Is economic boom around the corner?

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.

  1. Anonymous says

    “Robust 4% growth that is underpinned by savings and capital investment is not the same as robust 4% growth underpinned by debt and consumption.”

    C’mon, friend, you can’t have savings without debt, and you can’t have capital investment without consumption.

    Also: “The outlook is unclear.”

    Yes it is. Always has been. Sometimes we fool ourselves into believing it’s not.

    1. Edward Harrison says

      It’s not a question of whether there is consumption, debt, savings or capital investment. As you correctly state, they are all present in any economy. It is a question as to whether growth is underpinned by capital investment or debt accumulation. I would argue that any economy that accumulates debt out of proportion to growth in a way which creates a significant rise in debt to gdp is at risk of a nasty correction when debt levels decrease.

  2. hbl says

    Excellent question, and good call early this year on the fake recovery. I agree it’s possible we could have a multi-year expansion (personally I’d give it less than even odds). I think it would depend on many factors including on risky assets not realizing how far ahead of fundamentals they are, and on the growth of emerging economies (especially China) not faltering… China appears to be on shaky ground but credit bubbles certainly can last years.

    I’m still not convinced by the “printing money” factor explaining the stock rally, though no doubt it helped some. MZM is only up $150 billion or so from March, which is less than a 2% expansion in broad money supply… Now I know liquidity is more complicated than one money supply measure, but wouldn’t it require more than a 2% expansion to be the primary driver of a >50% expansion in stocks (for example)? What am I missing?

  3. Anonymous says

    It is and will be a depression. The only “boom” is going to be the KABOOM.

    The USA is insolvent. Bernake is hanging counterfeit destroying the dollar, we take in 2t and blow 4t out the door, we can’t sell/borrow vis-a-vis bond sales the difference so we counterfeit enough to service debt.

    Our books are as cooked as Enron’s we owe north of 80 trillion.

    The banks are and ever will be insolvent.

    Housing will not recover, 24 million vacant and on the market homes, and buyers? There won’t be mortgage fraud again.

    The market – a rigged casino, as the “Fed” (oh, that’s right if they tell the market will tank).

    Employment- there is NO such thing as a jobless recovery.

    Once the currency goes or the banks go the gig will be up.

    Welcome to the new Banana Republic. The Fed blew up the market with too much money and too little regulation.

  4. Anonymous says

    garden-variety recession ????????

    This big one again has been avoided by the phoney money printing the last decade or so. Unfortunately now reality will settle in as more and more pimps (Wall Street) types hype a strong recovery and bernanke is a genius non-sense.
    The debt and leverage is still around while incomes are stagnant and the dollar is being questioned.
    We may have a short term reprieve from our saviour Bennie Printman Bernanke, but the fundamentals of this lopsided economy are horrible and will take years to retructure and resurrect to a more balanced one.

  5. kfizzle says

    Great post Ed. Your ability to balance “what should be” and “what is” is really unparalleled in the blogosphere, and I applaud you for it.

  6. dansecrest says

    I’m with Rosenberg, and I actually think it’s quite clear. This is a classic bear market rally of a size that befits the size of the recession/depression we are in. Rosenberg has been pointing out these classic bear market rallies for the last several years, if I recall correctly.

    I just don’t see the case for a renewed multi-year expansion. The U.S. consumer doesn’t have the assets to borrow against like before. And expecting China to fuel a global boom doesn’t make much sense either, since they are dependent upon exports and an undervalued currency…

    1. Edward Harrison says

      it’s not as simple as that. You could have said the same after the destruction of stocks in 2002. The 50% appreciation in stocks and the nascent stabilisation in house prices says the U.S. consumer does have the assets against which to borrow.

      It is far from clear.

  7. dansecrest says

    Both stocks and especially housing are still far down in value compared to their peaks in 2006-2007. So you do have much less in the way of assets for collateral (housing, housing, housing).

    On top of that, many of the previous debts still have to be repaid.

