Don’t Be Fooled

August 1, 2009

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Last week, we posted a couple articles discussing Tim Bond’s bullish arguments favoring a swift V-shaped economic recovery (see PIMCO Versus Barclays: Economic Pessimist – Economic Optimist and You Fools Don’t Get It: This Is A V-Shaped Recovery!) Our friend Michael Panzner takes issue with Bond and presents the other side. – Ilene

Don’t Be Fooled

don't be fooled Courtesy of Michael Panzner at Financial Armageddon

I was originally going to write about something else, but after a loyal Financial Armageddon visitor alerted me to the following Financial Times commentary, "Insight: Learn to Love the Recovery," by Tim Bond, head of asset allocation at Barclays Capital, I changed my mind. Frankly, I couldn’t believe this piece of propagandistic excretia was written by a senior financial industry executive who makes decisions about where to invest. Because some FT readers might be fooled into thinking Mr. Bond had something useful to say, I felt duty-bound to respond to his "insights" with a few brief comments of my own (interspersed with his italicized text):

Never has a bull market climbed a steeper wall of worry. In spite of a proliferation of positive economic indicators, the consensus remains gloomy. Bullish economists are than hens’ teeth.

The average forecast for third-quarter US gross domestic product growth is a weak 0.8 per cent, which would be by far the slowest first quarter of any recovery on record. Since 1945, the average annualised real US growth rate in the first two quarters of recovery is 7 per cent. History provides abundant evidence that the deeper the recession, the stronger the bounce. Even the recovery from the Great Depression conformed to this rule, real US GDP grew 10.8 per cent in 1934 and 8.9 per cent in 1935.

There are so many inconsistencies and logical fallacies in the above paragraph that it’s hard to know where to begin. Among other things, Mr. Bond assumes that the consensus is correct in seeing a third-quarter uptick in GDP. That may or may not be the case, but given how wrong economists have been about every aspect of this downturn so far, I’d lean towards the latter. Even if they are right, what evidence does he have that a third-quarter rebound will be the turning point, rather than the equivalent of an economic dead-cat bounce? Moreover, his assumption that the postwar time frame is the relevant reference period when it comes to forecasting the kind of recovery we might eventually expect to see is laughably ignorant given the extraordinary upheavals of the past two years. Paradoxically, he also makes reference to the upturn that followed the Great Depression, conveniently ignoring the fact that the earlier downturn dragged on for more than twice as long as the current one has before things turned around.

Yet today’s consensus assumes this time things will be different. The persistence of such pessimism is striking given a strong Asian recovery is visible, with output, employment and demand all following V-shaped trajectories, and regional industrial production rapidly bouncing back above the previous peak. Yet this recovery is dismissed by western analysts, who appear unable or unwilling to believe the region is capable of endogenous growth. That 2009 will be the second year in a row in which the increase in Chinese domestic demand exceeds that of the US is a point roundly ignored.

Actually, anybody who’s been paying attention knows that most mainstream forecasters still seem to believe that what we are going through right now is "more of the same" — that is, the same kind of (admittedly severe) cyclical downturn we’ve seen in the decades since World War II, rather than a bursting-credit-bubble-induced secular unraveling. The fact that Mr. Bond fails to grasp that the alleged V-shaped rebound in China and its sphere of influence is anything other than a steroidally-inflamed mirage spawned by a government-ordered blast of reckless spending and an XXX-rated orgy of forced bank lending makes you wonder why he still has a job (oops, I forgot: competence is not a prerequisite when it comes to those who are paid to make "forecasts" for a living).

The fate of the Chinese economy is supposedly in thrall to the US consumer, in spite of clear and persistent evidence to the contrary. The US economy, which provides a home to 17 per cent of China’s exports, is still seen as the arbiter of growth in Asia. This obstinate adherence to an outdated assessment of economic dependence is not the only gaping intellectual flaw.

I suppose in one respect he’s right: China is no longer as in thrall as it was to the US consumer; rather, the country now seems to be dependent on the whims of 1) panicky authorities, worried about the domestic social consequences of a global collapse in growth and trade; 2) corrupt and overextended lenders, who have apparently mistranslated the words "bad loan" and "malinvestment" into "any borrower will do"; and, 3) speculators, who’ve decided that all they need to do to get through these troubled times is to buy a lot of stocks, commodities, real estate, etc. — using tons of borrowed money — and they will invariably make a killing.

The 9.5 per cent US unemployment rate is also viewed as an obstacle to recovery. This objection ignores the many contrary examples of high unemployment rates and subsequent recoveries, not least in the US. Thus in 1982, US unemployment hit 10.8 per cent, yet GDP soared at an average annual pace of 7.7 per cent over the next six quarters.

