2009 February 21 Saturday
Fast Economic Decline Ominous
Former Federal Reserve chairman Paul Volcker says the economy might be deteriorating even faster than it did during the Great Depression.
In fact, the 81-year-old former chairman of the Federal Reserve said, "I don't remember any time, maybe even the Great Depression, when things went down quite so fast."
He noted that industrial production is falling in countries across the globe faster than in the U.S., one result of the decline caused by the breakdown of unbridled financial markets that operated on a global scale.
"It's broken down in the face of almost all expectation and prediction," he noted.
Some people argue this financial crisis was an unforeseeable "Black Swan" but Volcker is having none of that.
Volcker is also one of the few economic thinkers out there who is not enchanted by the idea of this being a "Black Swan," or a once-in-100-years event: "The financial world follows a normal distribution pattern. If you think that you're a financial engineer, you're not a very good financial analyst."
The "Black Swan" interpretation is appealing to those (e.g. bank CEOs, financial regulators, politicians) who want to be absolved of responsibility. "Wasn't my fault that some extremely unlikely event happened".
I agree with Volcker that complex financial instruments that are touted as innovations are not adding any value.
Mr Volcker, a former chairman of the Federal Reserve famed for breaking the back of inflation in the early 1980s, mocked the argument that "financial innovation," a code word for risky securities, brought any great benefits to society. For most people, he said, the advent of the ATM machine was more crucial than any asset-backed bond.
"There is little correlation between sophistication of a banking system and productivity growth," he said.
Japanese exports are cratering and production is way down.
What's more, according to the cabinet office in Japan, overseas orders fell a whopping 26.8% in December and 16.7% for the fourth quarter of 2008. While a manufacturing survey conducted by the cabinet office indicated core orders would rise 4.1% in the first quarter of 2009, we think this forecast may prove to be too optimistic. We would not be surprised to see core orders decline in each quarter of 2009. Japanese industrial production fell 9.6%. Exports fell 35.1%.
Also, according to the VDMA machine makers association, German plant and machinery orders fell a massive 40% in December from the same period a year ago, with export orders declining 30%. While mining-machinery orders are expected to increase in 2009, we believe the outlook could become more pessimistic with a further decline in commodity prices.
Industrial production in the Euro zone is down 12%.
European industrial production dropped the most on record in December, pointing to a deepening economic slump in the fourth quarter.
Output in the euro region fell 12 percent from the year- earlier month after an 8.4 percent decline in November, the European Union’s statistics office in Luxembourg said today.
Taiwan is tanking.
According to Barry Eichengreen, an economist at the University of California at Berkeley, the 40 percent decline in Taiwan's industrial production at the end of last year was the "canary in the coal mine" of Team Asia's formidable export machine. At about the same time, Japan's exports fell 35 percent, Korea's 17 percent, and China's fourth-quarter gross domestic product was essentially flat -- no economic growth at all.
If the current decline continues the annualized rates look scary.
A sharp drawback of global demand - especially from the U.S. - is dragging Japanese GDP down quickly.GDP fell largely on exports, which account for an average of 17% of overall domestic production (GDP) in the last three years. In the fourth quarter of 2008, real exports fell 13.9% since Q3, which is a massive 45% annualized decline. Anemic global demand is killing Japan.
An article in the Wall Street Journal asks "If Japan's economy collapses". That the WSJ is entertaining that possibility shows just how far things have deteriorated.
If Japan's economy collapses, supply chains across the globe will be affected and numerous economies will face severe disruptions, most notably China's. China is currently Japan's largest import provider, and the Japanese slowdown is creating tremendous pressure on Chinese factories. Just last week, the Chinese government announced that 20 million rural migrants had lost their jobs.
Closer to home, Japan may also start running out of surplus cash, which it has used to purchase U.S. securities for years. For the first time in a generation, Tokyo is running trade deficits -- five months in a row so far.
George Soros says the financial system collapsed and is on life support. That is an insightful way to characterize it. Most of our banks have failed but have been rescued by the US and other governments.
"We witnessed the collapse of the financial system," Soros said at a Columbia University dinner. "It was placed on life support, and it's still on life support. There's no sign that we are anywhere near a bottom."
Where's the bottom? We are in deep trouble if the current rate of decline continues into the summer.
The government policy response has been enormous. Obama's intervention makes FDR's spending look like piker small stuff.
The 1930s began with federal outlays representing just 3.4 percent of the nation's economy as measured by the gross domestic product. Roosevelt's efforts to fight the Depression with government spending caused outlays to rise to 10.3 percent of GDP by 1939 and to 12 percent by 1941 on the eve of U.S. involvement in World War II.
