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State of the Economy Part III
- Ben Bernanke
- Black Swan
- China
- Commercial Real Estate
- CPI
- CRE
- CRE
- Creditors
- default
- Default Rate
- Double Dip
- Excess Reserves
- Great Depression
- Gross Domestic Product
- Housing Market
- Japan
- Larry Summers
- M1
- Market Crash
- McKinsey
- Personal Consumption
- Real estate
- recovery
- Savings Rate
- Stimulus Spending
- Tim Geithner
- Unemployment
- United Kingdom
From The Daily Capitalist
This is Part III of my three part series on the state of the economy going into 2010. Part II appeared yesterday, and Part I appeared on Wednesday. This weekend I will combine the three parts into one downloadable PDF.
The Consequences
The Impact of Deleveraging
The economy is still a mess and structural problems will act as a brake on economic growth.
McKinsey has an interesting chart showing the average deleveraging time frames of 32 U.S. financial recessions since the Great Depression.
We are in the "belt-tightening" form of recovery (No. 1). GDP averages are negative to low growth for the first 1 to 3 years, with growth resuming thereafter in years 4 to 6.
The research by Reinhart and Rogoff I mentioned above measures business cycle timelines on a worldwide basis--average 6 years:
It appears we have another 12 to 24 months of deleveraging of bank and household debt if you believe history will repeat itself.
CRE deleveraging will commence in earnest this year. There is about $3 trillion of CRE debt to private borrowers. Here is a CRE refi chart done by IREI:
If the default rate tops out at 6% this year, then expect $15 billion of defaults this year increasing to about $20 billion in each of the next three years. There is a great deal of capital waiting for CRE to collapse and they will set a floor on prices competing for foreclosed projects. This will prop up the market and help the deleveraging process.
There are too many "ifs" to put a date on this period, but as shown in the historical data above, this could last two to three years. I often say that this cycle is unprecedented and past history is not necessarily a good gauge of the future, so take that into consideration.
There is a question of the FHA continuing its easy credit because of its financial exposure to the mortgage market. They are facing calls from some in Congress to continue to ease credit standards and others who demand fiscal responsibility. On the other hand, Fannie and Freddie are loosening loan standards. If credit tightens, then prices will fall. Regardless, residential real estate lenders will continue deleveraging.
Assuming easy federally-induced credit, residential real estate prices will slowly stabilize despite supply from the shadow market.
Inflation/Deflation
Deleveraging points to continuing deflation. On the face of it, CPI, less energy, is starting to rise:
What the CPI doesn't measure is real estate: deflation will occur in commercial real estate, and to some extent, residential real estate. The deleveraging process will continue to restrict credit, which in turn will suppress M1. When the banks become healthy, then "excess" reserves become a problem.
The Fed now believes that they have saved the world and that the economy is in recovery and they are starting to talk about their "exit" strategy. That would involve paying interest on "excess" reserves as an attempt to sop them up.
If you believe the Fed that we are in full recovery mode, then why aren't banks lending? Why is credit continuing to collapse? If you believe that we aren't in full recovery mode, then you know why banks aren't lending. In either case, the banks have no incentive to give up their reserves until they have deleveraged sufficiently to believe they have weathered the storm.
Even if we assume a recovery is well on its way, and the banks believe this, then why would banks not lend to their customers? One could argue that they would rather service customers and rebuild their commercial loan business than receive interest from the Fed on reserves. After all, that is what banks do to make money.
Recovery: Yes or No?
The Fed is in a quandary. Too much tightening and the economy could, in their view, collapse (the dreaded "double dip"). Too little and we could see substantial inflation.
The economy is in recovery but not for the reasons the Fed and the Administration believe. I have been saying for some time that all economies repair themselves unless the government interferes with the process. Bankruptcies, unemployment, management’s drive for more efficiency, and debt reduction are all part of the process that goes on despite the government's policies to prevent it.
