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Sunday, September 20, 2009

A couple of Bullish Views

by Calculated Risk on 9/20/2009 01:07:00 PM

From James Grant in the WSJ: From Bear to Bull

Knocked for a loop, we forget a truism. With regard to the recession that precedes the recovery, worse is subsequently better. The deeper the slump, the zippier the recovery. To quote a dissenter from the forecasting consensus, Michael T. Darda, chief economist of MKM Partners, Greenwich, Conn.: "[T]he most important determinant of the strength of an economy recovery is the depth of the downturn that preceded it. There are no exceptions to this rule, including the 1929-1939 period."

Growth snapped back following the depressions of 1893-94, 1907-08, 1920-21 and 1929-33. If ugly downturns made for torpid recoveries, as today's economists suggest, the economic history of this country would have to be rewritten.
"At the business trough in 1933," Mr. Darda points out, "the unemployment rate stood at 25% (if there had been a 'U6' version of labor underutilization then, it likely would have been about 44% vs. 16.8% today. . . ). At the same time, the consumption share of GDP was above 80% in 1933 and the household savings rate was negative. Yet, in the four years that followed, the economy expanded at a 9.5% annual average rate while the unemployment rate dropped 10.6 percentage points."
Our recession, though a mere inconvenience compared to some of the cyclical snows of yesteryear, does bear comparison with the slump of 1981-82. In the worst quarter of that contraction, the first three months of 1982, real GDP shrank at an annual rate of 6.4%, matching the steepest drop of the current recession, which was registered in the first quarter of 2009. Yet the Reagan recovery, starting in the first quarter of 1983, rushed along at quarterly growth rates (expressed as annual rates of change) over the next six quarters of 5.1%, 9.3%, 8.1%, 8.5%, 8.0% and 7.1%. Not until the third quarter of 1984 did real quarterly GDP growth drop below 5%.
And from McClatchy Newspapers: Ex-IMF chief economist has rosy recovery view
[Michael] Mussa, the former chief economist of the International Monetary Fund, presented a decidedly upbeat economic forecast last week that turned heads in the nation's capital. ...

"The recession is over and a global recovery is under way," he began, unveiling a pile of data and historical charts to support his view that forecasters regularly underestimate recoveries – and are doing so again.

Where the IMF foresees just 0.6 percent year-over-year growth in 2010 in the U.S. economy and 2.5 percent globally, Mussa sees 3.3 percent growth in the U.S. economy next year and 4.2 percent growth globally. He projects a U.S. growth rate of 4 percent from the middle of this year through the end of 2010.

"All forecasts tend to underpredict the recovery. … I think that's what we are seeing this time," said Mussa, now a senior fellow at the Peterson Institute for International Economics, a leading research organization in Washington.
Mussa pointed to forecasts made at the end of the 1981-1982 recession, the closest approximation to today's deep downturn. ...

The Reagan administration projected a growth rate from December 1982 to December 1983 of 3.1 percent, as did the Federal Reserve. In fact, the real growth rate turned out to be 6.3 percent.
Mussa concurs with most mainstream forecasters that consumers won't lead this recovery, and that Americans will sharply boost their savings to a 7 percent annual rate by the end of 2010.

What, then, will drive growth? Business investment, Mussa said ...
I disagree with these views.

First, I expect a decent GDP rebound in Q3 and Q4 because of an inventory correction and exports. However this boost will be temporary.

But what will be the engine of growth in 2010? Usually consumer spending and residential investment lead the economy out of recession. Although I started the year expecting a bottom in new home sales and single family housing starts (and it appears that has happened), there is still too much existing home inventory for much of an increase in the short term.

And even Mussa agrees that consumers will remain under pressure as they repair their household balance sheets - yet he expects growth in business investment?

Goldman Sachs put on a research note on Friday: Capital Spending: The Caboose of a Slow Train (no link). Although the analysts noted a possible equipment replacement cycle, they also noted:
Few businesses will step up capital spending sharply unless they see a meaningful improvement in end demand for their products. Since the most important component of end demand for US companies is the domestic consumer, our cautious view of the outlook for personal consumption also implies a cautious view of capital spending, other things being equal. In essence, capital spending is the caboose of recovery, not the locomotive.
There is already to much capacity, and until end demand absorbs some of that unused capacity, there won't be a meaningful increase in capital spending.

And on the comparison to the early '80s recession (both Grant and Mussa made this comparison), Krugman had some comments in early 2008: Postmodern recessions
A lot of what we think we know about recession and recovery comes from the experience of the 70s and 80s. But the recessions of that era were very different from the recessions since. Each of the slumps — 1969-70, 1973-75, and the double-dip slump from 1979 to 1982 — were caused, basically, by high interest rates imposed by the Fed to control inflation. In each case housing tanked, then bounced back when interest rates were allowed to fall again.

... Post-moderation recessions haven’t been deliberately engineered by the Fed, they just happen when credit bubbles or other things get out of hand.
And that means that the Fed can't just cut interest rates and boost housing. This recession is very different than the early '80s.

This time housing will remain under pressure until the number of excess housing units (both owner occupied and rentals) decline to more normal levels.

So I think an "Immaculate Recovery" is very unlikely.