7 Arguments Against a Quick Recovery

CNN’s survey of 45 “leading economists” last week indicated that 90% of them believe that the recession will end this year and none of them believe that it will persist beyond early next year. This is indeed good news for the market. All the leading economic indicators show that a recovery is imminent with the exception of unemployment, which apparently is of no account since it is a trailing indicator.

What puzzles me however is that in all my reading, and conversations with upbeat financial analysts, I have not been able to find a cogent rationale explaining the mechanism that would enable this recovery to take place.

Actually, beyond the belief in the voodoo of economic cycles and faith in the prognostication of leading indicators I haven’t even seen a vague rationale. So maybe there are some readers that can help me with this because I would really like to hear a realistic argument for imminent economic recovery.

But first I will present some rationales for why I can’t see any kind of significant recovery taking place for the next decade or so and possibly much longer if the reality of the situation continues to be ignored.

1. It’s the debt stupid. The cause of the so-called financial crisis has not been addressed in any meaningful way shape or form. Excessive consumer, and government debt on the municipal, state and federal level, are what caused the financial crisis and attempting to treat the symptoms while completely ignoring the disease cannot solve the problem. The Fed and the Treasury are doing everything they can to get the banks lending again (but at the same time the banks are being admonished to deleverage and avoid the credit risks of the past). But lend to whom exactly? To American consumers at least in part I would assume so that they can continue the spending spree that has driven growth not only for the US, but also to a large part, the world economy. But isn’t excessive consumer debt what precipitated this crisis in the first place? It wasn’t just a real estate bubble that set this thing off; it was much more of a credit bubble; it was all the leverage on top of leverage on top of leverage. It was consumers using their home equity as a kind of ATM to buy more goods and services, which was good for the economy for the short run but when one uses debt to create more debt it has to end somewhere. The term real estate bubble may be misleading because price is only relative to what is affordable. Real estate prices in Canada have, on average been higher than the US for a number of years and so far have not come down anywhere close to the extent that US prices have. The difference is that very few Canadians bought homes with no money down and the banks made few sub-prime or teaser rate loans. And liar loans, so common in the US would have been very difficult to obtain in Canada as income on mortgage applications was actually verified. Canadians also on average saved money, unlike Americans whose savings rate went negative some years ago. In addition credit at any level was never, in general, as wildly easy to obtain in Canada as it was in the US. So then explain to me how going back to the easy credit that caused this problem is going to solve it.
2. Americans hate to pay taxes. The US has by far the lowest per capita tax rate in the first world. The economic theory has long been that the more you lower taxes the more you simulate the economy. The US Treasury is now attempting to stimulate the economy by taking on an additional debt burden of approximately five trillion dollars over the next two years. This is a staggering sum that must be financed through the sale of US Treasury bonds, a big chunk of which must be vended to foreign buyers. So far foreigners have been willing buyers because countries like China and Japan need to keep exporting to the US and have been willing to keep lending to enable the US keep buying from them. But this process is sucking up a considerable amount of the world’s capital and if that capital starts to flow away from Treasury bonds to anywhere else interest rates on US bonds will have to go up to whatever level that will continue to attract buyers. Every stock market rally now causes Treasury bond interest rates to rise and this in turn causes mortgage rates and consumer rates to rise in a cycle that will be self-defeating for an economic recovery. It made some sense for the Bush administration to try to avoid having a severe economic downturn on its watch and to delay the inevitable through economic stimulus tactics; but what is the Obama administration trying to buy time for? Divine intervention? Stimulus is somehow an ironically appropriate term for what the government is doing but shouldn’t some measures be taken to bring the economy to real health instead of pumping it full of amphetamines just to jump start it once again for a short time horizon? Isn’t there a danger of killing the patient with these remedies? Tax cuts are merely a method of getting consumers to once again to live beyond their means. Can even the US government afford to swallow this kind of debt or have we now moved completely beyond the realm of Keynesian economic theory and entered that of Peter Pan?
3. China can’t save the world economy. China, unlike the US, has substantial cash reserves, and recent spending on infrastructure by that country’s government has caused a worldwide boom in commodity prices and helped stock markets, especially resource based ones like Canada’s. But China, like Japan, over the long term, must export, not only to thrive but merely to survive, because neither has the natural resources to support their populations. I always found it laughable when American economists, and the politicians who bullied the Japanese government into dropping their rice subsidies, were telling that country to develop an internal market and quit relying on exports. This was coming from people living in a country with vast agricultural lands, oil, natural gas and coal fields and huge mineral resources, addressed to 120 million plus people inhabiting a group of resource poor, rocky islands. China does have more space to grow crops than Japan and has substantial coalfields but its resources are stretched to the limit and it needs to import a great deal of oil, minerals, and fertilizers. China's agricultural production has actually fallen steadily over the last decade due to the nutrient depletion of soils and the gradual draining of the deep aquifers under the North China plain. China also faces and enormous deficit problem, no less serious than that of the US although it has not shown up on the monetary ledger yet. I am referring to their looming environmental crisis. Already millions of Chinese are dying every year from the effects of industrial pollution. This environmental debt, which must also be paid, is the elephant that the Chinese government can not come to grips any more than the US government seems able come to grips with its financial debt.
4. The US banking system is corrupt. Enough has been written on Seeking Alpha’s pages about how the major banks were blatantly allowed to cook their books for the first quarter and how billions of dollars of tax payer funds (or borrowing through Treasury bonds) was funneled under the radar to banks through the government financing of AIG’s CDSs, so I won’t rehash the details of all that here. That this fraud has been so blatantly ignored by the markets is astounding to me though. Simon Johnson, the former chief economist for the IMF, wrote in last month’s Atlantic that the US economy is in a death spiral, the kind that he has seen many times before among his emerging market clients. He believes that there is no hope for the US economy unless the government takes immediate steps to rid the country of the corrupt oligarchy that controls its financial institutions and hugely influences government policy.
5. The real estate problems aren’t over. This month the wave of resets for ARMS and ALT-As begins to gather new momentum and will carry on through 2012. Many of these kinds of mortgages were bought by speculators and absentee landlords a few years ago who are now deeply upside down in their equity and will have little incentive to renew even if they qualify. Economists are seemingly ignoring this situation as they ignored the sub prime situation two years ago. And remember every stock market rally causes bond and therefore mortgage rates to go up. As I am writing this Dow has ticked up over two hundred points today and ten-year Treasury bond prices have dropped over two dollars (also in one session) with yields rising accordingly. What would a 10,000 plus point Dow cost in interest rates and how could those needing mortgage renewals afford it?
6. Unemployment. Although this is considered a trailing indicator it cannot be ignored. The enormous scaling back of GM and Chrysler’s production will have huge repercussions. The big corporations whose share prices have held up during this down turn, like Wal-Mart (WMT) and IBM, are the ones who have been, directly or indirectly, responsible for exporting jobs overseas. The world still wants to sell to the US but seems more and more reluctant to buy from it. And US corporations seem less and less willing to set up at home. Even GM is still making a profit in China.
7. This is not a regular economic cycle. The last recession was caused by the collapse of the dot com bubble, which had little relation to the real economy; nevertheless both the S&P and the NASDAQ took a licking from which they never really recovered. This time it’s real estate and investment banks and the real, not just the virtual, economy that have been drubbed. And today GM, for god’s sake, declared bankruptcy. While it’s true that at the end of the second world war the US government had a large debt but it wasn’t as large as this one and it was owed largely to its own citizens through the sale of war bonds; so when it was paid back it was reinvested or spent by its citizens and this helped to cause the post war boom. This time much of the government debt is owed to foreigners so that is not going to happen.

