Valero Energy has just announced it is shutting down its Delaware City Refinery.  This is a major news announcement because refiners should be seen as a canary in the coalmine for end-user demand and Valero is one company in the oil patch which has been loath to cut workers to improve the bottom line. This announcement is an indicator that, despite a technical recovery, the economy still has major obstacles to overcome.

Business Wire reports:

Valero Energy Corporation (NYSE: VLO) announced today it intends to permanently shut down its Delaware City refinery due to financial losses caused by very poor economic conditions, significant capital spending requirements and high operating costs. The shutdown will affect approximately 550 employees at the plant.

Valero notified refinery employees today of the impending shutdown, and will immediately begin negotiations with the refinery’s unions regarding the effects of the plant closure and the employees’ severance packages. A safe and orderly shutdown of the refinery will commence immediately. Valero remains committed to its marketing businesses in the Northeast and will continue to reliably supply its customers, partially through higher throughput rates at the company’s other refineries.

“The decision to permanently close the Delaware City refinery was a very difficult one,” said Valero Chairman and CEO Bill Klesse. “We have spent the last year diligently trying to avoid this situation, and I have worked closely with Gov. Markell in an effort to find a different outcome. Earlier this fall, we shut down the gasifier and coking operations in an attempt to improve reliability and financial performance, but the refinery’s profitability did not improve enough. Additionally, we have sought a buyer for the refinery, but feasible opportunities have not materialized. At this point, we have exhausted all viable options.

“We realize that the decision to close the refinery affects many employees, their families, and the community. We are thankful to our employees for their service, and we will treat them fairly during this difficult period.”

In the fourth quarter of 2009, the company expects to report a pre-tax charge of approximately $1.7 billion to $1.8 billion, or $2.00 to $2.15 per share after taxes, related primarily to asset impairment, employee severance and other shutdown costs. The company estimates the cash portion of the pre-tax charge will be in the range of $125 million to $150 million. The current and historical financial results of the affected operations will be shown as discontinued operations in the company’s financial statements.

The new CEO Bill Klesse came to Valero via Ultramar Diamond Shamrock (UDS), which Valero acquired at the top of the market in 2001. So, company ethos may be different than under Bill Greehey who was very committed to community. And Delaware City is an old Getty/Shell-Motiva oil refinery and a legacy asset of Blackstone-controlled Premcor, the company run by former Tosco head and Salomon Brothers commodities trader Tom O’Malley. So, it was not core to Valero’s operations. Valero already cut staff there in September. And the Shell-Motiva JV had serious operating difficulties with the asset before offloading it to Premcor.

Nevertheless, this was a refinery which has been upgraded significantly to process less expensive heavy, sour crude oil. The fact that Valero is laying off workers and shuttering the entire site tells you that the situation is bad. They are saying in effect “we cannot continue to operate at a loss through this business cycle.” If Valero can’t make money, no oil refiner can.

I see this in a macro context as a sign of cyclically weak end-user demand.  I do think peak oil is for real but the world is awash in oil and oil products right now.  Witness the recent post by FT Alphaville’s Izabella Kaminska, which points to a glut of distillate entering the season of high distillate demand:

We feel it’s Olivier Jakob at Petromatrix who really expressed the matter best on Friday. As he wrote (emphasis FT Alphaville’s):

As per our Tuesday ad hoc note on floating stocks; on a crude equivalent basis all of the OPEC and half of the IEA estimated oil demand growth for 2010 is already parked at anchor in floating stocks and these idled cargoes filled with oil are getting more and more attention.

By the end of the winter there is likely to be as much distillates afloat as in the total US at the end of winter 2007 and we expect that it will be more and more difficult for some of the Wall Street commodity banks to avoid mentioning the subject and to continue to hide the floating storage fill-up as “demand from emerging economies”.

The ICE Gasoil contango is currently widening and this will not work towards the reduction of these floating stocks. In an environment of spare refining capacity the only solver to the growing floating stocks of Distillates is a sharp reduction in OPEC supplies [ahem…Daily Mail], but only lower prices would trigger that.

The only answer that we see to GOD (Glut of Distillate) is a flat price correction sharp enough to force more OPEC supply cuts.Starting 2010 with WTI at 80+$/bbl and a contango in a low demand environment there will not be much returns to be expected from commodities by some of the largest financial institutions; hence with the evidence of the GOD being harder and harder to hide we would not be surprised if in a few weeks some of the Wall Street commodity banks start to change their tune and start to publicize the GOD. A flat price correction would anyway be needed in the first quarter to allow a repositioning from the large financial players at better entry levels.

Which, of course, doesn’t mean banks have been hoarding oil in a bid to drive the prices up. It means, if anything, they’ve been too slow to acknowledge the extent of the oversupply in the market and degree of muted demand, as well as depended too much on the idea that economic recovery will help spur demand by the year’s end.

Meanwhile, as Jakob states, the solution to the glut lies in Opec shut-ins — not more output.

The fact that oil is trading at $80 a barrel in this climate should tell you that it is trading more as a financial asset than on supply/demand imbalances. Is this why Warren Buffett is buying yet more oil assets? Watch refining margins; they are telling indicators.

Disclosure: I have owned owned shares and call options in Valero and other refiners for a number of years, but I sold all positions in 2007.

Related posts:

• Refiners as proxy for demand: layoffs for first time at Valero
• Valero crushes earnings: I was wrong
• Refiners as a canary in the coalmine
• Stocks pummeled as value plays increase
• Germany: Hertie as a symbol of recession

From Bloomberg:

Confidence among U.S. consumers unexpectedly dropped in November as the loss of jobs threatened to undermine the biggest part of the economy.

The Reuters/University of Michigan preliminary sentiment index decreased to a three-month low of 66 from 70.6 in October…

Rising joblessness puts the economy at risk of slipping into a vicious circle of firings and declines in consumer spending that will limit the emerging recovery.

I don’t pay as much attention to consumer confidence as I do to some other economic data because I have yet to see enough statistically significant correlations between confidence and future economic paths.  However, I do realize there is a connection having recently posited the following about a term I coined unemployment rate illusion:

behavior changes in accordance with the nominal numbers used as economic signposts in an economy…

The parallel of money illusion to unemployment rate illusion is that a higher posted rate of unemployment can have a serious negative impact on consumer confidence and personal consumption (think balance sheet recession). All else being equal, higher unemployment rates mean lower confidence and consumption…

• If people see 12-13% in 2010, they will be floored, angry, and looking for someone to blame. As Democrats control Washington, they will get the lion’s share of the blame and lose big time in 2010.
• Making matters worse, this is the kind of shock that causes people to put their checkbooks away and go home for the night a.k.a sending us into a double dip recession.

So I am concerned that we are going to se a relapse. (Note: I have moved from seeing a double dip recession as a 1/3 chance to a base case scenario). My optimism about recovery is now fading.

Unfortunately, similar downbeat confidence numbers are also coming from the Conference Board index which unexpectedly fell in October:

The Consumer Confidence Index, released by The Conference Board, sank unexpectedly to 47.7 in October — its second-lowest reading since May.

Forecasters predicted a higher reading of 53.1. A reading above 90 means the economy is on solid footing. Above 100 signals strong growth.

The index has seesawed since reaching a historic low of 25.3 in February and climbed to 53.4 in September.

The connection to markets comes again via David Rosenberg from this past October 29th who I seem to be quoting a lot recently. In reference to the Conference Board numbers, Rosenberg said (highlighting added):

So many people are deluding themselves that we have some sort of durable recovery on our hands and yet consumer confidence, at 47.7 in October, is unbelievable — the lowest this every got in the 2001 recession, which included the 9-11 terrorist attacks, was 84.9. Think about that for a second. If the equity market is catching on to the view that we could be in for some slowing in the data, then a significant correction after a 60% surge is very likely. This is a time to be raising cash if you haven’t done so already — valuation, technicals, fund flows and fundamentals at this juncture are all near-term obstacles.

Related posts:

• Consumers ‘do believe in the green shoot story’
• Unemployment rate illusion
• The slow but inexorable decline of jobless claims
• A note on government statistics and unemployment
• Data on past consumer deleveraging during recessions

You have probably heard the term money illusion.  I want to coin a related new term called unemployment rate illusion because I think it is significant in light of some of the things David Rosenberg said earlier today about the unemployment rate in the U.S.

Wikipedia’s definition of money illusion is good:

In economics, money illusion refers to the tendency of people to think of currency in nominal, rather than real, terms. In other words, the numerical/face value (nominal value) of money is mistaken for its purchasing power (real value). This is a fallacy as modern fiat currencies have no inherent value and their real value is derived from their ability to be exchanged for goods and used for payment of taxes.

The key here is that behavior changes in accordance with the nominal numbers used as economic signposts in an economy. This is one reason why governments are often accused of manipulating their economic statistics in order to present a more regime-friendly face (see here and here).

The parallel of money illusion to unemployment rate illusion is that a higher posted rate of unemployment can have a serious negative impact on consumer confidence and personal consumption (think balance sheet recession). All else being equal, higher unemployment rates mean lower confidence and consumption. So, a lower unemployment rate is a better unemployment rate as far as incumbent politicians are concerned.

Now, you don’t have to be a conspiracy theorist and think that the government is deliberately suppressing the unemployment rate to understand what I am about to say. You just have to understand economic cycles in the context of the note from David Rosenberg today.

What I am talking about is the second paragraph of a quote I highlighted (bolding added):

But in a nutshell, to be calling for a 12.0-13.0% unemployment rate is meaningless except that it is very likely going to be a headline grabber. The most inclusive definition of them all, the U6 measure of the unemployment rate, which includes all forms of unemployed and underemployed, is already at 17.5%. The posted U3 jobless rate that everyone focuses on is at 10.2% (though if it weren’t for the drop in the labour force participation rate, to 65.1% from 66.0% a year ago, the unemployment rate would be testing the post-WWII high of 10.8% right now). The gap between the U6 and the official U3 rate is at a record 7.3 percentage points. Normally this spread is between 3-4 percentage points and ultimately we will see a reversion to the mean, to some unhappy middle where the U6 may be closer to 15.0-16.0% and the posted jobless rate closer to 12%. This will undoubtedly be a major political issue, especially in the context of a mid-term elections and the GOP starting to gain some electoral ground.

Let me put this quote in unemployment rate illusion terms:

• People pay attention to the posted U-3 rate of unemployment. Right now it is 10.2%, which is high.
• However, it could be much higher – 10.8% – because a lot of people aren’t getting counted. They are dropping out of the labor force and artificially suppressing the labor force participation rate. This will change when recovery takes hold as a better economy brings back those discouraged workers.
• It’s even worse than that because, U-6, the most comprehensive rate of unemployment is sky-high at 17.5% and much higher relative to the posted rate than is normal. Even if U-6 declines to 15-16.%, using a normal gap to the posted rate gets you a posted rate of 12-13%. Nothing has changed, discouraged workers have re-entered the labor force. It is unemployment rate illusion.
• If people see 12-13% in 2010, they will be floored, angry, and looking for someone to blame. As Democrats control Washington, they will get the lion’s share of the blame and lose big time in 2010.
• Making matters worse, this is the kind of shock that causes people to put their checkbooks away and go home for the night a.k.a sending us into a double dip recession.

This is a case where unemployment rate illusion is definitely not a good thing.

What to do? 

Well, if you’re the President, you have to under-promise and over-deliver. President Obama has been doing exactly the opposite. Of course people are going to be angry when you promise 8.0% unemployment and instead we get 10.2%. Right now, Obama should be talking about 13% unemployment.

Moreover, Obama needs to throw his weight around. He should be telling people publicly, “my policy team is telling me that if we don’t get what we want through Congress, this fragile and unsatisfactory recovery will crumble and we will see 13% unemployment or much worse. And it will be the Republicans fault that this happened.”

Then he should turn to the Republicans and say, “give me everything I want or the economy will crumble and I will make sure you get the blame.”  Remember, that’s what Hank Paulson did and it worked brilliantly (a 777-point implosion in the Dow helped). What is the Republicans’ BATNA (best alternative to a negotiated agreement)? Nothing.

If you’re a Republican you should continue on the same course. Obama shot himself in the foot in January and February by not taking the Hank Paulson approach. Now, you get to label him a ‘socialist’ or anything you want. And you get to tell people that stimulus is budget-busting pork designed for the Democrats’ union buddies that doesn’t work and bankrupts America. It’s been working so far. Given the fact employment is likely to rise to a post-Great Depression high, why wouldn’t you continue on the same path? Don’t fix what’s not broken.

…coming soon to a TV screen near you.

