Niall Ferguson: No One Has The Faintest Idea When The Economy Will Recover


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Harvard AND Oxford Professor, thank you!

Niall Ferguson: No One Has The Faintest Idea When The Economy Will Recover

by Niall Ferguson

May 29 (FT) —He thinks Obama’s economic forecasts are as much of an outlier possibility as another Great Depression. He’s also concerned, as we are, that there’s just not enough money in the world to finance all the borrowing the U.S. and other big countries will be doing over the next few years.

Barron’s: Is the worst over for the global stock markets and the economy?

Ferguson: It may look that way, but appearances can be deceptive. The stock market has actually tracked almost perfectly its downward movements between 1929 and 1931. Now that doesn’t mean that we are going to repeat the Great Depression. I don’t think we will, because the policy responses have been different. It would be excessively optimistic, however, to conclude from a relatively small set of green shoots in the economic data that we are all going to live happily ever after. It is certainly way too early to say the Obama administration is right that the economy is going to grow at 3% next year and 4% in 2011. I find that scenario as implausible as a rerun of the Great Depression…

When will the recovery come?

Nobody has the faintest idea what next year is going to look like. It isn’t clear yet that this is just a common recession. This is probably more like a slight depression. We won’t see a big V-shaped bounce. Much of the consumption growth in the decade up to 2007 was fueled by things like mortgage-equity withdrawal. That game is clearly over. Strip that out, and you are looking at an annual economic-growth rate in the U.S. closer to 1½% to 2% than 4%.

What is your disagreement with New York Times columnist and Princeton professor Paul Krugman about massive government borrowing?

This is one of the most interesting questions of the moment. The view of Keynesians, their Econ. 101 textbooks and the Nobel laureate at Princeton is that the world has an excess of savings over investments and therefore the deficit can be almost any size and it will be financed.

That is the problem with violating ‘Lerner’s Law’ and making the argument in the wrong paradigm. It invariably gets shot down like this:

My sense is that if the U.S. government tries to borrow $1.8 trillion in a year, that is an awful lot of bonds to sell at the same time [as] all the other major governments. It looks to me like a supply-and-demand story, and what tends to happen in those stories, regardless of the macro environment, is that the price of bonds tends to fall. The U.S. 10-year Treasury rate has moved up more than 100 basis points [one percentage point] since January. There is a problem in Britain, where the Bank of England had to protest about fiscal stimulus because it was causing a huge interest-rate problem. It is also happening here.

It is the blind arguing with the blind.

With this attitude it very well may take a world war to generate enough deficit spending to restore output and employment.


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James Grant


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(email exchange)

>   
>   Hi Warren. I heard James Grant speak yesterday. He was funny, entertaining, articulate
>   and full of historical knowledge, but I found his monetary analysis appalling. He wants
>   the U.S. (and the rest of the world) to be on a strict gold standard.
>   
>   It seems to me that the consequent reduction in flexibility and efficiency could be a
>   death sentence for hundreds of millions of people around the world. What do you think ?
>   

Agreed!

The gold standad wasn’t abandoned because it worked so well!

The gold standard panic of 1907 was so bad they created the Fed in 1913 to keep it from ever happening again.

It happened again and even worse in 1929 to the point gold was dropped domestically in 1934.

No depressions since as the supply side constraints on ‘money’ were eliminated and counter cyclical fiscal policy became viable.

They kept the Fed open anyway and gave it other things to do.

Send this along to Jim, thanks!


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Budget surpluses and depressions


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After the last budget surplus ended in 2001, Bloomberg stated it was the longest period of surplus since 1927 -1930.

Prof. Fred Thayer wrote this before the surpluses of the late 90’s:

http://www.epicoalition.org/docs/thayer.htm

Here’s part of the intro:

From the origins to World War II

In its first 150 years, the government periodically undertook systematic multi-year reductions in the national debt by taking in more revenues than it spent.

Each of six such sustained periods led to one of the six major depressions in our history. The last three of these crashes were the truly significant depressions of the industrial era.

This is the record:

1. 1817-21: In five years, the national debt was reduced by 29 percent, to $90 million. A depression began in 1819.

2. 1823-36: In 14 years, the debt was reduced by 99.7 percent, to $38,000. A depression began in 1837.

3. 1852-57: In six years, the debt was reduced by 59 percent, to $28.7 million. A depression began in 1857..

4. 1867-73: In seven years, the debt was reduced by 27 percent, to $2.2 billion. A depression began in 1873.

5. 1880-93: In 14 years, the debt was reduced by 57 percent, to $1 billion. A depression began in 1893.

6. 1920-30: In 11 years, the debt was reduced by 36 percent, to $16.2 billion. A depression began in 1929.

