Thursday, April 23, 2009

Timing the Depression

The question has been asked for 2 years nonstop. Seemingly no other question can be answered without first addressing this one. We hear it in the media. We see it in the eyes of the shopkeeper. Many now feel it in their own pocketbooks.

"When is this all going to end?"

I remember receiving flak for throwing around the "D" word in late 2008. "Your analysis would have more credibility if you ceased using the word 'Depression,'" wrote one reader. "To say our situation is bad is one thing. To call it a depression is irresponsible," commented another.

In Part II of my Themes for 2009, I wrote:

"The rapid decline in asset prices, slowing business activity and subsequent unemployment is going to have grand implications for the overall economy. As the year wears on, the “D” word (depression) will start to become more widely accepted. The consensus view for a second half recovery will be pushed back yet again as it becomes apparent that monetary stimulus is having little effect on the credit markets."

Nary a day passes now, only 4 months into the year, without an encounter with the Depression analogy. The "D" word is being thrown around like the "F-Bomb" at a Hip-Hop festival. Most economic indicators have surpassed their extreme levels of previous recessions, so the only comparison left is the Depression. Others don't have statistics that go back that far. And a few even give indications that what we are experiencing now is worse than the 30's, providing a "come to Jesus" moment for the economist analyzing the data. "I'm not sure what this means," is the typical response.

A sobering report was put out a couple of weeks ago titled, "A Tale of Two Depressions" by economists Eichengreen and O'Rourke. Instead of simply comparing the US experience of now to the 30's, the pair instead decided to look at the global impact. Considering the Great Depression and today's predicament are both global phenomena, I though this was a reasonable exercise. From the article:

This and most other commentary contrasting the two episodes compares America then and now. This, however, is a misleading picture. The Great Depression was a global phenomenon. Even if it originated, in some sense, in the US, it was transmitted internationally by trade flows, capital flows and commodity prices. That said, different countries were affected differently. The US is not representative of their experiences.

Our Great Recession is every bit as global, earlier hopes for decoupling in Asia and Europe notwithstanding. Increasingly there is awareness that events have taken an even uglier turn outside the US, with even larger falls in manufacturing production, exports and equity prices.

In fact, when we look globally, as in Figure 1, the decline in industrial production in the last nine months has been at least as severe as in the nine months following the 1929 peak. (All graphs in this column track behaviour after the peaks in world industrial production, which occurred in June 1929 and April 2008.) Here, then, is a first illustration of how the global picture provides a very different and, indeed, more disturbing perspective than the US case considered by Krugman, which as noted earlier shows a smaller decline in manufacturing production now than then

And now three charts that accompanied their report. Note: in each chart the X-Axis represents months from the peak.

The first is global industrial production.

The second is global stock prices.

And this is global trade.

They go on to explain that public policy responses have been swifter this time around. But whether that has any effect on the economy is a matter of intense debate that has raged on for decades. Keynesians constantly point to any intervention that has failed as "insufficient." It is a clever argument that cannot ever really be refuted. Presumably, they will say that this round of interventionism was also insufficient upon its inevitable failure. In their mind the potential for "stimulus" is infinite.

Regardless, what is clear is that today's economy, if measured globally, is collapsing at a trajectory faster than that of the 30's. It is commonly held that the Smoot-Hawley tariffs are the cause behind the collapse in global trade of the 30's. Yet trade is collapsing at a much faster pace now without such protectionism. I should mention however, that our economy today and the economy of the 30's are composed differently. We were primarily an agrarian economy back then, based mostly on production. Today, we are a consumerist economy, based mostly on debt. I'll leave it up to you to determine whether that is more beneficial or detrimental. But the answer might not be as obvious as it looks on the surface.

