A Bad Case of Economic Hypochondria?

Leo Kolivakis's picture

Via Pension Pulse.

Following my latest post on whether the Fed has defused the neutron bomb, a senior pension fund manager sent me a link to AXA Investment Managers' latest weekly comment by Eric Chaney, Deflation may have won a battle, but not the war.

is an excellent read which demonstrates why any discussion on the
inflation/deflation debate that doesn't take into account what's going
on outside the US is missing the bigger picture. I quote the following:

Although contemporaneous estimates of output gaps are somewhat elusive, the broad picture is clear: a
growing portion of the global economy is facing inflation risks and the
bulk of developed economies is no longer in the deflation danger zone.

This uneven dynamic distribution matters a lot for investors, who need
to make up their mind about inflation. One key lesson from the past
cycle is that price movements have a larger common component than in
previous times; call it the globalisation factor. Matteo Ciccarelli and
Benoît Mojon estimated that “(inflation rates of) OECD countries have a
common factor that alone accounts for nearly 70% of their variance” (ECB
working paper, October 2005), a finding that is consistent with later
research by Haroon Mumtaz and Paolo Surico (Bank of England working
paper, February 2008). In such a world, the fact that China, India and
Brazil have entered into the inflation risk zone matters more than
Spain, Ireland and Greece being on the brink of deflation.

Mr. Chaney concludes by stating:

sum, there is no evidence that deflation has gained much ground during
the summer. For sure, a double dip of the US economy would tick a few
boxes in the deflation camp. Yet the
most likely scenario in our view is that the US has embarked on a slow
growth cycle, the mirror image of the artificially debt-fuelled previous
decade, rather than on a stop-and-go cycle.
Once the markets get
a clearer picture of business cycle developments, which may
unfortunately take several months, there are good reasons to believe
that the current deflation buzz will be quickly replaced by its
opposite. In the meantime, enjoy the bond rally!

There are
other encouraging signs suggesting that the global recovery is back on
track. This past week, the CPB Netherlands Bureau for Economic Policy
Analysis released its World Trade Monitor for June 2010, showing that world trade was up 0.7% month on month after an upwardly revised 2.3% increase in May.

is this significant? Because, as Yanick Desnoyers, Assistant Chief
Economist at the National Bank of Canada discusses below, Global trade volume finally back to its previous peak:

to CPB Netherlands Bureau for Economic Policy Analysis, the volume of
world trade grew 0.7% in June after an upwardly revised 2.3% gain in
May. This represents the ninth increase in ten months. Global trade
volume is now expanding at a 21.2% growth on twelve month basis, just
shy of the 23% peak registered in May. In the second quarter as a whole,
global volume trade was up a significant 15.3%. As today’s hot chart
shows (click on char above), it took only about a year for world trade
volume to virtually get back to its previous peak.

the global industrial output side, the index is already in an expansion
mode with a 0.7% gain above its previous peak, despite the fact that IP
is still down 10% in advanced economies.
After all, it seems
that fears of sovereign debt contagion from the Euro zone earlier in the
spring did not have a material impact on global trade volume. Despite
an upcoming slowdown in the U.S., we are still forecasting an above 4%
global GDP growth in 2010.

What this tells you is that
this cycle is different than previous cycles because the emerging
economies are the source of growth. Too many analysts are focused solely
on what is going on in the US and other developed economies. I too had
written about Galton's fallacy and the myth of decoupling, but maybe this view needs to be revisited.

even in the US, I tend to think there is way too much gloom & doom,
a point underscored by Ross DeVol, executive director of economic
research at the Milken Institute, who wrote an op-ed in the WSJ this
past week, The Case for Economic Optimism:

and doom is the hallmark of the current economic debate, as the most
recent congressional testimony from Federal Reserve Chairman Ben
Bernanke demonstrates. Despite Mr. Bernanke's generally upbeat message
on the Fed's official forecast, which calls for moderate economic
growth of somewhere between 3.0% to 3.5% this year, the market and the
media fixated on his acknowledgment that the outlook was "unusually
uncertain." Those words have only reverberated in the past few weeks,
bolstering economic pessimists.


a point at which pessimism becomes a self-fulfilling prophesy, scaring
businesses away from investing or hiring. The dark tone of today's
discourse is at risk of doing just that.