There have been no such multi-year budget surpluses and debt reductions since World War II and, significantly, no major new depression. The record suggests that reducing the debt never sustained prosperity, even when the debt was virtually wiped out by 1836. The highest deficits were those of World War II, ranging from 20 to 31 percent of Gross National Product. For a few years following the war, the debt was greater than GNP, the only such case in history. The wartime borrowing and spending actually ended the Great Depression.


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Re: Budget surpluses cause depressions


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(email exchange)

All a bunch of true but not relevant crapola.

All 6 US depressions were preceded by the first 6 periods of budget surpluses.

The 7th ended in 2001, as Bloomberg announced it was the longest surplus since 1927-1930.

The difference now we are not on the gold standard so the Treasury can deficit spend at will to restore and sustain aggregate demand.

Yes, it is that simple.

A payroll tax holiday and a few hundred billion of revenue sharing and within a few weeks everyone will wonder what all the fuss was about.

And if nothing fiscally is done, it will be like the early 90’s where the deficit went up via falling tax revenues and rising transfer payments until it gets large enough to restore output and employment.

But that can take a few years.

And nothing is gained by not doing a proactive fiscal adjustment.

(And don’t forget the energy policy to keep gasoline and crude oil consumption down!)

Happy Holidays!

Warren

>   
>   On Mon, Dec 22, 2008 at 7:24 PM, Morris wrote:
>   

How Recessions become Great Depressions

By Martin Hutchinson

Remember the Great Depression of 1921? Or of 1947? Or of 1981? Each of those years began with many of the same problems evident today, or that were evident in 1929-30. Yet they did not produce more than garden-variety recessions, which were soon over. It is instructive to examine why.

The preconditions for depression in 1921, 1947 and 1981 were similar to those operating today, and rather more severe than those of 1929-30. In each case, a large percentage of U.S. assets, built up over the preceding few years, had become obsolete and needed to be scrapped. In 1921 and 1947 the excesses consisted of surplus capacity built to provide munitions for World Wars I and II, together with the boom-time optimism additions of 1919 and 1946. In 1981, the excess consisted of a combination of U.S. factories that had become hopelessly internationally uncompetitive (think Youngstown, Ohio) and capacity that was impossible to retrofit to meet new tighter environmental standards, imposed with such enthusiasm in the 1970s.

All three of these downturns involved an “overhang” of assets that were no longer worth their cost, and associated debt that would default, similar to the housing overhang of 2008. Only in 1929-30 was the overhang less obvious initially, but an overhang was produced during the downturn by the insane political imposition of the Smoot-Hawley tariff, decimating world trade.

The 1921, 1947 and 1981 recessions were short and fairly mild, and 1929-32 became the Great Depression because of government action responding to the initial downturn. In 1929-32, as is well known, government produced the Smoot-Hawley tariff and the huge tax increase of 1932; and the Federal Reserve failed to prevent money supply collapsing after the Bank of the United States crashed in 1930, sparking widespread runs on banks across the country. As a minor addendum, President Herbert Hoover and his acolytes also followed a policy of keeping wage rates high, which was continued by President Franklin Roosevelt and the Democrats after 1933 – thus condemning 20% of the workforce to a decade of unemployment while unionized labor fattened its working conditions.

The mistaken policies of 1929-33 were generally not followed in other downturns. In 1921, Treasury Secretary Andrew Mellon, who believed in allowing the private sector to liquidate its way out of recession, was at the peak of his powers; he therefore organized no bailouts, but instead cut public spending to reduce government’s burden on the economy (he was still there in 1929, but was consistently overruled by Hoover.) In 1947, the Republican 80th Congress also cut public spending sharply and passed the Taft-Hartley Act restricting union power. The backlog of growth potential from technological advances made during the Great Depression and World War II might have lessened the destructive force of 1947’s downturn anyway, but Congress certainly helped rather than hurt. In 1981, incoming President Ronald Reagan restricted government’s spending growth, cut top marginal tax rates and allowed the Paul Volcker Fed to squeeze inflation out of the system – all actions that brought recovery closer.

In none of the 1921, 1947 or 1981 recessions did government engage in massive bailouts (the Chrysler bailout – only $1.5 billion, less than 0.1% of Gross Domestic Product – was passed in 1979, before the main leg of recession hit). Neither did the government indulge in stimulus packages in 1921, 1947 or 1981 (although President Reagan’s tax cuts had some stimulative effect in 1982-83); instead its stand on public spending on all three occasions was markedly restrictive. Finally, at no time in 1921, 1941 or 1981 did the Fed run a negative real interest rate policy; instead real interest rates were positive in all three years, sharply so in 1921 and 1981.

