Lakshman Achuthan: Climbing the 'Wall of Worry'

Lakshman Achuthan is managing director of the Economic Cycle Research
Institute and managing editor of ECRI’s forecasting publications. He
frequently appears on CNBC and CNN and is quoted in the New York Times,
Newsweek, and The Economist.

Harlan Levy is a business reporter and columnist at the Connecticut daily newspaper the Journal Inquirer.

Harlan Levy (H.L).: What does the stock market’s volatility really say about the economy?

Lakshman Achuthan (L.A.): It’s telling me two things: One is it’s confirming what other leading indicators have been telling us about the economy, and that is
we’re in a recovery. However, we certainly have a lot of angst and concern and questions and even disbelief in the rise of the stock market, and that may actually be a good thing, as the proverbial wall
of worry that the market needs to climb during the beginnings of new
cyclical bull markets.

H.L.: What do the third-quarter earnings tell you?

L.A.: That people have underestimated the extent of the recovery. I
know that much of the reason behind companies beating the market’s
expectations of their profit growth is top-line revenue growth.

And if you step back for a minute and think what goes on with profits and how they relate to the economy, part of what a recession is at its heart is related to companies “right-sizing” so that they can again become profitable in a weaker business environment. This happened in a very vicious and quick way over the past year or year and a half and has largely run its course, and it’s part of the reason the recession itself was so severe, as evidenced by the 7 million-plus jobs that were lost.

H.L.: How big a drag is unemployment, and when do you see real positive
changes?

L.A.: While clearly people who are unemployed are going to consume
less, and that’s a drag on the economy, however, the high unemployment
rate itself, approaching 10 percent and very likely to go above 10
percent in the months ahead into early next year, is not a bar to
recovery.

If high unemployment was a bar to recovery, then we wouldn’t have very many recoveries, because it’s always the case that it rises into a recovery.

In the spring of 1933 the unemployment rate that is comparable to the
rate today was at 25 percent, yet the economy embarked on a blistering
recovery averaging 10 percent growth for the next four years, and at
the same time the unemployment rate fell by 3 percent in each year.

And to put this in perspective, we just had the worst recession since the Depression, and of course we’re going to have high and rising unemployment.

A couple of technical points on the unemployment rate that we should
remember: First, population growth requires that we add about 125,000 jobs each month in order to hold the employment rate steady. The second point is that as it becomes more evident that the economy has bottomed
and is beginning to recover, this draws more job seekers into the job
market, because they rightly understand that the chance of getting a
job is improving, and this drives up the unemployment rate as well,
because that rate is a reflection of how many people are actually
looking for jobs.

H.L.: Many Republicans have been loudly complaining about the massive and growing deficit. Are they off-base?

L.A.: Deficits certainly matter, but deficit projections are relatively
poor guesses of where the deficit is headed. Let’s recall that in the
year 2000 projecting the deficit from the top of a boom, the experts
estimated we would have a $5 trillion surplus and used those estimates
to justify tax cuts.

Recently, projecting from the bottom of a bust, the same experts are projecting a $9 trillion deficit. My guess is that we’ll end up somewhere in the middle of those wild extremes, and it still is a very big number.

But to keep that number in perspective you have to think about the size
of our economy, which is roughly $14 trillion, and how fast it’s
growing. Are we growing at 1 percent, 2 percent, 3 percent or more?
When you think about an economy of that size growing at 3 percent, it’s able to handle what otherwise might seem an unmanageable deficit.

H.L. How good is the news about existing and new home sales, really?

L.A.: I wouldn’t get overly excited about it and say we’re off to the
races, but I do believe that is consistent with our view that the home-price cycle has bottomed and is now improving. This is a positive
not only for homeowners, but also for banks, which are holding a lot of
housing-related debt.

H.L.: What do you think of pay czar Kenneth Friedman’s slashing cash
compensation, requiring stock compensation to be held for two to four
years, and eliminating guaranteed bonuses and retention bonuses by the
25 most highly paid executives of the seven companies that have
billions in government assistance?