But policies of the Fed and the government miss the most important thing necessary for a recovery: deleveraging.
They have been trying to re-inflate the housing market, prop up banks with bad loans, pump massive amounts of credit into the system, bail out financial companies, and spend tomorrow's wealth on wasteful stimulus projects. When the stimulus spending wears off, the economic effect wears off as well. Their pursuit of these Keynesian fallacies has accomplished nothing other than to increase federal debt and bail out their Wall Street cronies who should have failed. It appears, fortunately, that there is not much political appetite for more stimulus spending other than as proposed in the Administration's jobs bill.
Almost all of the improvements in the economy are the result of the normal organic business cycle repair process. We see margins improve as companies strive for efficiency and lower costs, but sales have declined as well putting pressure on earnings. For example, Coca Cola's growth comes from foreign sales (79%) whereas U.S. sales are down (4%). Ditto Levi Strauss, Tyson, Burger King, Kellogg, Sara Lee, etcetera. Many companies (ex. financials) are seeing improvement from better margins, not sales growth. This is more of a one-time event in the business cycle: how much more can they cut? The future will depend on sales growth.
The good news is that deleveraging will continue and the government can't stop it. But they can delay it which would be bad for recovery.
Whither 2010?
What is most likely to happen in 2010:
- Personal consumption expenditures will remain constrained.
- The household savings rate will remain high.
- GDP will, on a real inflation-adjusted basis, decline to near zero by Q3 or Q4.
- Deflation will continue in real estate, especially CRE, as banks repair their balance sheets and deleverage.
- Inflation will remain low.
- Unemployment will stay high, probably over 9% for the year.
- The fear of sovereign defaults will support the dollar.
- The Treasury will have no problem selling debt to U.S. investors (rising savings) and foreign investors (seeking safety).
- China, Japan, and the UK (the Big 3 creditors) will continue to buy U.S. Treasuries.
- Interest rates will remain low.
- Any attempts by the Fed to tighten credit will be abruptly reversed as economic weakness is seen.
- Exports will be sluggish as the world's economies struggle.
- Taxes will increase modestly this year (an election year).
- A VAT-type tax will be formally proposed next year.
- China's credit tightening will burst their new real estate bubble and harm domestic consumer demand.
Caveats
The problem with any kind of economic forecasting is that the world has a tendency to do things economists don't see coming. I am humble enough to recognize that. Here are some things to think about that could change my scenario:
- The government panics (again). Stagnation is not something Chairman Bernanke foresees happening. He's hoping for a straight-line recovery. I am aware that he always covers his Delphic statements with caveats, but I think he, Larry Summers, and Tim Geithner think "We did it! We saved the world." When the double-dip hits, it is hard to predict what they'll do. In their Keynesian-Monetarist world view, they will be compelled to do something.
- A taxpayer rebellion alters the power structure in Congress. Mind you, I don't have much faith in either party, but if a tea party backlash shows up at the polls in November, it could slow down some of the social legislation the Democrats propose. It makes more likely the possibility of tax cuts instead of more spending. Less legislation equals less change which creates more certainty in the minds of business people about their future.
- I find that I have very little insight into what drives the market from day to day, so I'm not giving stock market advice. Of course I'm not alone. I think most stock market analysis is mere guess work. For what it's worth, the rally starting last March is a faith-based rally. I think most traders believe in the conventional wisdom on government intervention in the economy. I would buy David Rosenberg's view that the market has been overpriced. If you want market advice go elsewhere.
- Catastrophe. The bad Black Swan. It's always out there: an EU credit collapse, stock market crash, al Queda, Iranian nukes, Israeli-Iranian war, massive earthquake in California, Pakistan falls to the Taliban. Use your imagination here.
Last Thoughts
I am very aware that it is easy to always be negative or positive because of one's view of the world. It is quite difficult for me as a free market advocate to be positive. I try to fight my tendencies and be wary of this trap. I try to see things as they are, not as I would wish them to be. So I want to end this survey on a positive note.
