Summary: This cycle (a series of crisis, response, euphoria, repeat) has lasted so long that it’s easy to forget the larger dynamics at work. The forest is more than the trees. Here we briefly review what’s happened, what’s happening, what might happen — focusing on the US.
- The storm begins
- Phase 2: the cure fails, the storm returns
- Phase 3: rinse, repeat
- How will this cycle end?
- For more information
(1) The storm begins
This cycle started with the 2008-09 crash. My opinion then was the same as Dr Lanning said in the movie I, Robot “Everything that follows is a result of what you see here.” This global deflationary episode will continue with the inevitability of a falling rock until a new equilibrium appears and the massive global imbalances get resolved (despite the hysteria, debt is only part of the problem).
This event (Fall 2008 – Spring 2009) was similar in magnitude and scope to 1929-30.
- “The Labor Market during the Great Depression and the Current Recession“, Linda Levine, Congressional Research Service, 19 June 2009
- “A tale of two depressions: What do the new data tell us?“, Eichengreen, B and K O’Rourke, VoxEU, 8 March 2010
Unlike 1929-30, the world’s governments responded after after several months with massive fiscal and monetary stimulus programs — first aid that prevented the crash from becoming a depression.
(2) Phase 2: the cure fails, the storm returns
The 2nd phase began in Spring 2010. The massive stimulus programs had faded (since they did nothing to address the underlying problem, as many top economists said when they were devised). No self-sustaining recovery recovery had ignited, and the developed nations were slowing. This was a minority opinion then, as Fed Governor Janet Yellen showed in her speech yesterday, in this slide of the March 2010 consensus forecast by Blue Chip Economic Indicators — vs. the actual 2011 GDP (the lower 2011-2012 black line should be red dots).
Then the euro-crisis began. As before, in broad outline this was expected (i.e., the rescue package had been crafted in late 2009).
“It is a national and imperative need to officially ask our partners in the EU for the activation of the support mechanism we jointly created.”
— Prime Minister George Papandreou, requesting a 45 billion euro loan from the Troika (EU, the European Central Bank, and the International Monetary Fund), 23 April 2010
Europe responded with a series of too small, too late, poorly crafted “rescue packages.” The US responded in Oct-Dec 2010 with QE2 and a massive but poorly designed fiscal stimulus. Neither provided more than a palliative to the fundamentally weak US and EU economies.
(3) Phase 3: rinse, repeat
Now we begin the 3rd phase, with slowing in America, China and Europe (probably India and Japan as well). Are we, USA, the world’s save haven? US economy has been relatively strong, buoyed by our high fiscal deficit: $1.2 trillion for the 12 months ending May (8.5% of GDP!) — and $5.9 T since Nov 2007 (boosting our total public debt by 113%).
What’s the Blue Chip forecast for the US (as of May 2012, source)? They’ve marked 2012 down a little since their March 2010 poll, but not 2013. I suspect both are probably still too high. The Fed staff is too optimistic, as usual (as in their 2007 reports showing that there was no residential real estate bubble).
The actual data does not look good, as in this presentation yesterday by Philip Suttle of the International Institute of Finance. These are QoQ numbers, and so do not fully reflect the slowing in the past week’s durable goods and employment reports (e.g., over the past 2 months manufacturer’s new orders are down 15% SAAR).
Another IIF graphic, from “Sovereign Debt and Banking Problems: Quo Vadis?” by Hung Tran, comparing us to those profligate socialists in Europe. We make Europe look good.
Our credit metrics are among the worst of the major nations. This has not been recognized yet, despite repeated warnings from the ratings agencies, the IMF, and the BIS. When it happens, perhaps during the “fiscal cliff” negotiations later this year, the effects might be severe. Also from Hung Tran’s presentation:
Moody’s provided another perspective in their March 2010 Aaa Sovereign Monitor. This proved accurate (much of their analysis is of excellent quality, more so than their ratings). For more details see this post. The lower right quadrant is a bad place to enter, and painful to leave.
(4) How will this cycle end?
“In the long run we are all dead. Economists set themselves too easy, too useless a task if, in tempestuous seasons, they can only tell us that when the storm is long past the ocean is flat again.”
— John Maynard Keynes in A Tract on Monetary Reform (1923)
I do not know how this cycle will end. I believe that conditions will get worse before they get better. Even wise decisions by the great nations, perfectly executed, will create a transitional period of turmoil. Should decisions be delayed until the turmoil begins, so that they’re made in haste under pressure, then the odds increase of policy and execution errors. A lot.
Another effect of governments taking the necessary steps only after the chaos begins: under stress people tend to narrow their circle of care. Who is “us” and who is “them”. Coordination both within and between nations becomes less likely; conflict becomes more likely.
No matter what the result, eventually these things will sort themselves out. The US has many strengths, as do the other great nations. These events will become memories for our children, then footnotes to their grand-children. But the effects will ripple into the future, since those nations that do well will become leaders in the 21st century.
(5) For more information
- A status report about the US economy (we party so hard we cannot hear the alarms ringing), 27 March 2012
- About America’s economic recovery: the good news and the bad, 1 May 2012
- About the May jobs report – a few new jobs, bought at great cost, 1 June 2012
- The Titanic’s lessons for us about the coming economic crisis, 4 June 2012
- America is rich and powerful because we can borrow. Will this debt build a stronger America?, 5 June 2012
- The Fate of Europe has become visible. Only how and when the break comes remains uncertain., 6 June 2012