Back to the global imbalances norm
Here is my mantra regarding so-called ‘unsustainable’ debt levels. I feel strongly about this topic so I’ll repeat it and show you a few statistics on consumer debt from the recent US government data:
[P]oor 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.
–Is economic boom around the corner?, Sep 2009
See, things don’t move in a straight line – not on the way up and not on the way down. The problem with big macro calls is all about timing. When it comes to the ‘New Normal’, the balance sheet recession, deleveraging or whatever moniker you want to put on this post-crisis world, there are plenty of ways to forestall the inevitable.
Here are the assumptions to the macro story I have been peddling since about March or April of 2009:
Assumptions
- Kicking the can down the road is par for the course. Politicians are loath to take bitter pills and will usually do whatever they can to cover-up systemic problems. (See A few thoughts about the euro crisis and the psychology of change)
- Monetary and fiscal stimulus work. How do you cover up a systemic problem? Well, when one injects a lot of money into the system, it does boost the economy. Government has an unlimited arsenal of money printing and fiscal stimulus it can provide in a fiat currency system. The question is how much will they inject and how well spent is the money. (See Is economic boom around the corner?)
- Government has a vested interest in the status quo. The reason government covers up is that crisis usually exposes bad decisions. It’s Warren Buffett’s aphorism "when the tide goes out, we see who’s been swimming naked." If government is filled with people who can be blamed for the problem, basic human psychology says they will cover it up and hope for the best. (See A few comments about Tuesday’s election’s impact on the economy)
- When bad things happen, government has the power to make these things go away by changing rules. The best way to cover up is to simply change the rules of the game – pass new legislation, not enforce rules, manipulate data, etc. This covering up can forestall a crisis for years. The question as to whether forestalling becomes prevention depends critically on whether the root causes of a crisis are dealt with (See The Fake Recovery)
- Doom merchants lose credibility by not appreciating this. If you are going to market a story of angst and woe, you had better have some nice qualifiers in case things don’t go pear-shaped, because you lose all credibility if they don’t. Why? People don’t like doom merchants. People want you to tell them all is well. Even Cassandra was not listened to; that’s a parable for doom merchants to heed (see The psychology of economic forecasting).
- Usually, forestalling doesn’t become prevention. ‘Growing’ your way out of a crisis is a bad way to deal with systemic issues. Usually what happens is that people lose their way because the forget about the systemic issues altogether until another downturn brings those issues into view.
- Pollyannas will eventually also lose credibility. Because forestalling doesn’t lead to prevention, those who cry, "It’s all good" on the way down to an eventual bust are found out as charlatans. It’s not all good. And there is nothing wrong with saying so. We should hope for a good outcome but we must also make the necessary preparations for downside risk – as individuals, companies and as a collective whole. (see Geithner: jusqu’ici tout va bien)
Those are the assumptions that led me to my post "The recession is over but the depression has just begun". Those are also the same set of assumptions that made me Cautiously Optimistic Into 2011, by the way.
Now, let’s look at this regarding consumption trends. Here’s what I said yesterday in a post about Nouriel Roubini:
My view is that we are in a secular phase of deleveraging, a balance sheet recession for households and financials. However, the balance sheet recession creating deleveraging pressure will not be overwhelming in all instances; excess liquidity and fiscal stimulus can counteract it, driving a cyclical recovery. When recession hits, the deleveraging resumes with a great vigour, made more extreme by defaults and financial distress. This is an economic view about decreased volatility followed by increased volatility, i.e. of greater upside but also greater downside.
What I am saying is this: we are in a recovery. Consumers are not going all-in for deleveraging in that environment. End of story.
I don’t care whether we are in a a balance sheet recession, the new normal or what have you. When stock markets are up, hiring trends are improving, companies are making more widgets, why would you hoard cash or increase precautionary savings?
This is from Andy Lees at UBS this morning [emphasis added]:
Ten year Treasury yields last traded at 3.39% – (Five year swap spreads last traded at 23.88 whilst the high yield ETF was last at 91.78) – whilst the 30 year mortgage rate has drifted to 4.77%. US data showed the savings ratio dipping back to 5.3%, still relatively high by long term standards, but gradually deteriorating. In May 2009 near the height of the crisis it rose to 8.2% and has since been gradually drifting lower; through Q2 2010 it averaged 6.2% declining to 5.9% in Q3 and 5.4% in Q4. On the one hand we can say that the falling figure is presumably indicative of improving confidence, however on the other hand it is very evident that if the household saving rate is declining then the government should not also be running such a large deficit. In Japan total cash earnings and winter bonus payments fell by 0.4% y/y in December, the first fall in 10 months, boding ill for any reduction in the government deficit.
