I am spurred to discuss macroeconomic matters due a couple of recent articles. One was written by Drs. Kenneth Rogoff and Carmen Reinhart, of whom I have written many times. They argue that the economy of the past several years was not just a larger or ‘great’ recession but something worse, in contrast to the view of the Federal Reserve and many others that this was just worse than other recessions but not qualitatively different.
From the body of their article :
We … have consistently argued that the popular term “Great Recession” is something of a misnomer for the current episode, which we have argued would be better thought of as “the Second Great Contraction” (after Milton Friedman and Anna Schwartz’s characterization of the Great Depression as the Great Contraction)…
Figure 1 (attached) compares the still unfolding (2007) financial crisis with U.S. systemic financial crises of 1873, 1893, 1907 and 1929. As the figure illustrates, the initial contraction in per-capita GDP is smaller for the recent crisis than in the earlier ones (even when the Great Depression of the 1930s is excluded). Five years later, the current level of per-capita GDP, relative to baseline, is higher than the corresponding five-crisis average that includes the 1930s. The recovery of per-capita GDP after 2007 is also slightly stronger than the average for the systemic crises of 1873, 1893 and 1907. Although not as famous as the Great Depression, the depression of the 1890s was dismal; in 1896, real per-capita GDP was still 6 percent below its pre-crisis level of 1892.
There is much more in this article.
It is difficult to see how Rogoff and Reinhart cannot be correct. Even in the 1929-33 period, very little depositor’s money was lost. Many banks closed, many of them very small ones, but often the losses were absorbed at the shareholder or director level. In contrast, the largest financial institutions in the U.S. went bust or would have without extensive intervention. Sheila Bair has written a book that now reveals what presumably we all knew, which is that Citigroup was insolvent in the crisis. Fannie Mae, Freddie Mac, AIG, Wachovia, Lehman, Countrywide, on and on. What this implies is absolutely massive mismarking of assets to liabilities, and an unimaginably large amount of bad investments.
The mis-matching of assets and liabilities for the above to have occurred must have been massive. How can that not be reflected in the real economy for some time to come?
Last year, I analogized the remedy the authorities have prescribed in a post titled On Treating Economic Crises the Way We Treat Heart Failure. To summarize, it argues that our modern economic doctors have made the same mistake as doctors of not long ago when they treated the syndrome of congestive heart failure. We were taught that if the heart was weak, well then, it should be stimulated. It turns out that doing so made the patient feel better for a while, but when one or two drug candidates were put to the test, they ended up overstimulating the heart.
Against prevailing wisdom, it turned out that the two best remedies to heal weak hearts were A) beta blockers, which temporarily weaken the heart in a manner that allows it to gradually gain strength over the intermediate and long run, with better duration and quality of life, and B) ACE inhibitors and their relatives, which neither stimulate nor weaken the heart but do help the heart and the entire body recover from the heart failure syndrome. (Stimulants that strengthened the heart and led patients to feel better also shortened their lives. The analogy with what might go wrong with over-stimulating post-Lehman is clear.)
While the authorities did their best when faced with the terrible circumstances in 2008-9 they did not anticipate, they followed a prescription for prior recessions. This involved pulling future demand forward by lowering short term rates to near zero and keeping them there. Innumerable speeches and comments from the Fed and the administration’s best economists show that they anticipated that economic growth would come to trend quickly. They did not anticipate a sluggish recovery and now find themselves trapped in the emergency remedies of zero short term interest rates and money-printing, now called quantitative easing.
And despite all the support for the economy from Washington, the sales and profits cycle for public corporations may be pointing downward before anything like a full recovery has occurred. From Reuters (LINK):
Sales stumbles raise fresh worry for corporate America
* Most companies that reported earnings missed sales expectations
* Slump showing limits of margin expansion
* ‘Crack in the armor’ of profit growth story
Here are some quotes:
A majority – 54.3 percent – of the 70 companies in the widely watched Standard & Poor’s 500 Index that have reported results so far have missed analysts’ revenue forecasts, according to Thomson Reuters I/B/E/S.
The list of companies’ reasons for weak performance has expanded, with some citing a decline in demand in the United States – until recently a more reliable source of growth – as well as in Europe, which is mired in a debt crisis.
American Express warned that its cardmembers’ spending was starting to wane…
International Business Machines Corp, the world’s largest technology services company, missed analysts’ sales forecasts for a fifth consecutive time with a 5 percent drop in the third quarter, as corporate customers in the United States and Canada cut their spending on equipment and services.
What, you ask, about earnings? The article goes on:
Of the S&P 500 companies that have reported so far, 64.3 percent have beaten Wall Street’s lowered expectations. At the start of the third quarter on July 1, analysts expected those 500 companies to collectively increase profits by 3.1 percent, a forecast that was cut to a drop of 2.1 percent by Oct 1.
I don’t know whether the U.S. is in a fresh recession, but falling corporate profits are a warning sign. So is seeing so many companies ”miss” on sales. So is the following from Business Insider (LINK):
Morgan Stanley just published its October read on its proprietary Business Conditions Index and it collapsed to 41% from 55% in September…
Despite the stronger than expected employment report for October, both hiring indices fell to multi-year lows. The hiring index dropped 10 points to 44%, low since December 2009, and the hiring plans index sunk 13 points to 44%, low since August 2009.
Long term, continuation of the money printing as promised by the Fed almost guarantees higher stock and commodity prices over time. In the short run, though, anything can happen. Federal Reserve interest rate manipulation and direct purchase of securities from governmental or quasi-governmental mortgage agencies are meeting a cyclical business slowdown in the setting of a global economic down cycle.
What will happen next (besides an election)?
I guess my only insight for the present is that corporate sales and earnings, and companies’ comments about the months ahead, provide an unfiltered view of economic trends. While it’s somewhat early in earnings season, for the second quarter in a row corporations are not reporting much if any earnings growth. In that setting, their averred concern about the issues that are referred to as the “fiscal cliff” makes it sound as though the current slowdown in earnings growth (or actual decline, especially in inflation-adjusted terms) might continue for a while.