If someone could show me how US economic growth can really be revived by next year without a mere middle of the W bounce I would be very pleased. Personally what I see right now for the US economy, at best, is about ten years of flat economic growth and consumer austerity coupled with higher taxes while the government and citizens pay down their debts and work on becoming truly more energy and financially self sufficient.

Either that or a prolonged series of dead cat bounces on the way to eventual economic oblivion.

Disclosure: No positions

Comments

[Davewmart:]

I'm afraid I agree with most of your analysis as far as the US is concerned.
However I would differ from your prognosis for China.
That is not to say that you have not correctly identified problems.
Build-over of agricultural land is an issue, and adversely affects food production, but the increase in food imports is mainly due to higher consumption, not a failure of indigenous output.
The present low birth rate will lead in due course to reduced pressures on land.
Pollution is overwhelmingly caused by coal mining - roughly 95% of spoil is from this source, as is most air pollution.
Unlike the US China is engaging on a massive program of nuclear plant production:
nextbigfuture.com/2009...
the pebble bed reactors can be factory mass-produced, and installed in place of the coal-burning unit at existing coal plants.
By 2020 Chinese capability with this program will have increased so that truly massive quantities of reactors will be able to be built yearly.
Modest improvements in design, for instance switching to thorium fuelled reactors either in a CANDU or in a molten salt reactor, mean that fuel can be burnt at multiples of present efficiencies and supplies will last for many thousands of years at least:
energyfromthorium.com/.../
The technology is available to deal with many of our current issues, it is just that America prefers to spend it's cash on dead-beat social security panhandlers - the banksters.

