Attention All 'V' People

Summary

• How bad is it? If we extrapolate the NABE's estimates out further into the future, we get real GDP back to even 13 quarters after it had reached its prior peak in Q4 2019.
• In other words, the current base case is as long and much deeper than 2008-09.
• No, far more important: what happens when this disaster begins to dawn on everyone right now expecting way, way beyond the best case?

Around the same time Lehman Brothers and AIG became headline news in the middle of September 2008, none of the mainstream econometric models thought it was possible for the US economy to suffer so severe a shock that it would induce monetary policymakers to unleash ZIRP. Worse, the models all predicted that it would be impossible for anything to force the Fed down to zero and keep the central bank there for two years.

The zero lower bound (ZLB) is a constant bogeyman for Economists, denoting not just difficulties in nominal interest rate measures surmounting it but more so the level of economic damage (and the implied dereliction of duty) it would take for this to happen.

While Ben Bernanke was crafting the narrative of his heroism and courage, hardly anyone dared to ask why he hadn't seen GFC1 coming. The very notion of a global monetary panic had been heartily dismissed, especially with this particular guy at the helm (who had made his academic reputation as some kind of Great Depression scholar; obviously not the right kind). Even after the crisis began showing signs, he most famously ignored them telling everyone subprime was contained.

In the (very) few cases when someone did openly wonder, his dissembling answer would always depend mostly upon the vague notion of "complexity." I'll supply one such example here gleaned from an interview then-Chairman Bernanke gave just two weeks before being forced down to the zero lower bound in December 2008:

I and others were mistaken early on in saying that the subprime crisis would be contained. The causal relationship between the housing problem and the broad financial system was very complex and difficult to predict.

But, damn it, that was your job!

He like every other Economist had fallen into a trap, one they had all set for themselves through econometrics. As Ronald Coase had warned whilst accepting his Nobel Prize, these academics only speak gibberish because they long ago gave up on trying to understand the real economy in pursuit of quantifying unicorns and windmills.

As a result, if the models tell the Federal Reserve's bulging ranks of Economists there's no danger, who is Ben Bernanke to think otherwise for himself? Groupthink given the gloss of objectivity by "science"; really GIGO.

By 2011, obviously, even the capital "E" Economists had been struck flatly upon their heads by reality. Not only ZLB, but ZLB at two years and counting. The impossible had happened becoming even more impossible-r by the quarter.

Trying to figure out what had been missed, several of the Federal Reserve's researchers wrote a paper that instead perfectly demonstrates the absurdity of the entire discipline. The models, to put it bluntly, didn't model reality.

For one thing, confirmation and recency bias was rampant. Since nothing bad had happened in a long time, and drawing statistics from this period when nothing bad had happened in a long time, the models assumed ("random good luck" as Stock and Watson called it) that nothing so bad could happen.

Rather than figure out the inherent flaws in that thinking as well as the monetary system behind everything, they all assumed the breakdown in it as nothing more likely than a small random error. We all paid the price for that one.

More than anything, though, Economists should have been aware that we live in a dynamic world (duh!). Yet, most models incorporate only static assumptions that are rarely revisited, and as a result they almost always overestate the upside compared to any departures downward.

[R]elying on model stochastic simulations that assume constant parameters and variances, and so abstract from data and parameter uncertainty, contributes to an underestimate of the probability of encountering the ZLB. Our results indicate that time-varying parameters, measurement error, and parameter uncertainty can noticeably raise the estimated probability of hitting the zero lower bound, indicating that future research should incorporate these factors in the analysis.

But it wasn't just underestimating the probability of reaching the ZLB, though. As the authors also conclude, the major error was in how the US economy stayed in that weak state for far longer than anyone had been thought, and calculated, possible.

What has been a surprise is the magnitude and duration of the constraint imposed by the ZLB in the United States and in some other countries.

You aren't supposed to be forced down to zero and get stuck there. Japan was judged to be the outlier, not the base case.

