Tim Duy: Not So Bad?

Tim Duy gives and answer to Brad DeLong's question:

Not So Bad?, by Tim Duy: Brad DeLong is puzzled. Earlier this week, defending Greenspan-era monetary policy,

Now we are not yet out of the woods. If the tide of financial distress sweeps the Fed and the Treasury away--if we find ourselves in a financial-meltdown world where unemployment or inflation kisses 10%--then I will unhappily concede, and say that Greenspanism was a mistake. But so far the real economy in which people make stuff and other people buy it has been remarkably well insulated from panic at 57th and Park and on Canary Wharf.

Today Delong adds:

I still do not understand why the real side of the economy is doing so well in relative terms. The worst financial distress since the Great Depression ought to trigger the worst downturn in demand, production, and employment since the Great Depression. It hasn't--at least not so far.

Good questions; I think economic activity has surpassed most peoples’ expectations. My answer to DeLong’s question comes in three parts:

1. The nature of the expansion defines the nature of the following contraction. The post-tech bubble expansion was anemic by most measures, and never gained much traction until the housing bubble arose. The primary channel through which housing supported the economy was via consumer spending, generating a tepid growth dynamic compared to the equipment and software investment boom of the 1990’s. The tepid upside suggests a tepid downside. I would be more worried if the chart for equipment and software:

looked like the chart for residential investment:

And given trends in new orders, I am hoping it won’t:

2. The impact of the consumer slowdown is partially offshored, a point which I think deserves greater attention. This shifts job destruction to an overseas producer. In fact, as spencer at Anger Bear shows, the recent improvement in the real trade balance has less to do with rising exports, which continue to follow recent trends, than the sharp slowdown in real import growth. Note too that exports are not falling as they were in the 2001 recession as the global economy has held up better than expected.

3. Perhaps most importantly, however, is the massive liquidity injections from the rest of the world, or what Brad Setser calls “the quiet bailout.” In the first half of this, global central banks accumulated $283.5 billion of Treasuries and Agencies, something around $1,000 per capita. This is real money – I outlined the likely implications in January. Foreign CBs are happily financing the first US stimulus package; will they be happy to finance a second? Do they have a choice? Their accumulation of Agency debt is also keeping the US mortgage market afloat. Do not underestimate the impact of these foreign capital inflows. If the rest of the world treated the US like we treated emerging Asia in 1997-1998, the US economy would experience a slowdown commensurate with the magnitude of the financial market crisis. The accumulation of US assets is also forcing an expansion of foreign CB’s balance sheets, creating global monetary stimulus that allows the rest of the world to decouple from the US economy, supporting continued US export growth (see point 2 above).

Ideally, the slowdown remains moderate, allowing for a rebalancing as we expand export and import competing industries domestically, narrowing the current account deficit and eliminating the necessity of foreign official financing. This means accepting a period of time with suboptimal domestic demand growth and structural adjustment. Excessive fiscal stimulus risks testing the willingness of foreign CBs to continue to accumulate US assets. Moreover, I believe that excessive stimulus will eventually foster a more damaging inflationary dynamic, but such a process would likely build over a long period of time – the seeds for the 1970s were planted in the 1960s.

In short: External dynamics play a significant role in explaining the relatively mild US downturn. As long as foreign CBs are willing to accumulate US debt, the US government is willing to issue debt, the Federal Reserve is willing to accommodate the debt with low interest rates, we will avoid the most dire deflationary predictions.

Comments

[spencer]

We also have the impact of the great moderation so that firms have kept their inventories in good shape and as of yet have not had to liquidate inventories. The great moderation sharply reduces the probability of a classic recession.

[robertdfeinman]

I guess well-fed economists don't have too much personal experience with loan sharks. The sharks are lending US banks money at favorable terms, but what you have to pay back accelerates later.

These investors aren't interested in the nominal 7% or whatever they are getting at the moment, they are interested in the influence they will have later on.

