Back in February, I asked you if we were experiencing a recession or depression. A plurality said it was a depression with a small ’d.’ I agreed and went on to explain why. Since then, things have changed and we seem to be on the verge of what I call a technical recovery (or a fake recovery – take your pick). We may even be on the verge of a multi-year economic expansion – something bears like David Rosenberg should not rule out. But vigilance is still required. I will explain why.
Since the recovery talk has gathered steam, a lot of well-respected economists and policy makers have begun to construct what I consider a revisionist history of events. It goes something like this:
We have just experienced a major economic downturn. Coupled with a financial panic of major proportions, the global economy suffered a severe shock. However, we have learnt how to deal with such crises due to our experiences during the Great Depression. The liquidity crisis was overcome through deft monetary policy. And fiscal expansionary policy aided a return to business as usual much sooner than many would have believed.
As a result, it is quite obvious we have been through a severe contraction, but nothing more than a garden-variety recession complicated – of course – by a financial panic. Back in February, a lot of economists made alarmist predictions of woe, foretelling a global Depression. This was wrong-headed and reckless as we see today. GDP has likely turned up in this third quarter and will continue rising for the foreseeable future. With the worst of things behind us, we can normalize monetary and fiscal policy and return to a more robust economic path.
On the surface, this narrative is compelling. But, I believe it is based on a flawed analysis. I would like to present a different narrative here for you to dissect.
GDP is a poor measure of growth
As Joseph Stiglitz recently wrote, GDP is a very poor measure of growth and economic health. And he is right. There are many questions of statistical accuracy in its measurement. But, more than quantity, I have problems with GDP as a measure because of quality. Robust 4% growth that is underpinned by savings and capital investment is not the same as robust 4% growth underpinned by debt and consumption.
The problem I have with the recent history of growth in the United States, the United Kingdom, Spain and Ireland in particular is that the growth was underpinned by high debt accumulation and low savings. As debt is a mechanism through which we pull demand forward, the debt and consumption has meant we have been growing today at the expense of future growth.
Low quality growth can go on for a long time
This dynamic can continue for a very, very long time. In the United States, by virtue of America’s possession of the world’s reserve currency, an increase in aggregate debt levels has been successfully financed for well over twenty-five years. Mind you, there have been a number of landmines along the way. But, time and again, these pitfalls have been avoided through asymmetric monetary policy and counter-cyclical fiscal expansion.
So, poor quality growth can continue for very long indeed. And it is this fact which allows the narrative of easy money and overconsumption to gain sway.
The boy who cried wolf
A soothsayer who counsels against this type of economic policy, but who warns of impending collapse will surely be seen as the boy who cries wolf. Think back to 2001 or 2002. Did we not witness then the same spectacle whereby the bears and doomsayers were let out of their holes to warn of impending doom from reckless economic policy? By 2004, unless these individuals changed their tune, they were long forgotten or even laughed at – only to resurface in 2007 and 2008 with their new tales of woe. Knowing this shapes the psychology of economic forecasting and is why missing the turn is disastrous for one’s career. Efforts to avoid missing the turn are also part of a very large pro-cyclical psychological force underpinning a cyclical bull market.
The fact is: low quality growth does not lead to immediate economic calamity. It can continue through many business cycles. Even today, it is wholly conceivable that we could experience a multi-year economic expansion on the back of renewed monetary and fiscal expansion.
Marc Faber: “Don’t underestimate the power of printing money”
You will recall that I wrote a post at the depths of the market implosion highlighting a phrase by Marc Faber, “Don’t underestimate the power of printing money.” This quote has stuck with me as asset markets have soared in the intervening time. What Faber was alluding to was the fact that printing money works. It does goose the economy as intended and it can induce a cyclical recovery.
Nevertheless, the recovery is likely to be of poor quality due to significant malinvestment. Debt levels will rise and capital investment will be directed toward riskier enterprises. Look at what’s happening in China. Are you telling me stimulus is not working? It most certainly is.
In the west, stimulus is also working. It is designed to stop people from hoarding cash and to consume. It is also designed to get people out of savings accounts and into riskier asset classes. it is doing just that. In response to a Spanish-language article on just this topic, I wrote in today’s links:
Europeans are abandoning savings accounts in favour of riskier assets as low interest rates have created a liquidity-seeking-return dynamic. This is true as much in the US as it is in Europe and it proves that a wall of liquidity can induce a cyclical recovery based on asset price inflation aka the fake recovery. The question is what comes next?
Liquidity is seeking return. It is pure speculation whether the upturn that underpins this dynamic has legs. I see an even chance that it does, which is why, despite my recent mild bearishness, I am a lot more upbeat about the economy and markets than a lot of others in the blogosphere.
So where does that leave us?
The outlook is unclear. The Obama Administration looks ready to take a victory lap judging from recent statements. Officials say they are also withdrawing liquidity in anticipation of an upturn in the economy (though some believe these claims exaggerated). So, that is the one side – which Goldman’s Jim O’Neill takes.
On the other side of the argument is the fact that employment is still weak and incomes are down – the most since the Great Depression. After a decade with no income gains and still weak employment prospects, the ability of households to refuel a debt-induced upturn seems limited – as the recent data on consumer credit demonstrates. This is the side that David Rosenberg takes.
I take neither side. I am just not that clairvoyant. Both scenarios are plausible outcomes. But, I am still very worried about the low quality of any growth we will get in an upturn and the widening gulf of economic fortunes that result. I am equally worried about how even a low quality upturn will sap the will for reform in the financial arena. Mostly, I am worried that the eventual collapse – if it doesn’t happen now – will be much worse when it does happen.
Please listen to the half-hour audio clip with Marc Faber from yesterday. He does an excellent job of giving voice to some of the ideas I just laid out in his usual semi-apocalyptic style. The clip comes via Bloomberg’s On the Economy podcast, a show I recommend highly. Click here for the show’s webpage and instructions on how to listen to broadcasts.
(mp3 Audio embedded below)
Update 07 Feb 2010 – Note: as this post is from September 2009, the audio clip is no longer available. If I wrote it today [February 2010], I would be more bearish medium-term because it is obvious that in 2010 fiscal and monetary policy will become less supportive of recovery. Political pressures to remove fiscal and monetary stimulus are too much to bear. As a result, I give a double dip recession slightly better odds than a multi-year recovery now. But the analysis framing my thinking is largely the same.
For a precursor post, see “The Fake Recovery” from May 2009. For a more updated view on the same themes see, “The recession is over but the depression has just begun” from October 2009, “I am now moving from multi-year recovery to a double dip baseline” from November 2009 and “Moving away from stimulus happy talk to focus on malinvestment” from December 2009.