Saturday, January 30, 2010
The Brat May Be Contained
Regarding yesterday's economic news: Q4 GDP will probably be revised down somewhat, but the important thing is that most of the number came from clearing and replacing inventory, which is more of a one-shot deal than most like to acknowledge. However Chicago PMI (which is a three month average) came in beautifully, and appears to indicate that we have enough of a carrying wave to get us through February.
So the bottom line is that T-bill yields are telling us that we are in danger of sliding back down later this year, which means that Congress had better get on the stick and do something to boost the economy ASAP to carry us through the danger period.
How big is the danger? Let me tell a tale with pictures.... (Click on these and open them in separate window or tab). If you don't really look at these graphs you won't get it.
The first point I want to make is that this recession is like no other Post WWII. First, it is global, and second, we are so far from getting back to where we started that it is worrisome and poses special risks.
The current period is most like the 75-84 sequence. During this period the US turned in three separate recessions (IMO, two, because I count the 80s as one). The danger we now face is that 2010 in the current sequence may really be 1981 instead of 1983.
Inflation and interest rates eroded effective incomes back then, which built up a monumental adjustment triggering successive downturns.
Fed Funds were raised, which precipitated the second slide.
Some still lambaste Volcker over this, but no, he was right, because....
The adjustment wasn't over - look how retail first sagged then legged down, precipitating the first downturn and then the hard adaptation in the 82 recession.
Inflation was too high, and only knocking the expectation out of the system crushed interest rates for consumers, which slowly restored the ability to buy. Retail sales did not return to 78 levels until 1985-86.
A lot of credit is given to tax cuts, etc, during the Reagan era, but that wasn't the important factor for consumers. It helped companies! It helped production - which helped jobs, which helped consumers. But many consumers saw their net taxes increase, due to the broad-based consumer tax raise in the form of the SS deal.
You see the steep rise in CMDebt (Household outstanding debt) beginning in 1984. Interest rates were so much lower that it created the ability to purchase because debt carrying costs were so low. That fueled problems later on, but it did restore consumer buying power.
So now let's look at the same sequence of graphs for our time:
This is why the Fed keeps promising that it will keep rates low for "an extended period". It does not want to return us to contraction by playing with rates.
Well, well, well. Kind crammed those retail sales down, didn't we!!!
How badly? We haven't fallen as far from the peak as we did during the earlier cycle. I keep reading economists saying we've never experienced this before. Piffle. We fell faster this time, but in percentage terms, we haven't fallen as far.
But this last graph, oh, this last graph tells a tale of sorrow, tribulation, and great worry.
Note that CMDebt is scaled to the right, which obscures the painful fact that CMDebt now is approximately equivalent to GDP, whereas, OMG, in the previous period it was more like 1/3rd of GDP. Expecting retail sales to bound joyously upward to their previous levels is like expecting the law of gravity to repeal itself.
So we still have a major structural adjustment LEFT in the system, and rates can't fix this problem. That's why keeping inflation under control is far more important then any other factor - it was inflation that eroded the spendable incomes of the population in the 70s, and if we set up that dynamic again, we are going to leg downward again.
This is foundation I needed to go back and really address Thai's comments about government control and taxation. Thai claims I am not really a conservative. I don't care about the conservative or liberal labels. I would like to see debate from either viewpoint. I do care about REALISM, and the US economy is now and has been, and will be predicated on the prosperity of the median person.
The awful amount of indebtedness still persisting in the system is the sand in the gearbox. Glad you nailed it on the head.
If we deflate, the debt becomes ever larger as a relative burden.
If we inflate too much, spendable incomes will contract, and we'll tip back into contraction.
The federal government appears to be trying to borrow more in the theory that this will compensate for those blasted peasants not spending and those blasted banks not lending money to peasants who can't pay them back.
I'm failing to find an on-line chart for it, but look at the rate of household formation now vs. in the 1970's. I'm still running with the hypothesis that overall inflation is largely a generational phenomenon, caused by a rapid increase in the number of young families. Young families need things, not cash, and are anxious to borrow for them. Older folks just don't need as many things, and have a greater demand for cash and investments.
I'm not the only one to predict this, but if the Fed tries to create inflation under these conditions, the hypothesis is that they won't manage to raise the general price level--they'll just cause "bubbles" in some parts of the economy while depressing prices in others.
The exception to this case is when there is a well-established infrastructure for carrying on market activities in an alternate currency--like Weimar Germany with gold, or South America with the dollar. In such a case, you still don't get a general price increase in the secondary currency, but the primary currency is completely trashed. Gresham's Law creates the velocity required for general price increases.
Anyone who desires to be debt free, and is trying to pay down their credit card debt, should be allowed to do it interest free.
It's the best way to help the economy on so many levels at the same time.
We keep talking about stimulus and we have given so much money to the banks. I would prefer that we had spent money to help people pay off debts at a reasonable rate.
Fiat finance requires expanding money via credit creation, if the above example is followed the US system will collapse. I am all for it!
Mortgage debt in 2002 was running around 4.5 trillion by 2008 it was over 10 trillion. This level of mortgage debt in such a short time frame was not generated by strawberry pickers in Stockton buying overpriced houses but a national refi credit binge.
No magic political lever can make this mountain of debt disappear and make whole both mortgage holders and the banking system.
I have been advocating this idea for two years, so the banksters have had a two year head start tacking on their interest rate charges when consumers needed to be getting out of debt.
However, any interest rate of 4.99-5.99 or less can actually be accelerated downward, so I would not be against a low interest rate.
I just made the classic mistake of hearing hoof beats (indeed seeing them on your blog links) and thought I must be listening to horses. I now know it is something else (a zebra?)... That is a compliment by the way.
It was my bad and I was simply thrown for a loop and commented- perhpas I should have held my "tongue".
People are always such marvelous paradoxes when you get right down to- yet another reason I love our species so much.
Oh and PS re: "I do care about REALISM, and the US economy is now and has been, and will be predicated on the prosperity of the median person."
We completely agree. Though I might add you first have to define which viewpoint you are looking at "realism" from before you can decide on which realism to accept.
This is perhpas the main lesson in life my profession has truly taught me.
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