Look at the history of oil production. During the first phase western oil firms controlled the resources and did the processing. They paid a nominal amount to the host countries.

Now the vast majority of oil resources are owned by the countries themselves and the western firms are reduced to taking on just a service function, while the big profits go elsewhere.

Wait a few years and see what the IPO's and buyouts managed by US firms look like. Who will be getting the lion's share of the revenue from the deals?

[Michael McKinlay]

It works until it doesn't ...

What I believe we will see is that ( for practical purposes) we've reached peak oil and that implies peak real credit and therefore peak real money. Going forward there will be lower highs and lower lows in world GDP.

At some point the model will snap as fractional reserve banking implodes. Then we will see how the lack of redundancies in the system ( just in time theory ) serve us.

In the meantime inflation is destroying the consuming class around the world.

[Ryan]

Other countries exported deflation for awhile, we happily exported debt, now the relationship is a inflation-risk tradeoffs. As usual, I think America is getting the better deal.

[ilsm]

There is plenty of liquidity and some of it is finding its way to productive investments.

It may be whatever the liquidity trap it is limited in scope.

As to peak oil.............

If I were a Saudi prince with large US D holdngs I would corner the market on research in renewable energy.

The world demands an endless supply of energy.

Peak oil opens the door for other sources of energy.

When peak oil crashes the party, some will make a lot of money and the world will grow on new power, hopefully green, sources.

In the mid 80's oil prices declined to less than $20 (it cost about $5 to deliver Saudi crude to the tanker) a bbl. This killed the motivation in the US for alternatives, and conservation.

Peak oil will be good if it means that so much oil is demanded versus economic supplies that the low cost producers cannot drive the price of the narcotic down to keep the addict coming back.

The next bubble, thanks Onion, needs to be in US technology for new energy sourcing.

[Michael McKinlay]

ilsm says...
"There is plenty of liquidity and some of it is finding its way to productive investments."

Most of the money being invested these days is vulture capital trying to pick up cheap assets. But this is a tricky business as the Saudi's found out with Citi. There is very little investment going they way of new productivity, most is capital preservation.

With peak oil upon us the demand destruction in the world economy will be staggering and the consequences terrible. To date there is no major government planning for the coming energy shortages.

[Dickeylee]

Our national debt is pushing 10 Trillion $$, gas is over $4/gal, real inflation is near 9%, the gov't is bailing out the banks to the tune of tens of Billions, etc...but things ain't that bad? WTH-markets up 3 days in a row, so break out the bubbly?

[Sandman]

Duy, Duy, Duy you better than anyone should know this is just the beginning. Watching the global boom go bust will be far worse.

2nd half GDP will be slammed globally. You take the guess what will happen after that?

[don]

"If the rest of the world treated the US like we treated emerging Asia in 1997-1998, the US economy would experience a slowdown commensurate with the magnitude of the financial market crisis."
I doubt it. If foreign official dollar purchases slowed, interest rates would rise, but the attendant improvement in the current account balance would more than offset the contractionary effect of the rise in interest rates. (BB curve shifts back, dollar depreciates, IS curve shifts outward, interest rates and output rise.) It would be like a huge fiscal stimulus package. The economies of the purchasers would slow markedly, however.
Why do I always see claims that reductions in official purchases abroad would slow the U.S. economy? Where is the model behind this? It certainly flies in the face of the standard Keynesian analysis, which would say the intervention is shifting demand from the U.S. abroad, ala the old 'devalue your currency and export your unemployment' strategy.

[Hidden Effects]

How could it be so bad when every failure is bailed out with more easy money? The Fed balance sheet hides some of the losses that will come due. As usual, almost no one sees the hidden effects, which take time to show up.

No surprise Delong and other promoters of Greenspan's easy money at every turn cannot see it as a mistake. What Warren Buffet called the greatest transfer of wealth in history is something these economists do not even begin to understand.