Related posts:

• Rosenberg: U.S. unemployment rate headed for 12.0-13.0%
• Comprehensive unemployment rate is 17.5%
• Unemployment: U-6 data versus the Great Depression
• Consumer confidence sinking
• A note on government statistics and unemployment

I have just taken a look at the consumer credit figures for September, released just yesterday by the Federal Reserve. The data do show some modest deleveraging, especially when looking at the recent increase in nominal GDP. However, it is still not clear to me that the scale of deleveraging is great enough to induce a recessionary relapse.

My baseline for deleveraging is Debt to Nominal GDP – when debt to GDP goes down, that shows deleveraging. For example, for the latest data released in September for Q2 2009, Private sector total debt to GDP (incl. financial services) in the U.S. was 292.2% of GDP. Because of the huge drop in nominal GDP, this was actually up from 283.0% when the recession began in Q4 2007. For households, the number was 96.8% in Q2 2009, up slightly from 95.9% at the end of Q4 2007.  What this shows is that deleveraging has yet to begin in earnest as debt levels have remained relatively high even while GDP had collapsed.

The lack of deleveraging is probably a result of financial stress. In the Great Depression, the personal savings rate dropped from 4.5% in 1929 to 4.1, 3.9, –0.9, and finally -1.5% in 1930-1933.  People had to use savings to service debt as the deflationary spiral took hold.

So, in the absence of quarterly data on debt levels, I look at data from things like consumer credit for a proxy.  On a seasonally-adjusted basis, consumer credit declined to $2.471 to $2.456 trillion. That is the lowest since June 2007 and marks the ninth consecutive monthly drop.

However, looking at the non-seasonal data makes plain what is happening:

Nonrevolving credit is now increasing along with GDP. Look at the area highlighted in red; that coincides with the 3.5% real GDP print we just saw. On the other hand, revolving credit is getting crushed. Below is the reason why (click to expand):

Credit from commercial banks and savings institutions have dropped off a cliff.  When you hear people saying that banks aren’t lending, this is what they are talking about. In Q3, banks are lending again (think cash for clunkers) because nonrevolving debt is up.  That’s also why GDP is up. But, revolving credit lines (credit card lines) are being cut.

My conclusion is largely the same as last month, namely I had anticipated more deleveraging than we are seeing. However, consumer credit is only coming down on the nonrevolving side. And given the stabilization in house prices and increases in refinancing activity, I wouldn’t expect mortgage debt levels to be down substantially. When we see Household Debt to GDP levels from Q3, they probably will not be substantially lower than they were in Q2.

This does support recovery but only at the risk of continued high levels of debt to GDP.

G.19 data series – Federal Reserve

Related posts:

• Data on past consumer deleveraging during recessions
• Consumer credit falls 4.4% from year ago levels
• Why is everyone saying consumer credit is falling? It’s not.
• Do the personal income data demonstrate unbalanced reflation?
• Household debt as an indicator of secular bull and bear markets

Several notable economists prognosticated on what Japan should do to get out of their malaise in the 1990s but none of them understood the problem or the options available to the sovereign government. They all gave poor advice. The way Japan recovered after that decade of poor economic outcomes was through fiscal policy. Monetary policy had little to do with it, as Richard Koo has demonstrated in his recent book on the country.

Let’s eliminate a few misconceptions.  Japanese households do not fund the deficit.  A government default is not possible (unless Japan chooses to do it, which I suppose they could do as they are pretty clueless).We learned that interest rates do not sky-rocket and inflation does not accelerate when deficits and debt issuance are on-going and huge – quite the opposite. If the BOJ should want to increase the money supply, devotees of the money multiplier model (including numerous Nobel Prize winners) would have the BOJ purchase securities. When the BOJ buys securities reserves are added to the system. However, the money multiplier model fails to recognize that the added reserves in excess of required reserves drive the funds rate to zero, since reserve requirements do not change until the following accounting period. That forces the central bank to sell securities, i.e., drain the excess reserves just added, to maintain the funds rate above zero. If, on the other hand, the BOJ wants to decrease money supply, taking reserves out of the system when there are no excess reserves places some banks at risk of not meeting their reserve requirements. The BOJ has no choice but to add reserves back into the banking system, to keep the funds rate from going, theoretically, to infinity.

In either case, the money supply remains unchanged by the BOJ’s action. The multiplier is properly thought of as simply the ratio of the money supply to the monetary base (m = M/MB). Changes in the money supply cause changes in the monetary base, not vice versa. The money multiplier is more accurately thought of as a divisor (MB = M/m).

Their export model is dead, the Chinese are eating their lunch, so the Japanese have to switch to a domestic consumption based model.  How do you do that without spurring lots of unemployment in the absence of government spending?

It is clear to me that the neo-liberal period in Japan has devastated the security of the middle class which accounted for more than 80 per cent of the population. A person could rely on retaining full-time employment on good wages for life as long as they completed secondary school. The 1991 recession which followed the real estate collapse and poor investments by the financial sector led to the “lost decade”. The Japanese government under the neo-liberal helm of Prime Minister Koizumi started deregulating things that had previously been integral to providing this security, including cutting back government spending. See Koo’s book. His evidence is very compelling here.

Around 30 per cent of Japanese workers are employed in low-paid, casual jobs that offer no security. While Japan enjoyed stable growth this was not a problem. But the numbers of temporary workers has risen as the revered life-time employment system that generate prosperity in the Post-World War II period for the vast majority of workers has been steadily dismantled under neo-liberal urging.

I can do no better than to relay discussions I had on this point with Professor Bill Mitchell of the University of Newcastle in Australia.  Bill eloquently summarises the neo-liberal insanity which is destroying this country:

The neo-liberals are running rampant now and predicting a maelstrom. This dominance of neo-liberal thinking will be a major constraint on the new government and it is already showing a compliance to the views.

The family-first policy proposals are a sop to the intergenerational debate.

The decision to shift spending priority to welfare away from national infrastructure provision is an example. The new Prime Minister has already said he will raise taxes to “pay for” the new spending initiatives. He has also promised to cut spending on major infrastructure.

The private investment jackals who have been indulging in wasteful, inefficient yet highly profitable private equity projects in the West are poised to capitalise on this shift in Japanese sentiment. They see Yen-signs before their eyes and are on the move already.

One commentator in today’s Australian says Australia investors are “primed and ready, as Japan rebounds from the global downturn with more resilience and speed than expected …”

The upshot according to the Australian commentary (consistent for a News Limited journalist) is that there will be:

… a focus on public-private partnership projects – a new concept for Japan. They are now essential as government debt soars past double the country’s annual economic output, with public infrastructure spending totalling $7.5 trillion since 1991. And the latest central government stimulus package crowded out bond-raising opportunities for regional governments.

Infrastructure is emerging as a new “asset-class” in Japanese financial markets. We never learn!

If they really understood the fiat monetary system they could continue to provide public infrastructure and extend better safety net protection for the poor. The large deficits that the Japanese government runs is symptomatic of the huge saving desire of the domestic population. Not even the traditionally strong net export performance can offset the high saving ratio.

The saving ratio will also decline as more safety net provisions are extended to the population, who at present feel as though they have to provide for their own retirements. The introduction of a national superannuation scheme would also help.

In that sense, the deficit would fall anyway as consumption increased.

Related posts:

• Japan’s easy money policy was the trigger for the tech wreck
• Is Japan next on the road to quantitative easing?
• Japan does not demonstrate the failure of stimulus
• Japan: stimulus without reform leads to a policy cul de sac
• The Japanese Problem is now ours

The data released this morning by the U.S. Department of Commerce’s Bureau of Economic Analysis on personal income somehow managed to show weakness in income and consumption as well as savings.  I see this as proof that Americans are not saving and hence not deleveraging, but they are also so income constrained that their consumption should not be expected to increase markedly either. This points to a mild recovery.

The numbers from September show a significant decline in consumption from the cash-for-clunkers juiced August numbers.

Personal outlays — PCE, personal interest payments, and personal current transfer payments — decreased $48.8 billion in September, in contrast to an increase of $138.2 billion in August. PCE decreased $47.2 billion, in contrast to an increase of $139.8 billion.

If you take out August and cash-for-clunkers and look back at June and July, September’s consumption numbers are up a tick (annualized $10.53 trillion in personal outlays versus $10.44 trillion for July and $10.42 trillion for June).

So consumers are spending money. You can see this in the savings data as well.

Personal saving — DPI less personal outlays — was $355.6 billion in September, compared with $307.0 billion in August. Personal saving as a percentage of disposable personal income was 3.3 percent in September, compared with 2.8 percent in August.

3.3 percent is higher than 2.8 percent but it is a lot lower than 5.9 percent, which is where things were in May. I took this issue up at length in my post, “Americans are not increasing savings” earlier this month saying:

Savings rates averaged 9% through 1982. They were consistently above 7% through 1992. Since then, savings rates have collapsed. From Jan 1969 to November 1997 (comprising all monthly data since record-keeping began), the 10-year average savings rate was higher in every single month than the 5.9% savings rate achieved in May 2009.

So 2.8% is ridiculously low and inadequate to meet Americans’ needs in terms of reducing debt and Baby Boomers’ preparing for retirement. Absent asset-price appreciation as a source of savings, we are going to be in for some tough sledding in a few years. Clearly, record low interest rates are reducing the propensity to save.

On the other hand, incomes are still constrained. The BEA reports:

Personal income decreased $0.1 billion, or less than 0.1 percent, and disposable personal income (DPI) decreased $0.2 billion, or less than 0.1 percent, in September, according to the Bureau of Economic Analysis…

Real disposable income decreased 0.1 percent in September, compared with a decrease of 0.2 percent in August. Real PCE decreased 0.6 percent, in contrast to an increase of 1.0 percent.

This puts personal income on par with Aug 2007 levels, as income is being reduced by high unemployment.

My analysis says the data are pointing to a mild recovery on the back of consumer spending which is being spurred by low interest rates. As a result, savings are now going back down to dangerously low levels. This mix is a direct result of policy decisions made in Washington, which are designed to recreate the pre-crisis status quo ante. Thus far, they have been successful.

Related posts:

• Do the personal income data demonstrate unbalanced reflation?
• Savings in America hit 5%, up from nil last year
• Third quarter GDP growth comes in at 3.5%
• Highlights from report with Q1 U.S. GDP down 6.1%
• Why the personal consumption data is important to the stock market

This is a cross-post from an article I wrote at the finance site New Deal 2.0, a one-stop-shop for current news, sharp analysis and potential solutions of the country’s fiscal crisis. Edward linked to this in this morning’s links, saying “I don’t agree 100% but this is a good overview” – tied to the Austrian business cycle theory as he is!

He asked me to post this here as well. I hope this will help identify some of the flaws in conventional economic orthodoxy.

Fears about the falling dollar are stoked by neo-liberal money myths that harken back to the gold standard system.

It seems there isn’t a day that goes by without more commentary on the demise of the dollar and the concomitant risk of a collapse of the world’s reserve currency. Again, the reasoning here appears largely to be based on the tyranny of orthodox neo-liberal economics. Orthodox economists view dollar depreciation as an imminent danger which raises the relative costs of imports, and imparts an inflationary bias to the economy. Moreover, they argue that depreciation leads to expectations of further depreciation and fuels the run out of the currency.

So, in the logic of this view, there may be no interest rate that is high enough to counter expectations of losses due to depreciation and possible default, which means that there will be no alternative but to urgently restore reserves of foreign currency either through renegotiation of foreign debt obligations, international donor assistance or default, especially given our supposedly “reckless” and “irresponsible” government spending, which is supposedly robbing future generations of growth and prosperity.

Large deficits are not the problem

Let’s all take a deep breath here: Whilst the dollar index has fallen some 15% from the high sustained earlier this year, it is still above the lows sustained at the height of the credit crisis reached about a year ago. Secondly, there seems to be a fear that the current fall in the dollar could well engender inflation, and create a panicked response from policy makers where the Fed actually does raise rates and the Treasury begins to reduce government spending. Given high prevailing debt levels and the weak state of the consumer’s personal balance sheet, this would be an unmitigated disaster.

It is true that excessive government deficit spending can be inflationary, and could therefore cause some impact on exchange value of dollar. But this can’t be viewed in some sort of vacuum. The size of the deficit is irrelevant in itself. There is no meaning in the terms ‘large deficit’ or ’small deficit.’ You have to relate them to the extent of labor and capital underutilization, which is a human measure of the aggregate demand deficiency. The fact that labor underutilization is now in excess of 16 per cent in the US (combined unemployment, underemployment and hidden unemployment) and capacity utilization is in the 60-65 per cent range rather than 90 per cent range sends one very clear message – the deficit is not large enough.

