Thursday, June 11, 2009

The Opportunity Cost Of Green Shoots

JPM's Michael Cembalest with a terrific compare and contrast between the current economic situation and that of the 70's. Useful to not that no matter how many contrasts on draw to previous major recessions, what we are living through now is so much more than a simple manufacturing recession as Rosie keeps pounding the table. Anyone who believes that the impact from the unwind of 50 years of progressively cheaper and pervasive credit will be resolved within a 1 year of the Lehman bankruptcy is either hopelessly naive, or ideologically conflicted, or both.

As we've been saying, it's not the change in the trajectory of the global economy, but the cost of engineering it, that clouds the outlook. One example: the cash-for-clunkers program that drove German auto sales higher may cost German taxpayers at least $3.5 billion, even after the sales tax and foregone unemployment cost benefits. Such programs simply pull forward future demand, and displace other non-auto purchases. The world has never relied before on a coordinated avalanche of fiscal and monetary stimulus, and financial guarantees. I find investment commentary that hails the arrival of better data without acknowledging its potential costs to be incomplete.


The Ultimate Fighting division of heavyweight economists has been active, with Paul Krugman and Allan Meltzer exchanging sardonically-worded "history lessons" with each other. Here's a chart I pulled together to try and grasp the fireworks. Today's "output gap" (a theoretical measure of spare capacity) is around 2x the 1970s version. That should give the Fed ample room to keep monetary policy easy for a long time. But how easy? The expansion of the monetary base is already 4x greater than its 1970s counterpart, and heading higher. So far, the money multiplier (which drives inflation) has been weak, but the Fed is making a huge bet they can control all of this. The size of the monetary and fiscal expansion reminds me of that giant boulder at the beginning of "Raiders of the Lost Ark"; recent increases in commodity prices and Treasury/Agency yields suggest it may be gaining on us.

On residential real estate, the foreclosure wave is hitting higher-end properties. The consequences for home price deflation, rental markets and bank losses are considerable. As long as Notice of Defaults are at all-time highs, we are nowhere near the bottom in housing.

As for the dollar, we can put off a discussion on its status as the world's reserve currency for another day. We don't think it’s disappearing, but the Portuguese, Spanish, Dutch, French and British probably didn't see the end coming either. Joseph Yam, the storied head of the Hong Kong Monetary Authority, refers to the eras of reserve currencies as Portugal (1450-1530), Spain (1530-1640), the Netherlands (1640-1720), France (1720-1815) and Britain (1815-1920). 100 years looks like a long time.

The notion that the Chinese yuan could replace the US dollar as the world's reserve currency may strike some as odd, or at least very premature. But in 1920, only 7 years after the creation of the U.S. Federal Reserve, the notion that the dollar would replace the British pound probably sounded even more bizarre, given the recent memory of US defaults on Civil War debts, a major depression in 1893 and the Panic of 1907. I thought it was notable that the Chairman of the state-owned China Construction Bank called on the United States and the World Bank to begin issuing yuan-denominated bonds, after several other steps taken this year to increase the yuan's convertibility.

Source: Michael Cembalest Sphere: Related Content
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