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Jim Cook



Every once in a while I switch the TV channel from Fox to CNBC to see what the liberals are saying.  After listening awhile I get a deep sense of hopelessness and foreboding for our country.  The most important thing for the left is giving money to people.  They are happy to see the growth of food stamps, disability payments, housing subsidies, free healthcare and all the other welfare benefits.  They utterly fail to see the damage it is doing to the recipients.  Whole cities that once flourished have deteriorated into rotting eyesores populated with shambling hulks of chemically dependent drones.  These people are no longer employable.  They have become incompetent and helpless and the liberals can’t see that it’s their doing.

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The Best of Jim Cook Archive

Best of Doug Noland
September 30, 2009
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Doug Noland

From Bear to Bear:

I was inspired to put a few thoughts together after pondering Jim Grant’s interesting op-ed piece in last Saturday’s Wall Street Journal, “From Bear to Bull.”

Along with Mr. Grant, I don’t want to be associated with the term “permabear.” It implies a dogmatic lack of objectivity - the kiss of death for sound analysis. I’ve been bearish for awhile and I remain so. My view is firmly analytically based. Yet it doesn’t mean that I expect the stock market to always go south or the current recession to last indefinitely. Indeed, I am firmly in the global reflation camp, going so far as to posit the emergence of a powerful “Global Government Finance Bubble.”

I remain bearish because, from my analytical framework, deleterious Credit system developments suggest worse yet to come - perhaps much worse. The global Credit boom has not fully run its course, so the depths of the downturn remain indeterminable.

Total U.S. system Credit almost doubled during the nineties to $25.4 Trillion. System Credit has again doubled to end Q2 at $52.8 Trillion. I view this – in conjunction with corresponding global excesses - as history’s greatest Credit Bubble. Over the past 12 months, Treasury debt increased $1.9 TN and GSE MBS jumped $400bn – and counting. I believe unprecedented Credit-related maladjustment over decades continues to manifest itself in a severely impaired U.S. “Bubble” economy.

Such deep structural impairment is rectified only through a long and sobering period of retrenchment and rejuvenation, with adjustment not gaining critical momentum until Bubble-era destabilizing Monetary Processes are discontinued, stable financial flows are established, and significant economic liquidation has transpired. From my analytical perch, I don’t yet see the beginnings of significant structural readjustment. Determined to limit the level of hardship, policymakers have moved aggressively to sustain previous financial and economic structures. Both from a domestic and international standpoint, sound financial and economic footing will not have a chance until some semblance of a disciplined monetary regime supplants the current “system” of synchronized Credit inflation.

There is a popular view that holds that the U.S. economy benefits from an inherent upward trajectory, a dynamic some say ensures a resumption of growth as soon as financial crisis headwinds tail off. And then there is history – always elucidated so eloquently by Mr. Grant – that suggests the worse the economic downturn the more robust the subsequent recovery. I tend to dismiss the “inherent upward trajectory” thesis and believe the historical reliable recovery viewpoint requires important qualifications.

First, the “inherent upward trajectory” thesis does not square well with my analytical framework. First, I believe that the Credit/financial system generally dictates the workings/“trajectory” of economic system activity. This has especially been the case over the past two decades on the back of profound developments throughout contemporary money and Credit. The bursting of the Wall Street/mortgage finance Bubble marked a momentous inflection point in Credit. The “trajectory” of Credit – its type, flow and quantity - going forward will be markedly different from the past twenty years, which will translate into a much altered economic landscape. These days, caution is in order when it comes to extrapolating past economic performance.

I would also caution against using historical parallels. This time is different: History’s greatest Credit Bubble; unmatched changes to the underlying structure of the U.S. “services” and unbalanced global economy; and an unrestrained and rudderless global monetary “system” are just the most conspicuous characteristic that set the current backdrop apart from anything previously experienced.

Jim Grant quoted one of my favorite economic analysts, Michael Darda: “The most important determinant of the strength of an economy recovery is the depth of the downturn that preceded it. There are no exceptions to this rule, including the 1929-1939 period.”

It is worth noting that the level of nominal GDP from 1929 was not attained again until 1941 – after bottoming seven years earlier in 1934 (five years after the crash!). Statistically, GDP posted relatively strong growth in 1935, 1936, 1937, 1939, 1940 and 1941 – but in aggregate this period of “strength” only returned output back to the late-twenties level. And anyone turning bullish in 1931 – two years after the financial Bubble burst – would have had to endure a nominal GDP drop of another 25% and even worse percentage declines in the stock market. It was many years after the bursting of the financial Bubble before bullishness had much relevance.

For comparison, Q2 2009 nominal GDP was about 3% below the peak level from last year, with the consensus view holding that this will be almost fully recovered next year. It is hard to read dire expectations from current economic forecasts. And keep in mind that non-financial Credit grew 6.0% last year and expanded about 4.5% annualized during this year’s first half. We have by no means experienced the worst-case scenario from a Credit standpoint.

