Duncan’s Economic Blog

Getting Nervous about Growth

Posted in Uncategorized by duncanseconomicblog on November 19, 2009

I’m becoming nervy about the global economy again. To be honest as regular readers will know I’ll always been quite nervy.

Giles notes that Brad Delong is getting twitchy too.

In somewhat contradiction of this politics-captured idea, BDL thinks Politics, not economics, will run out of capital first when it comes to the need for another rescue.  That is Brad DeLong’s scary verdict when he says the chance of a Great Depression is now 5%.  Because the last time we bailed the banks, we got not enough back, and public/congressional impatience is now wearing thin:

the failure of the Fed and the Treasury in the aftermath of Lehman to grab a share of the upside from its capital injection and purchase operations for the public in the form of warrants means that there is no coalition anywhere for a repeat or anything like a repeat of propping-up the banking system:the right thinks it is an unwarranted intervention in the free market, the left thinks that it is a giveaway to the undeserving and feckless superrich, and the center is bewildered because it is an enormous and poorly-structured intervention in the market, it is a giveaway to the undeserving and feckless superrich, and the optics are terrible.

Brad DeLong ought to be counted one of life’s optimists – someone who like Krugman thinks we could afford more stimulus – so this is worrying.  The next time we have to do it, we must get more skin in the upside.

It seems that the strategists at SocGen are getting really nervy.

Under the French bank’s “Bear Case” scenario, the dollar would slide further and global equities would retest the March lows. Property prices would tumble again. Oil would fall back to $50 in 2010.

Governments have already shot their fiscal bolts. Even without fresh spending, public debt would explode within two years to 105pc of GDP in the UK, 125pc in the US and the eurozone, and 270pc in Japan. Worldwide state debt would reach $45 trillion, up two-and-a-half times in a decade.

The bank said the current crisis displays “compelling similarities” with Japan during its Lost Decade (or two), with a big difference: Japan was able to stay afloat by exporting into a robust global economy and by letting the yen fall. It is not possible for half the world to pursue this strategy at the same time.

SocGen advises bears to sell the dollar and to “short” cyclical equities such as technology, auto, and travel to avoid being caught in the “inherent deflationary spiral”. Emerging markets would not be spared. Paradoxically, they are more leveraged to the US growth than Wall Street itself. Farm commodities would hold up well, led by sugar.

Mr Fermon said junk bonds would lose 31pc of their value in 2010 alone. However, sovereign bonds would “generate turbo-charged returns” mimicking the secular slide in yields seen in Japan as the slump ground on. At one point Japan’s 10-year yield dropped to 0.40pc. The Fed would hold down yields by purchasing more bonds. The European Central Bank would do less, for political reasons.

SocGen’s case for buying sovereign bonds is controversial. A number of funds doubt whether the Japan scenario will be repeated, not least because Tokyo itself may be on the cusp of a debt compound crisis.

The simple facts are that the private sector, in the absence of public support, is still contracting. Europeans, Asians and Americans are all relying on each other to provide final demand. We can’t all export our way to growth. The banking sector is still damaged. Financial flashpoints remain in Central & Eastern Europe, the possibility of a real estate bubble in China, a secondary banking crisis in the US driven by commercial real estate problems, a second housing market dip in the UK and US.

Despite all the worries over inflation I simply don’t see it. I don’t, for reasons I’ve been making clear for months, see any functioning transmission mechanism between money growth and prices in the near future.  My real concern remains deflation. SocGen’s advice – buy sovereign bonds, may not be a bad idea.

7 Responses

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  1. Bill le Breton said, on November 19, 2009 at 10:15 am