Jun 02 08:11 AM

[Mayer Amsch...:]

Two suggestions as to why this might be:
#1: The Fed stopping the bleeding of the banks and fears of future inflation. If deflation were still a reality, hoarding cash would be the way to go.
#2: Look at the website for the government bureau of labor statistics.
A quick search of crude goods PPI versus finished goods reveals that, in the year ending in April '09, prices of finished goods dropped 3% but crude goods dropped 40%. That's a huge tax break right there. So even if your sales dropped, if your products sell at small margins, falling prices of raw materials makes a huge difference. However, commodities have been shooting up again. I would look to the rate of change of GDP, unemployment, and finished prices versus that of commodities to see when the "tipping point" is near. My random guess is that equities lose steam in the next month and soften throughout the summer.

Jun 02 08:53 AM

[cabaretewil...:]

What the Rep's should be shouting out every day is "It's the DEBT stupid" until main street gets it. You did a great job of explaining things. Now we need to get the message out.

Jun 02 09:24 AM

[John Bowman:]

The newsletters I receive from analysts who predicted the current economic climate correctly aren't optimistic at all. As a matter of fact, they forecast prolonged agony for years.

I don't put any faith in the combined wisdom of politically correct "leading economists" who didn't see this mess that we are currently in.

Jun 02 09:44 AM

[TeresaE:]

While you make some good points, you are off on a few facts.

China is just fine, with nearly 2 billion people, now that they have our cash (which we still owe the debt for), our patents, our equipment and our mega-corporations & governments balls, they will be just fine. China will love it when our economy finishes it collapse and we start selling our natural resources on the cheap to eat.

You also state, "...This is not a regular economic cycle. The last recession was caused by the collapse of the dot com bubble, which had little relation to the real economy; .."

How untrue. What everyone fails to recognize is that in '97, '98 & '99 there was a multi-trillion dollar industry that was created for a one second problem: Y2K.

Housing replaced the Y2K techs, dot com IT guys and the bankrupted manufacturers (as they had to compete with China).

Housing and free debt were the only things our economy had.

Now they are gone to and trying to re-inflate that bubble is not sustainable.

Jun 02 09:52 AM

[Old Trader:]

Regarding China's export based economy, I believe that you're presently correct, but I also think the Chinese are aware of their problems and are addressing them. Of course, trying to shift from export-driven to more of an internal consumption economy is a huge task, and will not be accomplished overnight. Their current stimulus plan seems to be a first step. Additionally, there seems to be some growth in trade amongst the members of the SE Asia bloc, so some of the focus on exports to the US might be diverted to that trade.

Jun 02 10:48 AM

[Vienna:]

I think that it is commonly known that China has 1,3 billion inhabitants.

Putting up such numbers should prove your comment invalid just be reading the second line (where I stopped) It seems that everybody needs to place higher number, so that the article sounds interesting.

For this reason, me like many others do not believe ANY US statistics, follow your common sense in tims like this when dealing with numbers.


On Jun 02 09:52 AM TeresaE wrote:

> While you make some good points, you are off on a few facts.
>
> China is just fine, with nearly 2 billion people, now that they have
> our cash (which we still owe the debt for), our patents, our equipment
> and our mega-corporations & governments balls, they will be just
> fine. China will love it when our economy finishes it collapse and
> we start selling our natural resources on the cheap to eat.
>
> You also state, "...This is not a regular economic cycle. The last
> recession was caused by the collapse of the dot com bubble, which
> had little relation to the real economy; .."
>
> How untrue. What everyone fails to recognize is that in '97, '98
> & '99 there was a multi-trillion dollar industry that was created
> for a one second problem: Y2K.
>
> Housing replaced the Y2K techs, dot com IT guys and the bankrupted
> manufacturers (as they had to compete with China).
>
> Housing and free debt were the only things our economy had.
>
> Now they are gone to and trying to re-inflate that bubble is not
> sustainable.

Jun 02 10:50 AM

[Jimbo:]

A grim, but true analysis.

Jun 02 10:56 AM

[AndrewBaker:]

A really good and well written article that I agree with wholeheartedly. Why with so much being voiced about the true state of the economy, do people, privately and commercially, still keep ramping up the markets and acting as if we're coming out into a brave new world (with acknowledgements to Huxley)?

Perhaps that's it: we're all now being born knowing our place and aware of our leaders' infallibility; except for just a few like you, me and others on here and elsewhere, all of whom are staggered at what is still taking place and being presented as a solution.