This was, essentially, what former Fed Vice Chairman Stan Fischer had apologized (but only to a foreign audience) for in 2014.

Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back. Indeed, research done by my colleagues at the Federal Reserve comparing previous cases of severe recessions suggests that, even conditional on the depth and duration of the Great Recession and its association with a banking and financial crisis, the recoveries in the advanced economies have been well below average.

Lest you think that having recognized their error the models must have been corrected for it, I only ask that you think back to late 2018. Using the same statistical constructions, Jay Powell had been… under-optimistic?

Not remotely. Despite the distinct lack of evidence for any inflation, including that scenario being outright rejected in the bond market as far back as 2017, all the mainstream models (and Jay Powell's mouth) kept predicting accelerating growth and recovery. Paging Stan Fischer, over-optimistic still by default.

The reason for reviewing this tortured recent history of econometrics will be obvious when you see what comes next.

And that is, more estimates being made for what comes next. We've survived the non-economic shutdown, hallelujah! Except, only now is it time to begin surveying the damage especially as survivor's euphoria fades. The rampant "V" narrative in the mainstream and trading on Wall Street is derived from the belief there won't be any damage beyond the extreme short run - and that's already past tense.

Except, case after case now the modeled projections are appearing all eerily the same way. I showed you last week what it's expected to look like in Europe, and before that the CBO's figures as they relate to the US labor market. They are only outwardly "V"-like, in truth devastatingly bad.

All of them: massive shrinking this year and only a partial comeback being extended well beyond the visible horizon.

Another set of mainstream projections has been tabulated and supplied by the National Association for Business Economics (NABE). According to its latest panel views, real GDP is anticipated to rebound sharply in Q3 and Q4 surprising no one (except, apparently, everyone who is already an optimistic "V" person).

In fact, their projected number for the next quarter is nearly double digits, and what would amount to the biggest positive since 1978. And then next year, 2021, the economy would grow at 3.6% for the year, which would be almost double the best year posted since Ben Bernanke's massive screw up.

We are entering the window of gigantic positives - all of them leaving us instead with an enormous economic disaster on our hands.

You can see what I mean when I write that all the projections are starting to look the same. It's as if Economists and their faulty models understand reality in a way that doesn't penetrate the NYSE's closed corridors.

Not one "V" person is expecting this sort of "V." Not one.

And yet, all of these projections are being put together by the mainstream econometric models, those which we know for a fact are… overly pessimistic? No. They are, time and again, proved to be wildly over-optimistic.

As I've written too many times lately, the best case is downright atrocious.

How bad is it? If we extrapolate the NABE's estimates out further into the future, we get real GDP back to even 13 quarters after it had reached its prior peak in Q4 2019. That's nearly the same length of time as the Great "Recession" and its false recovery, the very same one which had confounded the optimistic projections the last time we did this.

In other words, the current base case is as long and much deeper than 2008-09. Let me repeat that: the best case as long and much deeper than the economy of GFC1. And that's assuming everything goes perfectly, including 3.6% real GDP growth not just in 2021 but also 2022 and into 2023. What are the chances of that happening?

Don't ask Stan Fischer.

What that ultimately means is even more profound, even though it's already ridiculously profound starting here. What I mean is, because we keep seeing this best case and because it is so bad that can only mean the risks to it are entirely on the downside. And I don't just mean model risks or the high probability the economy will fail to live up to these optimistic assessments.

No, far more important: what happens when this disaster begins to dawn on everyone right now expecting way, way beyond the best case? Those who are being led to believe this is all one big nothing, sporting no lingering after-effects. The risks of another leg in GFC2 are much, much higher because even hitting these forecasts would leave such a massive scar, a gigantic economic hole.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Comments

[turboelec]

Timely article that captures the old joke about economists that fall down a well will always assume a ladder is handy.