[Michael McKinlay]

Hidden Effects

The more successful the economist the more he takes at face value. It is inherent for success in politics and economics that the truth be camouflaged from the public.

There are some glimmers though, Stiglitz for one.

[anon]

"Why do I always see claims that reductions in official purchases abroad would slow the U.S. economy? Where is the model behind this?"

hear, hear!

[Movie Guy]

I read Brad's post earlier today...and now Tim's.

When a national economy is this early in the first stage of major downturn, how are such observations of any meaningful value?

All is not well. Anyone who suggests that it is has no clue as to the scope of the problem within the financial markets. I spent a few hours with senior bankers of a major national bank on Thursday, listening to their issues and anticipated consequences of the undoing of key banking laws or provisions thereof. Now, to brush that off is foolhardy...should anyone attempt to do so.

The bottom line fallout from the volume of on balance sheet and OFF balance sheet debt that must addressed by the nation's banks has yet to be observed because we're early in the cycle of dealing with the debt coverages. Very early, so DeLong's thinking is perhaps well ahead of what may follow.

The operational economy - one based on wholesale, intermediate, and retail sales - is quite different than the financial investment side of the economy. We have already noted the reduced availability of credit being extended to business customers and therein lies some tightening not yet visible across the board. Consumer credit has taken its hits, but again there will more to come.

The crisis is still in the first quarter of play. In fact, only a few series of downs have occurred. Trying to predict the outcome of the game at this stage would be laughable.

This is a very serious crisis. And any attempts to generate support for the operatives - Greenspan, Congress, banks - in the conduct of their affairs during the past business cycle is over the top in my judgment. Collectively, they created the conditions along with U.S. trade policy to cause the crisis in the financial markets. Those who disagree will likely have the opportunity to read well documented reports later which will connect some of the dots.

Businesses will fail. Banks will fail. And the nation's citizens will be demanding that the Congress take action to prevent this level of stupidity, theft, and gross negligence going forward.

Why should anyone be surprised that the operational economy is still functioning reasonably well when the Fed actions of lowering short term interests to save the financial system has not negatively impacted general business operations? Therein lies the saving grace, however temporary as it may be.

Moreover, the notion that U.S. exports will keep growing substantially while it is based on a limited scope production platform and is meeting with a shrinking global economy (other nations' economies are slowing as well) makes little sense. The growth will slow as well unless the U.S. Dollar continues to implode, and if that happens it is not favorable news.

Some need to sit back and watch the movie a little longer. The opening credits are about to end. Much more to come.

[Gegner]

Well said, Movie Guy!

[reason]

Don (& anon)
Surely you have heard of the J-Curve. There is a difference between short run and longer run effects. You need only to check out the economic history of (say) Indonesia or Argentina to understand what might happen.

[Blissex]

«These investors aren't interested in the nominal 7% or whatever they are getting at the moment, they are interested in the influence they will have later on.»

It is also industrial policy and an export subsidy for the Chinese. They could subsidize exports to the USA directly, but then WTO rules prohibit that, so they just subsidize the buying of those exports by keeping the dollar high and USA consumers flush with loans.

Subisidizing export prices is more precise than subsidizing the incomes of importers, because the latter benefits all exporters.

But the Chinese leadership know that the former can't be done, and anyhow the latter effect is small, because Chinese exporters are by far the biggest beneficiary of a strong dollar policy fueled by the Bank of China, one that also leads to the destruction of the production base of the USA and to very cheap capital exports from the USA to China.

As long as it is mostly Chinese exporters that benefit from Chinese indirect export subsidies, China will continue to accumulate reserves and buy USA IOUs with them.

[Blissex]

«At some point the model will snap as fractional reserve banking implodes.»