    If you want to get really twitchy, Duncan, have a look through:
    http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2009/Midnight+Candles+Gross+November.htm
    A convincing analysis by Bill Gross reminds us that assets didn’t always appreciate faster than GDP. “For the first several decades (from 1950) economic growth, not paper wealth, was king. We were getting richer by making things, not paper. Beginning in the 1980s, however, the cult of the markets, which included the development of financial derivatives and the increasing use of leverage, began to dominate.” See his Chart 2.
    He suggests we could return to a sustained period where again GDP has to lead assets. And if growth remains suppressed … (another argument for targeting NGDP?)
    He ends with this quote (apologies for length):
    “Asset appreciation in U.S. and other G-7 economies has been artificially elevated for years. In order to prevent prices sinking even lower than recent downtrends averaging 30% for stocks, homes, commercial real estate, and certain high yield bonds, central banks must keep policy rates historically low for an extended period of time. If policy rates are artificially low then bond investors should recognize that artificial buyers of notes and bonds (quantitative easing programs and Chinese currency fixing) have compressed almost all interest rates. But while this may support asset prices – including Treasury paper across the front end and belly of the curve, at the same time it provides little reward in terms of future income. Investors, of course, notice this inevitable conclusion by referencing Treasury Bills at .15%, two-year Notes at less than 1%, and 10-year maturities at a paltry 3.40%. Absent deflationary momentum, this is all a Treasury investor can expect. What you see in the bond market is often what you get. Broadening the concept to the U.S. bond market as a whole (mortgages + investment grade corporates), the total bond market yields only 3.5%. To get more than that, high yield, distressed mortgages, and stocks beckon the investor increasingly beguiled by hopes of a V-shaped recovery and “old normal” market standards. Not likely, and the risks outweigh the rewards at this point. Investors must recognize that if assets appreciate with nominal GDP, a 4–5% return is about all they can expect even with abnormally low policy rates. Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets – while still continuously supported by Fed and Treasury policymakers – is likely at its pinnacle. Out, out, brief candle.”

    Imagine a global Lost Decade that would see, in this country, FTSE bumping along at 3,500, house prices 50% of 2008 values, unemplyment at “?” and intercommunity strife smashing the social fabric of the country.

    This is why we cannot afford to lose the political battle. We have to resist the all too human desire to blame and penalise the blameworthy and seemingly unpenalised – it would be cutting off our nose to spite ourselves.

    Paul Sagar reminds us that Keynes was a campaigner – a campaigner against a then global march towards totalitarianism. We face a similar imperative.

    B le B

    • duncanseconomicblog said, on November 19, 2009 at 11:48 am

      Bill,

      Gross is always interesting.

      And Brad Delong is right – the political problems associated with the last bank bailout 9and the coming round of bonuses) wil make any second bailout much harder.

      I worrry that we are stumbling, globally – or at least in the West, into a Japan situation.

      • dannyboy said, on November 19, 2009 at 9:23 pm

        I’m inclined to agree the next crisis is more political than financial.

        Seems that GB, mervyn etc are doing their best to move the bankers closer to the bonfire in preparation.

        Meanwhile, am still waiting for the explaination of how the state can control long term interest rates after the initial fanfare!

  2. David Heigham said, on November 19, 2009 at 5:28 pm

    The underlying position for the world economy is that we have every reason to think that markets and governments will tolerate higher levels of government indebtedness than seen for two generations; but no reason to think tha they will tolerate a perspective of unlimited rise in that indebtedness. That leaves two routes open: a fall/ stagnation in world GDP or a rise in consunption in the surplus countries. It follows that we can only be confident that we are moving out of recession if consumption demand in the surplus countries is growing comfortably faster than their GDP.

    The rest of the argument is detail, trimming and distraction.

  3. duncanseconomicblog said, on November 20, 2009 at 9:23 am

    Dannyboy,

    Monday without fail!

  4. Bill le Breton said, on November 20, 2009 at 11:05 am

    David
    As we won’t know exactly when that intolerance will hit the UK’s ‘paper’ and as the UK will need to compete to supply the consumption in surplus countries if/when that rises, don’t we need immediately and whilst tolerance exists, to begin to rebuild, rejuvenate and redirect our productive capacity through investment (in physical and mental capacity) led at the outset by Government appropriation?
    That requires understanding by our political class and then leadership (and communications) of the highest quality. It requires a movement.
    B

  5. freethinkingeconomist said, on November 20, 2009 at 2:12 pm

    Personally, I am more optimistic, because:

    1. I think the Tories DO have a plan B: it just won’t go in a manifesto
    2. I think the UK has plenty of sources of growth, such as housing construction
    3. and our consumers have more debt tolerance than bears like Fathom think
    4. I may have underestimatd the lags for getting export growth

    The big risks are definitely political though – if the Tories somehow get simultenous debt-revulsion and QE revulsion. Or: they get QE revulsuion, the markets get debt revulsion, the Tories get spending revulsion, and hell breaks loose.


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