We will see how the economist's optimism holds ups in the next few days. Mnuchin and Powell will assemble a star-studded plunge protection team that will certainly put a stop to any decline in financial assets. The retail investors must not lose faith in QE, zero rates and easy credit. Were that to happen, then someone might realize that growth estimates have been cheerily projected in a most unrealistic halcyon manner.

take care
rwmccoy

[TheLongerView]

Excellent article. There is a deep and well-developed literature on the perils of economic forecasts. It is very easy to go back and look at expert predictions in many areas, finance certainly being one of them, and notice how awful they are. However, nobody gets paid the big bucks, whether they are a financial analyst or the Fed Chair, to admit they don't know diddly about what lies ahead. What is important is the perception. Every day in the Wall St Journal, one can read a very convincing explanation by all sorts of experts as to why the market went up or down the day before. Hindsight is always perfect. Meanwhile we have 100 year bonds being issued recently by Argentina, Tesla over $1000 a share, and Nikola selling at a higher market value than Ford, even though they are nowhere near building their first vehicle. We are also seeing for the umpteenth time in history where certain countries are trying to borrow their way to prosperity. It hasn't ever worked despite many dozens of attempts for over a thousand years, and it is not going to work now.

[jtighe65]

Jeff: Here we are on June 11 and thank goodness the Waterpark is open--or oops, this isn't the waterslide? Great article (as always) and prescient timing.

[Maxwells Demon]

@Jeffrey Snider @Robert P. Balan There is an old saying on Wall Street, "They don't ring a bell at the top." Back in the early 1980's I was selling interest rate risk hedging strategies to banks and the bond market which had been tanking hard for years staged a couple of months rally. I came into work and open the WSJ to find a two page ad in the center by Merrill Lynch that was headlined "Bonds, the dawn of a new bull market!" I kept charts of bond futures in those (done by hand as it was pre computer) and on that day bond futures opened at a new recovery high, and the finished higher but on the lows of the day. The next day they gapped lower, it was well over a year before the bond market even returned to that recovery high making new all time lows in the interim. I kept that "bell" in my desk for years as a reminder that the old saying was wrong.
I'm reading the increasingly arrogant and bullish comments both here and in other threads and today the stock market is putting in a 4 day island reversal top after a long recovery run . And sure enough, there are articles calling this the beginning of a new bull market in stocks.
Been at this game for over 40 years including as the DIrector of market risk management for a Major bracket Wall Street firm, studied all the important technical systems (ultimately, their true value is the discipline they enforce if you actually follow them) and I have two pieces of "wisdom" to impart here:
1. History doesn't repeat, but it rhymes.
2. This sure looks like 1980/81 - as Yogi purportedly said, "Deja vu all over again."

[mrbloom]

"The zero lower bound (ZLB) is a constant bogeyman for Economists..."

Perhaps in our infinite wisdom we could create a ZLB Vaccine to save us all.

[bengalesq]

I try to keep up. I do.
".....these academics only speak gibberish because they long ago gave up on trying to understand the real economy in pursuit of quantifying unicorns and windmills."
The tone is certainly worth the read all by itself.
Love to know when. When will the dawning come home to roost?

[nopilikia]

Take heed old Wall Street wisdom. Bulls make money, Bears make money, Pigs get slaughtered. Methinks there be a lot of piggies in the market now days. Watch out little piggies.

[Old (very) Guy]

Soon after WWII Winston Churchill once told an interviewer that when the UK was a colonial power it ran a monstrous capital account deficit for almost 300 years. When asked why no one stopped it, he replied: "We didn't know."

[Grain-of-salt]

Bears have been writing many similar articles in the last months, yet the market kept rallying.
The Fed and Trump will do everything to keep the market green, at least until the elections...

[Salmo trutta]

re: "Not only ZLB, but ZLB at two years and counting."

Bernanke doesn't know a debit from a credit. Bernanke initially claimed that the GFC was a capital crunch (hence TARP and the EESA of 2008, to “stabilize bank capital ratios”), just as he claimed that the Savings and Loan Association Crisis was. The 1980’s and 1990’s S&L crisis was created by the DIDMCA of March 31st 1980 (which turned the nonbanks into banks). The GFC was also created by the DIDMCA (by new money substitutes, new savings’ products, as predicted in May 1980). Greenspan’s put just accelerated the time frame - by dropping legal reserves by 40 percent.