Mr. Bond uses a baseless assumption — the current unemployment rate is at or near its peak — and a bogus comparison — today’s unemployment rate means conditions are similar to what they were back in 1982 — to make a ridiculous argument. I wonder: Does this reflect the sort of analytical talent you need to manage other people’s money?

Similarly, few commentators consider the possibility that the large post-Lehman rise in US unemployment was a mistake on the part of panicky managements. Yet this is precisely what trends in labour productivity growth, not to mention common sense, tell us occurred. In the first half of 2008, labour productivity growth averaged 3.3 per cent, while the unemployment rate rose to 5.6 per cent. At that point, there was no evidence US companies were overstaffed. Thereafter, output collapsed, yet business productivity growth remained positive, registering an average yearly pace of over 2 per cent, as companies shed labour at a faster pace than they reduced output. Businesses, like markets, panicked after Lehman went under. Employment and output were both reduced far more than it turned out to be necessary, as businesses temporarily and understandably assumed a worst case scenario.

Again, Mr. Bond makes a number of dubious assumptions and ridiculous assertions. Was it really "a mistake" that "panicky" managements slashed payrolls, or was it an entirely rational response to epic declines in global cross-border trade, orders, and revenues, a sudden seizing up of many traditional financing mechanisms, and a dramatic about-face in the spending habits of overleveraged consumers, among others? While Tim Bond and his fellow economic revisionists might have a different spin on things, my recollection is that much of corporate America — not to mention Wall Street and Washington — remained upbeat on the outlook for the economy up until the very moment the bottom fell out, sucked in by the reassurances of mainstream prognosticators who failed to see the meltdown coming until it was too late?

Just as global output is performing a V-shaped recovery, there is a big risk US employment will do the same, with monthly payrolls showing surprising growth by the end of 2009.

If Mr. Bond engaged in even a modicum of research that went beyond crunching massaged and mangled economic statistics and hobnobing with clueless policymakers and delusionists in the financial industry — say, by reading a small town newspaper or talking to people on the streets about what is really going on, he would quickly realize just how out-of-touch and ignorant he sounds — then again, maybe not — when he makes statements like those in the paragraph above.

If unemployment is one half of the bearish consensus, de-leveraging is seen as the other main obstacle to recovery. Yet increases in private leverage never play a significant role in recoveries. Indeed, since 1950, US private sector borrowing ex-mortgages has declined an average 0.1 per cent of GDP in the first year of recovery, with non-financial business borrowing declining 0.6 per cent of GDP.

The fact that Mr. Bond is effectively discounting the role that leverage played in creating the mess we are in, and takes no real account of the fact that the financial industry is almost completely dependent on government largesse while many lending and market mechanisms are in disarray or have broken down, suggests to me that he is experiencing a degree of denial — or, perhaps, incoherence — that is breath-taking. The fact that total debt as a percentage of GDP is at record extremes and the overleveraged consumer, who represents about two-thirds of the U.S. economy, has neither the will nor the wherewithal to spend more or increase his borrowing appears not to mean much to Mr. Bond, who keeps insisting, bizarrely, that the postwar period is the correct frame of reference. Who in their right mind would argue that the events of the past two years bear even a passing resemblance to what has occurred over the past six decades?

A regression of the household savings rate on the wealth-to-income ratio tells us the former has made the appropriate adjustment to declines in the latter. In fact, the rally in the stock market, the low level of interest rates and the stabilisation in house prices all tend to limit the risk of a further sizeable increase in the savings rate. So over the rest of this year, the standard cyclical timing of a US economic turning point tells us pessimistic expectations are likely to collide with the economic reality of a strong recovery. The net result is almost inevitable, in the shape of an inexorable continuation of the equity rally.

In many respects, Mr. Bond’s final paragraph is the pièce de résistance, a fitting climax to a stuporous journey through economic la-la land. In fact, some might say the collage of bogus relativistic comparisons, irrelevant details, distorted "facts," circular reasoning, and logical inconsistencies is like a WTF?-Wet Dream stoked with lashings of LSD. Is he really saying that a few months worth of a few seasonally-adjusted data points represents "stabilization in house prices"? Is he suggesting that current debt levels and the long-term trend of historical savings rates relative to disposable income are not all that important in assessing whether an "appropriate adjustment" has been made in the savings rate? Why does the "standard cyclic timing of a US economic turning point" matter when the events of the past two years have been neither standard nor cyclical? And since when is a "rally in the stock market" a driver for "an inexorable continuation of the equity rally"?