More thoughts on the fake recovery
A recent post I published on both Credit Writedowns and Naked Capitalism, “Both initial claims and continuing claims now pointing to recovery,” has left the impression that I am a wild-eyed bull – for which I have been duly smacked about the head. This is far from the case. A recent post by Nouriel Roubini to which Marshall Auerback alerted me is very much in line with my viewpoint. I would like to share snippets of that post with you along with some quotes from my own past posts and updated commentary to clarify how I see the economy progressing. But, I also want to reiterate the point of NOT viewing the economy only through the lens of recent events, and of taking a measured, objective view of data.
Roubini’s post has the delightfully long title, “Green shoots or yellow weeds? A trifecta of risks to the early bottoming out of the recession and short-term economic recovery and to the medium-term actual and potential growth prospects of the global economy.” That’s quite a mouthful. He begins as follows:
Recent data suggest that the rate of economic contraction in the global economy is slowing down and we are closer than six months ago to the trough of the recent severe global recession. But while the rate of economic contraction is now lower than the free fall and near-depression experienced by many economies in Q4 of 2008 and Q1 of 2009 the recent optimism that “green shoots” of recovery will lead to the recession to bottom out by the middle of this year and that recovery to potential growth will rapidly occur in 2010 appears to be grossly misplaced. A careful assessment of the data suggests that rather than green shoots there are plenty of yellow weeds both in the short term and in the medium term. Here there are three important ways that our views differ from the current optimistic consensus.
Let me get to those three ways in one second. First, a translation of what Roubini is saying: this is no garden-variety recession, it is the D-process as outlined by Ray Dalio (see post here). Therefore, there will be no V-shaped recovery. I happen to agree with that assessment. Back in February, I said we are in a mild depression with a small ‘d.” The unwind process will be very different.
In Roubini’s post, he enumerates three reasons why he does not see an early or V-shaped recovery.
First, the current deep and protracted U-shaped recession recession in the US and other advanced economies will continue through all of 2009 rather than reaching a trough in the middle of this year as expected by the current optimistic consensus.
Second, rather than a rapid V-shaped recovery of growth to a rate close to potential US and global economic growth will remain sluggish, sub-par and well below trend growth for at least two years into all of 2010 and 2011; a couple of quarters of more rapid growth cannot be ruled out as we get out of this recession towards the end of the year and/or early next year as firms rebuild inventories and the effects of the monetary and fiscal stimulus reach a delayed peak. But at least ten structural weaknesses of the US and the global economy will cause both a below trend growth and even the risk of a reduction of potential growth itself.
Third, we cannot rule out a double dip W-shaped recession with the wings of a tentative recovery of growth in 2010 at risk of being clipped towards the end of that year or in 2011 by a perfect storm of rising oil prices, rising taxes and rising nominal and real interest rates on the public debt of many advanced economies as concerns about medium term fiscal sustainability and about the risk that monetization of fiscal deficits will lead to inflationary pressures after two years of deflationary pressures.
Please read the entire Roubini post which is linked below. It is quite thorough. In it, he references a piece by Robert Gordon regarding jobless claims signalling the end of recession that I have also covered. However, I don’t think the recession has ended or is about to end as Gordon indicates. I said when reviewing Gordon’s work:
So, jobless claims are definitely a number to watch as we head into the spring and summer. Absent claims numbers averaging 700,000 by mid-to-late summer, it will be safe to say, we are on the road to recovery. What kind of a recovery we get is another entirely different question.
So I see Roubini’s view as very much in line with what I said in my post “Both initial claims and continuing claims now pointing to recovery” – key bits are now highlighted below, but you will notice he stresses the downside risk in his post title whereas my title stresses the upside surprise.
And for the record, I have said I see a recovery happening probably in Q4 2009 or Q1 2010 (see my post “The Fake Recovery”).
The real question is how robust a recovery are we going to have and this is directly related to why the jobless claims series has been sending a false signal. Now, initial claims has been sending a recovery signal since January. Yet, continuing claims continued to rise more quickly until last week. In the past, one had seen these two series as harbingers of imminent recovery. But, I am talking Q4 here. Why? Deleveraging.
In the end, consumers are going to be forced to reduce debt and save more in this more cautious financial environment. Team Obama does seem intent on re-kindling animal spirits but the personal savings rate has gone up nonetheless. This will be a drag on GDP growth going forward and means that the economy’s rebound will be more tenuous and slower to develop. In my view, this means recovery will be delayed and once it gets going it will be weak. The potential for a double dip is very high.
So, to be clear, first derivatives are starting to turn up and since recession is a first derivative event, we are probably going to see an end to this recession soon enough. But, with structural problems still remaining, the U.S. economy will be weak for a long time to come.
