Tuesday, January 06, 2009

Pessimistic views on the global economy

Stock markets have been strong in recent weeks – in anticipation of an Obama fiscal-led recovery - and many financial analysts are predicting the end of the panic and a reversal toward economic normality. That is a false perspective – the US, Chinese and European economies are in free fall. As with the Great Depression the dramatically low interest rates are not doing the trick and there are inevitable political difficulties in getting an effective fiscal stimulus package to work.

US job losses in 2008 are the worst since the end of WW2 – 2.4 million Americans lost their job in 2008 and yet the severe financial jolts occurred late in the year. Clearly the worst is yet to come as deleveraging throughout the economy occurs to offset decades of excessive borrowing.

Paul Krugman has come out and said it plainly* – this looks like a ‘second’ Great Depression. Janet Yellen has described the downturn as likely to be the longest and most severe since the Great Depression.

I am a pessimist and view the current stock market mini recovery not as a leading indicator of future prosperity but as a false dawn. The real effects of the disastrous financial crisis are only beginning to be felt.

* Excerpts of Krugman's views:

" Let’s not mince words: This looks an awful lot like the beginning of a second Great Depression.

... We weren’t supposed to find ourselves in this situation. For many years most economists believed that preventing another Great Depression would be easy. In 2003, Robert Lucas ... in his presidential address to the American Economic Association, declared that the “central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades.”

Milton Friedman, in particular, persuaded many economists that the Federal Reserve could have stopped the Depression in its tracks simply by providing banks with more liquidity, which would have prevented a sharp fall in the money supply. Ben Bernanke, the Federal Reserve chairman, famously apologized to Friedman on his institution’s behalf: “You’re right. We did it. We’re very sorry. But thanks to you, we won’t do it again.”

...Yet credit remains scarce, and the economy is still in free fall.

Friedman’s claim that monetary policy could have prevented the Great Depression was an attempt to refute the analysis of John Maynard Keynes (but) The failure of monetary policy in the current crisis shows that Keynes had it right the first time. And Keynesian thinking lies behind Mr. Obama’s plans....

But these plans may turn out to be a hard sell. News reports say that Democrats hope to pass an economic plan with broad bipartisan support. Good luck with that.

In reality, the political posturing has already started, with Republican leaders setting up roadblocks to stimulus legislation while posing as the champions of careful Congressional deliberation — which is pretty rich considering their party’s behavior over the past eight years.

More broadly, after decades of declaring that government is the problem, not the solution, not to mention reviling both Keynesian economics and the New Deal, most Republicans aren’t going to accept the need for a big-spending, F.D.R.-type solution to the economic crisis.

The biggest problem facing the Obama plan, however, is likely to be the demand of many politicians for proof that the benefits of the proposed public spending justify its costs — a burden of proof never imposed on proposals for tax cuts.

This is a problem with which Keynes was familiar: giving money away, he pointed out, tends to be met with fewer objections than plans for public investment “which, because they are not wholly wasteful, tend to be judged on strict ‘business’ principles.” What gets lost in such discussions is the key argument for economic stimulus — namely, that under current conditions, a surge in public spending would employ Americans who would otherwise be unemployed and money that would otherwise be sitting idle, and put both to work producing something useful.

All of this leaves me concerned about the prospects for the Obama plan. I’m sure that Congress will pass a stimulus plan, but I worry that the plan may be delayed and/or downsized. And Mr. Obama is right: We really do need swift, bold action.

Here’s my nightmare scenario: It takes Congress months to pass a stimulus plan, and the legislation that actually emerges is too cautious. As a result, the economy plunges for most of 2009, and when the plan finally starts to kick in, it’s only enough to slow the descent, not stop it. Meanwhile, deflation is setting in, while businesses and consumers start to base their spending plans on the expectation of a permanently depressed economy — well, you can see where this is going.

So this is our moment of truth. Will we in fact do what’s necessary to prevent Great Depression II?"

Update: earlier views that the recovery of US employment reflected spurious seasonal effects are confirmed. In December US unemployment jumped by 525,000 to 7.2% of the workforce. This is a 16 year high. 2.6 million Americans lost their jobs in 2008. In total 11 million Americans are unemployed. My earlier forecast that US unemployment will hit 10% looks close to the mark - official forecasts are around 9% by end of 2009. The US economy is in freefall.


civitas said...

Harry, you are indeed a pessimist. A couple of things to remember....US unemployment, even at current levels, would be considered low in much of western Europe. It's all relative.

Nothing is "permanent", certainly nothing to do with the US economy. To say that it might be permanently depressed is as unrealistic as saying it was going to be permanently on steroids as it has been for the last 7 years.

As for Krugman, it would be tough to find anyone, much less any economist, who is as often wrong as Paul Krugman. Any fair-minded review of his predictions will lead to this conclusion.

