Monday, August 24, 2009

Eeek! Economics!

The biggest impediment to being right for an economist is the lack of fixation on time. Gary Shilling, Noriel Roubini and Nasem Taleb are all prescient economists who predicted the current deflation.....for years. In other words they were wrong until they were right. That is one of the advantages of being an academic. One can work in relative obscurity apart from occasional snickers during presentations of papers for years until reality turns to agree. Then you are a rock star....until you're not.

My economic based view has been tested the past several months. While being quite confident that March represented a buying opportunity, I have been much less assured since mid year while the market keeps moving higher. While the massive asset price lifting power of billions of public dollars has been demonstrated clearly the hangover that policy will produce has been largely ignored.

What has not changed is the massively important credit and debt aspects of the global economy and the U.S. economy specifically. The US debt to GDP ratio continues to rise with the public debt portion taking over an additional and substantial portion of total debt. Until debt declines we
are simply adding gasoline to the fire and eventually we will burn.

Those who see green shoots assume a typical "V" shaped recovery from a production/consumption recession. This is a credit and debt induced collapse and adding additional debt will not solve the problem. The public injection of capital allowing the banking system to continue to not recognize its insolvency and allow a market clearing event to take place rests on a misguided combination of fear and hope.

Schumpeter's creative destruction has been thwarted allowing zombie institutions to ultimately keep private investment to in check while ironically encouraging, once again, riskier speculation with the knowledge that public money would be made available to bail out failure.

If there is any rationale to the current public policy it is to buy time, keep the population placated and HOPE that a demographic tailwind rights the boat.

The US economy has been +70% driven by consumer spending and negative savings rates over the past 20 years. The is reasonable behaviour that will rekindle that irrationality in the near future.

The baby boom generation has seen its retirement savings decimated. Credit is no longer easily available. Unemployment appears to be structurally elevated for the foreseeable future.

Let's look at the green shoots. Housing. The good news is that there is some activity in housing. The vast majority of that activity is in foreclosure sales. That is in and of itself positive. It clears inventory, and inventory remains very high. Like the Cash for Clunkers program the government tax credit program may pull demand forward into 2009 from 2010.
This is another example of a buying time policy. Which in a normal recession would work well as spending returned. The housing stats reported last week are strong only if listening to spinmeisters. A suspicious increase in Northeast Condo sales was the only data that turned the numbers positive. Single family homes were still weaker.

The growth this past quarter seem largely limited to inventory rebuilding and cost cutting. Again, both positives for economic recovery, but with unemployment high and credit limited is it sustainable? Retail analysts continue to see very low store traffic and increasing pressure on rents by storeowners to landlords. Conversely real estate owners, i.e. landlords are facing severe financing problems of their own. Commercial real estate loans are the 1000 pound gorilla unless we begin to see a re-emergent consumer.