Jun 16

Rough Seas Ahead: The Greatest Deleveraging versus Government Stimuli


Today, we revisit From the Northwest Quadrant’s blog entry of September, 2010. Just nine months ago, we noted the following:

“The Greatest Deleveraging in the History of the World” continues, only slightly impeded by governmental efforts to borrow against future economic growth (that’s what a loan/bond really is) or coerce/convince others to do so as well. In other words, this is a trend that will take time to play out and will eventually reassert itself after the effectiveness of government roadblocks decline.”

Today, it looks like the effectiveness of those government roadblocks are indeed declining.

In the US, a recalcitrant congress concerned about record $ (but not % of GDP) deficits, is not about to think about fiscal stimulus…at least not until we get closer to the election next year when it will be time to strategically ‘buy’ votes.

Meanwhile, an increasingly politicized Fed is stunted from looking towards another version of monetary stimulus.

Perhaps a continued focus on a declining dollar will be the manner in which a ‘stealth’ monetary stimulus is accomplished – it worked after the Great Depression. (Of course, the ongoing subsidy to the large banks, in the form of virtually zero interest on borrowings from the Fed, is another form of ‘stealth’ monetary stimulus…for the banks!)

Meanwhile, ratings agencies have begun to circle around the politicians who are discussing a needed borrowing limit increase for the US Treasury.

More importantly, the agencies have already stated that fiscal problems in a country’s government can spill over into the creditworthiness of its banks. Certainly that is a major fear in the Eurozone, and it probably should be a fear in the US.

But, what is likely to happen next?

For that we go back to what we have noted previously. In fact, it has been noted by others. For example, who said this back in February, 2009 (Answer at the end of this blog entry)?

“As a consequence they (Japan) suffered what was called the ‘lost decade,’ where essentially for the entire ’90s, they did not see any significant economic growth. So what I’m trying to underscore is…that this is not your ordinary, run-of-the-mill recession.”

Less well known, but much brighter on these matters, than our mystery speaker above, Richard Koo of the Nomura Institute maintains that the US does not have to make the same mistakes as Japan…even though it certainly looks like we are doing so. He has even noted similarities between US and Japanese housing prices over similar periods.

And, Koo is not alone. Steve Roach, non-executive chair of Morgan Stanley Asia, recently called US consumers ‘zombies’ who threaten the global economy…but with good reason.

Gavyn Davies, another highly regarded economist, wonders if the US economy may be approaching ‘stall speed’, at which an inevitable movement to recession occurs. Despite this, his analysis provides recession to be a 30% probability at this time.

And, crunching the numbers at the reliably accurate Economic Cycle Research Institute, Lakshman Achuthan expects much slower growth over the next couple of quarters.

At what point will Congress and/or the Fed act (even as inflation seems to be seeping into the system — but not for all the usual reasons, like output constraints)?

You see, that is now the operative question for US investors.

The ‘balance sheet recession’ noted by Koo (or, as we have called it, ‘The Greatest Deleveraging in the History of the World’) will go on unabated, and it will only be temporarily sidetracked by macro actions by governments.

We have already seen what QE2 has done to risk assets. But, when the great experiment called QE2 pulls into port, we need only play the movie backwards to guess what will happen to those same risk assets….unless we see another giant ship on the horizon.

Choose the ship you may desire, but the economic seas will remain what they are for the US until the economy is sufficiently deleveraged.

(By the way, the speaker who, in February 2009 compared the US recession to Japan was President Barack H. Obama.  Please feel free to draw your own conclusions.  And, as always, you may post your comments using the link below.  Thank you.)