DEBT AND DELEVERAGING: A FISHER, MINSKY, KOO APPROACH
by ilene - November 18th, 2010 3:34 pm
DEBT AND DELEVERAGING: A FISHER, MINSKY, KOO APPROACH
Courtesy of The Pragmatic Capitalist
The following paper by Paul Krugman is an excellent analysis of the current situation in the United States. Professor Krugman accepts Richard Koo’s “balance sheet recession” and draws similar conclusions to Koo – primarily that government must maintain large deficits in order to offset the lack of spending by the private sector. The key component missing in both Krugman and Koo’s argument is the idea that a nation that is sovereign in its own currency cannot default on its “debt”. Nonetheless, the conclusions we all come to are similar – a temporary deficit is not only necessary, but an economic benefit during a balance sheet recession:
“In this paper we have sought to formalize the notion of a deleveraging crisis, in which there is an abrupt downward revision of views about how much debt it is safe for individual agents to have, and in which this revision of views forces highly indebted agents to reduce their spending sharply. Such a sudden shift to deleveraging can, if it is large enough, create major problems of macroeconomic management. For if a slump is to be avoided, someone must spend more to compensate for the fact that debtors are spending less; yet even a zero nominal interest rate may not be low enough to induce the needed spending.
Formalizing this concept integrates several important strands in economic thought. Fisher’s famous idea of debt deflation emerges naturally, while the deleveraging shock can be seen as our version of the increasingly popular notion of a “Minsky moment.” And the process of recovery, which depends on debtors paying down their liabilities, corresponds quite closely to Koo’s notion of a protracted “balance sheet recession.”
One thing that is especially clear from the analysis is the likelihood that policy discussion in the aftermath of a deleveraging shock will be even more confused than usual, at least viewed through the lens of the model. Why? Because the shock pushes us into a world of topsy-turvy, in which saving is a vice, increased productivity can reduce output, and flexible wages increase unemployment. However, expansionary fiscal policy should be effective, in part because the macroeconomic effects of a deleveraging shock are inherently temporary, so the fiscal response need be only temporary as well. And the model suggests that a temporary rise in government spending not only won’t
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The Chances of a Double Dip
by ilene - September 18th, 2010 5:47 am
The Chances of a Double Dip
Courtesy of John Mauldin at Thoughts From The Frontline
I am on a plane (yet again) from Zurich to Mallorca, where I will meet with my European and South American partners, have some fun, and relax before heading to Denmark and London. With the mad rush to finish my book (more on that later) and a hectic schedule this week, I have not had time to write a letter. But never fear, I leave you in the best of hands. Dr. Gary Shilling graciously agreed to condense his September letter, where he looks at the risk of another recession in the US.
I look forward at the beginning of each month to getting Gary’s latest letter. I often print it out and walk away from my desk to spend some quality time reading his thoughts. He is one of my "must-read" analysts. I always learn something quite useful and insightful. I am grateful that he has let me share this with you.
If you are interested in getting his letter, his website is down being redesigned, but you can write for more information at insight@agaryshilling.com. If you want to subscribe (for $275), you can call 888-346-7444. Tell them that you read about it in Thoughts from the Frontline, and you will get an extra one month on your subscription. And now, let turn to Gary.
The Chances of a Double Dip
By Gary Shilling
Investor attitudes have reversed abruptly in recent months. As late as last March, most translated the year-long robust rise in stocks, foreign currencies, commodities and the weakness in Treasury bonds that had commenced a year earlier into robust economic growth – the "V" recovery.
As a result, investors early this year believed that rapid job creation and the restoration of consumer confidence would spur retail spending. They also saw the housing sector’s evidence of stabilization giving way to revival, and strong export growth also propelling the economy. Capital spending, led by high tech, was another area of strength, many believed.
Not So Fast
But a funny, or not so funny, thing happened on the way to super-charged, capacity-straining growth. In April, investors began to realize that the eurozone
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Fed Z1: From Bad To Getting Worse
by ilene - September 18th, 2010 4:38 am
Fed Z1: From Bad To Getting Worse
Courtesy of Karl Denninger at The Market Ticker
There’s a lot of mind-numbing figures and facts in here, but a few things stick out like a sore thumb.
Let’s first start with the graphs, which I have updated.
Hmmm….. there’s a bit of a hook in there at the back end. Where’s that coming from?