So the correct policy response is to spend until we get to full employment. That is the only consequence of excessive deficits — insolvency is not possible. Your social security check will never bounce in a country issuing debt in its own freely floating non-convertible currency.

The size of our government deficit is endogenously determined, which is to say that it has no external cause; it is a function of internal, domestic phenomena. Today, the deficit is largely a function of weaker spending power and concomitantly lower economic growth. (”Good government spending” more or less seeks to fill private output gaps; “bad government spending” is a consequence of government not taking responsibility for filling the spending gap and instead letting this occur via the automatic stabilisers). So the scenario of ever-increasing deficits is unlikely because as economy heats up, deficit shrinks and turns to surplus (as during the Clinton years and also the 1920s).

The orthodox interpretation of a nation with a declining currency and a large current account deficit appears to indicate that the nation concerned is “living beyond its means” — with excessive domestic demand that boosts imports; the excessive demand also fuels inflation that restricts exports. The presumption is that the resultantly large deficit must be “financed” by flows of foreign reserves, which, for the most part, must be attracted by high returns and a stable political, economic, and social environment.

From the US perspective, this means that if America cannot continue to attract these needed reserves, it must raise rates to attract new foreign capital, which in turn will slow its growth to reduce imports; lower prices and wages could also encourage exports. The obvious portent of the default on foreign debt obligations is then used to argue in favour of restricting government spending. Thus, both monetary and fiscal policy ought to be tightened to encourage such capital flows even as this reduces the need for them. In other words, an emerging markets’ crisis writ large.

Deflation or inflation?

But the reality is not so much that the US is inflating, so much as that the rest of the world is deflating relative to the dollar. Import prices are still generally falling, inflation remains quiescent and private credit growth is now contracting. These are hallmarks of deflation, not inflation. Additionally, the US is not borrowing in a foreign currency (in contrast to Iceland or Latvia or the Asian countries during the 1997/98 emerging markets’ crisis), so it does not face an external funding constraint.

What about China? True, there may be some indications that there is some shifts in terms of private portfolio preferences. Perhaps the Chinese don’t want to buy as many dollars as they did before. Perhaps hedge funds are now laying on a big “short dollar” trade in the markets. These are one-off portfolio preference shifts and it seems inadvisable for US policy makers to respond to every single vicissitude of changing market sentiment. That way leads to Latvia and economic implosion.

It’s hard to believe that a nation with 10% official unemployment and likely double that when one factors in underemployment is actually “living beyond its means.” It is even crazier to suggest that we should scale back government spending and private consumption, when there is substantial unused capacity and under-utilised resources (particularly labour). In those circumstances, the nation could not possibly be living beyond its means.

What about those terrible “global imbalances” that we are told must be rectified, what I call “the cult of zero imbalances”?

Well, let’s consider that as a possible policy response.

Policy fables

According to the G20 communiqué, those countries running current account deficits, most notably the U.S., would have to define ways to boost savings. Nations running surpluses – China, Germany and Japan, among others – would detail how they propose to reduce any reliance on exports. The U.S. would likely need to commit to a sharp deficit reduction by government. Europe would need to commit to improving competitiveness. That could mean introducing “labour market reforms” (an interesting choice of language here), which generally is code for being able to sack workers and destroy the power of trade unions.

The collective impact of these measures? We want more domestic led consumption in Asia and the EU (especially Germany), but then the two largest economic areas (the US and Europe) would have to deflate their economies. The former, by reducing the public net spending which would thwart the goal of “boosting” saving, and the latter, by widespread shedding of workers and the resulting collapse in consumption (and rising deficits via the automatic stabilizers as welfare payments and crime rose).

These, of course, are the traditional “remedies” proposed by the IMF — and we can see what a great job this organisation has done. Just ask any Argentinean. Neo-liberal-based policy recommendations almost invariably make things worse. We have ample examples of this in Asia, Russia and Brazil during the 1997/98 emerging markets and more recently in Iceland and the emerging market economies of Eastern Europe.

Goldbug mentality still dominates

It is important to understand that much of the economic orthodoxy is still dominated by the “gold standard paradigm”.

Under the Gold Standard, the leading economies of the world, through their monetary authorities, agreed to maintain the “mint price” of gold fixed by standing ready to buy or sell gold to meet any supply or demand imbalance. Further, the central bank (or equivalent in those days) had to maintain stores of gold sufficient to back the circulating currency (at the agreed convertibility rate). The currency was strictly convertible into gold at the fixed parity. So this was a convertible, fixed exchange rate system.

Gold was also considered to be the principle method of making international payments. Accordingly, as trade unfolded, imbalances in trade (imports and exports) arose and this necessitated that gold be transferred between nations (in boats) to fund these imbalances. Trade deficit countries had to ship gold to trade surplus countries. Money literally did “flow” between countries (which is why we still speak in terms of “capital inflows” and “capital outflows” even though the reality of current modern monetary operations is that we electronically credit and debit bank accounts).

This inflow of gold into surplus countries allowed them to expand their money supply (issue more notes) because they had more gold to back the currency. This expansion was in strict proportion to the gold-currency parity. The rising money supply would push against the inflation barrier (given no increase in the real capacity of the economy) which would ultimately render exports less attractive to foreigners and the external deficit would decline. The trade deficit country would lose gold reserves and this would force their government to withdraw paper currency which drove up unemployment and drove down the price level. The latter improved the competitiveness of that economy. The two adjustments – for the surplus and deficit countries — helped to resolve the trade imbalance. But it remains that the deficit nations were forced to bear rising unemployment and vice versa as the trade imbalances resolved.

So under the Gold Standard, the government could not expand base money if the economy was in trade deficit. It was considered that this constraint acted as a means to control the money supply and generate price levels in different trading countries which were consistent with trade balances. The domestic economy, however, was forced to make the adjustments to the trade imbalances.Monetary policy became captive to the amount of gold that a country possessed (principally derived from trade).

In practical terms, the adjustments to trade that were necessary to resolve imbalances were slow. In the meantime, deficit nations had to endure domestic recessions and entrenched unemployment. So a gold standard introduces a recessionary bias to economies with the burden always falling on countries with weaker currencies (typically as a consequence of trade deficits). This inflexibility prevented governments from introducing policies that generated the best outcomes for their domestic economies (high employment). Ultimately the monetary authority would not be able to resist the demands of the population for higher employment.

We no longer have this currency system, but traditional economic thinking and modelling is still based on it, which is why notions of “affordability” and “sustainability” still dominate our economic discourse. But given that we operate under a fiat currency system (where government declares money to be legal tender), we face no operational constraint per se, or issues of national solvency.

So, in regard to the dollar, what is our advice to Lawrence Summers, Tim Geithner, and Ben Bernanke? Do nothing. In the words of the English poet, John Milton, “They also serve, who only stand and wait”.

Related posts:

• The dollar is rising against floating currencies
• The Cult of Zero Imbalances
• Hyperinflation, national bankruptcy, dollar crash and other exaggerations
• Japan does not demonstrate the failure of stimulus
• Japanese defend dollar’s status while China tears it down

Last year at this time I posted “The Economy’s Four Horsemen,” which described macro cause and effect leading into and out of recessions.  When looking at income, spending, output and employment, it is income which is the steer variable going into a downturn.  Year-on-year changes in income precede changes in spending, output, employment and recession. So, in order to gauge what is likely to occur in any business cycle downturn and plan your business spending accordingly, you need to know what is happening to personal income.

To get a grip on this, I am going to look back at prior monthly data series on personal income dating to 1929.  What I am looking for is to pinpoint when in the economic cycle the change in personal income reverses course and whether this presages recoveries as well as recessions.

Here goes.

(click on image to enlarge)

*Note on data: I am using a six month average of the year-on-year change in inflation-adjusted personal income.

Top in personal income growth precedes recession. What I found is that a downturn in the change in personal income almost always precedes recession – and often by a large margin.  This proves that an individual business could look at the data on personal income and get a hint of an impending downturn – and react accordingly.

War used to stoke domestic income growth. There were a few false tops, however.  Most of them were war-related. For example, during World War II, there was a false top in 1941. But, by mid-1942, wartime production caused a renewed boom in personal income. the lag between the false top of Sep 1941 and the renewed turn in Jun 1942 was pretty significant. But, this was a clear aberration. As were the false tops in Dec 1950 associated with the Korean War and the ones in Feb 1966 and Nov 1968 associated with the Vietnam War. It seems post-depression, the ginning up of the military industrial complex was a significant factor in preventing economic bust.

Near-recessions in the mid-1970s and 1980s. After the Wars, a mid-1970s and mid-1980s dip were evident as well. However, in neither case did the change in inflation-adjusted personal income go negative.  Think of these as almost-recessions.  The markets went lower as well. In the mid-1970s, the near-recession personal income trough came in Jul 1977. The Dow peaked in Dec 1976 and kept falling until Feb 1978. In the mid-1980s, the numbers hit a trough of 1.9% in September 1987 when the stock market crashed. There were relapses in 1993 and 1996 as well. But, markets did not fall.

Recovery seems to precede uptick in income growth. While incomes suffer before recession on the way to recession, they lag on the way out, making recessions that much more painful. (See chart above). An increase in the change in personal income does not presage recovery.

Income-less recoveries in 1991, 2001, and 2009.  In each of the last three recessions, average year-on-year real income changes were negative. It is still negative now (-2.6% year-on-year, –2.5% average year-on-year, and –1.3% year-on-year adjusted for inflation).

So what does this say about the current cycle?

There are no false bottoms in the real income data. So,the data suggest that we are in recovery (maximum decline in personal income was November 2008), but that we are still in a very weak period in which a double dip is possible (average real personal income change is still –1.3%). Also, average real personal income losses have been less than they were in 1980 when we were in the first dip of the last double dip recession – one benefit of not having high inflation.

As far as I can ascertain, the data don’t really reveal any patterns between the stock market and personal income.

Related posts:

• Do the personal income data demonstrate unbalanced reflation?
• US personal income data for September shows pullback
• Why the personal consumption data is important to the stock market
• Recession: How Long and How Deep?
• Data on past consumer deleveraging during recessions

You have probably heard a lot of chatter from the media about a newfound thrift amongst American consumers.

The general take is that Americans, faced with lost incomes and wealth and burdened by record levels of debt, have moved away from the asset-based consumption models of yore. Instead of using the 401(k) or the house to do one’s savings, Americans are now saving the old-fashioned way by cutting spending and stashing money away in bank accounts.  The commonly-held belief is that we are witnessing a secular change away from excess consumption toward thrift in the household sector.

Not true.

If you haven’t noticed, asset markets in the United States are all rising: stock prices, bond prices, house prices, even gold prices and commodity prices. This certainly is not lost on the mutual fund industry.  And it is not lost on American households either.  The savings rate has declined to 3.0% after briefly hitting an 11-year high of 5.9% in May.  Welcome back to the asset-based economy.

(click on image to enlarge)

In the charts above, the left side shows how savings levels spiked up in response to the recession and credit crisis. The right side shows a fall off in the savings rate since May, just after the jobless claims numbers first began to recede.

A few factoids about the savings rate:

• Savings rates averaged 9% through 1982. They were consistently above 7% through 1992. Since then, savings rates have collapsed. From Jan 1969 to November 1997 (comprising all monthly data since record-keeping began), the 10-year average savings rate was higher in every single month than the 5.9% savings rate achieved in May 2009.
• Measuring the 12-month average savings rate, savings troughed in America at an all-time low of 1.4% in April 2008.
• Average savings has since increased monthly to the present 3.9%.
• The monthly savings rate peaked in May 2009 at 5.9%.  It declined every month to August, hitting 3.0% in August.

What should be evident from the charts above is that the collapse in savings coincided with the secular bull markets in bonds and equities and with a secular build-up of debt (see “Household debt as an indicator of secular bull and bear markets”).

My takeaway from the data during this past downturn is that American households are not necessarily saving more. As asset prices have risen, a return to the asset-based economic model seems to be taking hold. Let’s look to future personal income data from the BEA to confirm if this trend holds.

If so, the feedback between asset price increases, collateral for bank lending, increased consumption and economic growth could be more powerful than is commonly assumed. This is what could drive a multi-year recovery… that is until the next debt- and asset bubble-induced downturn ends this brief nirvana.

Related posts:

• Do the personal income data demonstrate unbalanced reflation?
• Chart of the day: Savings Rate
• US personal income data for September shows pullback
• Household debt as an indicator of secular bull and bear markets
• Stephen Roach: Americans’ abandonment of overconsumption is a good thing

I found the recent consumer credit data unsatisfying because the data seemed to point in two directions. The seasonally-adjusted data showed a large $12 billion decrease in consumer credit which received headlines. Meanwhile, the non-seasonally adjusted data showed a large $7 billion increase in consumer credit. I suspect this divergence has a lot to do with cash-for-clunkers (post here), but we can’t be 100% sure until we get another month or two of data.