The IMF was also out this week with some dire warnings. They now suggest that the total credit losses are to top $4 Trillion Dollars. Only $1.2 Trillion have been acknowledged thus far. They were also kind enough to tell us what we already knew: that the world as a whole is in recession - a feat not accomplished since WWII. Below are a few charts they used in conjunction with their report:

The only ones surprised by this activity are, once again, the Keynesians. They held all along that the amount of debt didn't matter. Unfortunately, these are the same people in charge of government and central bank monetary policy. They are the same people in charge of our financial institutions. And they are the same people (primarily) who are teaching our children about how to engage in business. I hate to sound like a broken record. But anytime I attempt to dodge the issue in favour of non-partisanism, I feel like I'm doing my readers a disservice. So when trying to determine how much worse the economy will become, I would be remiss not to mention that people in positions of influence will be doing everything in their power to ensure recovery is delayed.

An economy based on reality would never have become so debt-dependent in the first place. But in the absence of their constant interventionism, we could have conserved the remaining amount of capital we did have for productive uses. We could have wiped out trillions worth of uncollateralized debt at the expense of the arrogant investors who bought it. And we could have allowed asset prices to fall to natural levels, where the aforementioned savings were sufficient to service the lower amount of debt. It would have been a terrible experience. Unemployment would have rocketed to 15 or 20%. Total GDP would have fallen by a commensurate amount. But at least there would be a relatively low tax rate, a stable government and competent people would have taken over the reigns of poorly run industries. Instead we have the opposite. And guess what? Unemployment is already approaching 15% (if measured properly) and GDP will likely lose at least 5% this year while flatlining for a year or two thereafter (if you are to believe the polyannas). To put it another way, the amount of capital required for debt servicing as a percentage of total GDP is being propped up, thus sacrificing capital that could be used to invest in productive endeavors and strangling the economy.

But not only do we have incompetent policy-makers poisoning the economy with their "debt does not matter" ideology, there are other sections of the economy that are imploding with a lag. Commercial Real Estate is one I've often written about. And right on time, the evidence is pouring in. We learned this week that Q1 retail vacancies surpassed those of the entire previous year. Office and hotel occupancy rates are not doing much better. We also learned of the long awaited bankruptcy of General Growth Properties. GGP owns owned more than 200 shopping malls. What price will their creditors fetch for the properties when put up for sale? And what will this added supply do to the resale values of other properties? How will the GGP bankruptcy affect other REITs in refinancing their debts?

We are also learning that notices of defaults are rising in some of the most hard-hit areas of the residential markets. Foreclosures had moderated due to state moratoriums, but as soon as the moratoriums expired, we have spikes in activity. Again, the interventions are counter-productive, because a swath of properties will hit the market simultaneously, thus pressuring prices even more - resulting in more underwater homeowners and more foreclosures. But now new sectors of the mortgage market are getting creamed. I warned of this in 2007. It is not only the low income areas experiencing defaults. Mid and high income areas are now feeling the pain. Consider the chaos that a 25% price cut has caused for bank balance sheets. Now consider that prices are still falling and notices of default are still rising from their already record levels. Consider that it takes many months thereafter before a) banks repossess the property and b) they write down the value of the loan. How absurd does it sound that we're being told that banks are now on the mend and reporting profits?

Which leads to my next gripe: Timmy Geithner's bank stress tests. I've been meaning to comment on this for a long time. But every day the tragic comedy unfolds a little more and the absurdity of the exercise grows. This week, the subjects of the tests (yes, the banks themselves) are publicly debating what information should be revealed and to whom. I don't know whether to laugh or cry. But I do know what I won't be doing. I won't be taking the results of these tests any more seriously than I plan to take Will Farrell's forthcoming film, "Land of the Lost." Now before you jump to conclusions and picture Farrell playing the role of Tim Geithner in a captivating drama, let me assure you that Land of the Lost is not about the goings-on inside the Treasury Department - as appropriate as that may sound. It's about time travel and terrifying dinosaurs.

But to call this exercise "absurd" is giving it too much credit. First, as Yves Smith has been pointing out since it was announced, it is not even possible that the team of investigators can conceivably do a thorough enough job in the amount of time they've been given. It took a team of ~120 6 months to untangle Citigroup's commercial real estate exposure alone in the early 90's. We're being told that 200 can dissect the entire books of 19 banks in 2 months.