The Milken Institute's new study, "From Recession to Recovery: Analyzing America's Return to Growth"
is based on extensive and dispassionate econometric analysis. It
concludes that the U.S. economy remains more flexible and resilient—and
has more underlying momentum—than is generally acknowledged. In fact,
our projections show cause for measured optimism: A return to modest
but sustainable growth is close at hand.


businesses are capable of navigating around policy uncertainty and the
twists and turns of a volatile global economy. While slow
private-sector job growth is to be expected in the early stages of a
recovery, the U.S. should add 1.5 million jobs in 2010, 3.1 million in
2011, and 2.6 million in 2012. That will translate into real GDP growth
of 3.3% in 2010, 3.7% in 2011, and 3.8% in 2012.


In this
pessimistic climate, this forecast will likely be considered
contrarian. So why is our economic outlook more sanguine than the
current consensus? For one, robust (albeit moderating) economic growth
in developing countries, particularly in Asia, will provide support for
U.S. exports. Look no further than Caterpillar, which reported a
doubling of its earnings in the second quarter of 2010 and whose
product line is sold out for the rest of the year.


business confidence is already spurring strong investment in equipment
and software. Record-low U.S. long-term interest rates are supporting
the recovery. And the benign inflationary environment allows the Fed to
keep short-term interest rates near zero until late this year, or even
into 2011 if it desires.


Historical context offers further
reason to expect a rebound. The peak-to-trough decline in real GDP
during this recession was 4.1%, making it the most severe downturn
since World War II. But throughout the postwar period, the rate of
economic recovery from past recessions has been proportional to the
depth of the decline experienced. While this relationship has been
somewhat variable, it is well-established. Our projections for GDP
growth are above consensus but are substantially below a normal rate of
recovery after a recession of this severity.


naysayers are right that there's a "new normal" economy, but it's not
that the potential long-term growth rate of the U.S. is substantially
diminished, as they say. It's that this time, the fulfillment of
pent-up demand will be subdued because consumers were living so far
above their means during the bubble years. Nevertheless, consumer
durables and business investment in equipment will see some previously
postponed purchases finally happen—if not this year, certainly by 2011
and 2012.


What needs to happen on the policy front in order to build momentum?


the first place, small businesses need access to more bank credit to
create jobs. Banks feel conflicted by calls from the Obama
administration to increase lending while regulators are instructing them
to add to their reserves. Regulators need to be reminded that some
risk is necessary in a market economy.


The White House also
should press Congress to pass legislation modernizing Cold War–era
restrictions on exports of technology products and services that are
already commercially available from our allies. This would boost U.S.
exports and reduce the deficit. And if the White House is serious about
doubling exports by 2015, it needs to push trade deals with South
Korea, Colombia and Costa Rica through Congress.


For its part,
Congress must move immediately to restore the lapsed R&D tax
credit. Even better, it should expand the credit and make it permanent.

Congress also should pass legislation to temporarily extend the
Bush tax cuts that are set to expire at the end of this year. It's
important not to remove any economic stimulus as long as the
sustainability of the recovery is in question.

Another must-do:
by 2012, Congress needs a credible long-term plan in place to reduce
the deficit. If it doesn't, international financial markets might force
our hand by demanding a higher rate of return on U.S. Treasurys.


has to focus like a laser on helping businesses create jobs, while the
rest of us should avoid talking ourselves out of a recovery by
dwelling on the doom and gloom. The U.S. economy has already adapted to
serious imbalances in record time: There's ample reason to believe in
its dynamism in the months and years ahead.

While US consumers were living beyond their means, they're paying down
debts fast. The amount consumers owed on their credit cards in this
year's second quarter dropped to the lowest level in more than eight years as cardholders continued to pay off balances in the uncertain economy.

Moreover, the FT reports that US credit-card losses are falling faster than expected,
with the six largest card issuers expected to earn nearly $10bn more
in the coming 12 months than predicted, says a study by Moody's:

Historically, US credit-card write-offs have tracked the unemployment rate.
But for the first time in a decade, loans considered uncollectible by
lenders are falling faster than the jobless rate, prompting analysts to
revise earnings models.


The divergence from past experience reflects bank efforts to weed out risky borrowers, moves by consumers to pare back debts after the excesses of the past decade and new credit card rules intended to discourage reckless lending.


are getting back to an old-fashioned basis of lending, providing
credit only to people who have the ability to repay,” said Curt
Beaudouin, an analyst at Moody’s.

while everyone is focused on weakness in the job and housing market,
listen to Brian Wesbury of First Trust Advisors below who thinks the US
economy is fine and that the country's just suffering from a case of
what he calls "economic hypochondria."

Wesbury blames stimulus for delaying the recovery, which is arguable,
and his assertion that the economy is "fine" is ridiculous, but I think
he's right on upward pressure on growth, expecting the economy to
accelerate over the next year.