Internationally, the potential to become Great Depressions: 2001 was marginal as the asset overhang, from stock and telecom sectors, and was bailed out by the Fed (at the cost, we now know, of a worse recession 7 years later.); 1991 had only a modest overhang of bad housing finance assets – the rest of the economy was in great shape after the ebullient 1980s; 1974 had a substantial overhang, but the novelty of both high oil prices and environmental restrictions made the overhang less obvious than in 1981, and President Gerald Ford’s restrictive public spending policy, together with a 2001-like monetary bailout through high inflation and lower interest rates prevented it from metastasizing; 1970, 1958 and 1937 had no great new asset overhangs to deal with, although in 1937 the economy was still unbalanced from 1929-32. Thus only about a third of recessions have the potential to turn really nasty, and it appears that government actions, in one direction or the other, determine whether they do so.

Internationally, the Japanese recession after 1990 involved a huge asset overhang, from stock and real estate investments made during the 1980s bubble. The Japanese authorities got policy partly right. They did not sharply increase taxes as did Hoover in 1932, nor did they become significantly more protectionist – indeed they liberalized somewhat. On the other hand, they indulged in an orgy of unproductive infrastructure spending, driving their public debt ratio to over 180% of GDP and “crowding out” private sector borrowing, which was restricted anyway by banks’ lack of capital. After 1998, they drove real interest rates below zero, reducing the domestic savings rate and delaying true recovery.

That recovery only occurred when Prime Minister Junichiro Koizumi cut wasteful infrastructure spending and moved towards a balanced budget, thus freeing up finance for the private sector. However, new Prime Minister Taro Aso’s insistence on wasting yet more money on public spending and the Bank of Japan’s failure in 2006-08 to raise interest rates to a positive real level may well produce in Japan a recurrence of downturn like that of 1937 in the United States, an entirely unnecessary aftereffect of poor public policy.

In the United States in 2008, the current unpleasantness clearly has the potential to become much worse. The asset overhang from the housing bubble is comparable to those of 1921 and 1981 (relative to the U.S. economy) and probably larger than that of 1947, when the memory of Great Depression prevented much postwar “irrational exuberance.” Moreover, public policies of bailout, spending stimulus and negative real interest rates all tend towards producing a “Great Depression” although some of the worst mistakes (protectionism, savage tax rises) of 1929-32 have so far been avoided.

This time around, bailouts have been used on a scale greater than Hoover’s Reconstruction Finance Corporation. The Troubled Asset Relief Program (TARP) gave a spendthrift lame-duck administration and a personally conflicted Treasury secretary complete license to throw money at any problem that appears politically threatening – thus the current attempt to use bank bailout money to assist auto manufacturers, even after Congress has failed to pass an aid package. An initial recapitalization of the banking system, costing about $200 billion, may have been necessary, but the TARP proposal to spend $700 billion on dodgy mortgage assets was an appalling waste of money and in the event unworkable.

In any case, the initial injection of capital to banks should have been definitive. When Citigroup came back for more, only weeks after having been given $25 billion of new capital, it should have been forced into bankruptcy, possibly through an orderly liquidation under government-appointed administrators to minimize market disturbance and unanticipated losses. The financial services industry needs to downsize, which involves removing the worst-run competitors, an accolade for which Citigroup certainly qualifies. Conversely the automobile industry should be able to survive, but only after Chapter 11 filings have removed old union contracts and pension obligations, and allowed the U.S.-owned auto companies to streamline their model ranges and reduce wage costs to their competitors’.

By prolonging the life of incompetent banks and overstuffed union contracts, the government is making matters worse and increasing the probability of serious trouble. It is essential that TARP be closed down and that the window for government bailouts, in banking and elsewhere, is slammed firmly shut. By preventing the market’s destruction process from operating, the government makes the recession almost certainly deeper and without doubt horribly artificially prolonged.

Stimulus plans also raise the chance of a Great Depression because of the deficits they cause. When the government sucks more than $400 billion out of the U.S. economy in two months, it should not be surprised when the credit crunch worsens for the private sector. Indeed, the earlier tax rebate stimulus of the summer may well have caused the surge in unemployment, of over 400,000 per month, which occurred from September onwards. The crunch point for finance availability in a crisis occurs not in the large companies (except those that are due to fail anyway) but in medium-sized and smaller companies, the principal creators of jobs, who find credit lines pulled and survival impossible. The money for stimulus packages has to come from somewhere; when the public sector deficit is already bloated, it comes straight from the job prospects of small company employees and the self-employed.

Loose monetary policy can work either way. When an asset overhang is limited, it can make finance cheaper, raising equilibrium asset prices and limiting the force of a downturn. It was successful in doing this in 1974 and 2001, at the cost of worsening inflation in the 1970s and a more virulent asset bubble in the 2000s. However, when the asset overhang is large enough and the collapse in banking confidence sufficiently severe, loose money can no longer bail the system out of a downturn. Instead it becomes a further depressing factor, eliminating the returns for saving, preventing capital formation and keeping stock and asset prices above the depressed level at which further investment is truly economically attractive. That’s what happened after the Smoot-Hawley tariff disrupted economic activity in 1930, and it is what appears to be happening after the banking crisis of September-October. Whether or not negative real interest rates produce inflation, they will certainly in such circumstances delay recovery.

