The Wall Street “Geniuses” Are At It Again – This Time In Chart Form
Business Insider ran a piece yesterday, motivated by a number of charts submitted by analysts on Wall Street. The piece refers to the analysts as “geniuses.”
Call me stupid, but I’m having a hard time seeing the ingenuity. In fact, I’m seeing nothing but a bunch of errors in the associated chart commentary. And so, being the faithful public servant that I am, I decided to devote a post to correcting some of those errors.
For this chart, it would have been worth noting that the US is still in a liquidity trap. The definition of a liquidity trap is a situation in which conventional monetary policy has lost its effectiveness – i.e., when increases in the money supply do little boost economic activity. The reason why the US is in a liquidity trap is because the market-clearing interest rate is currently below zero percent, which is as low as short-term nominal interests rates can go.
The research on liquidity-trap economics suggests that there are two ways to get the economy going again: through more fiscal stimulus or through more explicit central-bank communication. (The latter would involve more credible commitments from the Fed, such as a commitment to let inflation overshoot – and no, 2.5 percent inflation isn’t bold enough – or a commitment to weaken the value of the dollar.) Neither of these channels has been pushed seriously. To that end, Wien’s commentary is misleading: we will only have to rely on more monetary expansion/M2 in the years ahead if policymakers at the Fed and in Congress keep failing on the job.
Shilling is mostly correct here, except for the last line. There is nothing “massive” about stimulus spending in recent years. When the housing bubble burst, the economy lost roughly $1.2 trillion in annual demand – about $600 billion from spending directly related to construction activity, and another $600 billion from consumption spending, which had been driven by soaring home prices. The American Recovery and Reinvestment Act pumped about $300 billion per annum into the economy in each of 2009 and 2010. And guess what: $300 billion is not $1.2 trillion. In this context, it would have been more appropriate to call the stimulus effort “minuscule” rather than “massive.”
I don’t know whether the debt series in this chart refers to overall debt or to just public debt. Nevertheless, it would have been worth noting that a key difference between the 1947-1985 period and the 1985-present period relates to the trade deficit.
By definition, a trade deficit implies debt accumulation, which must occur in either the public sector, the private sector, or in some combination of both sectors. A trade deficit, moreover, also serves as a drag on growth – there is, after all, a variable in national income accounting called “net exports.” Given this, it would make sense that the period after which the trade deficit exploded would be associated with slower real GDP growth per additional dollar increases in debt.
So, in short, Certo’s chart doesn’t warrant an elaborate discussion about “the real economy, policy considerations, and investment prescriptions”; it simply warrants a serious discussion about reducing the trade deficit.
For this chart, it would have been worth noting that ECRI’s track record in recent years has been horrible. In fact, ECRI was one of the key players propagating the double-dip scare story in mid-2011. Anyone familiar with the data knew that the economy was not on the verge of another recession – housing starts and car sales, two key cyclical indicators to watch, were steadily improving amid the double-dip rhetoric.
Given this track record, BI should have perhaps put a big asterisk next to Achuthan’s commentary – either that, or just drop the chart and commentary altogether.
Juckes could have mentioned here that not all economists agree that money was too loose in the years leading up to the housing collapse. As I’ve mentioned before, adjusting the Taylor rule for the trade balance would have almost certainly predicted that money was actually too tight back then. Considering that the US is still running a large trade deficit of more than 5 percent of GDP (that is, if the economy were at full employment), a case can be made that money is probably still too tight today. If Juckes were serious about calling attention to potential future asset bubbles, then a better strategy would be to examine trade imbalances rather than the fed funds rate – especially since the latter is a poor indicator of easy money when an economy is, as previously mentioned, stuck in a liquidity trap.
It would have been worth noting here that the trend shown in Cui’s chart is the exact outcome that neoclassical growth theory would predict. Investment spending should be strong in fast-growing emerging economies, as the convergence effect in a simple Solow-Swan growth model is driven almost entirely by factor accumulation. We can debate whether it’s time for China to move away from an investment-driven growth model toward a consumption-driven one, but we can’t debate the data on living standards. So long as GDP per capita in China remains a fraction of that in developed economies, Chinese investment spending will likely remain strong.
Remember when I said that monetary policy at the lower bound is all about expectations? Ducrozet’s chart shows exactly what I’m talking about.
Ever since Draghi made the decision to actually do his job – that is, to act as a lender of last resort to peripheral Europe – capital flight has reversed. The irony here is that Draghi really didn’t have to do anything except make a forceful statement about the ECB’s willingness to maintain fiscal solvency in Spain.
For this chart, it would have been worth noting to readers that Boone has trouble with arithmetic. As Dean Baker has pointed out, tirelessly, the demographic scare story is a fraud. The gains from relatively stable productivity growth always swamp the losses from poor demographics. In this sense, there is nothing that suggests that the euro area’s aging population will lead to “tough times ahead.”
Now, it’s undoubtedly true that the pointless austerity and unnecessary suffering in some countries in Europe will ensure that tough times remain ahead for the foreseeable future. But this is a matter of economic ignorance – not of an aging demographic profile.