Let’s delve into this issue a bit more because we are at  a critical stage in the economy right now. A lot of pundits are talking about a V-shaped recovery, while others are pointing to a secular move toward consumer deleveraging which basically spells no recovery.

I am somewhere in between, believing we will get a weak recovery that could or could not last more than a couple of years depending on the path of consumer deleveraging. While I do believe the U.S. economy is fast approaching ‘terminal debt,’ I am not convinced we are there in this particular cycle, largely due to the massive stimulus and easing. The posts which best outline this view are two recent ones, “The recession is over but the depression has just begun” and “A brief look at the Asset-Based Economy at economic turns.”

So, here are my questions on consumer credit:

• What happened to consumer credit in past downturns? 
• Specifically, how much did it decline from peak to trough?
• Was the decline mirrored by a similar fall in output as measured by nominal GDP?
• Is the pattern this time around any different?
• And what does that say about the thesis of secular deleveraging?

The way I am going to attack these questions is by looking at past recessions and peak-to-trough declines in both nominal GDP and consumer credit (note: the credit series is monthly, but the GDP series is quarterly – and I am leaving out the recessions in 1945 and 1949 because of wartime anomalies).  Here goes.

1953-54

• GDP declined 1.8% peak to trough. Consumer Credit declined 1.6%. It took 8 months to hit the previous credit peak.

1957-58

• GDP declined 2.7% while credit declined 1.6% from January to June of 1968.It took 11 months to hit the previous credit peak.

1960-61

• GDP declined 1.0% and credit also declined 1.0%.It took 8 months to hit the previous credit peak

1970

• Nominal GDP did not decline due to inflation. Credit did decline from October to November 1970 by 0.2% however.It took 2 months to hit the previous credit peak.

1973-75

• Again inflation meant nominal GDP did not decline. Meanwhile credit declined 1.8% from September 1974 to June 1975.It took 13 months to hit the previous credit peak.

1980

• Again inflation meant nominal GDP did not decline. Meanwhile credit declined 1.8% from February to June 1980.It took 12 months to hit the previous credit peak

1982.

• GDP declined 0.3% and credit also declined 0.1%.It took 2 months to hit the previous credit peak.

1990-91

• Inflation meant nominal GDP nearly did not decline (down –0.08%). Meanwhile credit declined 2.0% from November 1990 to well past the recession’s end in June 1992. It took an enormous 27 months to hit the previous credit peak. This was the worst credit cycle to date.

2001

• We cruised through this recession with neither a decline in nominal GDP or credit.

2007-2009

• GDP declined 2.7% and credit has already declined a massive 4.6%. This is the largest decline in consumer credit to date.

The table of data looks like this:

I draw the following conclusions :

• In an economic downturn, consumer credit has generally declined more than nominal GDP.
• The 1990-91 recession saw a very drawn out drop in credit and easily generated the longest time before credit regained its previous peak.
• The 2001 recession was unusual mild as it was the only time in the last 56 years that the U.S. has experienced a recession without a drop in consumer credit.
• The 2007-2009 recession has been unusually severe. The drop in nominal GDP is the largest in the last 56 years. However, the drop in consumer credit has been even worse at more than twice the largest previous decline.

None of this necessarily helps me decipher whether we are in a secular deleveraging cycle. But, the severity of the fall-off in consumer credit relative to output may point in this direction.

Related posts:

• Consumer credit down, but does it show deleveraging?
• Consumer credit falls 4.4% from year ago levels
• Unemployment claims falling faster than in half of past recessions
• Why is everyone saying consumer credit is falling? It’s not.
• Jobless claims rise slightly, weakness remains

But, everywhere I look, everybody is saying it is.

I would like to be true to the data and not just take the government’s seasonally-adjusted numbers at face value.

Judge for yourself. Here’s the data:

This is what everyone is focused on – the seasonally-adjusted data. The part in red shows consumer credit down $12 billion.

But, what about the actual unadjusted data?

What do you know, it’s up $7 billion. It is indeed down $4 billion for revolving credit as banks are cutting credit card limits. But, non-revolving credit is up over $11 billion.  It was decreasing and is down 4.4% year-on-year (see the section highlighted in green above), but that ended this month.

Yes, I too believed that consumers were poised to begin deleveraging, but with stocks up 60%, interest rates at record lows, and house price declines stalled, why would you do that?

Conclusion: consumer credit is increasing, not decreasing. I wish people would actually look at the data.

The question you should be asking is not whether consumer credit is increasing, but whether it will continue to do so after August and cash for clunkers.

Sources

G.19 Current – Federal Reserve

G.19 Historical – Federal Reserve

Related posts:

• Consumer credit falls 4.4% from year ago levels
• Consumer credit down, but does it show deleveraging?
• Data on past consumer deleveraging during recessions
• Chart of the day: consumer credit growth
• U.S. jobless claims fall to 3-month low, still over 600,000

The Federal Reserve has just released the most recent data on consumer credit. The data show outstanding consumer credit falling to $2.47 trillion in August from a December 2008 peak of $2.59 trillion – on a non-seasonally adjusted (NSA) basis. That is down 4.4% from the year ago period, continuing the acceleration of the year-on-year change that has been in place for 15 straight months. The seasonally-adjusted data tells an even worse story.

Clearly, consumers are not off to the races. Nevertheless, the NSA data do show a tiny pickup in overall consumer credit, although you have to go to the third decimal place to see it (from $2.460 trillion in July to $2.467 trillion in August.  You have to question the seasonal adjustments given where we are in the business cycle. So I am not using this data set.)

I was especially interested in the Federal Reserve’s data on Q3 consumer credit since I just crunched the numbers on their quarterly data and found that deleveraging in the household sector was not preceding as quickly as I had assumed (if at all).

What I am looking for is a sign of how consumer credit is proceeding as compared to output. But since we don’t have any monthly output data, we’ll have to wait. I will just comment on the trend.

The trend is down. Because of the decline in higher than normal inflation in 2008, we saw two peaks in year-on-year growth in credit. The first was August 2007 right before the recession began, when, adjusted for inflation, total consumer credit was growing 3.6% year-on-year. This went negative, reaching a trough of –1.5% in August 2008. Before climbing to a second peak of 1.5% in December.  Since then, the wheels have fallen off the cart and we are now down 2.9% year-on-year adjusted for inflation (all of the figures are NSA).

But, remember nominal GDP is down 2.4% year-on-year through Q2.  That is the key here.  When one makes a comparison of nominal GDP to consumer credit, there had been little deleveraging through Q2 2009.  Moreover, since prices are still falling (NSA CPI is –1.5% year-on-year through August), the change in nominal GDP will be lower than real GDP for Q3.

It is still not clear to me that debt levels, when measured as a percentage of GDP are decreasing significantly. I am, therefore, much less sold on the prospect of a secular deleveraging in the household sector than I was yesterday.

And since consumer credit is much more volatile than mortgage-related debt and a much smaller percentage of household debt, I am more interested in how the mortgage market is doing.  Right now, mortgage applications are through the roof because of ridiculously low interest rates.

Source

G.19 data series – Federal Reserve

Related posts:

• Consumer credit down, but does it show deleveraging?
• Why is everyone saying consumer credit is falling? It’s not.
• Data on past consumer deleveraging during recessions
• Chart of the day: consumer credit growth
• Household debt as an indicator of secular bull and bear markets

The following is a re-print of the latest monthly newsletter from Niels Jensen of Absolute Return Partners, published with the express permission of the author. Visit www.arpllp.com to learn more about Absolute Return Partners.  You can reach the firm  by email at info@arpllp.com.

The Absolute Return Letter

October 2009

A Country for Old Men and a Bit of Samba

The Man Card “Excuse me Sir, can I see your Man Card?” The stone-faced look of the security guard at Dallas Fort Worth Airport gave nothing away and, after two days of celebrating John Mauldin’s 60^th, my brain was probably operating somewhat below full capacity. “I need to see your Man Card Sir”. Couldn’t he just go away, I thought to myself, not really sure how to deal with the situation. Suddenly his face cracked wide open and in the broadest possible Texas drawl he said: “With those pink socks on Sir, I need to make sure you are a man”. Welcome to Dallas!

The highlight of the weekend was a two hour roundtable discussion on Saturday afternoon where John had asked 15 of his friends and business associates to share with the group what their fears and hopes were for the next 15-20 years. I duly noted that the issues on the minds of our American friends are not at all dissimilar to what we worry about in Europe – our children’s welfare, unemployment, immigration, racism, the impact of technology and the aging of our society to mention but a few.

This month’s letter is about demographics and is the second in our series about major trends defining the future of the world we live in. Last month I wrote about the energy outlook, and I had an unusually high number of emails commenting on the letter. Many of them made the point that the world is in better shape than I seem to think, even if oil supplies are dwindling, as natural gas reserves are ample. We just need to switch source. Whilst I don’t disagree that natural gas seems the way forward, one should not underestimate the task ahead of us. About 2/3 of all oil is used for transportation purposes and it is an enormous task to reduce our oil dependency. It will take many, many years and cost gigantic sums of money.

It is the banks, Stupid! Back to this month’s topic – in the financial press, there has been no shortage of attempts to apportion blame for the credit crisis. Disregarding the more obvious finger-pointing (it is the banks, stupid!), there seems to be a growing acknowledgement that large imbalances in the global economy are to blame for the current mess.

Put differently, a large number of countries – mainly Anglo-Saxon in origin but also the majority of our Eastern European friends – became credit junkies and spent beyond their means, year-in year-out. Conversely countries with large current account surpluses (e.g. China, Japan and Germany) were only too happy to deliver the drug to the intoxicated.

It is therefore too simplistic to suggest that only the deficit countries are to blame. The suppliers of credit must accept that they carry no small part of the responsibility, just like the drug dealers do when supplying junkies. In the past, I have been critical of Ms. Merkel of Germany when she stated publicly that Germany should continue to do what Germany does best, and that is to export goods of high quality. The obvious point here is that if Germany pursues such a strategy, the world will be no more balanced ten years from now than it is today, and a crisis similar to the one we have just been through could happen again.

It should therefore be obvious that not only should the deficit nations become more disciplined (i.e. save more and spend less), but the large surplus nations should actually put measures in place to ensure that their citizens save less and spend more. In practice, however, that is easier said than done. Demographic forces have a much bigger say on spending and savings patterns than generally acknowledged.

The Life Cycle Hypothesis My story begins with Franco Modigliani. In 1985 he was awarded the Nobel Memorial Prize in Economic Sciences for his life cycle hypothesis which (somewhat simplified) states that spending and savings patterns are predictable and largely a function of demographics. When you are in your 20s and 30s, savings are low as much of your income is spent on establishing a family, buying and furnishing your home, putting the children through education, etc. Then comes a phase, from your early to mid 40s until just before you reach retirement age, where your savings grow significantly. The outgoings are smaller during this phase of your life as the kids have left home, and you focus on accumulating wealth to pay for your retirement. Eventually, when you retire, your savings rate turns negative as you begin to live on your life savings¹.

Empirical evidence has since shown that this is generally true both for the individual and for society at large. Obviously, you don’t win the Nobel Prize for pointing out something that can hardly be classified as original thinking, but Modigliani’s claim to fame was to demonstrate the effect this pattern has on the general economy as the population ages. Let me introduce you to a chart constructed by fellow Dane Claus Vistesen who is an economist and active blogger. He has made a solid attempt to graphically illustrate the consequences of Modigliani’s work (chart 1).

Chart 1:   Age’s Effect on the Current Account

Source: http://clausvistesen.squarespace.com

The blue line represents the current account – it is in surplus when above the red line and in deficit when below. As you can see, when a country’s population is relatively young, the country should (all other things being equal) run a current account deficit. As the population grows older, and the savings rate rises for the reasons described above, the deficit turns into a surplus until such time that the elderly begin to dominate the young at which point the surplus turns into a deficit yet again.

Our export dependency Why is all this important? Well, take another look at chart 1, but focus on the purple line instead, which represents the country’s export dependency. Translated into plain English, Modigliani’s work implies that a country with an ageing population must grow its exports aggressively in order not to build up an unsustainably large current account deficit. Unfortunately, as you can see from the shape of the curve, it is not a linear function. The problem gets progressively worse as the population ages.