Ah but in the USA fractional reserve banking apparently has been all but abolished. I have always wondered why in early 1995 most financial indicators have started going up, and at a much faster rate than trend. Consider for example these two "blue chip" stocks:

http://finance.yahoo.com/q/bc?t=my&l=off&z=l&q=l&s=IBM
http://finance.yahoo.com/q/bc?t=my&l=off&z=l&q=l&s=PG

This happened perhaps not coincidentally not long after Newt Gingrich (and Alan Greenspana) took control of government.

Well, thanks to Barry Ritholtz for this first clue, the colossal increase in stocks purchased with margin:

http://bigpicture.typepad.com/comments/2007/10/margin-debt-gro.html

but where did all that credit come from? This post from a gold bug refer to a rather interesting article by Luskin (I am not joking... He did write once something that is not just stupid propaganda):

http://www.signallake.com/innovation/FedReserve1995.pdf
«The key event that happened around 1995 is that the fractional reserve ratio was not only lowered, it was effectively eliminated entirely. You read that right. The net result of changes during that period is that banks are not required to back assets which largely correspond to M3 or "broad money'' with cash reserves. As a consequence, banks can effectively create money without limitation. I know that sounds hard to believe, but let's look at the facts.»

[Blissex]

«And the nation's citizens will be demanding that the Congress take action to prevent this level of stupidity, theft, and gross negligence going forward.»

Grossly overstimating usians here. The 60% who think they will get into the top 1% of rentiers will instead demand to get a bigger cut of the "stupidity, theft, and gross negligence", because they think that they are WINNERS, and in the USA winners get bailed out by government welfare.

Average Usians have nothing against "stupidity, theft, and gross negligence", they just want more of that to go into their own pockets.

Thus all the demands for bailing out first shareowners and then homeowners, and anything to stop share and house pricing to revert to the mean.

[ndd]

Elsewhere I've described this situation as a Neutron Bomb over Wall Street".

So little ol' non-economist me a few months ago makes the heretical suggestion that allowing some big players in the financial sector to fail might just not cause The End of The World for the actual productive economy -- and here is some real world information suggesting that may be exactly so.

[Blissex]

«Average Usians have nothing against "stupidity, theft, and gross negligence", they just want more of that to go into their own pockets.»

Unless they are losers of course. Consider the issue of no bid contracts in Iraq going to Republican campaign donors, and the two possible reactions:

Un-American loser and whiner: "that's a scandal, it should stop, that's my tax dollars into the pockets of profiteers, i'll write to my democratic congressman.".

True-American winner: "Mr. Congressman I spending some of my precious time now on the phone to you to say that I didn't give all those donations to you and Republican PACs for nothing, get me a piece of that Iraq no-bid action, and I want results, stat."

[Lafayette]

A middle-class existence

Article: The impact of the consumer slowdown is partially offshored, a point which I think deserves greater attention. This shifts job destruction to an overseas producer.

The first phase of globalization, from the middle 1990s to 2007, that provoked job dislocation went for the fat; that is, the higher cost but lower value-added jobs of un- and semi-skilled labor.

This next phase is going (to try) to get at the muscle. I don't think it will succeed. Most of what could be devolved to the Far East has long since gone. Detroit is going to go through a major shakeout, but -- for instance -- when either all-electric, or hybrid cars, or both, come back in force, the job creation in the car manufacturing will be far less than it was previously. People will want cheaper, more efficient cars for some time to come.

The only muscle left is the higher skills-level jobs and China will not be "cherry picking" that employment. China will turn to, finally, Internal Demand intensification. Haven't we got enough household gadgets to last a lifetime that are Made in China? Those that lasted more than six months, that is. China is having some serious product Quality Control problems and that may be sinking in to many consumers both in the US and Europe.

We might put on the rose-coloured glasses anyway and think that the globalization impetus given to the third-world over the past fifteen years may have brought many of those countries to a threshold of sustainable Internal Demand. If that is the case, and we should see whether it is shortly, then they will be buying more sophisticated products (like airplanes and nuclear reactors) to slip into the comfortable accouterments of a middle-class existence -- of the kind that we obtained in the 1950s and 1960s.

