Wednesday, August 19, 2009

This Crisis Is Truly Different

The same economists who missed the downturn are now the same ones who are broadly proclaiming the recession is over and a new V-Shaped Recovery is here? Come on!

The wounded U.S. economy has shown signs of improvement in recent weeks on the backs of further fraudulent government slanted economic reports, but is this recovery sustainable? Absolutely not!

How can we sustain an economy after what has happened if we never really figured out what was wrong in the first place? Most economists are in the dark and still cant come to a consensus about what type of recession we just supposedly came out of? Was is the classic Inventory Recession or the worse of the two the Credit Recession?

tradersutra.blogspot.com/2009/07/whats-recession-anyway.html

What ever the final verdict (This was a Credit Recession BTW), it doesn't change the fact that this downturn was not conventional in anyway. The financial system has gone through structural upheaval that will take decades to resolve.

Most economic models are build like rubber bands, periods of pulling leads to snap backs in growth. This is what has typically happened in past recessions where the consumer has led the way. We are no where near this dynamic currently. The downturn was so severe that the rubber band basically snapped.

Why? Whats so different at the moment?

This downturn was caused by a breakdown in the financial system, and in the wake of a massive housing and credit bubble which led to a credit implosion or credit recession.

Historically, recessions have come about when businesses over-invested (Inventory Recessions) or when the FRB aggressively raised interest rates (Volcker in the late 80's). Once business inventories and staffing levels correct themselves, or once the Fed cuts rates, growth resumes.

Downturns caused by financial crises play out differently. The machinery of the financial system grinds to a halt, people cannot get credit to buy things and businesses cannot borrow money to expand. You see it already with credit limits being cut and the destruction of CIT Group.

The growth spurt we have seen is as artificial as the strippers at Runway 69 near Kennedy Airport. When you pump trillions into the economy, you will get a bounce, but without the consumer leading the way its all static.

Credit fuels everything in our economy, most importantly housing. Credit contraction makes recessions more painful and makes financial crisis last longer.

Americans are just over leveraged after 30 years of living off the credit hog. The ratio of consumer debt to the nation's total economic output rose to 97% in the first quarter of this year from 45% in 1975. But what humans generally do when confronted with death is self preservation. Thus currently, Americans are saving more and paying down debt, the savings rate was 1.2% of disposable income in early 2008. By the second quarter of this year, that rose to 5.2%. The more you save, the less you consume, which leads to less output. They say that for every 1% increase in savings takes away $100B in consumption.

This is also an interesting fact. In 1960, it took $1.50 of debt to generate $1 of GDP. In the 1970's it took $1.70, in the 1980's $3.20, and finally in the 90's an incredible $5.40 of debt to generate just $1 of GDP. The leverage here is just breath taking. The consumer led economy needs to deleverage along with the banking system. We are in the early innings of this phenomena

The total debt relative to GDP is now at 375%. The total debt stands at $52 Trillion relative to our $14 Trillion Economy. We have ever increasing debt issuance and a contracting economy. That math is easy to figure out. These levels are far worse then they ever were during any prior recessions or even depressions. We cant even rest on Japan, as even that was not as bad as its today with us. Japan topped out at 270% in 1989.

This is what exactly happened to Japan in the 90's. They lived the life for years, the bill came due. People started to save more and consume less. The BOJ had to bring in rates to near 0 levels to help crappy banks get out from underneath bad loans they had made during the frenzy. The government just kept the bad loans on the balance sheets, doing nothing, and the end result is what we have today 20 years later.

Japan needed to deleverage just as we will be forced to do so. Japan today 20 years later is at 110% level debt to GDP.

Asian economies save more because they need a competitive advantage to sell goods and services to the West. So they keep their currencies artificially weaker compared to USD.

All of the green shoots talk is based around the fact that what goes down must come up. The US Economy has proved resilient in the past, emerging out of deep downturns with force.

There is only one reliable regularity of the business cycle history in the United States, and that is deep recessions are followed by steep recoveries and economic forecasts almost never take account of this regularity. So this is where we get the V-Shaped recovery theories that most economists use far to much.

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