Given the fact that I have over 100 articles posted on Roubini’s site, it is hardly a surprise that my viewpoint is in line with his. But, I am at pains to stress this given the negative response I received from that recent ‘upbeat’ jobless claims post.
Look, the fact of the matter is we are in depression. This is no ordinary recession. That means the negative effects of deleveraging and its drag on growth will continue for the foreseeable future until the excesses are largely unwound – recovery or not. This is the principle reason, I do not see the recession ending this Spring despite the jobless claims signal. While I wrote the jobless claims post to highlight this fact, I cannot dismiss the data out of hand. The signal is there and it has been reliable for the 40 years of data collected on jobless claims as Robert Gordon has indicated.
In my view, econobloggers and their readers are suffering from the same recency bias that created the housing bubble – viewing future events through the distorted lens of recent events only, without adequate consideration of the natural boom-bust nature of the global economy. I said as much in my post, “Through a glass darkly: the economy and confirmation bias in the econoblogosphere.” Where the recency bias caused people in 2006 to extrapolate ever increasing asset prices and a world of low interest rates and muted business cycles, today it has caused many to think we are headed straight for the Great Depression II and that financial Armageddon is upon us.
However, the picture is not as stark as this. While we may be in a mild depression, policymakers around the world have gone to great lengths to prevent a Great Depression II. In my view, the Federal Reserve has effectively demonstrated it is willing to risk hyperinflation in order to beat back the deflationary forces. And with most major economies engaging in extreme fiscal stimulus and monetary stimulus, one can only conclude that the worst is over and we will see a cyclical recovery. Moreover, the gifts to the financial sector have been large and will continue (see posts here and here) and have diminished the crisis of confidence we suffered post-Lehman. You may not like the means used to achieve this, but the effects are clear.
This is what I call The Fake Recovery. Underneath the surface, all of the problems are still there to a lesser extent: the massive debt burdens, the weak financial sector, the poor savings in the U.S.. We are likely to see the lingering effects of deleveraging to fix these problems take a percentage point away from growth for some time to come. This means the recovery in 2010 is going to be weak. Could we see jobless claims average 450,000 in recovery? Certainly. And 450,000 jobless claims was a figure that meant recession in 2001, so that is no recovery to write home about. And, while it seems increasingly likely we will get a recovery by year’s end or Q1, a double dip recession like we saw in 1980-82 is still a very distinct outcome.
The reason that recovery will come and it won’t feel like one is simply because the terms ‘recession’ and ‘recovery’ are misunderstood. Most people would define a recession loosely as ‘a period when the economy is not doing well.’ A recovery is axiomatically then ‘a period when the economy is doing better.’ But, that is a misnomer. I don’t think many people get the fact that GDP as reported is a first derivative statistic or that recession is a first derivative term (i.e. it measures the change in output, income, sales and employment). Now, I tried to make this point in “Economic recovery and the perverse math of GDP reporting,” the point being a fall from 100 in year 0 to 90 in year 1 and jump back to 92 in year 2 would be considered a deep recession followed by a weak recovery. Anyone living through such an experience would not be experiencing ‘recovery.’ And as far as the U.S. goes, the middle class has been losing ground for some 35 years. The deleveraging process is going to further this sense of loss.
So, I have an idea which Marshall Auerback inspired. Let’s get rid of the term recovery altogether. Let’s call what we see coming an end of the recession or an end to the worst of it. My worry is that any recovery will be used to prevent true reform to our financial system, to roll back recent trends in regulatory oversight and anti-trust, or to provide sufficient relief to two-income families. Unfortunately, for most of us, it will not feel anything like a recovery. Yet, it may be used to continue business as usual.
I hope this helps to contextualize my recent post on jobless claims.
Update: I would also add that it is far from clear that we will get a recovery at all. While the balance of evidence seems to point in this direction, David Rosenberg in particular makes a good case as to why we will not. Meredith Whitney is equally compelling in arguing that the banking sector will come under more pressure than I envisage.
Overall, there are a number of data series to watch: weekly jobless claims and the employment situation report for employment. Monthly personal income and the average hourly/weeklyearnings from the employment situation report for income. GDP, ISM manufacturing, non-manufacturing, Philly Fed and Empire State survey for output. Monthly retail sales reports for sales.
I should also point out that just because we see a positive GDP number in any quarter does not mean that we are in a ‘recovery.’ We would need to see 5 or 6 months of positive numbers to realy gauge this. Therefore, likely it will be Fall of 2010 before the trend is clear.
Green shoots or yellow weeds? A trifecta of risks to the early bottoming out of the recession and short-term economic recovery and to the medium-term actual and potential growth prospects of the global economy – RGE Monitor