    On top of that, income is down big time. From

    the 2008 drop in median household income was the biggest since the Census Bureau started tracking this stuff in 1976. Income dropped $1,860 in 2008, and the next closest competitor is 1980, when it dropped $1,439. Last year was the worst year for household income in both absolute terms and percentage terms in the past three decades.

    And, as Ezra says, that was only 2008. This year is likely to be as bad — or possibly worse. Income drops typically persist for several years during a recession, and the combined impact of this recession is almost certain to do more damage to middle class incomes than any recession since World War II.

  8. dansecrest says

    Also, as Rosenberg continually points out, there was a massive secondary collapse in the stock market in 2002 (following the primary collapse in 2000-2001), so the 2002 analogy isn’t all that comforting.

    As you point out, the 2003-2007 recovery was a fake recovery, and we are now worse off in many ways. It seems to me that the duration of the bear market rallies (fake recoveries) will get shorter and shorter as the basis for the fake recovery becomes more and more tenuous (which will happen by the definition of a fake recovery). The last fake recovery lasted 3-4 years (2003-2007). It’s not clear exactly how long the current fake recovery will last, but multi-year seems a stretch to me. Most all current investors will be considering the 2 relatively recent stock market crashes…

    1. Edward Harrison says

      Great article by Rosenberg in this weekend’s Barrons that I just posted in the links. I’m not sure if you need an account to access. But, it is worth the read.

      1. dansecrest says

        Thanks for the tip on the Rosenberg article. The link you provided does require an account to read the full article (actually an interview), but a separate Google search for some reason brought me to a link to the full interview with no account required…

  9. OregonGuy says

    The direction of the economy is not clear because the recovery is not normal.

    Calculated Risk has said that residential construction normally leads a recovery. Residential construction is moribund and likely to remain that way for awhile.

    Manufacturing is improving. My company’s customers supply intermediate goods to manufacturers making consumer products ranging from small toys to autos. They report business has improved dramatically in the last month.

    Met with the bank (large regional) today on an LOC renewal. They report that wood products companies remain in the doldrums and see no hope for short- to medium-term improvement – a reflection of residential and commercial construction weakness. In general, all customers are cutting back on credit line usage and debt. Bank rep said Q3 and Q4 numbers will be weaker than Q2 because much of the Q2 profit was one-off; risk managers are not allowing new business fast enough to replace lost loan base.

    ECRI and others are bullish on leading indicators. ECRI cites housing sales activity as a recovery indicator. But these are transactions involving existing inventory – not new construction – and are being juiced by Government subsidies and lax underwriting by FHA. Hard to see this activity as a harbinger of real recovery.

    I remain agnostic.

  10. aitrader says

    Economic recovery has meant another Fed induced bubble over the last quarter century. The gold bubble in 1981 induced Volcker to whack out interest rates and then drop them through the floor leading to the bubble and crash in 1987. We went through Greenspan’s first bubble where folks were writing 100 million dollar deals on the back of napkins due to the massive liquidity Greenspan made available. After the tech bubble crash he, like Volcker++, dropped rates through the floor and gave us a housing bubble.

    Bernanke is using the same playbook. Only this time C&R RE, employment, trade, and the dollar are still stubbornly refusing to come back to norms.

    I refuse to succumb to the green shooters who think he can keep rates low and print us out of this crisis. Not only do I see a crash coming, I see it in mucher wider scope than the equities markets. In retrospect I suspect future historians will blame it on compettition by China, Russia, & the Euro countries for a new reserve currency that destabilized the dollar. I believe that is a symptom, not a cause.

    We Americans stubbornly refuse to get our own house in order. Austerity is what is needed. We need to bite the bullet hard and reconstruct a viable economy sans debt, built on savings, manufacturing high tech products the world needs and cannot get elsewhere, which sustained us up through the 1970’s. Without this, we are doomed – at best – to another bubble and crash. But I believe the most likely outcome this time around is simply a massive crash without the bubble.