L.A.: No one knew exactly what this would look like when government
stepped in to bail out the private sector, where those companies were
“too big to fail.” Now we’re starting to see all of the ramifications
associated with the bailout, and I don’t think anyone is happy to be
bailing out risk-takers or dictating compensation.

My expectation is that this will be so uncomfortable for everyone
involved that the bailout efforts will wind down faster than we may
otherwise expect.

Having said all of this, it’s clear that there is a lot of political
pressure that someone must pay for all the pain and suffering
associated with the crisis.

H.L.: Will the pay czar’s moves affect anyone else on Wall Street, and if not, how will that affect how Wall Street operates in the future?

L.A.: I don’t know how far the pay czar’s reach will ultimately, but
I’m reasonably confident in its ability to figure out a way to make
more money.

H.L.: Isn’t it true that the banks are still not lending as much as the
economy needs, and what’s your outlook there?

L.A.: As a student of the business cycle we have a slightly different
view on this issue than many others. Specifically, we expect loan
growth to slow well into the recovery, because it has always been this
way. Typically, the spending that occurs in the early stage of a
recovery isn’t dependent on borrowing, and certainly on the business
side of the equation, with idle capacity, most businesses don’t need to
invest further. That will come in the next stage of the recovery later
next year when we do expect loan growth to begin recovering.

H.L.: Some politicians and TV pundits are complaining about the weakening
dollar. Are they just plain foolish, and is a weak dollar good for the
nation?

L.A.: It’s hard to give a quick answer. In the near term, the impact of
a weaker dollar is supporting the U.S. economy, in particular the
manufacturing sector, as our goods are priced cheaper abroad. However, in the long term it is important to have stability in the currency.

H.L.: Is China’s insistence on pegging its currency the yuan to the dollar
perilous?

L.A.: Once you start digging into the linkages between the Chinese
economy and the U.S. economy, it quickly becomes apparent that neither
country would benefit from the other country’s economy from doing
poorly. In that sense I wouldn’t expect there to be full-blown economic
hostilities any time soon.

Comments

[User 504692:]

we play numbers games today, and I wonder in the 1930's how the Unemployment Rate was measured against today's rate....

as we know, real Unemployment is a lot higher than 10 percent, some have commented that we are North of 20 percent given the early retirements, the people giving up, and the underemployed...

the State Tax roles are going into the toilet, so what is real?

Oct 27 01:55 AM

[Moon Kil Woong:]

In general these a pretty balanced, moderate economist stances.

I would tend to say the market ic climbing a wall of money printed by the government and Federal Reserve more than a wall of money though. A rebound based on this is not real, lasting, or sustainable.

He is more corrrect when he says that a return to businesses investing in capital spending is neccesary for a recovery and resumption of growth. That has not happened yet. He also mentions that this precludes the decline in unemployment putting himself firmly in the camp that a jobs recovery is somewhat down the line.

My only major contention with his statement is the fact that deficit spending is sustainable with a $14 trillion GDP that is growing at 3%. Especially as Social Security starts to go negative. It is not.

Right now we have financed our deficit by tapping into social security and getting sovereign overseas funding. However, increasingly that funding is drying up and can't sustain the mounting volume of the debt. As the debt mounts it will become incxreasingly mandatory to get the US to self-fund the massive debt which will suck up our capital and deny businesses the capital it needs to expand and increase productivity. Money will become scarce and inevariably the ability to borrow will become so hard that lower growth will ensue. The government debt will become an economic black hole sucking the very life out of the US economy.

This is an economic inevitability. Recessions, depressions, high inflation, out of control spending, and reckless Federal Reserve rate policies will only hasten this. Now is not the time for sweet talking hard economic realities. We must prevent the US budget deficit from reaching critical mass.

Oct 27 02:14 AM

[cayman:]

one question that I would have like to ask is "what risk does he see for the US economy"

He seems to think of your garden variety recession, it's over move on. But he doesn't touch on the fact that the consumer is more damaged this time than ever + business has xcess capacity and are in no need of investing....so what are the drivers ?????

If I try answering that myself I'd say stimilus and windows 7.

Oct 27 10:25 AM