The US economy doesn't turn on a dime. But it almost does. That's what is so baffling about trying to make predictions about it. Is a ten-fifteen year recession as Japan has experienced going to happen in the US? No. The difference with the US economy is its flexibility, you don't see that to the same extent in other countries.

I'm sure this is going to sound like American exceptionalism and that's unpopular in many venues but there is much about the US economy that is simply different. And part of it starts with Americans. For example, would we sit around not spending for years, decades even, like Germans? Or Japanese? No. Now why we wouldn't is an interesting issue. I think that American expectations are simply different and that's not always good. But it is different.

conrad said...

"but there is much about the US economy that is simply different"

You can look at that in the opposite way too. No other government borrows hundreds of billions of dollars a year at the peak of the economic cycle. Even if this happens to be a short and mild recession (which seems unlikely), when and how does all this borrowing come to an end (let alone thinking about repayments)?

jc said...


Look at the aggregates. There is no deflation in the tridtional sense of the word.

Deflation always was and has been a material drop in the money supply leading to a fall in the general price level.

The opposite is occuring and before too long we could be looking at a serious inflation problem in the world as monetary expansion at present is truly astonishining.

What we have is a good old fashioned correction to the the leverage piled up since the beginning of the decade. This is not deflation although it hurts a lot as the correction continues.

Yet credit remains scarce, and the economy is still in free fall.

Krugman has always been a complete idiot when it comes to matter of macro-economics. The only people that listen to him are the Westside of Manhattan liberals.

Bank lending in the US has actually gone up. Yes that's right bank balance sheets have increased. If you don't believe me take a look at the recent fed stats.

This isn't to suggest the problems aren't serious, aa they are. But deflation it isn't. In fact since the break with gold the US would find it almsot impossible to suffer deflation as the Fed will simply print more money.

This isn't the 30's.

Why isn't it the 30's?

Between 1929 and 1932 US GDP was sawed in 1/2. The general price level fell 35% and nearly 3000 banks went bust. The bank bust was the cause of the drop in the money supply.

Son't listen to Krugman, harry. He says idiotic things.

jc said...

Exactly what Cinvatas said. It would take some huge policy mistakes to get the US in a coffin.

The flexibility of the economy is astounding.

this will pass over and the US will get back on its feet again.
Peopel who say stupid things about the US don't don't understadn the place, especially people like Krugman who ought to stick to international reade analysis, which is what he is good at (only).

jc said...


Interantional trade

civitas said...

well conrad, that's not really the opposite, is it? You're kind of making my point...."no other government......."

I don't believe the borrowing, or leverage, will come to an end. That's another US difference. When you have an economy like the US', it's going to be highly leveraged.

derrida derider said...

Oh, the US is different alright - its in a much deeper mess.

I think the most likely outcome is a painful but fairly short recession in most of the world (especially short in the NICs), but a prolonged one in the US.

Because, simply, their mismanagement of things has been worse than anyone elses.

civitas said...

Not only is the US not in a deeper mess, it will come out of its mess sooner. And that's because our economy is simply more flexible than any other economy.

jc said...


Have read about the leverage held by some of the euro based banks + UK. It's truly freaking ugly. Numerous euro commercial banks are at 340% which is way higher than the US.

Spanish banks have over $250 billion exposed to lat Am!

Given how inflexible that trash heap is I'd say that far the greater risk of imploding now looks like Europe. On top of that their labor market is hugely inflexible and the central bank there looks like its smoking crack as they don't see the huge problem and are actually talking about inflation as being the problem.

the US looks good in comparison..

The WSJ is reporting that O man is actually going to make 40% of the stimulus package into tax cuts for both business and individuals which makes the package far more acceptable to the GOP thereby speeding up the process by Feb at the latest.

Yep the US look better off at present.

observa said...

The largest part of the global economy is the developed West and its overall senesence is the problem now. I agree with Spengler(Asia Times) that it's always been about demographics. Essentially he argues that at beginning of the 80s the baby boomers were in there prime(20s-30s) and the new financial dawn facilitated the credit such a youthful demographic bulge required to facilitate its energy, talent and entrepreneurship, as well as taking over old capital and working it harder in new ways. First central banks piled on and then Asian savers with massive propensities to save, but without the same trust in their local institutional frameworks piled on to eventually fuel a massive Madoff scheme(so long Ponzi) and inevitable bust.

Finance is simply old people lending to the young and the mechanism by which youth creates wealth with leverage and the aged provide for retirement with the returns. The aged are between 47-64 now in massive numbers and with much of their savings now a fiscal illusion, are past their prime for credit and must save what they can furiously to top up their retirement savings. No more risk and leverage for them particularly with zero or negative real returns now. Where will the impetus come from to stop them catching the Japanese disease now? That is a formula for world depression as US car production slumps 53%, steel production and prices by 50% and the finance sector which represented around 45% of corporate profits goes likewise or worse. Try and add much more costly green energy to that lot and it will be the last straw.

observa said...