Second, the stress test's "more adverse" scenario assumes positive growth by the 4th quarter of this year and unemployment rising no higher than 10.4% anytime before 2011. Their idea of adverse closely aligns with mine - but only after drinking a gallon of kool-aid and wearing rose-colored glasses.

Third, and I'll cut this short, because I could go on all day. Banks only appear to be showing treasury officials what they want them to see and it does not appear that we will learn of any of these results in a transparent manner. They know that if they present a list of "healthy" banks, people will automatically assume that the others are doomed. And if they give comprehensive results, people will reverse engineer them to match real adverse economic situations - which will obviously tell us what we already know: most, if not all, of these banks are technically insolvent and require capital in the many trillions of dollars just to stay afloat.

In summary, the stress tests are a total charade. And there is no possible outcome that could prove "successful." If they report that all the banks "pass" nobody will believe them. If they release partial results, people will call their bluff. And if they tell the truth, people will panic. Timmy would have been better off doing nothing. But he felt like he had to do something. The first time he held a press conference without the perception of "a plan" the market fell faster than Britney Spears' career.

I could also go on and on about the accounting shenanigans taking place with Q1 bank earnings. But I will save myself the premature rise in blood pressure that further elaboration on that hoax would cause. Readers can simply visit any of the links to the right of this page and find damning condemnations, calls for resignations, and shocking exposés. Prepare to be appalled.

I continue to believe that the best way to measure this depression is not by magnitude, rather by time. I don't believe there is a certain unemployment level or stock market decline that one can point to and declare a bottom based on historical precedent. But once social preferences have altered themselves sufficiently (and probably overshoot on the side of frugality), the savings rate rises enough, and an entrepreneurial spirit replaces the "get rich quick" mentality of asset accumulation, we will have the foundation for a recovery. At this rate, that could take a decade or more.

It could have been different if our leaders had shown some backbone. But they all proved to be cowards. Every last one of them. Rudd, Brown, Harper, Bush, Obama - even their political adversaries. They had the opportunity to expedite this change. They could have proved themselves to be actual leaders. They could have told us, "this is going to be difficult - buckle down." But no, they had to keep up the image that nothing was wrong. They all elected to be con-men. "Confidence men." Instead of listening to the people who predicted that this would happen, they have chosen to listen to those who promised it was impossible. People like Professor Greg Mankiw of Harvard University and former chief economic advisor to President Bush. Professor Mankiw thought it prudent to let this "fantastic" idea be known to the public so he wrote about it in The New York Times:

At one of my recent Harvard seminars, a graduate student proposed a clever scheme to [make holding money less attractive].

Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.

That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10.

Of course, some people might decide that at those rates, they would rather spend the money — for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw — it’s a benefit.

This is a professor at Harvard University. These are our best and brightest? Advocating theft in order to coerce people into spending their money rather than saving it?

The question I am trying to answer is, "when is this all going to end?" I suppose that depends on how long we tolerate people like Mankiw passing off idiocy as policy. Because if we leave it up to them, we have the ability to turn what could be a healthy restructuring of our economy into a decades long period of progressively worse fundamentals accompanied by famine, disease and most likely war.

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mike.montchalin said...

One of the characteristics of 'money' is 'a store of value.'

Mankiw's student's proposal for automatic annual money destruction would make money less attractive. It is the same as making the future less attractive.

It is the 'store of value' characteristic that makes it possible for there to be a relationship between present value and future value.

The linearity of the 10% proposal doesn't completely destroy the future and present relationship of money but, it adds a whole new dimension of difficulty to the comprehension. Amortizations are tough enough without having to deal with a declining store of value, money.

RRB said...

Nicely done, Mike.

Fish10 said...


You know I agree with almost all your posts, and veer to the Austrian school like you.

However your lashing of the Keynesians may be a little unfair.

1) The deregulated, free-market capitalism that produced, owes more to Milton Freidman and his cohort than Keynes who wanted a managed economy.

2) The Great Depression was made even more calamitous than it needed to be, due to the attempt in the early Republican pre-Roosevelt adminstration to balance the budget and to the keep interest rates stable.

