The Bennett Newsletter
Markets rallied last week when Dr. Bernanke said he would do all it takes to revive the US economy. This credulity amazes me. What weapons does Bernanke have left? If spending trillions in stimulus and keeping interests rates at near zero has not worked, how can a another helicopter drop of cash into selected banks do anything except further enrich the banks? You can be sure they will not help the economy by creating credit. Banks prefer to continue to buy bonds!
Bernanke can only offer more of the same medicine. The first dose alleviated many symptoms but the vast subsequent doses were of decreasing marginal utility. They wasted resources but have added massively to debt.
I stand by my prediction, made in 2008, that the future is “L”-shaped. Asset prices will continue to deflate for a long period (it was 15 years in Japan), unemployment will be stubbornly high for a decade and future growth will be very slow.
My perception is supported by compelling evidence of declining GDP, declining housing prices, and (above all) by the lessons of history.
US Growth
The Government has revised its estimate of growth in the second quarter to an annual rate of 1.6% from 2.4%. This is a huge slowdown, consistent with Citibank’s Chair saying the economy has “stalled”. There are many other signs of retrenchment. Orders for large factory goods dropped in July. Investment appears to be faltering - orders for non-defence capital goods fell 8% in July. Companies are not building up inventory, and are not hiring more labour.
Retailers are discounting heavily. Real hourly earnings are down half a percent since February. Unemployment remains near record highs, and over 39 million people are on food stamps. In California, the average per capita debt balance for people with a credit report is $78,000.
Housing
Sales of new homes were the lowest since 1963, when records began. 23% of homes with mortgages are underwater and another 2.5% have less than 5% equity, meaning they are vulnerable to further price falls. 9% of mortgages are in default, their owners 90 days late in payments. Foreclosures are at record levels.
Yale Professor Robert Schiller believes a double-dip recession is commencing and the economy is “teetering on the brink of deflation”. He also believes house prices will decline for another 5 years. He is concerned about unemployment and thinks employing another person for every class room would be useful.
History
In a new paper, Carmen Reinhart caused considerable debate at Jackson Hole by insisting that the financial shocks since 2007 will inflict painfully slow growth and high unemployment on the US for a decade or longer.
Reinhart drew on the evidence in her book, “This Time is different”, joint authored with Kenneth Rogoff. The latest paper examines 15 severe crises since 1945, plus the 1930’s depression. It showed that shocks have enduring effects.
In the decade following a crisis, growth rates are significantly lower and unemployment is significantly higher. Housing prices take years to recover. Households and companies take around 7 years to reduce their debt and restore their balance sheets.
The big lesson of history is that crises were preceded by a decade-long expansion of credit and borrowing and retrenchment took almost as long after the crisis.
“Large destabilizing events, such as those analyzed here, evidently produce changes in the performance of key macroeconomic indicators over the longer term, well after the upheaval of the crisis is over,” Ms. Reinhart wrote.
Ms. Reinhart added that officials may err in failing to recognize changed economic circumstances. “Misperceptions can be costly when made by fiscal authorities who overestimate revenue prospects and central bankers who attempt to restore employment to an unattainably high level,” she warned.
Cycles
I have done some academic work on cycles. For example, there have been several secular bear markets since 1900:
1901-1920 (20 years)
1929-1932 (4 years)
1937-1941 (5 years)
1966-1981 (16 years)
2000-Present (10 years>)
My work on the 30 year Kondratiev wave, focused on the long depression in New Zealand c.1873-1895 during which there was fierce deflation.
I looked at the evidence again recently and developed the working hypothesis that the second Kondratiev is more destructive: 1815, 1870, 1930, and 2007 (?). The intervals is around 60 years + or – 10.The three preceding doubles were very destructive and this one could be worse because the financial part of the economy have grown exponentially.
Massive deleveraging is taking place in many assets, including housing and commercial property in US, UK and New Zealand, in many securitized products such a mortgages held by many institutions and of course the Fed. Moreover Government indebtedness has reached unsustainable levels in Japan, the US UK and much of Europe. These societies will suffer fiscally to repay this debt and also forgo many services. Moreover, debt competes with new investment. This scales down growth of business and may limit yields on equities.
It is possible to have brief rebounds in a downturn, but the trend remains bearish until deleveraging is near to complete.
Trichet
As Japan’s experience is looking more relevant to the US, Jean-Claude Trichet, President of the European Central Bank has started to warn of “lost decades”. He warns governments that they risk a decade of low growth if they delay reversing the surge of public debt resulting from stimulus and rescue operations.
Rather than stimulate now as the Fed is inclined to do, Trichet says the lesson of history is to reduce debt as a precondition of a sustainable recovery. To avoid this is to endure a lost decade.
At present (Trichet says) consumer, business and public debt ‘bears the ultimate responsibility for slowing the economic recovery”. He insists that debt reduction is necessary for growth and stability. He estimates that public debt has risen 20% in the Euro area since 2007 and 45% in Japan and the US.
He virulently attacks the American notion of spending now, while ignoring debt accumulation. That policy is “very dangerous for our economies”. Japan adopted it and paid the price. Temporizing created uncertainty. It is best to adopt an ambitious fiscal consolidation and price stability.
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