The IMF issued a similar message; “The pre-crisis pattern of global imbalances is re-emerging. Growth in economies with large external deficits, like the US, is still being driven by domestic demand. And growth in economies with large external surpluses, like China and Germany, is still being powered by exports”. It continued “As tensions between countries increase, we could see rising protectionism – of trade and of finance. And as tensions within countries increase, we could see rising social and political instability within nations – even war”. It said that the rising debt in the developed economies, the rising inflation within Asia and the rising food and fuel prices that are causing social unrest in the developing economies are all symptoms of these growing imbalances. It said that foreign exchange rate adjustments have an important role to play in re-balancing the economies and should not be resisted. If one country holds back, then adjustments across other countries need to be that much larger to accommodate it. Just reading the book the Corruption of Capitalism, it is very evident that leading up to the collapse of Bretton Woods and then ever since, with a very few exceptions, governments worldwide have continually opted for additional debt rather than the restructuring necessary for a sustainable path.
That’s exactly what I’m talking about. Now, let’s look at the data. Yesterday, the BEA in the U.S. released the Personal Income and Outlays report for December. That’s where you will find the data on personal consumption and the personal savings rate. Here’s what the report said:
Personal income increased $54.5 billion, or 0.4 percent, and disposable personal income (DPI) increased $47.3 billion, or 0.4 percent, in December, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $69.5 billion, or 0.7 percent…
Real PCE — PCE adjusted to remove price changes — increased 0.4 percent in December, compared with an increase of 0.2 percent in November.
So, personal income is up a decent amount but personal consumption is up even more. The personal savings rate has declined slightly as a result – at 5.3% in December, down from 5.5% in November. About two years ago, as the technical recovery took hold, I claimed that "Americans are not increasing savings". I said:
My takeaway from the data during this past downturn is that American households are not necessarily saving more. As asset prices have risen, a return to the asset-based economic model seems to be taking hold. Let’s look to future personal income data from the BEA to confirm if this trend holds.
If so, the feedback between asset price increases, collateral for bank lending, increased consumption and economic growth could be more powerful than is commonly assumed. This is what could drive a multi-year recovery… that is until the next debt- and asset bubble-induced downturn ends this brief nirvana.
Also see Americans are now back to the overconsumption norm for more of the same reasoning.
Here are what the charts look like. (I have taken 6-month rolling average data to smooth out the dataset).:
Here’s my takeaway: Americans did increase their savings rate during the downturn. And that is a good thing. But, the savings rate does not seem to be increasing any more. The average personal savings rate in the U.S. peaked at 6.4% in July 2009 through September 2009, just as the recession ended. The data in the intervening time do not suggest it will continue upward until another economic downturn hits. Deleveraging may continue in small measure, but I continue to believe that this balance sheet recession will see the bulk of deleveraging as a result of economic downturns.
Thanks for sharing your outlook including on the likely direction of the personal savings rate. Despite boomers’ retirement portfolios being way to small according to most reports, I suspect you’re correct that this won’t matter until another downturn.
There is one wildcard I sometimes wonder about… I’ve seen reports that many homeowners believe their homes are still worth at least what they paid, and often mentally anchor to the peak values. In other words, they consider falling house prices over the last couple years to only reflect foreclosure “fire sales” and not a reversion to pre-bubble price trendlines. I wonder how widespread that belief is, and to what extent it is causing people to save less than they otherwise would, because they believe their net worth hasn’t *really* gone down (if only those foreclosures would stop!)
Case Shiller and other measures of prices do include foreclosure sales, so perhaps the “perceived value” of home prices hasn’t come as close to mean reverting as many believe. If that’s true, what might change that perception? If the answer is nothing, then the savings rate is unlikely to increase outside of a downturn. But if enough time or current falling house prices would gradually drive home the post-bubble housing reality, perhaps that effect could drive a mid-cycle increase in the savings rate? For example in the years the boomer downsizing wave hits (if it does) and they can’t find buyers at the prices they want… But I suppose that’s probably a very slow motion thing (and thus not likely to lead to crisis on its own).
The biggest problem at this juncture is the lack of policy options. Rates are zero percent. That’s why QE is on the table at all. My question is how long the U.S. can forestall the deleveraging. The Japanese have spent twenty years battling this balance sheet recession. But that was in a more benign global environment. Will the US have the same backdrop? I don’t believe so. And if not, then what? My view right now is that it means serious problems in the next downturn.
Thanks for sharing your outlook including on the likely direction of the personal savings rate. Despite boomers’ retirement portfolios being way to small according to most reports, I suspect you’re correct that this won’t matter until another downturn.