The 1966 Savings and Loan Association crisis, which was precipitated in Dec. 1965 was dubbed the first “credit crunch”. It was due to the bust of disintermediation, an outflow of funds or negative cash flow (from just the nonbanks, who were backstopped by the FSLIC). The commercial banks haven’t experienced disintermediation since 1933 (as they have been backstopped by the FED ever since).

Raising interest ceilings on time deposits, as the Board did on five successive occasions beginning January 1, 1957 and culminating in the disastrous increase to 5 ½ per cent on December 6, 1965, simply allowed the banks to increase their expenses with no concomitant increase in income. It was the first increase that the thrifts couldn’t competitively meet, in their fixed, borrow short to lend longer, savings-investment paradigm.

Bernanke knew that the shadow banks and investment banks (truistic financial intermediaries) were rolling over a large percentage of their wholesale funding in very short-term financial instruments, in short-term debt collateral. However, just as during Dec. 6, 1965, Bernanke introduced the payment of interest on interbank demand deposits (creating an interest rate differential in favor of the commercial banks, the opposite of Reg. Q ceilings which created an interest rate differential in favor of the thrifts), which effectively inverted the entire money market, causing the nonbanks balance sheets to shrink by $6.2 trillion (causing a credit crunch). I.e., Ben Bernanke destroyed the nonbanks, exacerbating the duration of the GFC.

It was an incredibly stupid move in that the NBFIs are not in competition with the DFIs. The NBFIs, e.g., hedge funds, insurance companies, pension funds and shadow banks are the DFI’s (regulated member banks), customers. The DFIs process all of the NBFI’s underlying payment transactions, both clearings, and settlements.

Savings flowing through the NBFIs never leaves the payment’s system as anyone who has applied double-entry bookkeeping on a national scale should already know. By 2011 the remuneration of IBDDs exceeded all short-term funding for clear up to two years out. Ergo, Ben Bernanke bankrupt America.

[deeminimus]

I’m pretty sure Bernanke knows the difference between a debit and a credit. But I’m not sure he alone bankrupted America. As you mentioned, the DIDMCA changed the ballgame.
Why? As usual, Congress, who make the laws, are heavily influenced by powerful interests who line their pockets, looking to make profits for themselves.
www.investopedia.com/...
The S&L crisis was caused mostly by bad actors.
www.investopedia.com/...
TARP - Another program to address fraud when dubious subprime loans were integrated into bonds, then those were approved by rating agencies who were paid by the bond creators to not pay any attention. Some say that was fraudulent. But nobody was ever prosecuted for any of their actions.
www.investopedia.com/...

Sherlock Holmes couldn’t stop all crime even with his superior powers of deduction. Neither can Fed chiefs while playing whack-a-mole with scammers.

[Salmo trutta]

@deeminimus re: "know"

That's impossible. Savings flowing through the nonbanks never leaves the payment's system as anyone who has applied double-entry bookkeeping on a national scale should already know. Savings flowing through the nonbanks increases the supply of loan funds, but not the supply of money (a velocity relationship).

The NBFIs, e.g., shadow banks, are not in competition with the DFIs. The NBFIs are the DFI's customers.

WSJ: "In a letter of March 15, 1981, Willis Alexander of the American Bankers Association claims that: 'Depository Institutions have lost an estimated $100b in potential consumer deposits alone to the unregulated money market mutual funds.' As any unbiased banker should know, all the money taken in by the money funds goes right back into the banks, in the form of CDs or bankers acceptances or other money market instruments; there is no net loss of deposits to the banking system. Complete deregulation of interest rates would simply allow a further escalation of rates by the banks, all of which compete against each other for the same total of deposits."

Written by Louis Stone whom the movie "Wall Street" was dedicated to - Vice President Shearson/American Express

Ben Bernanke should be doing time in Federal Prison. He repeated the mistakes of the Great Depression (which his Ph.D. dissertation was all about, i.e., "cumulative representation of one's entire educational experience").