Now, with most OECD countries fast approaching the danger zone where an uncomfortably large part of the population consists of old-age pensioners, how do we get out of this pickle? We can’t all export our way out of the problem. Somebody needs to buy our products. I will get back to answering this question later, but let’s take a quick look at the so-called dependency ratio first. If the ratio is, say, 30, it means that there are 30 people at the age of 65 or older for every 100 people between the age of 15 and 64 (which defines the working population).

Obviously, the higher the dependency ratio, the fewer working people there are to pay for the elderly. At some point the cost of supporting the elderly will reach a level which spells economic disaster, and some of the more exposed countries may quite simply be forced to abandon their welfare standards to cope. More about this later – let’s get some data points on the table. In chart 2 below, I have tried to keep things relatively simple. I have assumed, for example, that the fertility rate will remain unchanged going forward. This may or may not be a reasonable assumption. Only time can tell.

Chart 2:   Old Age Dependency Ratios for Selected Countries

Source: http://data.un.org/

A walk in the park The first thing that struck me when I produced this chart was how relatively benign the US outlook is. I read an awful lot of US centric macro economic research (my wife thinks too much!) and, more often than not, there is a reference to the bleak future for America given the fact that baby boomers in large numbers will be retiring over the next two decades. However, when you compare the US numbers (a dependency ratio of 19 today growing to 34 by 2050) to most other developed nations, the US demographic challenge suddenly looks like a walk in the park.

No other country is aging as quickly as Japan. Saddled with a large number of old age pensioners already (the dependency ratio is currently 35), the ratio will grow to an astonishing 76 over the next four decades. The Japanese economy has struggled to drag itself out of a slow growth environment for the past twenty years (give or take). The problems in Japan are well publicised and are often blamed on failed policy measures. I just wonder how big a role demographics have actually played in all of this and whether the Japanese mire is a sign of things to come for the rest of us?

Europe is toasted The outlook for Europe doesn’t make for pretty reading either. In fact, you can argue that we are worse off than Japan given our lower savings, and it raises some serious questions about the sustainability of our entire welfare model. The IMF has calculated that the cost of age-related spending in the average advanced G20 country will cause public debt-to-GDP to grow to over 400%, with Spain and Greece reaching over 600% unless the existing welfare model is cut back (see the April 2009 Absolute Return Letter here). For comparison, Japan has the highest public debt-to-GDP ratio today at about 225%.

As our business partner, John Mauldin, always reminds us, what cannot happen, will not. We may have to prohibit the use of condoms (not advisable for other reasons), import more labour from countries with higher birth rates (immensely unpopular) or simply reduce old-age benefits. The latter carries its own set of challenges as the political influence of the elderly is on the rise, and it won’t exactly become any easier over the next 20 years to pass draconian legislation to reduce old-age benefits. Frankly, I have no idea how we will find a way out of this pickle. But find a way we will.

BRICs versus PIGS As far as emerging economies are concerned, the outlook is considerably brighter (note the big difference between the BRICs and the PIGS in chart 2) but perhaps not as straightforward as you may think. Most investors seem to buy into the idea that, over the next few decades, emerging markets will offer better investment opportunities than more mature markets, as their economies are likely to grow much faster, and you don’t yet pay for the faster growth through higher P/E ratios. Whilst we wrestle with depressing issues such as how to pay for the credit crisis and how not to bankrupt ourselves as we age, emerging economies should benefit from a growing labour force. In fact, as you can see from chart 3, in the next few years less developed countries, which tend to have very young populations, will actually outgrow more developed countries in terms of the size of the working population relative to the total population (which is good for economic growth).

Chart 3:   Working-Age Population as % of Total Population

Source: http://data.un.org/

The growing number of workers should, according to Modigliani, be followed by stronger economic growth and rising savings. If these savings can be invested into new productivity enhancing investments, emerging economies should enjoy much higher living standards in the years to come. You may raise a hand here and say “STOP – didn’t you just argue that countries with young populations should run current account deficits and hence low savings rates?”  It is indeed correct that ‘young’ countries should, according to Modigliani’s hypothesis, not be able to generate savings rates at the magnitude we have seen coming out of South East Asia in recent years.

Cheating is omnipresent But Modigliani didn’t take cheating into account. Virtually every country in Asia has artificially depressed its currency in recent years in order to export itself to prosperity. This cannot, and will not, go on forever. As living standards rise in these countries, and domestic demand fuels economic growth, expect their currencies to appreciate against the old world currencies.

At the same time, one should not ignore the fact that not all emerging economies have young populations. I have included the four BRIC countries in chart 2 in order to make this point clear. As you can see, by the middle of the century, China and Russia will actually both have a higher dependency ratio than the United Kingdom, whereas Brazil and in particular India should continue to benefit from relatively young populations.

In a recent research paper², BCA Research analysed a number of emerging economies and found that, broadly speaking, they can be divided into 3 categories – those where the working population is peaking just about now, those that will peak in the next 7-10 years and finally those where the peak is still 15-20 years away (chart 4).

Chart 4:   Demographic Profile of Emerging Economies

Source: BCA Research

It is clear from BCA Research’s work that some countries are in much better shape demographically than others. Most interestingly, China, which everybody (well, almost everybody) raves and rants about, does not look particularly attractive. Obviously you cannot judge the investment appeal based only on demographics, but if you add to that China’s fragile banking system and a construction boom which has left most new buildings half empty and led the Chinese authorities to block local access to hedge fund manager Hugh Hendry’s website, because he had the audacity to point out the insanity of many of the construction projects in China, then the Chinese investment story loses some of its glamour.

Too much of a good thing A great growth story like China will always attract plenty of capital but, in the case of China, you can actually argue that too much capital has been attracted. As I was taught at university, economic growth loses its momentum if capital spending outgrows labour because of the diminishing return on capital. BCA has illustrated this graphically (chart 5), and it is obvious that China is attracting too much capital for its own good. You want to invest where capital is scarce, not plentiful.

Chart 5:   Capital-to-Labour

Source: BCA Research

You are therefore likely to earn a higher return on investment by investing elsewhere in the universe of emerging economies. One such country is Brazil which does not attract nearly the amount of capital that China does. I have been keeping an eye on Brazil for some time now as I am intrigued about their fledgling oil industry, and the more I learn about this country, the more excited I get. The story has not gotten any worse in recent days after the International Olympic Committee’s decision to award the 2016 summer games to Rio de Janeiro. But that is an entirely different story which I may write more about another day.

Going back to the question I raised earlier, how do we get out of this pickle? As already stated, we cannot all become exporters as we grow older and domestic demand begins to fade. The only way out, if we want to maintain economic growth, is for the younger and more dynamic emerging economies to become net importers. This will require a sea change in policy, and attitude, in those countries. Most importantly, it will require the exchange rate cheating to stop once and for all. There is no alternative, unless you are prepared to accept negative GDP growth year-in year-out. And that is no fun.

Niels C. Jensen

© 2002-2009 Absolute Return Partners LLP. All rights reserved.

See other posts I have published referencing or presenting Niels’ analysis.

• The emerging markets crisis – Nov 2008
• Do BRICs (and Germans) Eat PIGS? – Feb 2009
• Europe on the ropes – Mar 2009
• The Fake Recovery - Apr 2009
• Green Shoots or Smoking Weed? – May 2009
• Make Sure You Get This One Right – Jul 2009
• The Hamster on the Wheel – Sep 2009

Related posts:

• Chart of the day: household debt vs. savings
• Chart of the day: Savings Rate
• Low savings, high debt and interest rate policy
• Savings in America hit 5%, up from nil last year
• Jim O’Neill on the Global Economy

Bill Gross has a piece out now on Pimco’s website suggesting we are about to witness a sea change in saving and spending habits, government intervention, and a host of other issues. This is not a buy-the-dips kind of atmosphere and it will last for, oh, 20 years.

Gross says:

This “new” vs. “old” normal dichotomy was perhaps best contrasted by Barton Biggs, as I heard him on Bloomberg Radio in early 2009, when he said he was a “child of the bull market.” I thought that was a brilliant phrase, and Barton is a brilliant phrase-maker. He went on to say though, that his point was that for as long as he’s been in the business – and that’s a long time – it has paid to buy the dips, because markets, economies, profits, and assets always rebounded and went to higher levels. That is not only the way that he learned it, but that is the way, basically, that capitalism is supposed to work. Economies grow, profits grow, just like children do. I think that’s why he said he was a child of the bull market, not just because he had experienced it for so long, but also because economic growth and higher asset prices are almost invariably a natural evolution, much like the maturation of a person. That’s how people grow, and so I think Barton was saying that capitalism just grows that way too.

Well, the surprise is that there’s been a significant break in that growth pattern, because of delevering, deglobalization, and reregulation. All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it’s time to grow up and become a chastened adult; it’s time to recognize that things have changed and that they will continue to change for the next – yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.

Not exactly a bullish scenario, is it?  More here.

Related posts:

• Bill Gross: “Staying Rich in the New Normal”
• Bill Gross: Sell equities and buy Treasuries
• Bill Gross: the new normal means investors should shun risk
• Ms. Watkins, why does Charlie have lit dynamite?
• Bill Gross: Government intervention in markets will last

According to the results of a study by the Spanish savings bank Caixa Catalunya, consumption will fall 4.1% this year, making the reaction to this downturn four times as severe as during the last big downturn in 1993.  Back then consumption only fell 0.9%.

The results are not only an indication of the deteriorated employment outlook in Spain but also of pressures due to the collapse in housing and shares as well as a loss of confidence by consumers.

The greatest falls are expected in the Canary Islands (-6%), Cantabria (-5.1%), Extremedura (-5%) and Navarra (-5%).

More here in Spanish from Finanzas.

Related posts:

• House price declines accelerate in Spain
• Spain gets deflation
• UBS: ‘The disaster in Spain will continue’
• Consumer credit down a massive 33% in Spain
• Spain: Bleak forecast puts unemployment at 22% in 2010

It has been my thesis for some time that we are seeing a secular change in consumption patterns in the United States.  This will have grave implications for a world economy used to seeing the American consumer as an economic growth engine and consumer of first choice. Retail sales in the United States have fallen 10% since peaking in November 2007. Much of this decline represents a permanent fall in consumption by overly indebted American consumers.

Having finally had a chance to dissect the retail sales data from last week, I wanted to show you a few graphs which indicate how much consumption has fallen in the present downturn and what the implication is for the future global economy. But, first, I want to start with a broader discussion as to why the fall in US consumption is a longer-term change and not a cyclical one.

The Balance Sheet Recession

Numerous economies seem on the way to recovery: Germany and France, Singapore, and Hong Kong, to name a few, have all posted positive economic growth.  China looks likely to hit its 2009 growth target of 8%. But, the U.S., generally assumed to be a leader in recovery, is looking like a laggard.  Mind you, there are other laggards like Spain and Ireland too.  Why are these countries lagging?  The Balance Sheet Recession.

Nomura’s Chief Economist Richard Koo wrote a book last year called “The Holy Grail of Macroeconomics” which introduced the concept of a balance sheet recession, which explains economic behaviour in the United States during the Great Depression and Japan during its Lost Decade.  He explains the factor connecting those two episodes was a consistent desire of economic agents (in this case, businesses) to reduce debt even in the face of massive monetary accommodation.

When debt levels are enormous, as they are right now in the United States, an economic downturn becomes existential for a great many forcing people to reduce debt. Recession lowers asset prices (think houses and shares) while the debt used to buy those assets remains. Because the debt levels are so high, suddenly everyone is over-indebted. Many are technically insolvent, their assets now worth less than their debts.  And the three D’s come into play:  a downturn leads to debt deflation, deleveraging, and ultimately depression.  The D-Process is what truly separates depression from recession and why I have said we are living through a depression with a small ‘d’ right now.

Secular inflation will be non-existent

Therefore, the problem is a lack of demand for loans not a lack of supply. The Federal Reserve can print all the money it wants. But, if there is little demand for more indebtedness, it is not going to have the desired effect of permanently reflating the economy – although it can create bubbles.

The corollary of this is that inflation will be non-existent on a secular basis. For the increase in liquidity to feed into consumer price inflation, people have to actually buy more stuff.  And that’s not what happens in a balance sheet recession because people are concentrated on reducing debt and increasing savings.

Moreover, there is a huge glut of excess capacity globally now that we have had a major fall in consumption. Producers are waiting for demand to catch up with supply – not exactly the sort of situation that makes for inflation. I should point out that capacity is not fixed – it grows obsolete if unused. So, much of the investment in manufacturing capacity in China and property in America is going to have to be liquidated eventually.

But, the economy doesn’t move in a straight line. It courses through cycles. Just as we could be entering a cyclical recovery in the middle of a depression, it is altogether possible that the Federal Reserve can produce high cyclical levels of inflation despite the secular trend toward disinflation. A lot of this is likely to come through commodity prices or destruction of the currency.