There is one wildcard I sometimes wonder about… I’ve seen reports that many homeowners believe their homes are still worth at least what they paid, and often mentally anchor to the peak values. In other words, they consider falling house prices over the last couple years to only reflect foreclosure “fire sales” and not a reversion to pre-bubble price trendlines. I wonder how widespread that belief is, and to what extent it is causing people to save less than they otherwise would, because they believe their net worth hasn’t *really* gone down (if only those foreclosures would stop!)
Case Shiller and other measures of prices do include foreclosure sales, so perhaps the “perceived value” of home prices hasn’t come as close to mean reverting as many believe. If that’s true, what might change that perception? If the answer is nothing, then the savings rate is unlikely to increase outside of a downturn. But if enough time or current falling house prices would gradually drive home the post-bubble housing reality, perhaps that effect could drive a mid-cycle increase in the savings rate? For example in the years the boomer downsizing wave hits (if it does) and they can’t find buyers at the prices they want… But I suppose that’s probably a very slow motion thing (and thus not likely to lead to crisis on its own).
The biggest problem at this juncture is the lack of policy options. Rates are zero percent. That’s why QE is on the table at all. My question is how long the U.S. can forestall the deleveraging. The Japanese have spent twenty years battling this balance sheet recession. But that was in a more benign global environment. Will the US have the same backdrop? I don’t believe so. And if not, then what? My view right now is that it means serious problems in the next downturn.
I suspect that rather than a long cycle between recessions I suspect that the next recession will be much sooner than usual. I do agree that governments are doing their damnedest to keep the old model running until it hits the buffers again, till after the next election at least.
The problem is that millions were made redundant in the last recession and if they think that unemployment of 10% will become the new normal then the seed for destruction will be sown. Britain learned in the eighties that a generation of unemployed become a serious drag on the economy. Until western governments realise
When the crisis started I thought that a long period of depression was inevitable. Governments have flooded banks with liquidity to solve a solvency crisis. They have created a false bottom to the property market, which needs another crisis to unwind. All they have done is kick the can down the road. Then the deleveraging will resume, and next time I suspect that governments will find it impossible to forestall it a second time. The sensible ones will have completed the deleveraging before then.
I suspect that rather than a long cycle between recessions I suspect that the next recession will be much sooner than usual. I do agree that governments are doing their damnedest to keep the old model running until it hits the buffers again, till after the next election at least.
The problem is that millions were made redundant in the last recession and if they think that unemployment of 10% will become the new normal then the seed for destruction will be sown. Britain learned in the eighties that a generation of unemployed become a serious drag on the economy. Until western governments realise
When the crisis started I thought that a long period of depression was inevitable. Governments have flooded banks with liquidity to solve a solvency crisis. They have created a false bottom to the property market, which needs another crisis to unwind. All they have done is kick the can down the road. Then the deleveraging will resume, and next time I suspect that governments will find it impossible to forestall it a second time. The sensible ones will have completed the deleveraging before then.
Good article.
With respect to the oft-discussed “consumer deleveraging”, it is a myth falsely enforced by the conventional wisdom which supposes that during a recession, households will always voluntarily pay down debt. Essentially all of the “consumer deleveraging” in revolving credit which has taken place during this downturn has been the result of involuntary write-offs, not due to consumers having changed their ways and becoming thrifty all of a sudden. The US consumer (and the US government) is still running on the old operating system which supposes that if you can’t afford it – just charge it. The imbalances are and will remain, the question is for how long. Perhaps with only the private sector participating in the credit binge it can go on for a while, but with the Federal govt. now also borrowing at what this year will likely be over 10% of GDP (thanks to the tax cuts), surely this trend cannot continue forever. Or can it?
See here: https://finance.yahoo.com/news/Consumers-Deleveraging-No-dg-1407378460.html
Good article.
With respect to the oft-discussed “consumer deleveraging”, it is a myth falsely enforced by the conventional wisdom which supposes that during a recession, households will always voluntarily pay down debt. Essentially all of the “consumer deleveraging” in revolving credit which has taken place during this downturn has been the result of involuntary write-offs, not due to consumers having changed their ways and becoming thrifty all of a sudden. The US consumer (and the US government) is still running on the old operating system which supposes that if you can’t afford it – just charge it. The imbalances are and will remain, the question is for how long. Perhaps with only the private sector participating in the credit binge it can go on for a while, but with the Federal govt. now also borrowing at what this year will likely be over 10% of GDP (thanks to the tax cuts), surely this trend cannot continue forever. Or can it?
See here: https://finance.yahoo.com/news/Consumers-Deleveraging-No-dg-1407378460.html