  11. dansecrest says

    In summary, here are 4 reasons we are NOT about to begin a multi-year economic expansion similar to that of 2003-2007. Feedback will be appreciated…

    1. The recent crash was the largest since the Great Depression and has YET TO BE DIGESTED. In particular, income and prices continue to fall.

    2. The crash came on top of a fake recovery fed by high levels of consumer debt and stagnating income. Thus, many households are FUNDAMENTALLY UNABLE TO EXPAND CONSUMPTION.

    3. Consumer and investor CONFIDENCE is down (as well it should be), based upon repeated recent setbacks to the economy and markets.

    4. The false sense that we are recovering rapidly is deferring discussion of the additional government intervention that will be necessary to reinforce the safety net and stabilize the economy. (Health care reform IS a step in the right direction, however.)

    1. aitrader says

      Simpler than that I think. Falling consumer demand is a symptom. Confidence is nearly impossible to measure and its effect it harder still.

      The fundamental equation is the deflationary effect of a collapse of trillions of dollars of credit and loan defaults. These were triggered by $147 USD/bbl oil prices. The $2 trillion the US gov has dumped into the system is a fraction of the deflationary effect of 10-15 trillion in evaporated credit and loan losses.

      I guess yet-to-be-digested sums it up well enough. The indigestion is of fatal proportion and the wheels have come off the economic wagon – globally.

      In my humble opinion…

  12. dansecrest says

    Thanks aitrader. Well said…

  13. Wag the Dog says

    The terminology of fake/technical, cyclical/secular, etc confuses me. When is a W-shape recovery a double dip recession? Is there some magical number X whereby a recovery is real if it lasts more than X, but is fake if it lasts less than that?

    I think this disagreement as to the resolution at which people view their prognostications is a major contributor to the disconnect between those who trade for a living and those who are simply trying to find a good long term investment for their low-yielding savings.

    So 2003-2007 is now to be classified as a multi-year fake recovery, too? Then we’re really already on the second leg of the double dip. We might need to invent a letter to describe a shape with three dips.
    Perhaps diminishing sine-wave was the most accurate. Durations of each fake recovery shorten due to the learning effect. There will be fewer suckers to sustain each subsequent upswing and ultimately we end up with where Japan is now.

  14. Name says

    “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.’”…

    and what happen? a rally of 50%+ in the stock markets. Now you ask people the same question and they say it is going to be a good economic growth, so can you guess what will happen? Stocks follow social mood, not news or indexes. At some point reality will deflate the mood as people cannot pay their bills and unemployment does not stop, and then…bang! crash again! we never learn, we just follow the herd

  15. LavrentiBeria says

    I’ll be honest with you, Ed. Trying to keep up with your changes of direction on these questions is quite a task. You say:

    “I take neither side. I am just not that clairvoyant. Both scenarios are plausible outcomes.”

    And this when you’ve clearly postulated that we’re in a secular downturn? Anything’s plausible, I suppose, but this sounds more like butt covering than economic forecasting. Come on, guy.

    1. Edward Harrison says

      Lavrenti, if you hadn’t noticed this post was from September when I felt a multi-year boom was probably the most likely outcome going forward. Since that time, monetary and fiscal stimulus are looking more likely to be withdrawn. I have become more bearish and so I see a double dip as more likely.

      In September, I might have said 50-60% multi-year recovery chance 30-40% double dip, 10% V-shaped recovery, 10% GDII. Now, I see Double dip as say 50%, multi-year (weak) recovery as 40%.

      1. LavrentiBeria says

        No, I hadn’t noticed. My apologies. Criticism withdrawn.

    2. Edward Harrison says

      Just to remind you – even Stephen Roach is ONLY predicting a 40% change of a double dip here. Most people are saying sustained recovery if you check analysts. So, I am not butt-covering when I talk about a double dip.

      But, you can’t go out and say this and this is definitely going to happen. That’s just nonsense in an environment where a large part of economic forecasting depends on what the government is likely to do. You can give odds as I have just done but you can’t make definitive statements right now.