For example, while the change in consumer prices has gone negative in the United States since the downturn began…

when one strips out food and energy, it has declined much less than even during the last deflation scare of 2001-2003, which caused Alan Greenspan to panic and reduce interest rates to 1%.

The discrepancy above is due wholly to changes in commodity prices.  So, if commodity prices re-assert themselves going forward, we could see a major uptick in inflation. Moreover, a fall in the value of the dollar could precipitate inflation as well.  And, finally, there is asset prices.  It is clear the Federal Reserve and the Obama Administration are targeting asset prices in order to reflate the economy. All of that stimulus can and will create cyclical inflationary forces which could be large. Nevertheless, the underlying level of demand is slack and that means secular inflation levels will remain subdued.  See my post “Central banks will face a Scylla and Charybdis flation challenge for years” for more on this concept.

This means the consumer will be under pressure

High debt and low inflation mean lower consumption growth.  It’s hard to spend more when you have a mountain of debt staring you in the face and its not getting reduced in real terms through inflation.

Look at the charts to the left.  They come from a story in Barron’s this weekend called They Shopped ‘Til They Dropped. They depict a tsunami of debt in the U.S. economy that has been building for four decades.  Even debt service levels have been inching inexorably higher since the 1980s. Clearly, the U.S. consumer is tapped out. And they are cutting consumption and reducing debt as a result.

So, for America, it is not business but consumers which are going to suffer a balance sheet recession.  In looking for evidence on Koo’s thesis, we need to look at consumption and retail sales.

Michael Shedlock recently reported on the horrible back to school sales numbers.  And Patty Edwards, a well-known Seattle-based retail analyst, was recently on Bloomberg radio with sobering anecdotal detail regarding the retail sector.  She sees no sign of an impending uptick in US retail sales and is very worried about the Christmas selling season. The audio of her conversation with Tom Keene is below (not available in the RSS feed).  It is very much in line with the balance sheet recession argument.

Shedlock’s post and Edwards’ view are very much in line with the retail sales numbers we saw late last week.  A lot of people had been looking for good retail sales numbers because they see recovery at hand.  But, the numbers disappointed, falling 0.1% from the previous month.

This puts retail sales 8.3% below year-ago levels and a full 10% below peak levels in November 2007. This is much more severe a decline than we witnessed in the shallow recession of 2001. When retail sales numbers hardly declined. In fact, on a nominal basis, they fell on a year-on-year basis only during September 2001 because of September 11th.

If one uses data both the present data series (1992 – present) and the previous data series (1967-2001), this downturn looks much more inline with the steep downturns of the 1970s and 1980s.

The key difference between then and now is the debt levels I showed you from the Barron’s article.  Let’s not forget low savings as well.

Macro Themes

One can only conclude that the asset-based economy of the last quarter century is over. It was based not just on a dubious productivity miracle but also on mountains of debt and over-consumption.  The new normal is debt reduction and savings.

What does this mean for the economy?  Here are a few macro themes:

1. Retailers are in a world of hurt, not just cyclically, but on a secular basis.  Listen to the Patty Edwards interview.  America has double the amount of retail space per capita that it did a generation ago. This is the definition of over-capacity. When a glut of supply meets a deficit of demand, you have the makings of a very bad outcome for the stocks in that sector. This is the same conclusion that the Barron’s article comes to.  The uptick in retail shares like JC Penney (JCP), Ann Taylor (ANN), and Macy’s (M) is all due to beating low earnings estimates. As a result, Abercrombie (ANF) has almost doubled. Nordstrom (JWN) is up 141% and Ann Taylor is up a massive 350%. Investors like George Soros are selling retail (Wal-Mart, Walgreen and Lowe’s).
2. Commercial Real Estate will feel the pain too. The Patty Edwards interview not only shows huge excess capacity in retail, but it shows that retailers are trying to re-negotiate contracts down.  They have Commercial REITS over a barrel because they can just threaten to close down outlets if they don’t get the contract price concessions they seek.  Back in January, I mentioned the fact that bankrupt anchor tenants like Circuit City  destroy the economics of malls for other tenants and create a domino effect.  So, if anchor retailers do not get the price concessions they want, they will shut down stores, creating a huge loss in income for all the other stores. Obviously, this will drive down the price of commercial real estate as there will be a huge glut of supply.
3. Export-oriented economies need to foster internal demand growth. Here I am talking about Germany, Japan, and China amongst the major economies.  The US consumer is out of gas and these countries are too dependent on exporting to US consumers. It is not clear who can replace her.  Certainly, the Chinese government and companies are doing their level best to foster domestic demand in China, even conspicuous consumption.  But, the Chinese are unlikely to replace Americans as the new global growth engine anytime soon.
4. The new normal is lower US and global growth. This all suggests that we are likely to see lower growth in the US and globally as a result – at least until the American consumer gets out of a hole or someone else picks up the slack.  That will likely mean we will see low-growth, short business cycles punctuated by fits of recession, all complicated by the three D’s (debt deflation, deflation, and depression).
5. One should fear a 1937-style relapse. If you recall, the Great Depression saw a major economic uptick in the years after 1932. No one would call this a boom (see the section called “recovery does not mean recovery” in my post “Economic recovery and the perverse math of GDP reporting.”) This was only a statistical recovery in the midst of a greater downturn. Eventually, stimulus was withdrawn and the economy tanked again. Richard Koo argues that Japan did not go into a 1929-style depression because it maintained much more stimulus than the US did in the Great Depression. If this stimulus is removed before the deleveraging and balance sheet repair is complete, you get a major relapse. So, beware of deficit hawks telling us that fiscal stimulus must end to eliminate deficits.  If anything, the government’s long-term deficit outlook should be eliminated via reigning in skyrocketing health care costs.
6. Banks will be in a permanent state of crisis. If we learn anything from Japan, it’s that time does not heal all wounds.  The Japanese tried to recapitalise their banking system by propping up zombie institutions.  That didn’t work.  It didn’t work in Japan in the 1990s and it didn’t work with Savings & Loans in the US in the 1980s. Why should we expect it is going to work now? But, team Obama has decided this is the way forward.  If and when an economic relapse occurs, the fragility of the banking system will be made manifest. Much of the so-called toxic assets is still on the balance sheet of American financial institutions. The same is true in countries like Germany, Spain and Ireland, to name a few. When another downturn hits, those assets will go bad and writedowns will drag down the weakest institutions.  This is the lesson of Japan.
7. Liquidate zombies while providing counter-cyclical stimulus. The banking example gives a hint to the correct policy response.  It is not a return to the bubble days of the asset-based economy.  It is not creating deficits as far as the eye can see while perpetuating overcapacity.  What policymakers need to do is allow bankrupt organizations to fail and reduce excess capacity, all the while providing enough stimulus to prevent worst-case outcomes.

When it comes to US consumers, weak spending growth will last for years. Ultimately, debt levels in the US economy must return to a sustainable level. This can happen over time, which would mean a decade-long low-growth, muddle-through economy – not a terrible outcome either for the economy or for asset prices.

Or it could happen overnight through default, bankruptcy, and liquidation – a Great Depression II scenario. The policy response in the US and elsewhere will make the difference. Right now, we are headed for a statistical recovery at best. If policymakers think we are off to the races and try to normalize policy, they will be making a heinous mistake.

Related posts:

• UK retail sales drop most in 22 years
• Data on past consumer deleveraging during recessions
• U.S. consumer spending down 1% in December
• Avoid consumer stocks
• Looking beyond the fake recovery

Many economic prognosticators believe Chinese consumption growth is key to a global economic recovery.  The US consumer, who had been the buyer of first and last resort during the bubble years, is tapped out and indebted.  The new engine of global growth must come from elsewhere.

On Friday, BBC Radio 4 released a broadcast called “Selling Cheese to the Chinese” recounting how Europeans and North Americans are aggressively hawking their culinary wares to the burgeoning Chinese middle class. For young twenty-somethings who have lost an appreciation for their own culinary history due to its suppression during Mao’s Cultural Revolution, western products have a certain appeal.

For those seeking status, there are even French wine and cheese parties designed to ‘educate’ about European culinary delights.  Some can even spend a month’s salary drinking single-malt Scotch in bars.  Welcome to the wonderful world of conspicuous consumption in China.  Is this the new source of global growth?  Western companies and entrepreneurs sure hope so because they are falling all over themselves trying to break into the Chinese market.  Personally, I am sceptical. This report tells the tale.

Have a listen below.

Source

Documentaries Podcasts – BBC World News

Related posts:

• China’s savings habit
• Conspicuous Consumption
• Folks trade down and shift to house parties to get a buzz
• The China gold announcement is not that significant
• Stephen Roach sees a W-shaped recovery for China

This comes from David Rosenberg:

Perpetuating the spending and borrowing cycle
We couldn’t believe this when we saw this quote from the U.S. Transportation Secretary (Ray Lahood) in yesterday’s NYT (page B3) on the "Cash for Clunkers" program: "There obviously is a real pent-up demand in America … people love to buy cars, and we’ve given them the incentive to do that. I think the last thing that any politician wants to do is cut off the opportunity for somebody who’s going to be able to get a rebate from the government to buy a new vehicle."

Are you kidding me? If there is pent-up demand for autos why do we need a rebate? If there are 20% more vehicles than there are licensed drivers, why the need to perpetuate this cycle of overspending? Why is it a politician’s job to create incentives to spend? Shouldn’t they be focusing their attention on health, education, defense, infrastructure, public safety, job skills and productivity growth (and perhaps the youth unemployment rate of around 20%)? We’re not exactly espousing an Ayn Rand libertarian view but at a time when the deficit is running at 13% of GDP, at what point is enough? These rebates are not manna from heaven – it’s a future tax liability to hasten a decision that the auto buyer would have made in any event.

Call this another data point demonstrating the desire to return to excess consumption and the asset-based economy of the bubble years.

More here (registration necessary).

Related posts:

• Why the personal consumption data is important to the stock market
• April U.S. retail sales: upside surprise?
• South Korea going gangbusters in contrast to UK
• Conspicuous consumption in China
• Rosenberg: ’Asia Revival May Be For Real’

Alcohol used to seen as a recession-proof good. This downturn is changing that thinking as evidence of cutbacks in spending, consumption, and on-premise drinking abound.  Back in the Spring of 2008, Nielsen conducted a bunch of surveys to see how the economy was affecting the consumption of wine and spirits.  The answer then was it was not yet a major impact. The Blog “Wine & Spirits Daily” reported:

When it comes to wine, 49% said the economy has had “no effect” on the amount they spend, while 37% said “just a little” and 13% said “significantly.” With spirits, 48% reported “no effect,” while 34% said “just a little” and 17% claimed a significant difference in spending. Beer, meanwhile, had 47% of consumers reporting that their spending hadn’t changed, while 40% said “just a little” and 13% said “significantly,” according to Nielsen.

But, by January of 2009, the industry was reporting a change in dynamic.  The Associate Press put out a story called “Is the alcohol industry recession proof?” which showed major impact being felt in the industry.  The big change in behavior is what is called off-premise drinking i.e. carry-out beer, wine and spirits instead of drinks in restaurants and bars in order to cut costs.

Consumers are eating out less as they try to save money, and when they do go, Cressy said, they’re limiting what they order. On-premise volume fell 2.2 percent last year.

Instead, people are drinking at home and buying from stores.

Off-premise volume rose 2.9 percent for the year.

So people are drinking, but they’re paring back, said David Ozgo, the council’s chief economist.

The number of drinking occasions is falling; he said he wasn’t sure yet how much they were dropping.

"They still want to have a good time, so a certain amount of those drinking occasions will be shifted to at-home," he said…

And the beer industry isn’t recession proof either, figures show. Earlier this month, SABMiller PLC, the maker of Miller Genuine Draft and Peroni Nastro Azzurro, said its beer shipments fell unexpectedly in the most recent quarter amid a worldwide slump in consumer spending.

And I know this trend has continued.  A source in the industry told me last month that her company was focusing on off-premise premium brands to add sales.  The point is to get customers to choose a premium brand in a higher price point now that they are spending less due to the off-premise drinking.

However, when it comes to beer, people are trading down. Real Time Economics says “Sorry, Bud: Natty Light Isn’t Just for College Anymore.”

Heineken sales sank 18% from the previous year in grocery, convenience and drug stores during the two-week period ended July 5, followed by Budweiser at 14%. Corona Extra sales dropped 11%, while Miller Lite declined 9% and Bud Light fell 7%. Coors Light sales held up better, falling less than 1% from a year ago.