Oh, that’s not so good. Business credit is going up again a bit, and of course The Federal Government is pumping new credit like mad – but is no longer simply trying to compensate for de-leveraging, they’re exceeding that.
This is decidedly negative – in fact, it has the potential to lead to an economic death-spiral if the government doesn’t cut this crap out in time.
Some of the other nasties in here are truly stunning. One of them is the ugly on Households – they lost a net $1.5 trillion in one quarter on their net wealth.
The 900lb Gorilla in the room is found in real estate. While we don’t have current numbers on that and won’t (the update is primarily equities) the ugly on the housing side is breathtaking. From a peak in 2005 of $13.1 trillion in equity in residential real estate, that value has now diminished by approximately half to $6.67 trillion!
Yet outstanding household debt has in fact increased from $11.7 trillion to $13.5 trillion today.
Folks, those who claim that we have "de-levered" are lying.
Not only has the consumer not de-levered but business is actually gearing up – putting the lie to any claim that they have "record cash." Well, yes, but they also have record debt, and instead of decreasing leverage levels they’re adding to them.
In short don’t believe the BS about "de-leveraging has occurred and we’re in good shape." We most certainly have not de-levered, we most certainly are not in good shape, and the Federal borrowing is what, for the time being, has prevented reality from sticking it’s head under the corner of the tent.
This cannot and will not continue on an indefinite basis.
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Are Bank Stocks Such a Good Buy?
by ilene - August 18th, 2010 11:37 pm
Are Bank Stocks Such a Good Buy?
Courtesy of Yves Smith at Naked Capitalistm
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A fund manager who will go unnamed mentioned to me that he is putting clients into bank stocks because they are trading at or below book value.
Now of course, individual stocks can and do always outperform the outlook for their sector, so there are no doubt particular banks whose stocks are cheap right now. But there are good reasons to question the notion that banks in general, and money center banks in particular, are a bargain.
First and perhaps most fundamental is the notion that bank equity is a readily-measured number, and that book value is therefore a useful metric. In general, even in companies in make-and-sell businesses, balance sheet items are subject to artful reporting. Notice, for instance, how every four or five years most big public companies take a writeoff that they classify as extraordinary, and equity shills dutifully exclude it from their calculation. In most cases, the writeoff is an admission that past earnings were overstated, but seldom is anyone bothered by what this says about the integrity of that company’s accounting or the acumen of its management.
Bank earnings, even under the best circumstances, involve a great deal of artwork, and most of all in the very big banks with large dealer operations. As Steve Waldman pointed out,
Bank capital cannot be measured. Think about that until you really get it. “Large complex financial institutions” report leverage ratios and “tier one” capital and all kinds of aromatic stuff. But those numbers are meaningless. For any large complex financial institution levered at the House-proposed limit of 15×, a reasonable confidence interval surrounding its estimate of bank capital would be greater than 100% of the reported value. In English, we cannot distinguish “well capitalized” from insolvent banks, even in good times, and regardless of their formal statements.
Lehman is a case-in-point. On September 10, 2008, Lehman reported 11% “tier one” capital and very
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REGARDING THOSE “STRONG” CORPORATE BALANCE SHEETS
by ilene - August 5th, 2010 2:56 am
REGARDING THOSE “STRONG” CORPORATE BALANCE SHEETS
Courtesy of The Pragmatic Capitalist
Brett Arends had an excellent piece on MarketWatch yesterday regarding the true state of US corporations. You’ve probably heard the argument before that corporations are sitting on record piles of cash – their balance sheets are in immaculate condition. Right? Wrong! These comments are generally made without accounting for both sides of the ledger. What is often ignored is that the total debts of these companies has also skyrocketed. Admittedly, I’ve been guilty of this in the past when discussing corporate cash levels and Arends (rightfully) sets the record straight. He notes that corporations are even worse off today (in terms of debt levels) than they were when the crisis began:
“American companies are not in robust financial shape. Federal
Reserve data show that their debts have been rising, not falling. By some measures, they are now more leveraged than at any time since the Great Depression.You’d think someone might have noticed something amiss. After all, we were simultaneously being told that companies (a) had more money than they know what to do with; (b) had even more money coming in due to a surge in profits; yet (c) they have been out in the bond market borrowing as fast as they can.
Does that sound a little odd to you?
