Wednesday, September 16, 2009

Green shoots -- not so fast

Best two perspectives on the current state of the economy come from Warren Mosler, and Steve Keen.

First Warren with a quick macro update:
Market functioning has finally returned, helped by the Fed slowly getting around to where it should have been even before all this started- lending unsecured to its banks, setting its target rate and letting quantity adjust to demand. It’s not technically lending unsecured, but instead went through a process of accepting more and varied collateral from the banks until the result was much the same as lending unsecured.

It is more obvious now that the automatic fiscal stabilizers did turn the tide around year end, as the great Mike Masters inventory liquidation came to an end, and the Obamaboom began. The ’stimulus package’ wasn’t much, and wasn’t optimal for public purpose, but it wasn’t ‘nothing,’ and has been helping aggregate demand some as well, and will continue to do so. It has restored non govt incomes and savings of financial assets to at least ‘muddle through’ levels of modest GDP growth, and we are now also in the early stages of a housing recovery, but not enough to keep productivity gains from continuing to keep unemployment and excess capacity at elevated levels.

This also happens to be a good equity environment- enough demand for some top line growth, bottom line growth helped by downward pressures on compensation, and interest rates helping valuations as well. There will probably be ups and downs from here, but not the downs of last year.
A nice alternative to the naysayers who take moral opprobrium against the recovery, declaring that the US cannot get its economic house in order without first fixing the banking system. The US has grown economically with a rotten banking system in the past, and can do so with the same rotten system in the future.

A longer term view now from Steve Keen
The final reason for me being a bear is that I am that practitioner of alternative medicine. Minsky’s “Financial Instability Hypothesis” has been ignored by conventional economists for reasons that are both ideological and delusional. A small band of “Post-Keynesian” economists, of whom I am one, have kept this theory alive.

According to Minsky’s theory:

* Capitalist economies can and do periodically experience financial crises (something that believers in the dominant “Neoclassical” approach to economics vehemently denied until reality—in the form of the Global Financial Crisis—slapped them in the face last year);
* These financial crises are caused by debt-financed speculation on asset prices, which leads to bubbles in asset prices;
* These bubbles must eventually burst, because they add nothing to the economy’s productive capacity while simultaneously increasing the debt-servicing burden the economy faces;
* When they burst, asset prices collapse but the debt remains;
* The attempts by both borrowers and lenders to reduce leverage reduces aggregate demand, causing a recession;
* If the economy survives such a crisis, it can go through the same process again, with another boom driving debt up even higher, followed by yet another crash; but
* Ultimately this process has to lead to a level of debt that is so great that another revival becomes impossible since no-one is willing to take on any more debt. Then a Depression ensues.

That is where we were … in 1987. The great tragedy of today is that naïve Neoclassical economists like Alan Greenspan and Ben Bernanke allowed this process to continue for another three or more cycles than would have occurred without their rescues.

In 2008, they did it again—only with methods they would have disparaged a mere year earlier (“Rational Expectations Macroeconomics”, a modern neoclassical fad, preaches that government intervention can’t influence the level of economic activity at all—yet another belief that reality has recently crucified). This time, while the rescue has worked, the recovery they expect afterwards can’t happen—because there’s almost no-one left who will willingly take on any more debt.
Is the US Consumer willing to take on debt levels we saw in 2004-2007? Will they be allowed to?

My take on the former is that the US Consumer did not think they were actually taking on a debt burden during the housing bubble, they believed that rising asset prices would reduce the debt. Without some leading sector fueling private income (from labor or capital) I cannot see much appetite to fork over 40%, 50%, 60% of household income on debt service for a property you can rent for 3-4x less.

My take on the latter is that the Government is under political pressure to not grow the deficit any more. Obama's first stimulus was too politically motivated to enable a second, unless he espouses a payroll tax holiday (which benefits everyone, and is therefore not politically useful). If the private sector is unable to increase its net equity and paid in capital, it will not have a broader base to shoulder additional debt.

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