      My odds are tilted toward double dip, largely because POLITICAL pressure to withdraw stimulus is so great and that is EXACTLY what I said three months ago. Recall this post:

      Deficit spending on this scale is politically unacceptable and will come to an end as soon as the economy shows any signs of life (say 2 to 3% growth for one year). Therefore, at the first sign of economic strength, the Federal Government will raise taxes and/or cut spending. The result will be a deep recession with higher unemployment and lower stock prices.

      When I wrote that in October I thought stimulus would last at least through 2010. But it is already likely to be withdrawn and that makes the deep recession I warned would come when the stimulus was withdrawn more likely to come by late 2010 or 2011 – which is what I am now saying. To my eyes that is very consistent.

      See also

      which outlines the specific reasoning when I made the change in November.

      1. LavrentiBeria says

        I was wrong. I apologized for the butt covering remark. It wasn’t enough?

        1. Edward Harrison says

          I actually wrote this one BEFORE you wrote your apology – which was duly accepted. Thank you. The first response was a little incomplete so I followed up.

          By the way, when I say “you you can’t go out and say this and this is ” I mean figuratively, not you Lavrenti personally. Thanks again.


          Now it’s super bowl time!

  16. Scott Murray says

    Hi Ed,

    It seems clear that central bank inflation targeting has been shown as a failure.

    Would you think that a system of targeting inflation AND private sector debt levels, would work?

    As you say debt increases are stealing growth from the future and if debt levels increase for too long, a long period of very low economic growth is inevitable.

    But from what I see governments are desperately trying to convince us to re-start on our debt binge, with their continual bleating about how banks are not lending.

    Thanks for your great web-site.

  17. Anonymous says

    I would supplement Faber by saying merely printing money has very little power. Lending or spending it into circulation is necessary, and even with a Bernanke helicopter drop there is no guarantee that the money would not go to pay down debt, or simply be saved.

    As Henry Liu points out, monetarists do not understand that fiat money is a credit instrument, not a debt instrument.

    Credit may come from sources other than banks

    Firstly, it’s possible to create a monetary system upon trade credit – the Swiss WIR is an example of a credit clearing union where billions of Swiss Francs’ worth of goods and services change hands not FOR Swiss Francs, but by reference to them. I think that in the Internet Age this type of ‘Peer to Peer’ credit is capable of becoming pervasive, with the right trust framework.

    Secondly, Treasuries may create credit directly – and indeed this was the premise of the Social Credit movement pre -WW2. There is no need for Central Banks – Hong Kong demonstrates this empirically, as they have never had one.

    I believe that – pending any internet driven changes -it is the duty of governments to create public credit necessary for the creation of private and public assets. This process would be managed by service-providers-formerly-known-as-banks within parameters laid down by a Monetary Authority.

    To those who say that Public Credit would be ‘inflationary’ I respectfully point out that it would be less inflationary than the existing broken system dying of capital starvation because:

    (a) operating costs would be less, since the service providers would receive performance related pay;

    (b) default experience would probably be less than recent disasters;

    (c) there would be no unnecessary costs in terms of dividends to shareholders, since the only capital needed is that required for operating costs.

    In other words, we should ramp up QE drastically not for the purpose of buying existing financial assets (and bailing out the rich) but for investment in productive assets. If private banks cannot or will not create credit on the basis of their own balance sheet then they may instead manage credit creation on the basis of the public balance sheet.

    Finally, the problem is not really a shortage of credit, but a shortage of the credit worthy. Here I agree with Buiter and Taleb: if debt cannot be paid, it will not be paid, and what is needed is a debt/equity swap on a massive scale.

    Maybe not equity as know we it, though….

  18. Plan B Economics says

    Sure this is a ‘fake’ recovery. Did we think we’d put all this stimulus in place and NOT have a large portion of GDP be driven by stimulus? The stimulus is doing what we expected.

    The critical question is can final demand pick up where stimulus leaves off?

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