A look at the facts shows that companies only have “record amounts of cash” in the way that Subprime Suzy was flush with cash after that big refi back in 2005. So long as you don’t look at the liabilities, the picture looks great. Hey, why not buy a Jacuzzi?
According to the Federal Reserve, nonfinancial firms borrowed another $289 billion in the first quarter, taking their total domestic debts to $7.2 trillion, the highest level ever. That’s up by $1.1 trillion since the first quarter of 2007; it’s twice the level seen in the late 1990s.”
This will also sound familiar to readers of John Hussman who has debunked the cash on the sidelines story more than once:
Interestingly, some observers lament that corporations and some individuals are holding their assets in “cash” rather than spending and investing those balances, apparently believing that this money is being “held back” from the economy. What
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David Tice Says Double-Dip Recession ‘In the Cards’ for U.S.
by ilene - July 31st, 2010 3:07 pm
David Tice Says Double-Dip Recession ‘In the Cards’ for U.S.
Courtesy of Edward Harrison at Credit Writedowns
David Tice, chief portfolio strategist for bear markets at Federated Investors Inc, talks about the outlook for the U.S. economy. He sees a double dip coming and argues against stimulus to prevent it, saying policy makers shouldn’t act as “Good Time Charlie” preventing the deleveraging of U.S. households.
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Ten Reasons Why This Has Been A Weak Recovery
by ilene - June 17th, 2010 11:58 pm
Ten Reasons Why This Has Been A Weak Recovery
Courtesy of Edward Harrison at Credit Writedowns
Comstock Partners latest weekly note called "Why it’s Still A Secular Bear Market" is in line with my view of the economy and market. They see the core issue as a longer-term deleveraging that cannot be solved by fiscal and monetary stimulus. I have said that this likely means lower inflation-adjusted stock prices when the stimulus-induced recovery fades. This is a view they also hold.
However, they also provide ten specific reasons why we should see the recovery as already under attack.
- While May retail sales were up 8% from the early 2009 low they are still 4.4% below the peak reached 2 1/2 years ago in November 2007. By way of comparison, over the last 43 years retail sales have seldom declined at all, even in recessions.
- May industrial production (IP) was 8.1%% over its June 2009 trough, but still 7.9% below the late 2007 peak. At its current level, IP is still where it was over 10 years ago in early 2000.. Never since the 1930’s depression has IP failed to exceed a level attained 10 years earlier.
- New orders for durable goods in April were up 21% from the low of March 2009, but still 22% below the top in December 2007. In fact new orders are at the same level as in late 1999, over ten years ago.
- Initial weekly unemployment claims steadily declined from 651,000 in March 2009 to 477,000 by Mid-November, but have been range-bound with no improvement in the last 6 ½ months. Furthermore the current number of claims is still in recession territory.
- April new home sales were up 14.8% from a month earlier and are up a seemingly robust 48% since the low. However, the current number is still a whopping 64% below the 2005 monthly peak. Prior to the current recession the last time new home sales were this low was in February 1991.
- Existing home sales in April were up 27% from the low in late 2008, but still 20% below the peak in late 2005. We also note that both new and existing home sales were boosted by the homebuyers tax credit that has already expired, and that the housing market has weakened considerably since that time.
- May vehicle sales of 11.6 million annualized were up
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Why The World Is Headed For A Balance Sheet Recession
by ilene - April 15th, 2010 2:32 am
"Balance sheet recession" explained. It characterized the Great Depression and Japan’s Lost Decade, and includes weak consumer spending and private sector deleveraging. During this process, the three Ds come into play: debt deflation, deleveraging, and ultimately depression. – Ilene
Why The World Is Headed For A Balance Sheet Recession
Courtesy of Edward Harrison at Credit Writedowns
In my post Koo, White, Soros and Akerloff videos from inaugural INET conference I highlighted four speeches from the recent George Soros-sponsored pow-wow. I have already written up a post based on the one by William White in "The origins of the next crisis."
This post serves to give you some colour on another of those speeches, the one by Richard Koo and his balance sheet recession.
Koo believes the US, Europe and China are headed for a period of incredibly weak consumer spending not unlike what Japan has been through. Let me say a few words about this balance sheet recession theme, private sector deleveraging, and the related sovereign debt crises. Then, at the bottom, I have embedded a recent paper of his which has a bunch of graphs that explain what Japan has been through as a cautionary tale for the global economy.