[Salmo trutta]

This is how Bernanke destroyed America:

2006 jan ,,,,,,, 45496 ,,,,,,, 0.04
,,,,, feb ,,,,,,, 43084 ,,,,,,, 0.01
,,,,, mar ,,,,,,, 41242 ,,,,,,, -0.02
,,,,, apr ,,,,,,, 42920 ,,,,,,, -0.03
,,,,, may ,,,,,,, 43648 ,,,,,,, -0.02
,,,,, jun ,,,,,,, 43278 ,,,,,,, -0.01
,,,,, jul ,,,,,,, 43328 ,,,,,,, -0.03
,,,,, aug ,,,,,,, 41162 ,,,,,,, -0.06
,,,,, sep ,,,,,,, 40865 ,,,,,,, -0.08
,,,,, oct ,,,,,,, 40088 ,,,,,,, -0.08
,,,,, nov ,,,,,,, 40543 ,,,,,,, -0.06
,,,,, dec ,,,,,,, 41461 ,,,,,,, -0.07
2007 jan ,,,,,,, 43113 ,,,,,,, -0.11
,,,,, feb ,,,,,,, 41214 ,,,,,,, -0.09
,,,,, mar ,,,,,,, 39159 ,,,,,,, -0.11
,,,,, apr ,,,,,,, 41072 ,,,,,,, -0.09
,,,,, may ,,,,,,, 42699 ,,,,,,, -0.05
,,,,, jun ,,,,,,, 42034 ,,,,,,, -0.05
,,,,, jul ,,,,,,, 41164 ,,,,,,, -0.08
,,,,, aug ,,,,,,, 39906 ,,,,,,, -0.07
,,,,, sep ,,,,,,, 40460 ,,,,,,, -0.07
,,,,, oct ,,,,,,, 40161 ,,,,,,, -0.04
,,,,, nov ,,,,,,, 40331 ,,,,,,, -0.04
,,,,, dec ,,,,,,, 41048 ,,,,,,, -0.04
2008 jan ,,,,,,, 42398 ,,,,,,, -0.07
,,,,, feb ,,,,,,, 41070 ,,,,,,, -0.05
,,,,, mar ,,,,,,, 39731 ,,,,,,, -0.04
,,,,, apr ,,,,,,, 41642 ,,,,,,, -0.03
,,,,, may ,,,,,,, 43062 ,,,,,,, -0.01
,,,,, jun ,,,,,,, 41616 ,,,,,,, -0.04
,,,,, jul ,,,,,,, 42083 ,,,,,,, -0.03
,,,,, aug ,,,,,,, 42055 ,,,,,,, 0.02
,,,,, sep ,,,,,,, 42456 ,,,,,,, 0.04
,,,,, oct ,,,,,,, 46930 ,,,,,,, 0.17
,,,,, nov ,,,,,,, 50363 ,,,,,,, 0.24
,,,,, dec ,,,,,,, 53723 ,,,,,,, 0.30

Note: these monetary flows have been mathematical constants for > 100 years.

[twoboilerfans]

Thanks for the great article. I’m an Cath lab/ICU Rn who spent the last 3 months in Covidville making all sorts of OT. I truly feel for those that lost their jobs and hope for a quick recovery for you. You would think healthcare is a safe place to be but they just discontinued our 401K match, no raises, no bonus, and no more PTO. I’m far from an economist but I have no idea where this V theory is coming from. And many businesses are closing by me and most restaurants that I go to are not hiring their staff back. Running skeleton staff. So sad. Stay safe everyone.

[clrodrick]

@twoboilerfans - From what I read it sounds like healthcare is suffering Covid-19 fall in revenue fall due to everybody *BUT* Covid sufferers avoiding doctor's offices & hospitals like the plague right now in addition to many hospitals discouraging patients coming in except for absolute emergencies. All that income from elective surgeries and much more is gone for the time being.

