The economy is nowhere near as robust as stocks would have you believe
Global Macro Monitor had good charts of the jobs report over the Easter weekend. I didn’t report on them because I was away for the weekend. But the first chart’s visual is similar to the one I showed you two weeks ago on job creation. As I said then, the chart looks good for Obama. If the pattern holds, then the chart will be a good one come the general elections in the fall because it will line up better with what people are feeling by that time. I don’t think it will but let’s see what happens.
In any event, a lot of people are still pooh-poohing the recovery because it has been so slow. Just to remind you, three years ago I said Technical recovery won’t feel like a recovery to most because this was a ‘fake recovery‘ predicated on monetary and fiscal stimulus. My contention all along has been that the underlying systemic issue of excess private sector indebtedness has merely been masked and it will re-assert itself in the next downturn. In the meantime, overindebted consumers are not going to turbo charge the economy by running up fantastic debts, especially when the housing ATM is out of dollar bills. That will keep unemployment high. The policy goal is to forestall the inevitable reduction in debt ratios and to even promote a modest releveraging. There are not only signs that consumers have started releveraging to a certain degree, there are also tentative signs of lenders loosening the purse strings, even going into the subprime market with gusto. So this is working, and that’s why you see the GDP figures going up.
But, most Americans still think the country is in recession.
Why? David Frum has a good take on this:
Friday’s weak jobs report is more than a disappointing blip.
It is a glimpse ahead of our disappointing future.
Nearly three years from the beginning of the economic recovery in the summer of 2009, the U.S. economy has replaced not even half the jobs lost in the slump of 2007-2009. At the current pace of job creation, it will take until 2017 to replace all the jobs lost.
But of course the population has grown since 2007, so "replacement" is not good enough. We are even further away from equaling the employment rate of 2007 — the proportion of the working-age population at work.
The new jobs being added to the U.S. economy pay less, on average, than the jobs lost — which is why the average rate of pay in the United States remains stagnant or even drops as the number of jobs slowly grows.
At the top of the economic heap, recovery has been more complete. The richest Americans suffered sharp shocks to their wealth when markets collapsed in 2008-2009. As financial markets have revived, so has the wealth of the top 1% (households earning more than $380,000 per year.)
The top 5% have done OK, too. (The top 5% begins a little south of $200,000 in household income.)
For most of the country, however, the outlook is — to borrow Peck’s title — "pinched." Young people who come of age in the crisis will earn less through their lives than those who came of age during happier times. Marriages break up. Babies are not born. A sense of unfairness spreads through the society. Politics becomes angrier and more paranoid — for those who take part — while many others drop out of public life entirely, disregarded and alienated.
My view is that the stock market has gotten way ahead of itself. Easy money has caused people to pile into risk assets as risk seeks return in a zero-rate environment. The real economy is nowhere near as robust as the increase in shares would have you believe. Moreover, even the falling earnings growth is telling you this.
Bottom line: The US economy is getting a sugar high from easy money, economic stimulus, and the typical cyclical aides to GDP that have promoted some modest releveraging. But the underlying issues of excess household indebtedness, particularly as related to housing and increasingly student debt, will keep this recovery from being robust until more of the debts are written down or paid off. That means the cyclical boost that comes from hiring to meet anticipated demand, construction spending, and increased capital spending isn’t going to happen at a good clip. Meanwhile, people are really struggling.
The hope is we can keep this going for long enough so that the cyclical hiring trends to pick up before overindebted consumers get fatigued again. Underneath things are very fragile. Any setback in the economy will be met with populist outrage – that you can bet on. My worry is that shares could get hit pretty hard in the next few months if margins start to compress as I anticipate they will. Can Ben Bernanke ride to the rescue during the general election season with QE3? I’m pretty sceptical.
For a long time I have had concerns that the stock market is in a bubble. They are over priced and earnings were boosted by easy cuts. Now the cuts are hurting margins. I fully expect a returns to revert to the mean over time and that means falling profits and falling PE. However I do not think that the US economy will have any more problems for most of this year. Though if more problems emerge in Europe then that could change. Though never underestimate the ability of extend and pretend.
”my worry”? I think you meant to say “my wish”.
No, that’s not what I mean. The last thing we need now is a violent selloff in shares.
Yes but I think that will be the outcome. One the penny drops and investors realise that the current market is false the race to the exits will result in a collapse. Even if you have the decline spread over 5 years the pain will be immense. What will happen is that as the markets fall it will trigger stop loss sell orders and that will trigger more sales. Then add to that you have High Frequency traders effectively front running a collapse. If prices fell 50% over 1 week or 5 years the outcome is the same for investors.
David, I know you’re being honest here but it comes across as negative. It’s a bit of a downer. There is always hope that it doesn’t have to end badly and that we can get through this with less pain.
I would rather think of it as realistic. Though if you split the overall situation into its components it might not look so bad.
First the world economy is pretty robust and there have only been three world recessions since 1945. These were all during times of crisis anyway. The oil shocks and then last the financial crisis. So the world economy will still be positive, until the next financial crisis.
Then if you look at the US the amount of deleveraging has been far more than Europe so that is also positive in the short term. My concerns are that US real estate is still significantly over valued and the more I look at the situation the worse it becomes. That said the US is fast at clearing up this problem. So if things deteriorate then the US will be able to clear out mal-investment and be ready for growth quicker than anywhere else.
Europe is still on the extend and pretend path, so I still expect things to unwind badly here. Everyone expects Greece to default, and eventually Ireland will have to default on all its bank debt, that will leave the soveriegn in a much better state, and in a manageable condition. Even with a higher sovereign debt level I think Ireland will be able to rejoin the Euro very quickly. What is holding them back is the bank debt.
Though defaults through Europe will definitely hurt the big US banks. Not so much directly but through the exposure to CDS. This is what will cause problems for the US. I fully expect the Fed to react with QE of unimaginable proportions to try and cover these liabilities. Which while saving the banks will destroy the dollar as a store of value. Then all out currency wars as the dollar plunges. Though the alternative is to let the big banks fold wiping out the CDS liabilities and letting speculators take their losses. That is effectively what Iceland did and the US and Europe should do. It is solvable but until you clean up politics and regulator capture you still have to worry.
Great talk from Dirk Bezemer (a Steve Keen-type) at INET:
The comment about the excessive leverage slowing capital formation and widening inequality was interesting. High debts and asset bubbles slow capital formation because so much income is drained to cover existing debt.
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