Meanwhile, sales of “subpremium” beers including Busch, Natural Light and Keystone posted “substantial gains”, according to Ad Age, which didn’t provide the specifics.

It’s a sign that despite the cheap, frat-party image of those brands (and debatable taste), consumers are focused on one thing right now: the bottom line.

Clearly, people still want to get a buzz, but they are not willing to pay the same price for that buzz.

Nevertheless, alcohol consumption is down – not just in the US, but globally. Another source who works at a major national beer distribution center in German told me a few months ago that staff was being cut as sales are down there. This pattern In the land of Oktoberfest was confirmed by the recent report showing German beer consumption is now down. 

According to German-language weekly Spiegel, beer consumption is down 5% this year.  This decline in beer consumption in Germany is the most on record. All of the major German-owned brands are getting killed: Veltins (–6.5%), Krombacher (-53%), Bitburger (-4.6%), Warsteiner (-6.5%), König (-6.7 %) und Jever (-7 %).

There are some clear trends from the anecdotes and data; people are indeed cutting back on consumption, trading down, and going off premise.  However, the loser here is less the wine and spirits makers and more the hotels, restaurants and bars. The pullback in alcohol consumption and sales is another sign that the travel and leisure industry is due for more pain to come.

Related posts:

• Conspicuous consumption in China
• Germany: Inflation tames retail sales
• April U.S. retail sales: upside surprise?
• The Economy’s Four Horsemen
• Why the personal consumption data is important to the stock market

In talking to the FT’s Gillian Tett, Hugh Hendry of The Eclectica Fund makes the hilarious metaphor of China as Santa Claus bringing gifts to a world constrained by excessive Western government debt issuance.  But, Hendry thinks the Asian surplus countries are the most exposed and most vulnerable because they are excessively dependent on foreign demand for economic growth.  Basically, Hendry sees China as a “deep out-of-the-money call option on America.” In Hendry’s view, Santa is not coming to town. And, if he is, he’s bringing lumps of coal.

Below is the video and two others of Hendry talking China, the Fed, Bonds, and Equities.  By the way, Hendry is bearish on equities, bullish on bonds.

• Bond bull, equity bear
• The Fed hasn’t done enough
• Bearish on China and gold

Read his June newsletter and comments about deflation here at Zero Hedge.  His view puts him in the deflation camp with David Rosenberg, but Rosenberg is more bullish on Asia.

Related posts:

• Hugh Hendry: China – The Emperor has no clothes
• China issues bonds to “promote the RMB in neighbouring countries”
• China to diversify out of U.S. dollars
• Will China enter deflation?
• China sovereign wealth fund diversifies into a massive loss

The data for personal consumption came out yesterday.  However, I have not had a chance to look at the data and write a post until now.  What I see right now is not good for a sustainable recovery.  Let me tell you why and how this could impact the chances for getting a longer cyclical bull market.

Every month, the Bureau of Economic Analysis (BEA) releases a data series called Personal Income and Its Disposition. This measures personal income received by Americans and how this money is either spent or saved.  If the increase in income is good, generally that will flow through to consumption and ultimately increase retail sales and GDP.

Last year, as the recession took hold and commodity prices soared the real growth in personal income turned negative. That is to say the amount of money people earned adjusted for inflation was lower than it had been just 12 months prior.  This trend began in January 2008, just after the recession began.  Since Americans were earning less in aggregate (due mainly to inflation and job losses), they were spending less.  I like to look at the 6-month average real personal consumption expenditures (PCE) number as a proxy for the trend in American spending habits.  I compare this average to the average just 12-months prior to see if consumption is trending up or trending down.

Clearly, consumption in the United States is trending down. In fact, the average real PCE has never been negative in the studies 50 years until March 2009. Only in the early 1960s did it flirt with negative territory. It now stands at –0.7%.  Translation:  Americans are spending less.  This is true for two reasons.  First, many are losing their jobs. Therefore, personal income is under stress.  But, Americans are also saving more.  The savings rate hit 5.7% in April, the highest rate since 1995.

If you buy into Richard Koo’s balance sheet recession idea which I presented to you earlier today (see Central banks will face a Scylla and Charybdis flation challenge for years), then you should expect the savings rate to continue to march higher as consumers focus on debt reduction at the expense of consumption.

Going forward, I will be looking to highlight a statistic I follow which gets to the heart of this which I will call the Consumption to Income Gap (CIG). This statistic identifies when the rate of growth of consumption lags or leads the rate of growth of income.

In the past 50 years, the CIG turning negative has signalled impending economic weakness because the flow of causation is income to consumer spending to production to capital spending to GDP 9see my post “The Economy’s Four Horsemen” for more on that topic). But, the CIG tends to turns positive when the economy is improving and consumers no longer feel threatened.

Now, if Richard Koo is right that we are poised for a longer-term ‘balance sheet recession,’ the CIG will stay negative for a long time and the savings rate will continue to increase.  At present, this certainly what is occurring (since September 2008). However, 2001 presented a mirror image of this phenomenon. After the recession of 2001, the CIG stayed positive throughout the recession due to unprecedented monetary easing and deficit-inducing fiscal stimulus by George W. Bush. Every month showed consumption growth in excess of income growth from April 2001 when the recession actually began until July 2004, a full 32 months after the recession had ended.

When the CIG turned solidly negative in January 2006, you could have seen this as a sign of economic weakness and a harbinger of the recession which eventually came in December 2007.

My view on how to view this statistic is this:  if the CIG continues in negative territory, look to the first outcome I outlined in Central banks will face a Scylla and Charybdis flation challenge for years as the likely scenario to expect.  However, if the CIG turns positive, this would mean the reflation trade has gained traction and scenario #2 would be the likely outcome.

In terms of the rally in shares now ongoing, scenario #2 is bullish for the period after 2009 because it means the economy will be supported by ‘excess’ consumption. On the other hand, scenario #1 is not bullish because it will mean a weak economy and a potential double-dip.

Watch the Consumption-to-Income Gap.  I think it will be an important statistic to follow in terms of gauging where consumer spending is headed and what impact that will have on retail sales, company profits and stock prices.

Related posts:

• US personal income data for September shows pullback
• Do the personal income data demonstrate unbalanced reflation?
• Personal income and recessions since 1929
• Savings in America hit 5%, up from nil last year
• Americans are not increasing savings

This is the conclusion that Wachovia Chief Economist Mark Vitner draws from the very bullish consumer confidence number we have just seen.  To fill you in on the details, the Conference Board said its Consumer Confidence Index leapt from a poor 40.8 reading in April to a less poor 54.9 reading for May. This was the highest reading in eight months.  But, the present situation is terrible, 28.9.  It is expectations that are through the roof with the reading jumping over 20 points from 51.0 to 72.3.  That is a gargantuan one-month move.

Let’s remember that confidence does not translate into consumption, especially as most of the uptick here was in consumer expectations.  Nevertheless, this has grabbed the market’s attention and U.S. stocks are up well over 2% as I write this.  If you were wondering whether the powerful market rally from March has legs, this should come as proof that it does.  The S&P 500 is now above its 20-day average trendline again.

I should caution that an uptick in expectations of this magnitude has a dark side.  If the economic data disappoint in June, we could see a sharp selloff.  That makes the June data and the early July earnings reports very crucial data points.

Source

The Conference Board Consumer Confidence Index™ Increases Sharply – Conference Board

Related posts:

• Consumer confidence sinking
• Major selloff coming?
• Philly Fed survey points to manufacturing rebound
• Australia is set for a slowdown
• If FedEx is losing money, you know the economy is in bad shape

This comes from Marc Chandler, head of the Brown Brothers Harriman Currency Strategy team (emphasis added):

After today there is an important US economic report every day this week. Tomorrow’s report on the March trade balance and Wed March business inventories may help economists fine tune their expectations for Q1 GDP revisions.  Currently the data is tracking a small upward revision to the initial 6.1% annualized contraction.  With a large output gap and increasing slack in the labor market and capacity utilization rates, neither the PPI nor CPI are likely to provide much of a surprise for investors.

One report that potentially surprise the market is US April retail sales. Recall in an unusual development, the US consumption grew in Q1 09 even though the economy contracted.  The consensus calls for a flat headline reading in April retail sales, but a couple of considerations suggest the risk is on the upside.  First, at the end of last week, several–more the a dozen–US retailers raised their earnings guidance after April sales data showed American shoppers were back in the stores (after a 1.2% contraction in retail sales in March).  

Reports suggest that clothing and discretionary spending led the way.  Retail Metrics, which follows monthly sales figures, said its overall index rose 1.5%.  Of note, last year, Easter fell in March.  This year in April and this may be a consideration in year-over-year comparisons.  Also, gasoline prices rose modestly in April and this also may help inflate the headline retail sales figure.

Separately, tax refunds and the payroll tax cut may give more Americans the wherewithal to act on pent up demand.  Unlike last year’s tax cut, that was given as a lump sum payment, which did not lead to a big jump in spending, this year’s payroll tax cut will be dripped in relative small sums and may be seen a permanent tax cut and therefore may bolster spending more.

My own view is that personal consumption expenditures, which are now more than 70% of U.S. Gross Domestic Product, are at an unsustainably high rate.  However, this has been true at least since the monetary easing campaigns of Alan Greenspan in 2002-2003.  While U.S. consumption must decline relative to overall GDP over the longer term, all indications suggest this is not happening at present.  As a result, retail sales growth may contribute positively to G.D.P. in Q2 as well.

It should be clear that the Obama Administration’s economic policy is causing a return to the unbalanced global growth dynamic where U.S. consumers were the consumer of last resort, whether intentional or unintentional.

Related posts:

• Strong May auto sales are bullish for retail sales
• UK retail sales drop most in 22 years
• Retail sales: don’t be fooled
• Chart of the day: Retail Sales
• Retail Sales: a belated look at Friday’s ugly numbers

This past week, I caught an article in Wirschaftswoche (WiWo), the German Business Week, which suggested that the South Koreans were very confident about their economy and had learned from the Asian Crisis.

Just today, the South Koreans released GDP numbers that many would find amazing, showing that the economy grew 0.1% in the first quarter compared to Q1 2008 Q4 2008.  Q4 2008 was a 5.1% fall, so that’s a pretty prodigious uptick which comes largely from household and private consumption.  It certainly begs the question as to whether the Asians are ‘de-coupling,’ a term I never though I would use in a positive sense.

What is clear from the reports at a minimum is that intra-Asian trade is increasing and keeping countries like Korea from feeling the full impact of the slow down in the West. (A 30% currency devaluation helps too.)

Below is a Bloomberg video on the Korean economy:

Also, here is what WiWo had to say (my translation):

South Korea wants to present itself at the just opened Hanover Fair as a country with a promising future – and as an unbroken dynamic export nation. The worst is behind the country. But, the Koreans find one development unpleasant.

Like a ballerina, the young lady dances around in front of the black sedan of Mr. Yoo. She leads the heavy but graceful Hyundai into the car park at the Seoul Lotte warehouse and bows so deeply that her little pink hat almost touches the ground. She chirps, that she is sorry for the precious time that had to be wasted by the important Client in the queue. Yoo Jae-Wook, head of consultancy Nemo Partners, sees the ‘parking show,’ as a good sign: “Every day the same large crowd. Officially, we have crisis, but they are all go shopping! ”

South Korea, this year the official partner country at the Hanover Fair, wants to present itself to the world as a haven of stability amid the present global crisis. This is not only outdoor advertising, but is quite the mood in the country itself. The fourth largest economy in Asia has come through the global shock calm. Quite unlike the Asian crisis of 1997/98, when some Koreans even donated their gold to support the economy. “In Seoul, they are not making cuts to their quality of life,” says Kim Nan-Do from the National University in Seoul. The Koreans, according to the local Siemens boss Josef Meilinger, understand the global crisis as an opportunity: “You look at which share of the world pie you can grab now.”

Crisis? What Crisis?

What crisis überhaupt? The Koreans come to Hanover full of self-confidence: “Our economy is overcoming the global crisis faster than other countries,” said Cho Hwan-Eik, president of the trade promotion company Kotra,. “We have high-performance products, sophisticated marketing strategies, and government and businesses have relatively low debt-burdens. Indeed, South Korea with government debt of 38.5 percent of annual gross domestic product is much better than Japan, for example, with almost 185 percent. The country has dealt with the recession from just over a decade ago and it is partially immunized against new problems – at least in many Koreans opinion. “The Asian crisis has made us seem well trained. We have learned to survive,” says business consultant Yoo.