[Aquarama]

I refuse to fly anywhere and I am not going to rent a hotel room for a long time.

[msteiner805]

While I agree with the premise of this article, I am torn between how massive the FEDs stimulus was/is and how the US might be the most attractive place for the world to invest in... have to keep reminding myself that the market is not rational and can remain irrational for .... decades?

I wouldn't be surprised if we test record highs prior to the election and then see some significant volatility after - like +/- 20% swings in either direction.

[Chris Valley]

Speaking as a person who still uses Washington Mutual checks.

Blaming Bernanke for not knowing the derivatives trades of AIG [etc, etc, etc].

Is the same as blaming Jerome Powerful for not knowing every time a bat flaps its wings in the night.

He's Batman. You put up the Bat Symbol. That's how it works.

[blenkep]

If the Fed can’t see what is happening in the economy and if they are not responsible for consequences of their ignorance then why do we have a Fed?

[Robert Falcone]

If I recall correctly there was only one person working in the derivatives department at the SEC by the time it all exploded. Noone was monitoring those trades.

[Chris Valley]

That sounds like the job of Homer Simpson?

[lol wut]

I'm going to take the over on NABE's prediction. In the words of someone else, "Parabolic moves don't end sideways."

[Algorithmic]

@Jeffrey Snider I/M/H/O solid article. Now how do you invest from this?

The only winners from the March bottom were really the "work from home" technology names. I used this period to eliminate 2 of my MLP oils and ladder into $CSCO and $T.

All dividend payers for this retiree.

[MW185]

If there’s anything we learned from COVID-19 (many other examples) far out models and projections don’t mean anything... I just ignore them... no one knows what’s going to happen... but everyone pretends like they do... just keep investing in good companies and more times then not you’ll be fine

[Salmo trutta]

@MW185 re: "no one knows what's going to happen"

We knew the precise "Minskey Moment" of the GFC:
POSTED: Dec 13 2007 06:55 PM |
The Commerce Department said retail sales in Oct 2007 increased by 1.2% over Oct 2006, & up a huge 6.3% from Nov 2006.
10/1/2007,,,,,,,-0.47 * temporary bottom
11/1/2007,,,,,,, 0.14
12/1/2007,,,,,,, 0.44
01/1/2008,,,,,,, 0.59
02/1/2008,,,,,,, 0.45
03/1/2008,,,,,,, 0.06
04/1/2008,,,,,,, 0.04
05/1/2008,,,,,,, 0.09
06/1/2008,,,,,,, 0.20
07/1/2008,,,,,,, 0.32
08/1/2008,,,,,,, 0.15
09/1/2008,,,,,,, 0.00
10/1/2008,,,,,, -0.20 * possible recession
11/1/2008,,,,,, -0.10 * possible recession
12/1/2008,,,,,,, 0.10 * possible recession
RoC trajectory as predicted.

[Milkweed]

Reminds me of my favorite joke about economist and politicians taking credit for the economy:

"It's like some guy standing at the end of an airport runway jumping up and down taking credit for planes landing".

The "V" will in fact be a check mark in the short to mid term but we'll eventually fully recover and of course officials will take full credit.

[Robert P. Balan]

"No, far more important: what happens when this disaster begins to dawn on everyone right now expecting way, way beyond the best case? Those who are being led to believe this is all one big nothing, sporting no lingering after-effects. The risks of another leg in GFC2 are much, much higher because even hitting these forecasts would leave such a massive scar, a gigantic economic hole."

Why am I getting the impression that this is desperate cry from all the "L People" that have been left behind?

[Lost-at-sea]

Because you confuse the fed bailout of the stock market with the current economic reality is why you think that.

[Robert P. Balan]

So when a hurricane pushes up oil prices, that does not matter? Looks like another L person left holding an empty bag.

[Milkweed]

"Why am I getting the impression that this is desperate cry from all the "L People" that have been left behind?"
**************

You mean check mark people and it's because we are right. It AIN'T going back to the way it was before CoV.