By contrast, government spending was 21 percent of GDP last year. Obama's economic recovery policies are expected to bring it up to 30 percent or more.
"The New Deal by today's standards involved a minuscule amount of spending," said Allan J. Lichtman, a professor of political history at American University. He said Obama is more of a "big spender" than was Roosevelt.
Paul Krugman points to a Federal Reserve report that foresees a very long slow recovery.
But my eye was caught by the following chilling passage (yes, things are so bad that the summarized musings of central bankers can keep you up at night): “All participants anticipated that unemployment would remain substantially above its longer-run sustainable rate at the end of 2011, even absent further economic shocks; a few indicated that more than five to six years would be needed for the economy to converge to a longer-run path characterized by sustainable rates of output growth and unemployment and by an appropriate rate of inflation.”
6 years till normality? I was hoping we'd have a recovery before Peak Oil hit. Looking unlikely though.
Did you read Mish's blog, I am convinced things are going to get a lot worse too.
Maybe the government would eventually get fed up and try to "create value" through the printing press (hyperinflation) years from now.
I wonder what is the savings rate in Sweden. I think they might (relatively) thrive in this environment.
WOLFBAIT - qv.A slang-term (believed to be of ultimate Australian provenance), that is descriptive of flatus of a specific kind ie heavily 'ovverloaded' with a vile, odiferous meat-like quality and intensity that has been compared to the initial whiff encountered on putting a can-opener to a can of 'King-Kuts Extra Tripe Meaty Enriched Dog-Food'.
By association, the term has been extended to other unpleasant odiferous situations and environments, in particular the general tone, conduct and level of cerebrity to be encountered at a WSJ or Economist editorial board meeting.
Don't be so glum, Randall. A world-wide economic depression will destroy enough demand to put off Peak Oil for years and years.
I look at the stock markets, and I don't see a whole lot of bargains there. Sure, one or two, which is a big improvement over past years, but not a whole lot of them. We are not repeating 1933 yet. At best, we are repeating 1930.
I'm not glum. I'm saving as fast as I can because in a depression Cash Is King.
Also, I'm about to do a post on a potential solution that Nouriel Roubini has proposed.
I read Mish. I am aware of his views.
I was referring specifically to "I was hoping we'd have a recovery before Peak Oil hit. Looking unlikely though."
Demand destruction will push off peak oil. Even if we don't have a recovery for 6 years, we will probably have one before peak oil. In the meantime, oil producers will leave more oil in the ground in currently active fields, and newly discovered fields will be less developed meaning their production will be able to ramp up faster.
The downturn in Asia is temporary and will reach bottom before the end of the year.
Japan is getting killed mainly due to the high Yen. Japan has had low interest rates since the early 90's. U.S. financial institutions borrowed in Yen for the past 7-8 years in their never-ending quest for more leverage. Now, they are having to pay it all back, which has fueled the demand for the Yen, thus sending it through the ceiling and choking off Japan's exports. The deleveraging process will likely complete itself in the next 6-12 month, with a subsequent fall in the Yen. Japan's economy will start to recover at that point.
The idea that a "collapse" of Japan's economy could disrupt supply chains around the world is silly. The fact that such supply chains exist means that the market exist for the Japanese manufacturers that feed these supply chains. As long as the market exists, suppliers will exist to fill it. If one supplier "collapses" other suppliers will step in to fulfill the market niche. An economy abhors an unfilled market niche the same way nature abhors a vacuum. Companies fail because their markets go away, not the other way around.
The rest of Asia will similarly start to recover next year. 2010 will be much like 1991 when the Western economies were in a funk, but Asia was doing well.
I agree that these complex financial instruments do not create value. In theory, they are supposed to allow investors reduce risk. In reality, they allow investors to pursue ever more leverage in their quest to be the ultimate yield hogs. I also think they represent rent-seeking on the part of the financial industry that would have been naturally down-sizing since the early 90's. The moral rot set in with Greendspan's bailout of the LTCM in 1998.
Demand destruction will not push off Peak Oil by much because the amount by which oil production has declined is pretty small. We'd need demand destruction on the order of tens of millions of barrels per day to make a substantial impact. So far production is down by just a few million barrels per day. Not much when total production is over 80 million barrels per day.
"6 years till normality? I was hoping we'd have a recovery before Peak Oil hit. Looking unlikely though."
If Obama makes sure that his new New Deal plan includes a massive plan for electric vehicles for all of the United States, then the current low oil prices will actually be a fortunate opportunity.
According to the Project Better Place of Silicon Valley, it would cost less than one year's imported oil to build the infrastructure to re-charge cars in every street and parking place, and to build battery exchange stations for swappable batteries.