With a bit of luck, that could do the US/EU a world of good. It doesn’t really matter that the nimble-fingers in China or Vietnam do the bulk of electric/electronic assembly work or force-fitted assembly of plastic toys, etc., etc. As long as they use their new-found revenue stream from exports to enhance their own existence, by becoming importers.

Why not?

[Bob]

>> if we find ourselves in a financial-meltdown world where unemployment or inflation kisses 10%-

Another case of somebody pointing out how we don't have to address a serious problem because the unemployment rate and inflation rate have been cooked to make them look much better than they really are.

As i said before this is also a case of how those cooked numbers are doing real damage.

Why are know-nothings like Duy even being given consideration and why are they given greater exposure here ?

Don't most people come to an information source with qualitative expectations ?

Kevin Phillips new book "Bad Money" has shown that todays unemployment rate and inflation rate are lies.

What do we gain by pretending they aren't ?

[Bruce Wilder]

I think this comment thread has headed way off into the weeds.

Tim Duy is an extraordinarily knowledgeable and articulate observer and analyst. Unlike many voices presented by the Media, he's dedicated to looking at the actual data, not in articulating an ideological narrative and avoiding actual facts while telling lies.

He's pointing out some facts about current economic conditions and events. I see no evidence whatsoever that he is being the least tendentious in doing so.

I happen to be of the opinion that the widely shared popular pessimism (70+% "country on wrong track" in polling) derives from a realistic appreciation of the implications of recent economic trends. Peak oil, the secular decline in manufacturing employment, the corruption and near-collapse of banking, etc. -- all of this adds up to a pretty significant crisis.

It takes some pretty smart guys like Tim Duy, to dig into the data and articulate what kinds of choices we have, or are (collectively) making thru institutions and policy. It's hard work, requires talent and intelligence, and it requires realism, which means accepting that things are the way they are, and if events do not match our expectations and analysis, that means our expectations and analysis should adapt. Too many of our talking heads take the easy way out, only retrospectively rationalizing what happened last week, last month, last year, never taking the risk of putting their analysis to the test of what happens next. Even among those, who do venture "predictions" there's too many, who cling to the safety of being a stopped clock -- a perennial optimist or a perma-bear, substituting narratives drawn from personal temperment, perhaps, for the hard work of getting right with reality, which entails weighing the significance of contradictory trends and signals.

What's gone wrong in the current recession, imho, points to structural problems of great significance -- in some cases, millenial significance. (You cannot exaggerate the world-historical importance of peak oil or global warming; the relation of the falling dollar to the frustration of the American Imperial project or the Rise of China is not without its drama, as well.)

Nevertheless, it is simply a fact that, by some measures, the recession, so far, has been mild. Far from painless, as real income is declining. But, if you know enough economics to be able to distinguish declining real income from inflation (and lots of people do stumble on that distinction, which may, or may not, signify a difference), then, yes, in some respects this recession has been mild.

I think we ought to be able to come to grips with the facts, without thinking that doing so makes anyone into a crooked hack like Phil Gramm, with his "mental recession".

I like rants slamming hackery more than most, but the key to a good rant is not the expression of disgust and frustration, the key is discretion in choice of worthy targets.

[Lafayette]

Self-fulfilling prophecy

There is some rational to the article.

All this worry-wort stuff is being bloated by media attention. They appear to be saying just about anything to make a journalistic deadline.

After all, how does Fox News, CNN or NBC make money? By selling commercials to pairs of eyes, which they attract best with sensationalism. Newspaper journalism is no different.

No economist worth their salt can guaranty that either the economic fundamentals or the expertise of financial management are even remotely akin to the Crash of 1929. (After all, hasn't Bernanke written extensively on the subject of the Great Depression? Yes, he has.)

But, that is precisely the analogy that journalists are trying to craft. Why? Because it is sensationalist, which sells news.

