Saturday, December 19, 2009

The Double-Dip Recession

Long essay, persuasive. There's a LOT which leads up to this, including the bank-problem, a listing of Gummint methods to prop up assets, and some guesses as to the response of the Obama Administration.

  1. The private sector (particularly households) is overly indebted. The level of debt households now carry cannot be supported by income at the present levels of consumption. The natural tendency, therefore, is toward more saving and less spending in the private sector (although asset price appreciation can attenuate this through the Wealth Effect). That necessarily means the public sector must run a deficit or the import-export sector must run a surplus.
  2. Most countries are in a state of economic weakness. That means consumption demand is constrained globally. There is no chance that the U.S. can export its way out of recession without a collapse in the value of the U.S. dollar. That leaves the government as the sole way to pick up the slack.
  3. Since state and local governments are constrained by falling tax revenue (see WSJ article) and the inability to print money, only the Federal Government can run large deficits.
  4. 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.
  5. Meanwhile, all countries which issue the vast majority of debt in their own currency (U.S, Eurozone, U.K., Switzerland, Japan) will inflate. They will print as much money as they can reasonably get away with. While the economy is in an upswing, this will create a false boom, predicated on asset price increases. This will be a huge bonus for hard assets like gold, platinum or silver. However, when the prop of government spending is taken away, the global economy will relapse into recession.
  6. I believe this dynamic will induce a Scylla and Charybdis of inflationary and deflationary forces, forcing central bankers to add and withdraw liquidity in a manic way. The likely volatility in government spending and taxation gives you the makings of a depression shaped like a series of W’s consisting of short and uneven business cycles. The secular force is the D-process and the deleveraging, so I expect deflation to be the resulting secular trend more than inflation.
  7. Needless to say, this kind of volatility will induce a wave of populist sentiment, leading to an unpredictable and violent geopolitical climate and the likelihood of more muscular forms of government.
  8. From an investing standpoint, consider this a secular bear market for stocks then. Play the rallies, but be cognizant that the secular trend for the time being is down. The Japanese example which we are now tracking is a best case scenario.
HT: Ritholtz


J. Strupp said...

That sounds about right. You know, something like the manic boom/bust cycles of the late 19th century. Fun fun for everyone.

J. Strupp said...

BTW dadster, Ritholtz did a pre-review of "Too Big to Fail" just below your linked entry. Read it if you have the time. It's a long read but it's outstanding.

Jeremy R. Shown said...

Are things really so bad that a lost decade is now looking like a best case scenario?

J. Strupp said...

No I wouldn't say that. That implies that we're like Japan. We aren't.

The American economy is the most dynamic and innovative in world history. We CAN fix this. Unfortunately for us, the fallout from severe finanicial crisis is something that lasts for many years. The question remains whether or not we have the backbone to take the necessary steps to keep our economy out of the abyss while we begin the lengthy process of repairing balance sheets and also whether or not we're willing to create REAL finanical regulation in order to make sure nothing of this magitude happens again.

Dad29 said...

The single most important difference between Japan and the US is demographics.

Japan, as a nation, is dying. No children there, and NO immigration.

J. Strupp said...

Agree with you there.