Wednesday, August 27, 2008

Zen trade

Yves points to a very interesting paper on exactly what a globally balanced world would look like in real terms. The surprise finding is that the biggest beneficiary of all this is Japan. Japan is actually interesting me more and more these days.
The US as a share of the world economy falls by just 4.5% while Japan's rises by 3.3%. The inflexible case, however, requires a much more radical realignment in the relative size of the major economies. The US declines by nearly 30% relative to the world while Japan grows by over 26%. (Combining the numbers, the adjustment would require over a 50% devaluation of the US dollar in terms of the Japanese yen).

Tuesday, August 19, 2008

Maudlin Melodies

John Mauldin typically posts some pretty good stuff at a reasonable frequency and with an emphasis on longer more thoughtful pieces, as opposed to the quick one off that has become the blogging norm. Today he has something from David Rosenberg, Merrill's chief economist. Rosenberg is pretty bearish, as is anyone in their right mind, frankly, though there's nothing that I would call new in what he's saying. A few things did catch my attention though. First, screw GDP:
More to the point, if you're waiting as an investor for GDP to actually turn negative, you're going to miss a lot of action along the way. I think the best example is to just go back to Japan. They had a real estate bubble that turned bust and they had their own credit contraction back in the early 1990s. Guess what; Japan didn't post its first back-to-back contraction of real GDP until the second half of 1993. By the time the back-to-back negative that people seem to be waiting for happened, the Nikkei had already plunged 50%, the 10-year JGB yield rallied 300 basis points, and the Bank of Japan had cut the overnight rate 500 basis points, which said a thing or two about the efficacy of using the traditional monetary policy response of cutting interest rates into a credit contraction (as we're now finding out here in the US).
Second, not everything gets marked to market instantaneously:
I was around in the 1980s, and I remember that it played out very similarly. What people called resilience and people called contained and people called decoupling were all very pleasant euphemisms for lags. That's what they are; they're lags. There are built-in lags. Housing peaked in 1988, rolled over, the credit crunch intensified in 1989 when RTC got into real action. Then 1990 ... two years after housing peaked, we had this very surprising consumer recession that caught even the Fed off guard.
Perhaps I'm just constitutionally bearish, but I feel like it's just common sense to suggest that the depth of the pullback in the US will eventually have an impact al over the world. But not right away. People take time to adjust to the reality that a lot of the wealth created in the last 10 years was illusory, and that the baseline is much lower than they think because they aren't accounting for the fact that we had one giant credit bubble that came in two episodes. We're not going back to 2005, but 1995.

Monday, August 18, 2008


The inflation-deflation question is to me the trickiest macro-economic call at the moment, probably due to the fact that it is really a political question at bottom. If we still used gold as money, the limited supply would mean that when the music stopped after the exuberant debt creation party, the room still had the same number of chairs. The fact that we print money calls this into question, though it does not assure it, as you still have to get that money into people's hands so that they spend it and it flows through the system. Interfliudity makes an interesting comment on this point, which speaks directly to the two great examples of modern deflation:
Japan's experience in the 1990s and the US' in the 1930s are often cited to suggest the inevitability of deflation, despite monetary policy heroics. But in both cases, the deflating country had a large, positive international asset position. To the degree money was owed by foreigners in domestic or pegged currency, the "national interest", looking past winners and losers, was to tolerate deflation.
This actually has a compelling ring to it -- to inflate or deflate is a political question that depends on whether you are a debtor or a creditor. If you are a net creditor nation, even though deflation is painful in domestic economic terms, it's even worse to let your debtors off the hook. As a net debtor, there's no reason to accept the pain of deflation, and the political calculation will always be to inflate.

The question in the current case of the US is to wonder aloud whether the US can engineer a quiet bailout where we exchange China and the gulf's ongoing support of the dollar for an agreement to actually pay these bills (i.e. not inflate). This would allow us to avoid the nastiness of a default, including a major currency collapse and a severe recession, and gradually bring our balance of payments in line via years of subpar growth and reduced standards of living. Theoretically you could engineer a kind of cancelling of the inflationary and deflationary forces -- debt restructuring as opposed to simple default. I'm not sure that's a geopolitically viable course of action unfortunately.

What ever happened to Stephen Roach?

I feel like he used to be much more visible, and I haven't seen him get a lot of airtime lately. Maybe this is just what happens to you if you see the bubble too early. Yves has dug him up however ...
At the root of the problem was America’s audacious shift from income- to asset-based saving. The US consumer led the charge, with trend growth in real consumer demand hitting 3.5% per annum in real terms over the 14-year interval, 1994
to 2007 – the greatest buying binge over such a protracted period for any economy in modern history. Never mind a seemingly chronic shortfall of income generation, with real disposable personal income growth averaging just 3.2% over the same period. American consumers no longer felt they had to save the old-fashioned way – they drew down incomebased saving rates to zero for the first time since the Great Depression. And why not? After all, they had uncovered the alchemy of a new asset-based saving strategy – first out of equities in the latter half of the 1990s and then out of housing in the first half of the current decade.....

Blogging Blodget

Henry Blodget has a post that gives the latest update on the only two overall market valuation measures that have ever made any sense to me -- Tobin's Q and the cyclically adjusted PE ratio. The upshot is really just what you'd expect, namely that US stocks are still a bit expensive by historical measures, and that's without even imagining that we are going to experience a tougher than normal cyclical downturn. Take a look at the chart to see just how bad it can get.

Monday, August 4, 2008

Good Quote

From Yves Smith:
Too many developed economies got addicted to asset inflation - the increasing valuations were the only source of yield to service the debt incurred in their purchase - a Ponzi scheme in the Minsky sense. Now that bubble has burst. Houses are a non-productive asset, a consumption good. Values have to fall to where they can be serviced from current incomes - whether via a mortgage payment or rent - or incomes have got to rise via wage inflation. I still don't see any other way out. The first decimates (many) banks, the second decimates the dollar.
This seems to me the crux of the inflation-deflation debate. The question is whether the Fed will backstop the fake money creation of the last ten years and bail out the banks and the housing market by inflating away the purchasing power of the dollar, or whether that invented money will be disavowed and we will end up with a deflation that begins with asset values and spread backwards to goods and services (imagine if your favorite cafe sits on real estate worth only half as much and so pays only half the rent).