And, if they repeat it often enough, any shoddy journalism can take on the trappings of truth -- and become a self-fulfilling prophecy.

Nine out of ten of these journalist miss an excellent opportunity to say nothing. But, for them, saying nothing doesn't pay the electricity bill, does it.

[Sandman]

Yes, and the 73-75 recession was mild to mid-74 when things fell completely apart.

FWIW, I am disappointed that Duy didn't doesn't get the inventory/commodity surge nature. It makes Q2 a lie. That massive amount of hoarding and over ordering compared to its actual demand was absurd.

That has to come off at some point. If commodities/materials continue to fall back, they will pronto.

Then the economy will take another downturn as basinwide manfucturing recession(basically inventory correction) begins.

Here is what happens: Export/Import economies crash, exporters who were using all those dollars to fund US debt get dried out leading to less debt steralization and higher rates as they ramp. Oil going down actually QUICKENS that process. We saw what happened when Oil dropped 30-40% in 06/07. Rates began to ramp that spring and didn't fall to the credit crunch(and Oil began to make punches at 75+ again, surprise surprise). Oil rising like it has, allowed the oil countries to quicken the steralization of debt even though Asia was peaking(now may be starting to decline). Oil falling means higher long term rates. Another possibilty is stock market crash keeping yields down which is very possible and as we watch the slight capital flight over the last 2 months, likely.

That is why ECB wants the US to raise rates and forget the debt markets. Basically because it would attempt to substain the current system instead of trying to push on a string causing a massive deleveraging. My take is it doesn't matter because we kill the exporter/importer economies no matter what as debt services outpace debt and long term yields ramp as steralization slows due to the exporters getting creamed.

Duy is buying into myths that don't exist and not properly analyzing the real economies.

That is the type of errors that kill you a year from now and make you a devil 5 years from now.

[Lafayette]

Club of Casandras

Sand: Export/Import economies crash, exporters who were using all those dollars to fund US debt get dried out leading to less debt steralization and higher rates as they ramp.

Please explain this nonsense.

What export/import economies? Why should they crash? Consider this graphic demonstrating World Merchandise Trade, here. Does that look like a doomsday scenario for a global crash of major proportions?

You'd be a bit wiser to consider the fundamentals before making sensationalist forecasts. Of, you can always join our august Club of Casandras that haunt this forum.

[Public/Private Debt to GDP Ratio]

Credit default swaps on treasuries are rapidly increasing, and people have started openly betting on the odds of default on the national debt. Public and private debt to foreign nationals is essentially already too high to be repaid, and will have to be rapidly expanded to keep home prices rising. Foreign credit is no longer being extended to private entities in any significant amount, so public debt is rapidly expanding to fill the gap. De factor adding of 5T in GSE paper to the national debt taxes the credulity of foreign lenders, and this still leaves another 7T in non GSE mortgage debt that will eventually have to be rolled over.

With no net domestic savings, 12T in mortgage debt to foreign lenders is a heavy burden that is squeezing out small business loans. The 12T number will have to be expanded steadily to keep prices rising. This is the result of using homes to store purchasing power for the future, because citizens lost confidence in the local fiat currency. Purchasing power stored in inflation hedges (such as homes) is not available to fund small business expansion, which is the primary job creation mechanism.

We need to restore citizen confidence in fiat currency as a long term store of value to free ourselves of dependence on foreign loans.

[Lafayette]

P/P: We need to restore citizen confidence in fiat currency as a long term store of value to free ourselves of dependence on foreign loans.

Well said. Now tell us how to accomplish that objective.

In Plain English, please ...

[Public/Private Debt to GDP Ratio]

"Now tell us how to accomplish that objective."

No more long term inflation. No more negative real after tax interest rates. Give domestic savers a fair deal.

[Lafayette]

P/P: No more long term inflation.

We do what for that? Pass a law?

C'mon.

[Public/Private Debt to GDP Ratio]

Simply create less new money.