Pure electric cars (5 seats) without batteries can be made for only $12,000, it is the battery that is expensive, and the Project Better Place and electric companies will take the responsibility for the batteries, as drivers will simply rent the battery and pay by the miles as the batteries are charged or swapped in 3 minutes. By 2012 the infrastructure will be ready for the Bay Area, Hawaii, Denmark, and part of Australia. The latest generation of electric cars supported by Renault and Nissan (made for Better Place company), have range 150 miles only due to the current lithium-ion batteries, but things are improving, and batteries can be swapped in the stations already.
To quote Gremlins 2, "Well, it's rather brutal here. Right now we are advising all our clients to put everything they've got into canned food and shotguns. "
Randall, if we have a 6 year depression, what makes you think current demand destruction reflects demand destruction 1 or 2 years from now?
Compare for example 1930 and 1933 in the tables at http://www.sjsu.edu/faculty/watkins/dep1929.htm
Cash is king, except during periods of hyper inflation. Then, I recommend canned food and ammunition.
All I'll say is that trying to raise money for a new venture in this environment is quite a challenge. I can readily see that if these conditions worsen and are prolonged that they will start to substantially delay the not only the commercialization but the development of new technology. I don't think this is a good thing. I'm not sure what gains financial engineering has brought to man but I'm pretty sure that real engineering has done a lot.
"I don't think this is a good thing. I'm not sure what gains financial engineering has brought to man but I'm pretty sure that real engineering has done a lot."
This is one of the few places where Government intervention can make a difference. But the Republicans consider science a terribly wasteful area of useless spending, and so they managed to remove the infinitesimal $100 million science money from the stimulus package a few weeks ago! That sum for science should have been $100 billion.
The fiscal stimulus contains a $10 billion increase for the National Institutes of Health and billions more for batteries and other alt energy efforts.
I do not know that we'll have a Depression scale decrease in economic activity. Seems to me the Fed ought to be able inflate us out of it. Also, Roubini's brief bank nationalization idea ought to end the zombie bank problem.
But I'm really not sure.
A few billions for alternative energy and batteries is not enough.
Moreover, "science funding" is a much broader thing. In order to re-industrialize the United States, we must first build a more solid educational and research base supported by government. While the private sector is key for the re-industrialization, basic research funding needs government.
Also some kind of reward system for buying and manufacturing in the United States is important because of the following fact: It is not true that cheap imports are helping the average citizen in the United States, since the final retail price of these imported cheap goods is only slightly lower than the competing goods manufactured in the US, it is the importing businesses that are pocketing the huge difference between the sales price and the wholesale import price.
The annual trade deficit has been 5 % of the GDP for more than a decade. It doesn't take a rocket science to realize that this is impoverishing the United States, regardless of the economists who say that the same money is being sent back to the US for investment by the foreigners.
it is the importing businesses that are pocketing the huge difference between the sales price and the wholesale import price
It humbles me to realize that is exactly what Ricardo predicted in 1817.
I really think we need to de-globalize the financial markets.
Seems to me the Fed ought to be able inflate us out of it.
That cannot work while China continues to manipulate currency prices. That can only work if the Asian countries float their currencies. But even then, I suspect we might end up in an inflation war as China tried to deflate its currency relative to the US dollar.
If the accumulated foreign trade deficit of the United States is $2 trillion, this means that each of our citizens owes $2,000,000,000,000/300,000,000 = $666,000. But 666 is not a lucky number.
The US has been threatening to bring a WTO complaint againt China for its currency manipulation. We could make good on it, and slap an import fee on Chinese goods to capture the difference for the US. It would put China in the position of buying T-bills with one hand and handing them back with the other, which is just fine by me.
Peak oil? In a worldwide recession? Good luck with that.
But that's exactly what we'd expect. The increasing geological difficulty of extracting oil in the face of rising demand causes a price spike independent of political factors, triggering a recession. In the recession, the investments required to maintain the current level of oil production cannot be made, so it begins an irreversible decline.
People who think we have not already hit and passed peak oil need to look at world oil production. IIRC, non-OPEC hit peak in 2004. Despite prices being considerably higher than the $25/bbl range of the early part of the decade, even OPEC producers are cutting back. If you think they're doing this while anyone has the ability to increase oil production and take the market from them, I want some of what you're smoking.
We need high taxes on petroleum. We need them to get people to respond to decreasing supply before it transfers huge amounts of money to hostile oil producers. Unfortunately, we've already let those hostile agents have more than ten trillion dollars and still have not learned our lesson.