Current policies could potentially turn today’s recession into tomorrow’s Great Depression. Let us hope that President-elect Barack Obama’s team of economic wizards can figure out a way of preventing this.


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Macro update


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Here’s my take on the events of the last year:

Paulson/Bush/Bernanke pressed a ‘weak dollar’ policy to use exports to sustain GDP, rather than a fiscal package to support domestic demand.

This kept the US muddling through but took demand from the rest of world.

The rest of world had become ‘leveraged’ to their exports to the US.

As US imports fell and US exports accelerated, the rest of world economies slowed and support was removed for their credit structures.

No government moved to support domestic demand until the modest US fiscal package of a few months ago. It was too little too late.

None of the credit based economies have the institutional structure to sustain growth and employment with soft asset/collateral prices.

No private sector loans are ‘safe’ when collateral values and income are falling.

The lesson of Japan is that with a general deflation of collateral values it took a federal deficit of at least 8% of GDP just to stay out of recession.

Not sure what it will take here.

The payroll tax holiday would be a good start and probably sufficient to reverse the shortfall of demand.

The US, UK, Japan, etc. will survive a slowdown due to their ‘automatic stabilizers’ that will rapidly increase deficits until they are sufficiently large to turn things around.

The eurozone doesn’t have the institutional structure that will allow this process to work as it does in the other nations with non-convertible currencies.

The eurozone can only hope the rest of world recovers quickly and supports eurozone exports.

Without a US fiscal package US domestic demand will remain weak until the deficit gets large enough via falling tax revenue and rising transfer payments.

Without foreign CB buying of USD, US imports will not increase enough to support rest of world demand.

All this means a decisive US fiscal response, such as the payroll tax holiday, will support:

  • Both US and rest of world aggregate demand.
  • Support the financial sectors from the bottom up.
  • Increase US real terms of trade.

(Not to forget the need for an energy package to keep higher crude prices from hurting our real terms of trade and reducing our standard of living.)


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Connolly

Agreed that government can buy stocks to keep them from falling, as HK did.

But the 1930s was a gold standard deflationary collapse.

The Fed was constrained from net buying anything due to the risk of losing gold reserves.

The risks are very different now with non-convertible currency/floating fx:

Depression risk might force U.S. to buy assets

by John Parry

“The Fed probably can’t fix it all on its own now,” Connolly said. “There is a chance the Fed gets forced into unconventional cooperation with government,” which could involve buying a range of assets to reflate their value.

Operationally this can be readily done. But what assets would the Fed want to reflate? Equities represent a return on investment, which is what it is. Yes, it might make sense to have a bid, like HK did, for ‘market-making stabilization’ purposes, but not to hold longer term, as that would be public ownership of the means of production, etc.

That would be reminiscent of some steps the U.S. government took in the 1930s when the economy was mired in deflation and high unemployment.

One turning point came when agricultural prices were restored to their pre-slump levels, Connolly said. Such measures were among the New Deal programs that President Franklin D. Roosevelt launched to bolster the economy.

Note that we don’t have a problem with low agricultural prices today!

Nor with low energy prices or plunging nominal wages.

Only housing prices have been falling due to excess inventory that I calculate will be cleared in a few months. The risk is that housing prices rise after that.

Either way, investors face bleak prospects now without some kind of further government intervention, he said.

Investors, yes. Consumers, not so bleak. Jobs and income are holding up, and most forecasts are only minor rises in unemployment. And with booming exports and the fiscal package in place, GDP has been revised up.

Those steps might offer clues to investors in stocks and commodities, which Connolly expects the government might be ultimately force to step in and buy to stabilize markets.

Yes, as above. Maybe some market stabilization in the financial sector. I don’t see anything in the real sector that needs more government buying right now. Seems CPI is high enough as is for more mainstream economists.

He expects that a depression may be averted, but only by the state and the Fed reinflating the price of such assets.

If we do get a recession, it will be due to falling demand from something like a tax hike to balance the budget.

Beleaguered housing, non-government fixed-income securities and even the now overvalued Treasury market have little hope of generating substantial returns for investors over the next few years, he said.

Earned income is sufficient to drive effective demand, even without investor income.

“If we don’t avoid depression, the only thing worth holding is cash,” he added.

As we watch it buy less and less CPI? Looks more like we are turning the currency into wallpaper, at least so far.

As long as resources producers spend their incomes on imports of real goods an services (and don’t ‘save’ it), world demand is likely to be sustained at whatever prices they wish to charge.

Twin themes seem to be continuing: weaker demand with higher prices. But no recession, yet.