It seems a recession is when pessimists lose their jobs and a depression is when the optimists lose theirs.

civitas said...

"The aged are between 47-64 now in massive numbers and with much of their savings now a fiscal illusion, are past their prime for credit and must save what they can furiously to top up their retirement savings."

This is an odd reading of the US, it's much more applicable to Japan where older people really do stop spending. They don't in the US, they move to golf communities, buy cars, and take cruises. Americans don't ever think they're old, that may be the main reason most don't save as much as they should, they don't actually believe they WILL ever be old. And baby boomers are probably the best example of this.

"No more risk and leverage for them particularly with zero or negative real returns now. Where will the impetus come from to stop them catching the Japanese disease now?"

The fact that Americans aren't anything like the Japanese. Hate to say it again, but Americans really are quite different as a group.

"Finance is simply old people lending to the young and the mechanism by which youth creates wealth with leverage and the aged provide for retirement with the returns."

Very applicable in Germany or Japan, not so much in the US where young people often have quite a lot of money.

derrida derider said...

Oh, I agree demography matters - especially the large working age cohort that always occurs soon after the onset of a demographic transition. The extraordinary growth in Europe in the 50s, Japan in the 60s and China in the 90s had a lot to do with that cohort. In fact it's why I'm quite bullish about most of the NICs, and the developing world generally.

Europe is condemned to chronically slow growth by its demography(though, like Japan, not as slow per capita GDP, and hence living standards, growth as you'd think). But an implosion is unlikely - that expensive social safety net really does slow changes in consumption behaviour in both directions and the over-cautious macroeconomic policy that made them miss out on the boom means that they've much more fiscal and monetary ammunition to fire off if needed than the US does.

THe US risks losing its reserve currency status if they try and reflate too hard - watch the value of the greenback slide over the next few years as foreigners value "the full faith and credit of the United States" (the backing for their currency) less. That means they, like us, will have to pay the full cost of their chronic current acount deficit created by their low public and private saving rate.

observa said...

civitas, I don't share your confidence about a $13 trillion a year economy that has seen its deficit grow 30% in around 3 months to $9 trillion and their Obamessiah wants more and don't mention Medicare and Social security liabilities. When the lad was there 18 months ago his response to my query what was the US like, he replied- I can't understand how they're supposed to be so rich since nobody seems to work. I gather he might have been passing anecdotal judgement on whitefellas so it will be interesting to see how all the suntans are doing later this year.

observa said...

Perhaps you might like to explain how a $13 trillion a year economy with conservatively now a $1 trillion structural deficit pays back that $9 trillion at present and counting? Traditionally policymakers get nervous about jobs and incomes when economies stop growing at all, let alone shrinking to pay of debt or am I missing something?

observa said...

Google 'Call this a crisis? Just wait' for a David Walker's (ex US Comptroller General)perspective on the current summer shower compared to the impending winter for those with faith in Keynes and the new liberal project.

Anonymous said...

I see the adjusted money base rose just under 140% at an annual rate but broad money only rose about 2% at an annual rate in the US.

Very similar to the great depression. The money multiplier is falling off a cliff also.

the latest CPI had core inflation rising at 0.4% at an annual rate for the latest three months.

That is deflation taking into account the quality of goods and the problems of the index.

The US is in big trouble. It cannot do anymore in terms of cutting raters and may well have a liquidity trap.

Gadzooks. They do need a large fiscal stimulus and damned fast.

This is the closest we will see the problems of the great Depression

jc said...

nonsense anon.

this is nothing like the great depression.

Between 1929 US GDP was cut in 1/2 while the general price level fell 30%.

This is similar to the panics experienced in the 1800's.

M1 and M2 are rising smartly.

Anonymous said...

M1 is but given the huge rise in the money base that is expected however M2 has risen only 1.6%.

Banks are not lending.

Deflation is occurring,

Monetary policy is impotent to all extent and purposes so it is all hands on deck for a large dose of fiscal policy.

We won't experience a depression but it certainly has all the hallmarks of a depression

hc said...

Rabee, See the Update. My earlier forecast that unemployment in the US will hit 10% seems pretty close to the mark. another half million join the jobless in December - the employment situation terrible.

bix1951 said...

Things in Los Angeles are not that bad.
Jogging through the neighborhood this evening I saw four new cars out of perhaps 200. That was a high ratio of new to old cars. My tennis friends are buying new cars, condos in Florida, cruising to Mexico, sending kids to private colleges. We are all very rich here.
I am in the rental business. I am fully occupied. Everyone is paying on time. My rents have not come down.
Robert Shiller said, "The future is of our making."
He means we can make a prosperous future or an impoverished future. It is in our hands. It is not written.

civitas said...

observa, optimism seems to be in rather short supply these days so you're hardly alone.

I remember reading somewhere that after the Japanese, Americans work more than any other nation. I believe we're often criticized for it by leisure loving Europeans.