I have described Koo’s thesis this way:
Nomura’s Chief Economist Richard Koo wrote a book last year called “The Holy Grail of Macroeconomics” which introduced the concept of a balance sheet recession, which explains economic behaviour in the United States during the Great Depression and Japan during its Lost Decade. He explains the factor connecting those two episodes was a consistent desire of economic agents (in this case, businesses) to reduce debt even in the face of massive monetary accommodation.
When debt levels are enormous, as they are right now in the United States, an economic downturn becomes existential for a great many forcing people to reduce debt. Recession
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IS THIS A “MAJOR MARKET TOP”?
by ilene - January 28th, 2010 3:10 pm
Brilliant theories (e.g. Robert Prechter’s market thoughts) and perfect timing are two different things. Pragcap’s timing has been exceptional. – Ilene
IS THIS A “MAJOR MARKET TOP”?
Courtesy of The Pragmatic Capitalist
A reader recently responded with several excellent reasons why this could be the formation of a major
Our Man In NYC:
Thanks for the great response. I’ll give you my brief thoughts on each topic you touched on.
- CRE: Still a huge problem, but it’s a slow motion train wreck. The majority of the troubles in CRE are spread out over the next 3 years and will hinder bank balance sheets, but won’t serve as the “all at once” wallop RRE was in 2008.
- RRE: I said that last years stability in housing was a head fake and I still think we’re heading lower, but the stimulus will continue to bolster prices in the near-term. There will be one last surge in activity as the tax credit ends this year. Late 2010 and 2011 has potential for substantial declines in residential as resets surge, foreclosures remain high, inventory remains high, stimulus ends and the laws of supply and demand reassert themselves after the government’s temporary price fixing. The next leg down isn’t quite here yet.
- Sovereign Risk: Greece is getting bailed out in all likelihood, but all in all, another slow moving iceberg. The S&P story on the UK is alarming. As readers know, I think debt is why we’re ultimately still in a bear market, but it’s not a NEAR-TERM concern.
- Liquidity: The Fed remains accommodative. China appears to be on the verge of a wind-down. Alarming, but at 10.7% GDP I think investors will ultimately view the near-term downturn as a buying opportunity in emerging
markets . Stimulus and accommodative policies are nearing an end, but the process will remain lumpy as
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Moving away from stimulus happy talk to focus on malinvestment
by ilene - December 21st, 2009 12:27 pm
Moving away from stimulus happy talk to focus on malinvestment
Courtesy of Edward Harrison at Credit Writedowns
For the period leading up to the panic last year, I had been warning of a rather severe recession. My view at the time was that what was needed was a realignment of America’s industrial organization away from finance and housing where serious overinvestment meant many firms would fail and asset prices would fall.This turned out to be an accurate view.
However, when Lehman Brothers collapsed in a heap, it was clear to me that we faced a stark choice. One choice was a deflationary spiral and the associated economic dead weight loss of a non-equilibrating global economy in Depression. The other choice was a soft depression cushioned by fiscal (and monetary stimulus). About a year ago I wrote an ode to Keynesian economics called Confessions of an Austrian economist in which I said that I choose fiscal stimulus to cushion the downturn and prevent a depressionary spiral.
The thinking was this: if government buoys the economy, the effects of deleveraging and the bankruptcy of large systemic players need not create a deflationary spiral that leads to a deadweight loss, social unrest or the usurping of democracy by populist autocrats.
But, I am going to move away from the happy talk about fiscal stimulus and re-focus on malinvestment (I have never really talked much about monetary stimulus as a solution). I am sure many of you saw this coming when I wrote “Stop the Madness now!” last month and I have been signaling my realignment with posts like “A few thoughts about the limitations of government.”
The reason is simple: in theory, fiscal stimulus can cushion the downturn and hasten real recovery by preventing a spiral into a non-equilibrating economic state. However, in practice, stimulus has been used as an excuse to maintain the status quo, prop up zombie companies and forestall the inevitable. This only lengthens the downturn, misallocating even more resources to less efficient uses. And all of the worries I had about social unrest, populism, and protectionism are coming true nonetheless.
To be honest, I always knew that the fiscal stimulus game was fraught with risk. Politicians will always use…
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW. She manages the site