates for the foreseeable future, and no companies are projecting increased profits.
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10 Responses to “Green Shoots Into Dead Weeds?”
Feeling a little doom-and-gloomy today, are we? If I didn't respect your opinion on matters economic, it would be less worrisome. Even more worrisome is that I find myself agreeing, at least in part. However, the final downturn has not begun. How's that for scary! We will see some uptick, perhaps the mirage of an uptick, as government attempts to hold back the inevitable in bad debt assumption and continuing credit collapse. The uptick will seem real in 2010-2011 and the belief will continue into 2012 despite growing evidence to the contrary.
By fiscal '12, the government will no longer be able to write multi-trillion dollar IOU's. The debt really is unsustainable. The inflation that the government is counting on to pay off the debt will not occur, as businesses, without credit, begin price wars, to attract consumers without credit, setting off unexpected deflation, spurred on by a collapsing bond and equity market. Aside – I was once a hyper inflationist, but the points you make about housing prices and the unavailability of unsecured credit, together with government's inability to assume enough of the risk, has drawn me to the dark side – Conclude Aside.
The point you make that, to me, is inescapable is that “creditors [eventually] will realize that problems are far bigger than the US Government can handle.” My only addition would be that creditors are not the only ones with their heads in the sand on this truth ; small businesses and consumers have also yet to come to grips with this. And, when this inability of the government to address the problem is forced into view and becomes an undeniable realization for all, the real crash will follow. Like the 30's, as you point out, a faux uptick for a couple of years, followed by the tsunami. You may have been off by a couple of years, thinking it would start in '07, but your analysis is excellent.
Yes, on a personal level I'm trying to read the tea leaves to figure out whether things can be extended for a few years like you suggest. I am very conflicted. On one hand, I believe that the reality of the situation points to things getting worse sooner rather than later. By reality I mean demand for products, personal income, default rates, foreclosures etc.
However from a political perspective, I believe that things could be put off by simply refusing to acknowledge reality and having targeted manipulation. For example the unemployment losses last month were 523k, but that counts 80k in census jobs…
So politically I believe that if everyone cooperates that it can be avoided in the near term, but on the other hand, I also think that we are grossly overstating the chances for global political cooperation. Economics is almost always impossible because forward projections are just as important as current dynamics.
I don't believe that it's that far fetched that another few months of suppressed demand will lead to such unrest in Japan and China that they completely change their tune. I also think that far from the situation being a product of panic, what you are saying is actually the rational analysis, and as people calm down they may be more likely to become pessimistic.
On the other hand I consistently underestimate how long it takes for people to realize what's happening, and there are so many moving parts that it is very hard to time things. For example, Britain is in completely awful shape, far worse than the US, and they were very close to complete collapse a few months ago. However, that was because of capital outflows into the the US and EU.
When it came out that the EU was far worse than people thought, then stuff flowed back into the UK and they got a reprieve. It's not that their situation has improved in absolute terms, just relative to the EU. In a lot of ways it not only matters where things should go, but the order in which they do.
As a starting point, I confess to a lack of knowledge on the international aspect of this crisis and am unable to respond to your points on China, Japan, Great Britain and the EU. If you could refer sources to further my education in that regard, it would be appreciated.
Having said that, I must agree that the term “global political cooperation” sounds more like an oxymoron than a reality. We remain a planet that is far more nationalistic than cooperative.
Regarding how long it takes people to realize what's happening, my response is anecdotal. As I was selling out of the tech market in late 2000, most were riding it to the bottom believing against the evidence that the market would recover from this “temporary” correction. Now, living in Scottsdale, AZ, I observe regularly that friends/homeowners are still listing their homes at '06 valuations, refusing to believe that the RE market has collapsed by nearly 50%. My conclusion is that people do not accept bad news readily, but will cling to unrealistic hope (irrational exuberance) until reality can no longer be denied. It is that type of anecdotal observation, combined with government's ability to present an appearance of improvement, that leads me to predict a longer time frame than you.
Question: If the situation continues to deteriorate, do you see the possibility of serious discord (perhaps disintegration) in the EU as nation states place national economic interests above their committment, easy in good times, to an economically unified Europe? Follow up question: what effect will a common currency have on this?
The next wave hasn't even started yet. The hyper-inflationary period and collapse of the dollar will begin probably by the end of this year. The collapse of commercial real estate has just started. The unwillingness of bond and mutual investors to provide funds to businesses with legacy costs and strong unions has started. And the increase in forced bankruptcies as credit companies raise rates and restrict credit in preparation for the new laws and rules has also started.
This is not 'doom and gloom'. This is being a realist.
You have two basic scenarios:
1) A free for all in which the EU and the Euro disintegrate.
2) Fortress Europe, they close their borders to foreign trade, create a European Minimum Wage with European Defined Benefit package which prevents “Social Dumping”.
Option 2 seems to be what the French Left and Center Right are shooting for, will the Germans go along with the French left or will they go with the British vision of free for all?
It's a good question and honestly I don't know. I've read many opinions. The problem with the EU was that Spain, Italy and Ireland were having major problems, but since the currency wasn't revaluing then it was driving them down even further. Also, a few countries have banking systems that are in danger and there is argument about how that burden should be split.
All of that suggests that there is a possibility that the EU could break up, as it would allow the different countries to have more of a natural correction. On the other hand, other analysts (even ones that are very pessimistic) say that there is no benefit to breaking up and they are more likely to issue common bonds and stuff.
The problem before was that Germany had a huge trade surplus and was in good shape, so it was expected that they would be asked to shoulder the burden. However, their economy is now contracting faster than ours so I haven't read as much about that. I think the greatest chance for breakup is if some of the countries rebound and others stagnate….if they all continue to contract at a record pace they are more likely to stick together I'd assume.
One Dollar and forty cents buys you a Euro today…
Ninety cents buys you a Canadian Dollar today…
The US Dollar has been collapsing in slow motion against all foreign currencies that are backed by anything that looks like a functional economy for the last eight years…
This is what happens when you have never ending trade deficits, outsourced manufacturing, outsourced services and don't produce anything other than weapons and raw materials…
Third world policies get third world results.
Tea Chef…
[...] The bulk of defaults are yet to come in housing, and the number of foreclosures over the next year (or 18 months at least) will dwarf the number of foreclosures thus far! Meanwhile, commercial real estate and credit cards have imploded, … Yes, …
[...] Green Shoots Into Dead Weeds? | The Moderate Voice themoderatevoice.com/33408/green-shoots-into-dead-weeds – view page – cached The popular consensus has become that the economy has bottomed and will most likely resume growth by the end of the year. Even a lot of bears like Paul — From the page [...]