In the areas of information technology, electronics, shipbuilding and auto industries, South Korean firms are forcing their way into the world class tier, but also lately in green technologies. In addition: The banking system is reasonably stable. “In comparison to the great Asian crisis a decade ago, our banking and financial system today is less vulnerable,” says Jong-Goo Yi of the state financial oversight of FSC. At that time, many indebted Korean conglomerates like the car manufacturer Daewoo and KIA, the Hanbo steel producer as well as several banks were forced into bankruptcy or had to give up their independence. Today, however, the liquidity of the 44 major Korean corporations is “so high that these companies have even more months to survive crisis,” says Yi.

Cautious optimism in the boardrooms

It is also reassuring, according to Yi, that the Korean banks, on average, have less than one percent of their loan portfolio in “toxic” assets – they have little invested in complicated derivatives. Accordingly, the financial structure is much healthier than in Europe or the USA.

In the boardrooms of the export-dependent companies, the typical sound is somewhat subdued optimism. In 2008, the export share of the economy was about 55 percent. Now, in the face of the crisis of world trade, sensitive setbacks are threatening. “Until now we have had the rapid depreciation of the won to hold us above water,” said Ko-Yung Sang of Standard Chartered Bank in Seoul. Against the dollar, the exchange rate of the Korean currency fell by almost 30 percent in the past twelve months. So Korea’s largest car manufacturer Hyundai / KIA lost in the U.S. less than one tenth of its turnover, although the total there saw a 40 per cent fall. The worst for Korea could already be behind them. The most difficult month was January, when the Korean exports crashed 34.2 percent. Afterward, the figures have improved. In March, the trade surplus was even at a record high of 4.6 billion U.S. dollars. For 2009, the economy ministry expects an increase of approximately 20 billion U.S. dollars, significantly more than previous estimates.

Even in crisis, South Koreans can rely on their main trading partner China, which at last count bought 23 percent of all Korean exports – 14 percent went to the European Union, and nearly ten to the U.S.. Above all, the shipbuilders were successful: Korean shipbuilders recorded a sales increase of 61 percent in March.

Such export power could ensure that South Korea’s recession in 2009 is relatively mild with a fall of minus two percent, the government previously estimated. Some prognosticators still hold a crash of up to six percent possible. The FKI Industries notes, however, that the mood among business people has improved significantly. “The downturn will lose significant momentum,” said JP Morgan economist Lim Ji-Won Lim. He holds a recovery already this summer for possible.

Need for social consensus is growing

Koreans feel uncomfortable, however, with the development of its labor market – despite the fact that other industrialized countries might be jealous at the figures. The unemployment rate has gone since February 2008 from 3.5 to 3.9 percent. Especially small and medium-sized enterprises should cut some 200,000 further jobs, which would bring the rate upward a further percentage point.

Therefore, the need for social consensus is rising. Entrepreneurs, workers and government have agreed on a program “to share the social pain.” In many companies the employees take up to 30 percent wage cuts. Managers voluntarily reduce their salaries, officials waive ten percent of their salaries and donate the money for the needy. Several unions, in fact notorious for militant strikes, want to work, fighting to forgo wage increases – in exchange for guaranteed jobs and recruitment.

In addition, the government is on a major stimulus program: 25 billion euros – about 2.5 percent of gross domestic product – to keep the economy on track: “The main objective is the preservation of jobs,” President Lee Myung-Bak announced.

The same applies for the job of dancing white car park in the Lotte department store. Strikingly, many customers pay with cash coupons, which the State distributed as part of the economic program to 2.6 million poorer citizens.

Watch developments in Korea. If we do see de-coupling oin the way up, it is going to be in countries like Korea where the upswing will happen first.

Source
Südkorea gibt sich auf der Hannover-Messe krisenresistent – WiWo.de

Related posts:

• South Korea going gangbusters in contrast to UK
• Asia is de-coupling
• Trade flows in flux: is this re-balancing?
• Pesek: Asia is de-coupling
• China warns that the west’s quantitative easing is inflationary

James Montier has a very good piece out via John Mauldin (JohnMauldin@InvestorsInsight.com) on the need for real economy stimulus over financial sector stimulus.

The quote I find most memorable goes to the heart of our debate about the financial system:

Investors seem to be rather excited about banks posting profits at the moment. Frankly, if a bank didn’t post a profit in this environment it should be shot out of kindness. The environment for profitability from banks has rarely been better, but that doesn’t make them solvent.

I thought the piece important enough to post parts here with a few comments. The original is on John’s site at the link at the bottom of this post.

As Albert and I regularly point out during meetings, we have never been more unsure on the inflation/deflation outlook. I have previously said I was torn between the deflationary impact of the bursting credit bubble, and the inflationary pressures of the policy response. When we read something by the deflationists we sit there nodding our heads in agreement, then we pick up something by the proponents of a return of inflation and we find ourselves agreeing with that as well. The respective sides seem deeply entrenched in their positions.

In contrast, we are trying to keep an open mind on the subject. Albert is biased towards a Japanese style outcome, and I am biased towards an inflationary outcome, but neither of us has any strong conviction.

Fisher and the debt-deflation theory of depressions

In the face of this uncertainty I decided to return to history and see what it has to say about the way out of a depression. My first point of call was Irving Fisher’s “The debt-deflation theory of Great Depressions” published in 1933¹. Fisher is probably most infamous to those in finance for his pronouncements of a new era of permanently high stock prices in 1929. But in the wake of his disastrous calls he turned to trying to understand the experience of the depression. Incidentally, he also invented the Rolodex.

In his debt-deflation theory, he posits “two dominant factors” in driving depressions “Namely over-indebtedness to start with and deflation following soon after… In short, the big bad actors are debt disturbances and price-level disturbances”. He continues “Deflation caused by the debt reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debt cannot keep up with the fall of prices which it causes. In that case, the liquidation defeats itself. While it diminishes the number of dollars owed, it may not do so as fast as it increases the value of each dollar owed.” That is to say, debt-deflation spirals can easily become self-reinforcing.

The good news is that Fisher is also very clear on how to end a debt-deflation spiral: “It is always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors… I would emphasize… that great depressions are curable and preventable through reflation and stabilization”. The irony of Fisher’s route out of deflation is that, probably only the Fed – after helping lead us into this mess² – can now get us out of it.

I am very much in the same situation as Edwards and Montier — struggling with the arguments for and against deflation versus inflation. At this juncture, it is far from clear where things are headed going forward. While I leaned toward deflation up until recently, the balance is tipping in the other direction for me right now.

You should note that the concept that easy money is a viable way out of a deflationary spiral is considered heresy in Libertarians circles. However, this is essentially what Irving Fisher has suggested. More to the point, he also says that one needs to fix the real economy first. People don’t buy things when they don’t have jobs. This one reason that increasing wages should be central to economic policy right now.

Montier uses an analysis by Christina Romer, the head of Barack Obama’s Council of Economic Advisors, to make his points. In discussing this with Marshall Auerback, he took issue with her underselling of fiscal stimulus. To his mind, fiscal stimulus is more important than monetary. Nevertheless, I think much of what she has to say is spot on. Below I have highlighted the bits I find most important.  In a nutshell, they are:

• The Great Depression’s fiscal expansion was small
• Printing money can break the deflationary spiral (this is essentially Paul Krugman’s philosophy.  I am instictively negative about the concept of easy money being used as a mechanism to stop a deflationary spiral, but this is the path we are on.  Call it an ideological bias on my part.
• If you stimulate, you cannot undo it overnight.  This was the mistake in 1937 and in Japan in 1997 (see my post, “Beware of deficit hawks“)
• The most important point as I see it is the need to get the real economy going.  In my view, this means increasing wages.
• Competitive currency devaluations ca actually be beneficial by creating inflationary expectations.  I am skeptical here.

Romer’s lessons from the Great Depression

After reading Fisher’s analysis of the 1930s, I came across a recent speech given by Christina Romer, who is now the head of the Council of Economic Advisers, and who made her name in academic circles studying the events which ended the Great Depression. In the speech, Romer offers six lessons from the Great depression for the current juncture.

Lesson 1 – Small fiscal expansion has only small effects

Romer wrote a paper in 1992³ arguing that fiscal policy was not the key driver in the recovery from the Great Depression. Not because fiscal expansion is ineffectual per se, but rather because the fiscal stimulus that was conducted wasn’t large. As Romer notes “When Roosevelt took office in 1933, real GDP was more than 30% below its normal trend level… The deficit rose by about one and a half percent of GDP in 1934″.

Lesson 2 – Monetary expansion can help heal an economy even when interest rates are near zero

Romer notes that actually it was the Treasury rather than the Federal Reserve that drove the monetary expansion (a peculiarity of the system under the Gold Standard). In April 1933, Roosevelt suspended convertibility to gold on a temporary basis, and the dollar depreciated. When the US returned to gold at the new higher price, gold flowed into the US, allowing the Treasury to issue gold certificates which were interchangeable with Federal Reserve notes. As Romer notes “The result was that the money supply, defined narrowly as currency and reserves, grew by nearly 17% per year between 1933 and 1936″. Romer argues that this “Devaluation followed by rapid monetary expansion broke the deflationary spiral” – empirical evidence to support Fisher’s hypothesis outlined above.

Lesson 3 – Beware of cutting back on stimulus too soon

The monetary expansion seems to have produced remarkable results in terms of real growth: the US economy grew by 11% in 1934, 9% in 1935 and 13% in 1936 in real terms. This lulled the authorities into thinking that all was well with the system again. Hence, in 1937, the deficit was reduced by approximately two and half percent of GDP. Monetary policy was also tightened, as Romer notes “The Federal Reserve doubled the reserve requirement in three steps in 1936 and 1937″. She concludes “taking the wrong turn in 1937 effectively added two years to the Depression”.

Lesson 4 – Financial recovery and real recovery go hand in hand

Romer points out the inseparable nature of the real and financial recoveries. This meshes with our analysis that the banks aren’t really the problem in a debt-deflation environment, rather they are a symptom of the problem. The current policy in the US seems to be aimed at “fixing the financial system”, witness Bernanke’s recent comments “Recovery is not going to happen until the financial markets and the banks are stabilized”. This appears to be a misperception, as, Romer notes “Strengthening the real economy improved the health of the financial system. Bank profits moved from large and negative in 1933 to large and positive in 1935, and remained high through the end of the Depression”.

Investors seem to be rather excited about banks posting profits at the moment. Frankly, if a bank didn’t post a profit in this environment it should be shot out of kindness. The environment for profitability from banks has rarely been better, but that doesn’t make them solvent. If you were starting a business today, then setting up a bank would be a very attractive option. However, history – as represented by the balance sheet – cannot simply be ignored when it is inconvenient. As John Hussman noted “The excitement of investors last week about Citigroup posting an operating profit in the first two months of the year simply indicates that investors may not fully understand the term “operating profit.” Citigroup could burst into flames while Vikram Pandit sells lemonade in the parking lot, and Citi would still post an operating profit. Operating profits exclude what happens on the balance sheet.”

Lesson 5 – Worldwide expansionary policy shares the burdens

Given the worldwide nature of the current slump, Romer makes an interesting point on the effectiveness of competitive devaluations, “Going off the gold standard and increasing the domestic money supply was a key factor in generating recovery… across a wide range of countries in the 1930s… These actions worked to lower world [real] interest rates… rather than just to shift expansion from one country to another“.

This is something that Albert and I have been discussing of late. We have been pondering the possibility of competitive devaluation (obviously ultimately a zero sum game in terms of exchange rates) having enough of an impact on local monetary creation to increase inflationary expectations, thus helping countries reflate. It appears as if Romer has sympathy with this view.

Lesson 6 – The Great Depression did eventually end

The final lesson that Romer offers may be of use to investors at the current juncture. She makes the point that the Great Depression did finally end. As Romer puts it “Despite the devastating loss of wealth, chaos in our financial markets, and a loss of confidence so great that it nearly destroyed American’s fundamental faith in capitalism, the economy came back. Indeed, the growth between 1933 and 1937 was the highest we have ever experienced outside of wartime. Had the U.S. not had the terrible policy-induced setback in 1937, we, like most other countries… would probably have been fully recovered before the outbreak of World War II” This is a reminder that the current obsession with no scenario being too pessimistic is probably ill advised.

I am going to stop here. But, Montier’s post has much more to it, so if you want to read it, click the link below.

Source
Roadmap To Inflation And Sources Of Cheap Insurance – James Montier via John Mauldin

Related posts:

• The Japanese Problem is now ours
• Hayek: “I am not only against inflation but I am also against deflation.”
• Nouriel Roubini: Will massive stimulus ward off stag-deflation?
• Some tidbits about stimulus, recovery, and the Great Depression
• Pushing on a string and similar notions on monetary policy ineffectiveness