This crisis was competely preventable (as is the environmental one that will come next) but to become suddenly fiscally virtuous in the middle of a melt-down will bring about economic and social collapse.

Anonymous said...

It is truly a function of time to the social context who drove into the ditch first. It is not about first to last or really ever was. We have already cut back since you work for the customer and we all know the attributes of them "no mercy". For decades we group think to the extent that who is correct Ivy or Main street. It does not matter since any economist worth his salt will tell you it is the indivudual who decides. Matt understands malinvestment and the overall discussion is about value you can bring. Vague yes, solution, no. Governemnt or the market, always has been as such.
I cannot find a pragmatic sector to preservation of resources and shoes on childrens feet and roof's over people in the growing swamps of regions to care for themselves with out what we know to be the root of progress other than unfettered maxim of freedom to decide. That is the risk and solution to progress in time. Until then symantic's to blindness will apply. We can see the weather but who can see the sign's of the times. I have found more answer's in 66 book's of one book and the author's i reas who applied there meaning's. Untill the 3 pillars of Abraham choose freedom all else is vanity.


Anonymous said...


Fred said...

I totally agree with most everything but especially the part about our weak leaders.

Good solutions are always simple and obvious and they are ignoring them: saving, frugality and letting the failures die and the strong survive.

mannfm11 said...

you might dispel some of the terms used to cover up what is going on. Matts' last example is how absurd everything is. If they loaned out all the money at -3% then those bills that had a particular number in them were confiscated, the amount of money sufficient to pay back the loans would be short 7%. This is true of all lending btw.

The other thing is a savings rate. If I receive something to save, someone has to spend it, borrow it or something of that sort. The true saving rate is acutally zero. In any case, most savings is put into debt instruments, meaning that debt equals savings and all savings is spent and owed and the collection of such debt without it being rolled over is in doubt. Banking is a double column fiction that is carried on to defraud the common people out of their property and has been carried to its extreme with the creditors of the banks being insured by none other than themselves while the bankers take all the property. Who else can make good on all the money on the banks other than the people that own all the money in the banks?

I can see where the goverment might get something that looks like a recovery going. What I can't see is how they are going to make this dead man walk without life support. A recovery under these terms is like saying a man on life support can run a 100 yard sprint. Not going to happen. The economy didn't have a heart attack, but instead collapsed under the weight of its own blood, the expanding credit system.

But, then again the game of speculaton goes on. Preowned home sales have yet to dip to 4 million on an annual basis. This figure had never topped 4 million for any extended period of time prior to this bubble and has not been down to the old peak for more than 12 years. 4 million was only hit briefly,maybe a year or 2 at a time maximum prior to 1997. There are 2 problems with the housing industry, supply of surplus units and home ownership in excess of sustainable numbers. The solution is to bid up builders so we can have even bigger supply, speculation of higher degree and more home ownership, prodded by $8000 tax credits. Got a fire in the basement, why not pump a tanker full of gasoline in so everyone can see it?

I know I am rambling here, but I am really joining the choir. I have been thinking about this stuff for so many years that it is all becoming absurd. I think I am going to quit work and get me a few of those dollars that have babies because the bankers seem to believe they exist. Or is it the economists that tell us we actually have a savings rate? In any case, when all there is that exists is either created at interest or loaned out at interest, how do we have more to pay back? The problem has no mathematical solution?

mannfm11 said...

Fish10, you are reading revisionsit history. Every bubble in history has been made possible by the endowment of some operation the ability to create money. This is not a free market system. Do you possess a bank charter that endows you to create money? The issuance of titles of nobilty are expressly prohibited the Federal government and the states by the constitution. Isn't the selective issuance of charters a title of nobility? This is not the free market, but some tilted plain. Had there not been a central bank, we couldn't have had the Great Depression. The problem was a creation of Congress. Government is for waging war.

Anonymous said...

You're a really good writer, Matt. Keep at it.

Rebeca said...

Overland Park police and the Federal Bureau of Investigation said the First National Bank of Kansas was robbed just after 1 p.m. Tuesday. The bank is located in the 8800 block of 135th Street.

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