I believe the U.S. is still the world's most dynamic, entrepreneurial country. Our capital and financial markets still give big rewards to successful companies. Every day I see people come up with new ideas for businesses and they risk everything for their dreams of success. These are the people who will rescue us. Now, if only the government would get the hell out of their way and let them do their thing.
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I am positive that we will have to rebuild our manufacturing base in Northa America. This will bring back jobs.
And we will -- once wages equalize between here and China.
But while this happens, inflation will be roaring its ugly head.
A x10 change in the value of the US dollar would go a long
way to equalizing wages...
But that means x10 higher gas and food prices here...
Socialized Healthcare is predestined to fail in the U.S. mainly because it has the word socialized in it and because of the misinformation about it. If you look at other democratic countries i.e. Japan, Singapore, Taiwan these countries have developed a reasonably effective socialized healthcare system. Some of them lose money but not on the scale that our system is. In Japan it is not free but greatly discounted and the care is very good as many of the physicians are educated in America. In Singapore it is not that good if you have a serious ailment but you have the option of going to a private hospital where the cost is much greater. Many of you are right in that many people bog the system down with trivial ailments. One of the major differences is that they don't dole out potent medicine like it was candy. Maybe big pharma is the obstacle. All our problems seem to point back to the politicians and lobbyists. We should study other systems and come up with a system integrating the best systems around the world.
We have decades of Depression ahead. Rebuilding infrastructure and such takes time.
I still think we have a long way to go till the bottom.
I believe unemployment will continue to rise and possibly double what it is today.
I am still in the Hyper-Inflationary camp. Government will inflate to pay for medical and social security. We have an a** ton of Baby-Boomers set to retire. The government will not sit back and let them die, the social unrest would be a greater cost to them.
I don't understand why people believe they will simply let it deflate and not come due with the goodies.
"ANYONE in the US can walk
in a hospital if truly sick
and get care
FREE"
This excerpt from one of the earlier posts highlights one of the common fallacies of those who support big government
It infers that those who don't pay for their own health care can get those services for FREE
The services may be FREE to the noted individuals but they are definitely NOT FREE to the remainder of the community that is tasked to pay for them
As in the rest of life, there just ain't no such animal as FREE lunch
And it's not even free to most people anyway. Maybe if you're illegal and don't have ID you might get away with one.
Otherwise, they'll hound you until you die for their money.
I don't understand why the 'TBTF' entities were not allowed/pushed to file for protection under federal bankruptcy laws and use the bankruptcy code to reorganize themselves, unwind it, and become legitimately profitable. As far as I know, it was never considered. So we are paying them to keep on screwing us, through the enabling behavior of our government of/by/for the people. Do any people besides the perps think this is working out well? Me neither.
The Fed's not in a quandary. It will opt for inflation over deflation in a heartbeat. Inflation is the Bernanke masterplan's desired outcome. There is no other viable endgame.
Thank you for posting this series ... very useful information. Thanks again!!
Great post! Very reasonable.
' Their pursuit of these Keynesian fallacies has accomplished nothing other than to increase federal debt and bail out their Wall Street cronies who should have failed'
I always find myself staggered by this American mind-set. Markets always correct themselves and that's it. Are you proposing that the Govt should've let Citi, BofA et al fail? Given what happened in the aftermath of Lehman, that would've been catastrophic. No one disputes that government spending isn't efficient and often finds the wrong places to spend but it has eased the transition from credit boom to credit bust that the markets wouldn't have done.
A shock capital market shutdown, an even bigger inventory liquidation, a much bigger spike in unemployment and full scale deflation would've been on the cards in much shorter space of time. This would've ripped through any semblance of social cohesion we have left and be far far more catastrophic than what has so far happened
Americans seem content on trillions of $ of tax money being pissed away on phony wars against tribesman, killing millions in the process but 'oh no, we can have free healthcare, that's my money, Joe Sixpack shouldn't be allowed free cancer care on me, it's not what the markets want'. Yeah the banks were bastards but we all had our free lunch, we all bought lcd tvs on plastic and all felt richer for a while.