For this chart, it would have been worth pointing out that the reason why there hasn’t been a material reduction in debt relative to GDP in the developed world is because there hasn’t been a material reduction in the trade deficits that various developed countries continue to run. The path of least resistance, after all, is a path toward balanced trade in the developed world.
Neoclassical trade theory states that rich, developed economies should be capital exporters to the developing world; because rates of return are typically higher in the developing world. When capital flows from the developing world to the developed world, the predictable outcome is an asset bubble in the developed world, as capital that is forced to seek higher rates of return in a low-return economy will ultimately make its way into risky investments, such as subprime mortgage-backed securities. So if you’re worried about debt and asset bubbles, by definition, you should also be worried about trade imbalances.
Cullen Roche gets it. This is perhaps the most important chart of our times, as it shows very clearly that the large public deficits of the past few years were a necessary outcome of the collapse of the housing bubble.
In the 2000s, the private sector was a huge net borrower; the household saving rate fell to nearly 0 percent, and capital investment by businesses was very strong. Then, when the real estate bubble burst in 2006, the private sector moved from a large net borrowing position to a large net saving position. Since the current account deficit was still kicking at this time, the implication was that large budget deficits in the public sector had to emerge. Again, this is an accounting identity: the public sector necessarily had to move to a huge net borrowing position in order to finance the current account deficit, because the private sector was no longer in a position to finance it. This is where we are today, with the public sector still running large budget deficits and with the private sector still deleveraging.
In fact, we should all be praising the government’s large deficits, as they are helping to support the demand that the private sector won’t provide. In other words, if you want lower deficits right now, you also want higher unemployment and weaker GDP growth. End of story.
Darby should have also noted here that a recovery back to trend construction and structures spending is not enough to get the economy back to full employment. A recovery back to trend residential investment implies a roughly $270 billion swing in demand, while a recovery back to trend structures spending implies a roughly $150 billion swing in demand. The economy is still grappling with a nearly $900 billion annual output gap. In addition, consumer spending is high relative to historical levels.
Therefore, in order to get back to full employment without inflating another bubble in housing or commercial real estate, the trade deficit will need to narrow.
Trennert wants to blame the liquidity trap caused by the collapse of the largest real estate bubble the world has ever seen on increased financial regulation. Nuff said.
It would have been useful for Juckes to point out that the reason why some economies in Europe are addicted to ECB funding is because of the anti-inflation cult that dominates governance at the ECB. As any serious analyst knows, the European crisis is, at its roots, all about wage-price imbalances.
During the boom years, wages and prices in the core of Europe became way out of whack with wages and prices in the periphery – with the latter growing much faster than the former, due to the enormous housing bubbles that the private sector recklessly bid up in some peripheral economies. The only way to restore competitiveness between the core and the periphery, therefore, is for wages and prices in the periphery to fall or for wages and prices to rise at a much faster pace in the core. Since the elites in the core have chosen to restore competiveness through deflation in the periphery, the predicted result of this policy has been to throw much of the periphery into an economic depression – which mandates that the economies suffering from depression will be addicted to ECB funding for some time.
All of this would have been useful information for Juckes to add – assuming that he even knows this story.
I actually looked at this issue very closely back in early 2012 and found that there hasn’t really been a bias toward low-wage hiring in recent years. And I know Brusuelas is familiar with my research, because I sent it to him in the past.
I don’t mean to talk up my own book, but any serious analyst should trust my research over Brusuelas’ chart. While Brusuelas aggregates employment growth into just four broader sectors, I looked at employment growth on a subsectoral basis, covering more than 80 different subsectors. It was a lot of work, but it was the proper way to do this sort of analysis.
It would have also been worth noting here that Fleckenstein has the same credibility problem that ECRI has. He, along with other notable investors such as Bill Gross, predicted that Treasury yields would rise right before the bond market went on an unprecedented tear in 2011, taking yields down to levels not seen in more than 60 years.
I have no idea what Juckes is even talking about here. The ECB wasn’t “hamstrung”; it purposefully chose higher unemployment and weaker real GDP growth by pushing deflation on the peripheral economies rather than inflation on the core economies.
Also, the comment about the US losing the “currency war” is frankly bizarre. For one, the US doesn’t even trade much with Europe, so there’s very little currency tension between the two economies. Second, as I’ve mentioned repeatedly, the US needs to close its massive trade deficit. Insofar as losing a currency war is associated with balanced trade, we should all be cheering whenever the dollar loses value.
It would have been helpful for Boone to note here that growth in Germany has come at the expense of poor growth in Spain and Italy. Germany doesn’t have some magic formula for resilience that Spain and Italy lack; rather, Germany has more political power – fullstop.
Pento is another analyst who should have zero credibility and who should not be allowed to publish anything in any major media outlet. After all, this is the same guy who predicted an “inflationary death spiral” in 2010. That BI would even let him talk about inflation despite being wrong on the subject every year for the past four years baffles the mind.
In sum, there are many things that are wrong with this piece by Business Insider – which shouldn’t be all that surprising, considering that the whole thing is motivated by the views of the “geniuses” on Wall Street, who, for some odd reason, can’t stop being wrong about everything.