I've been burnt with my shorts, and am a sore bear; but I've lengthened my time horizon, changed my market tactics, and will wait until the inevitable market collapse and eventual slow recovery from way down produces the "W"-in-waiting.

Good luck to all in your trading and stay close to your screens and tight, very tight, stops.

Jun 02 12:37 PM

[Darbyred:]

Debasement of the currency should be a reason.

Jun 02 03:10 PM

[isettj:]

You can rest assured that your assessment of the cause and effect of the precipitators of our current economic dillema holds in every point you have made. Having said what you have I would strongly recommend that you not run for office anytime in the next decade. It is quite evident that you would have a hard time finding a political party that you could represent while coming to Washington to be a part of the new "no more government like it used to be" to paraphrase our new Commander-in-Chief. It would seem highly unlikely that your assessment of the approach to "borrowing for today what you will never be able to repay tomorrow
" is going to continue until we as an economic machine quit demanding instant gratification as the propulsion to our last decade of impulse borrowing. It would be a major step toward recover if our political and banking community quit trying to find an authoritative source of information that would back their case for the best way to recover using their ideas. At this point it might not hurt us if we were to get the mass of the populous to decide for the ranking thinkers what they are willing to live with as it comes to the economy they are part of. We might be encouraged to hear a couple of real ideas come from that pool of experienced consumers and tax targets. Surely someone not running a bank or financial institution or in some form of political office could add a bit of reason to the conversation. Why don't we just listen for a minute and find out what it is on the their minds?
" what you

Jun 02 05:46 PM

[Fighting Yoda:]

China will come out better despite losing some (or maybe a lot) of its US exports. China is doing the right things and it has potential for consumption and infrastructure, also has the money to spend.

US unfortunately continues to follow the path to disaster - debt - 'borrow and consume'.

Jun 02 06:34 PM

[r0364:]

As an aside, I've always thought that the dot-com bubble collapse was caused by the lack of broadband or semi-permanent connections. The connections were too difficult and sporadic for consumers to spend long hours absorbing advertising as they are now.

Jun 02 10:48 PM

[Bob Powell:]

Indeed, it's a "debt crisis," not a "credit crisis."

But then, why is it that there's such a buildup of personal, fiscal, & trade debt? Answer: what's called "free trade" has undermined wages, the U.S. economy, and the tax base. Obama's stimulus is necessary, but is failing because he's not doing anything about decades of anti-stimulus that's called "free trade" ("trade" deficits subtract from GDP). See "Jobs & 'Trade' Data Update Apr09" on my site on what's happened.

On the auto company bankruptcies, "free trade" offshored so much of auto production and left insufficient work here to sustain legacy costs in competition with foreign car companies, which set up shop here without those costs. Other manufacturing went to Canada where they don't have to bear the cost of health insurance.

This structural devastation means the U.S. economy won't recover for at least a decade. Official government statistics are enormously flawed. Go to the Shadow Government Statistics site and read his primers and, especially, his article on hyperinflation.

Jun 03 03:36 PM

[Duude:]

I have to go along with the final conclusion of the above analysis while taking exception to some of the analysis. I think what is lost on so many is the fact that most universities teach Keynesian economics. While some economists learn what's wrong with this theory (ironic) many others adopt it as sound economics. With that I feel a great number are inspired by a leading indicator such as the stock market in coming to their conclusions. I believe the truth is the stock market, while a leading indicator, doesn't always point to recovery from recession but perhaps recovery from utter ruin. I seriously doubt the market will get over 10,000 in the next 18 months. I also doubt it will get above 9500 in the same time frame without a major correction. Much of the current medicine will create side effects in the not too distant future capable of keeping the patient sick and depressed for a while. We have plenty of potholes now and ahead to make a full recovery from recession unlikely before 2011-2012. But then, that's just my opinion.

Jun 04 12:43 PM

[JOSEPH FOSTER:]

FISHER YOUR ANAYLSIS IS CORRECT, I WOULD LIKE TO ADD ONE MORE NEGATIVE TO THE USA ECONOMY,
OUTSORCING EACH DAY AND MONTHS CEO EMPLOYING AMERICANS ARE TRYING TO FIND WAYS OF REPLACING THESE AMERICANS WITH LOW PAID, CHINESE, OR INDIAN OR SOME OTHER LABOUR CHEAPER THAN THE CHINESE LABOUR.
OUTSOURCING IS CAUSING MORE AND MORE AMERICAN JOB LOSSES.

Jun 09 02:24 PM