We have a lot of problems in Europe but free healthcare should be a right not a privilege. And a well developed benefits system it what defines us as a society.
Fuck the American Dream, it's not all about growth people
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TO ALL EUROS:
you don't know this but
ANYONE in the US can walk
in a hospital if truly sick
and get care
FREE..it is a fact!
what the socialists
here want to do is let
you walk in there with a
hangnail & have thousands
spent on their dumb asses.
ANYONE in the US can walk
in a hospital if truly sick
and get care
FREE..it is a fact!
I'd like to know how that works. The ER might splint a broken bone, and I might get away with stiffing them on the bill. But if the problem is cancer, for example, no one is going to "walk in" to any hospital and get $50k - $100k worth of surgery and chemo FREE. That's a fact.
It's not free, you get billed, and they will garnish your wages to get the ridiculously high price, they put on an emergency room visit. around a thousand dollars an hour.
This is exactly what the psychopaths want us to believe, whether true or not - their crimes will likely never be punished:
So kicking the can down the road will make it worse, which is why the problems of decades past now weigh so heavily upon us, such as our crumbling infrastructure. If precautions are no longer important and maintenance is sloppy/non-existent the dam will burst. Maybe not today.
Because of the now open corruption there is no other option. All the "confusion" of the leaders is now panic - not sound principles of high integrity and sharp reason.
The complacency of the masses has been orchestrated - and the price to pay is a dear one. Fuck the psychopaths, not the dreamers.
What worries me is the government has already shot its wad and cannot assist in any recovery without stirring hyperinflation or perhaps a devaluation. They spent every dime trying save the beast which ravaged everyone's pocket books and that beast is going to have one last go at it before it dies.
If we had accepted the fact that the banking system was diseased back in 2008 we could/should have rebuilt it on sound principles and let the existing structure die on the vine. But no, we had to shovel more and more manure on the vine to save the rotten fruit.
Now I fear it is too late to save anything. We can go two ways here. Limp along with high unemployment while deleveraging is completed or we can tank. The recovery will be much sounder and will actually come quicker if we tank. There will be more pain in the short term but we will come out better. If we limp along on life support we may slowly recover (over a decade or more) or we could still tank. The longer we continue like this the worse it will be if things fall apart a year or two from now.
+100
I am positive that we will have to rebuild our manufacturing base in Northa America. This will bring back jobs.
But while this happens, inflation will be roaring its ugly head.
Everybody has been screaming about inflation for the past 3 years (mostly gold bugs). I would honestly welcome inflation at this point. That would mean less houses underwater, rising wages, and our debt-to-GDP ratio would fall.
Exactly. If the money printed doesn't make it to the average person, nothing inflates.
In case they noticed... the money isn't making it to the average person. Only banks.
Economic support won't make to the average person until the reprobates higher in the food chain get to spend it first. Most notably, when the culture of banksters and their slavish supporters decide it's time to begin snuffing up cheap goodies with their stash of free money...yeh, the convenient keynesian collectivist way, which would not work without the evil "debt as money" monetary system. By then, the average person is left holding the bag. This means war.
They never rise fast enough to buy a loaf of bread.
You really think that a bunch of 50+ year-olds would start new businesses if governement got the hell out of the way?
The only thing these 50 year olds know how to do is build bigger houses, play golf and remortgage the house to get their kids into school.
Without government they know darn well that Gen-X and Gen-Y would lead them to the poorhouse.
They're not going to let go until inflation hits.
Wake up. Nothing major is going to get written down. It will get papered over. And if Debt/GDP goes down, it's because inflation will raise the denominator.
50+ need not start anything they just need to be recruited by the25+ who starts something ... I am sure all jobs do not require 25 year olds only ..