Daily Archives: September 25, 2012

Signs of a Structural Change in the US Economy

We had the privilege, a few days ago, of speaking with Dr. Lacy Hunt of Hoisington Investment Management on the topic of structural change in the US economy. In his most recent Quarterly Review and Outlook, he argues for depressed GDP growth for twenty years or more due to the high levels of debt in the US (see our discussion of his letter in The Policy of Doom). This we suggest represents a structural change.

Motivated by Dr. Hunt’s writing, we analyzed Chairman Bernanke’s Jackson Hole speech in The Hole in Jackson Hole. We suggested that both employment (Figure 6) and GDP (Figure 4) have recovered to trend and have little room for improvement from this point on. Furthermore we argued that these trends represent a structural shift and not a cyclical correction. In our conversation, Lacy suggested that we were on “the right track”.

Apart from discussing what we had previously written, Dr. Hunt suggested a number of aspects of the US economy that point to a structural shift. These we review briefly below.

Flash Point: You’ve got to ask yourself one question: “Do I feel wealthy?” Well do ya, punk?

In a recent Zero Hedge clip, our attention was caught by this part of a recent Bernanke interview (The Punchline In His Own Words: Bernanke Advocates Blowing Asset Bubbles As The Antidote To Depression):

There are a number of different channels — mortgage rates, I mentioned other interest rates, corporate bond rates, but also the prices of various assets, like, for example, the prices of homes. To the extent that home prices begin to rise, consumers will feel wealthier, they’ll feel more — more disposed to spend. If house prices are rising, people may be more willing to buy homes because they think that they’ll, you know, make a better return on that purchase. So house prices is one vehicle.

 The part of this phrase we emphasized seems to be the basis for current Fed policy. It also contains a kernel of insight into why the Fed is so dangerous and why its policies no longer work.

Why do they want the consumer to spend? To stimulate the economy. The ‘economy’ is the great abstraction that the Fed thinks in terms of. But they have it all backwards! Their focus is on the ‘economy’ and what they can do to it to shape it into a form they want. The problem is that the economy is an emergent phenomenon, the result of the collective financial interactions of all the individuals, corporations and organizations that participate in it. And the Fed has little direct influence or control over these participants.

The great fear of central planners is that natural systems such as economies and markets, if left to themselves, will self-destruct or at least be subject to cyclical downturns that cause distress to some participants. A frequent argument for their interventions is the allegory of the “Tragedy of the Commons”. The fallacy in this thinking we discussed in Negative Feedback, the Tragedy of the Commons, and Complex Systems. Complex systems do not respond in the long run either well or predictably to centralized planning and control.

The Fed Is Wrong

If we were to use the analogy of the Tragedy of the Commons, the Fed would be the town council urging everyone to buy more cattle to pasture to raise the aggregate income of the community. The consumer would be the farmer who sees progressively less return for the cattle he is already grazing and tries to reduce his herd and his exposure to the debacle in progress.

Since the recession began, we have regularly heard authorities urging policies that would encourage consumer spending. We have concluded in Portrait of the American Consumer, that:

At a ratio of 120% debt/income, the consumer has little room and apparently little inclination to take on more debt. Moreover, with interest rates across the yield curve at historic lows and the fact that consumers are not taking advantage of this suggests that we are at a credit limit.

In Flash Point: How Is the American Consumer Doing?, we noted that:

total household credit market debt is decreasing but this as we see above is entirely due to the decline in mortgage debt. The upturn in non-mortgage debt is troubling. We do not see that the consumer will be in a position to raise GDP significantly any time soon.

We maintain the position that the consumer has reached his credit limit and knows it. This of course renders all Fed stimulus ineffective in the most important segment of the economy. The Fed’s last bullet, the psychological inducement to spend created by the “wealth effect” in the stock market, seems to be giving little traction to the economy at the cost of creating a stock market bubble that must end in at least a violent correction (crash). This is paper wealth and a serious attempt by market participants to crystallize the apparent wealth as real wealth will crash the market.

Addendum 20131024

A short history on Alan Greenspan and bubbles from Mike Shedlock: Clueless Magoo’s Crash Guarantee.

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