We have gotten to a point where each country is trying to talk down its own economy in a pursuit of having the worst (DXY constituent) currency. Yesterday it was Bernanke warning about future growth prospects, last night it was Japan, and today it is Goldman Sachs, which is claiming that the economy is really worse than expected. What is the point of all this rhetoric: simple. In the current stock market bubble where the only driving force is the strength, or rather, weakness, of any given underlying currency (read- dollar), and where inflation and deflation pressures are inverted, such that a weak dollar would cause a market melt up, and thus, inflation spillover from overpriced stocks into commodities and other products, the only way to stimulate inflation is to posture having the weakest economy. Whether that is in fact "weakest" or merely most debt-laden, with worthless CRE, housing and other 'assets' serving as collateral on bank balance sheets, we leave to much smarter analysts such as Dick Bove and Meredith Whitney.
In less than one year Barack Obama has managed to convert America into a full fledged banana republic, simply with the goal of continuing to bail out the financial system.
Goldman's point, not that it matters, is that all of a sudden, economic prospects are getting much bleaker. Mr. Hatzius will emit whatever winds of change you can believe in, as suits Goldman's weekly prop exposure. Goldman should have just come out with a Conviction Sell rating on the US Dollar, and Conviction Inflation rating on BofA, JPM's and WFC's trillions of worthless assets and debt.
As even CNBC finally realizes the bait and switch currently in progress, expect propaganda central to radically shift their perspective and to gradually commence bashing the economic recovery. In a world where only the DXY matters, the weakest economy wins.
The Arithmetic of Recovery
Despite the sharp pickup in real GDP growth since the dark days of early 2009, we estimate that real final demand—net of the boost from fiscal policy—is still contracting at an annual rate of around 1% in the second half of 2009. Although we expect a moderate recovery of around 2% by the second half of 2010, such a 3-percentage-point improvement would be insufficient to offset the loss of 4-5 percentage points of stimulus from fiscal policy and the inventory cycle. Hence, real GDP growth is likely to slow anew to a below-trend pace.
The significantly stronger recovery that is now anticipated by a number of forecasters would require a much sharper acceleration in underlying final demand, along the lines of prior recoveries from deep recessions. But this ignores some key differences between the current situation and the aftermath of prior slumps. In particular, bank credit is tighter, the personal saving rate is much lower, the labor market is less cyclical, there is much more excess housing supply, and state and local budget gaps are deeper.
In Friday’s US Economics Analyst, we noted that several key indicators of final demand—including retail sales, capital goods orders, and exports—continue to look “L-shaped with a slight upward tilt,” to use the expression of San Francisco Fed President Janet Yellen. This remains true after today’s retail sales report. While “core” sales excluding autos, building materials, and gasoline rose a stronger-than-expected 0.5% in October, this was offset by a cumulative 0.3% downward revision to the prior two months.
Indeed, net of the fiscal policy boost from fiscal policy, we estimate that final demand is still declining at about a 1% (annualized) pace in the second half of 2009. This is shown in the chart below, which plots final demand both including and excluding the estimated impact of fiscal policy on real GDP growth.
Going forward, we do expect underlying final demand to improve gradually to a growth rate of around 2% in the second half of 2010. There are several reasons for this. The household financial adjustment will likely be further advanced as the saving rate rises and equity prices have recovered part of their earlier losses; business investment should stabilize as the commercial real estate downturn bottoms out and some firms replace worn-out equipment; and net exports should return to a gradually improving path, in lagged response to the renewed dollar depreciation.
But the key reason why our growth forecast is below consensus is that we expect the 3-percentage-point improvement in underlying final demand growth to fall short of the loss of the fiscal and inventory stimulus of 4-5 percentage points. Our projections for the latter are illustrated in the chart below.
In order to see the significantly strong recovery that is now anticipated by a number of forecasters, we would need to see a much sharper acceleration in underlying final demand. The main argument for such an outcome is that deep recessions have historically been followed by strong recoveries.
But we believe that such an extrapolation is too simplistic. It ignores far too many differences between the recent recession and the deep downturns of the past, e.g. those of 1973-1975 and 1981-1982. The following differences seem particularly important:
1. Bank credit is tighter. Although the deep recessions of the past often did feature significant financial distress, this was usually directly related to high short-term interest rates. Once the Fed cut rates and the yield curve started to steepen, banks’ willingness to lend rebounded sharply. This is visible in the Fed’s Senior Loan Officers’ survey, which showed that the net percentage of banks increasing their willingness to lend to consumer stood at +28% in 1975Q2 and +53% in 1983Q1, the quarters immediately following the end of the recession. In contrast, the same indicator stands at -1.9% now.
2. The personal saving rate is much lower. At the end of the 1973-75 and 1981-1982 recessions, the personal saving rate stood at 10% or more. Now, it stands at 3.3%. Thus, consumers have less wherewithal to support sharp pickup in consumer spending growth of the kind that often occurred following prior deep recessions.
3. The labor market is less cyclical. This may sound like an odd statement at a time when the Great Recession has just pushed the unemployment rate from below 5% to over 10%. But what we mean is simply that the labor market looks less primed for a sharp rebound than it did in 1975 or 1982, largely because of the changes in industrial structure and corporate behavior documented in our Brave New Business Cycle research of the 1990s. One quantitative measure of this is the share of workers on “temporary layoff,” which currently stands at 1.1% of the labor force compared with more than 2% in both 1975 and 1982.
4. There is much more excess housing supply. Although the 1973-75 and 1981-82 recessions also featured severe declines in housing starts and residential construction, the reason for these declines was mainly a tight monetary policy. This time, it is mainly the massive excess supply of housing, as illustrated by the 2.6% homeowner vacancy rate compared with respective rates of 1.3% and 1.6% at the end of the 1973-75 and 1981-82 recessions. Rental vacancy rates are also much higher now. Reversing a tight monetary policy is a much faster process than unwinding a large-scale housing supply overhang.
5. State and local budgets are in worse shape. State and local governments are seeing the biggest drop in tax receipts in postwar history. As of the second quarter of 2009, real receipts were down 7.9% on a year earlier, compared with peak declines of 4.9% in 1973-1975 and just 0.2% in 1981-1982. The decline is unlikely to end next year, so states and municipalities will probably need to continue tightening their belts.
Again, we do expect final demand to recover gradually in 2010 as noted above. But “gradually” is the watchword, and a V-shaped recovery remains unlikely.