Today’s Durable Goods report and this week’s housing data confirm sluggish recovery. Considering the double-digit federal deficit and zero interest-rate monetary policy, economic performance remains unimpressive. Expectations have been bolstered by stock market gains, and one would expect ultra-loose monetary conditions to support output. But I’m sticking with the view that the housing and consumption sectors of our economy will lag. Recall that the second quarter saw contractions in both U.S. household Credit and mortgage borrowings.

The consumption-based U.S. economy evolved over many years and is today poorly positioned for the unfolding global reflationary backdrop. Granted, policymakers reversed the downward financial and economic spiral. But stemming a crisis and fostering sound and sustainable recovery is not necessarily the same thing.

In past crises, government reflationary policymaking would help recapitalize the private-sector Credit system. Almost immediately, a Fed-induced manipulation of financial conditions would spur borrowing, lending, and leveraged speculation (not necessarily in that order). Private Credit growth would recover almost immediately, especially in housing related Credit. Indeed, home mortgage debt growth jumped to 9.4% in 1999 (post-LTCM reflation) and 13.4% in 2002 (post-technology Bubble reflation). This rapid increase in mortgage Credit corresponded to strong financial sector expansion – with financial sector borrowings increasing 16.2% in 1999 and 9.6% in 2002.

In my analytical vernacular, for two decades mortgage Credit demonstrated a robust “inflatationary bias.” This Credit characteristic provided the Federal Reserve a powerful mechanism for monetary stimulus. And the results were predictable: in crisis, the Fed would aggressively cuts rates, in the process creating a strong incentive for leveraged speculation in mortgage securities (and other risk assets). Meanwhile, the dramatic loosening in mortgage Credit would incite a refi boom and enormous equity extraction – not to mention a strong upsurge in home sales and construction.

The timely refi, home equity, construction and home transaction booms worked to both increase system Credit and boost economic output. And it was not long before this powerful reflationary dynamic created a self-reinforcing rise in home prices, household financial wealth, household consumption and business investment. It was like clockwork, ensuring virtually uninterrupted Credit expansion, the mildest of economic downturns, deeply ingrained confidence, and the greatest Credit Bubble in the history of mankind. The Fed misused its power to manipulate private Credit expansion, system spending, market psychology and financial speculation.

There is at this point ample confirmation that, with the bursting of the Wall Street/mortgage finance Bubble, this previously steadfast inflationary dynamic has turned impotent. The combination of securitized finance, the proliferation of leveraged speculation, contemporary unconstrained finance, and activist central banking nurtured a financial and economic environment unlike any in recent history. But analysts should no longer extrapolate from this previous boom period. Previous Credit and economic dynamics no longer apply.

And if the nuances of the past twenty years (or more) argue against extrapolation, I contend that the emergence of the Government Finance Bubble argue only further complicates drawing historical inferences. First of all, massive monetary and fiscal stimulus has supported system-wide incomes, spending, and corporate revenues. Policies also incited an unwind of bearish positions and a rather robust, albeit speculative, stock market rebound. Thus far, zero rates and Trillion dollar deficits has created the illusion of normalcy – when it comes to both the markets and real economy. This creates an “analytical” hook that will snare many.

In contrast to previous mortgage-Credit dominated reflations, the evolving global reflation will prove unique for its lack of self-reinforcing dynamics here at home. Before, a Trillion of net additional mortgage Credit would reliably inflate home prices and induce more borrowing, consumption and investment - all of which worked to bolster self-reinforcing confidence in the underlying Credit apparatus and the overall soundness of the general boom-time economy. Today, faith in this private-sector Credit machine is broken, while housing Bubble/consumption psychology is badly shattered.

The $2 Trillion of federal Credit over the past year may have stabilized national income, but it has not reflated home prices or rejuvenated household and mortgage Credit growth. I don’t expect another $2 Trillion to have a much bigger impact, creating a backdrop where the lack of a self-reinforcing private-Credit growth dynamic creates acute systemic vulnerability to any withdrawal of massive federal government spending. Moreover, any backup in market yields – perhaps in anticipation of Federal Reserve “exit strategies” – would weigh heavily on private-sector Credit recovery.

I’ll look to remove the bear from my lapel when a sounder Credit backdrop emerges at home and globally. It’s just not moving in that direction. I don’t see Trillions of federal government Credit as sustainable or constructive – and wouldn’t extrapolate recent system stabilization out to a sustainable economic recovery. I don’t see any semblance of restraint or monetary discipline – the requirements of a sustainable monetary regime – in key domestic Credit systems internationally. And I wouldn’t assume that the worst of Credit dislocation is behind us. And, I’ll add, the worst-case scenario at this point would include a robust global rejuvenation of Credit and asset Bubbles, rapid synchronized economic recovery, and a rebirth of bullish expectations. I do see all the makings for a grinding, debilitating, secular bear market.