Four dark clouds

The Dow went up a bit last night. Hooray!

But if you think this correction is over, think again. This is the correction we have to have.

Think about it. There are four big economies in the world: Japan, EU, China and the US. A dark cloud hangs over each.

Japan is far worse than markets or bullhawk economists predicted earlier this year. According to the NAB World In Two Pages report:

In Japan, the tsunami and power shortages associated with the nuclear emergency have had a far more severe impact on activity than initially indicated in the BOJ’s special Tankan survey. Real GDP fell by 0.9% in March quarter and the partial data available for the June quarter shows that activity levels are still low. Manufacturing output fell by 15% in March but recovered by only 1% in April. The monthly Shoko Chukin small business survey shows worsening falls in sales to June month. We have revised our 2011 forecasts down to flat output.

In the US, we’ve got a well publicised slowdown in industrial production. Last night the Philly Fed Index fell off a cliff, suggesting the big falls in the ISM last month are a harbinger of worse. Housing is going nowhere, the sharemarket is falling and very respectable commentators have declared the consumer dead and are forecasting recession in the near to medium term.

In the EU, it’s a debacle as usual. My guess is Greece will come through this latest round of crisis with a new bailout (that’s what the EU does best at the 11th hour) but so what? The new austerity package will only kick the can again and the periphery will remain in recession or at stall speed. The UK too is slowing again, with the retail rush stoked by the Royal wedding, hurriedly reversing.

In China, we still have good growth. But we also have the mother of all bailouts transpiring at local government level, a stubborn inflation problem, simmering unrest and the inevitability of more rate rises even as the housing market stalls. As an aside, India too has a big inflation problem and is now swiftly tightening.

And behind all of that, we have the withdrawal of QE2 stimulus hitting Wall St which drives the entire global reflation trade through emerging market equities, currencies and commodities. It is possible to climb the wall of worry when policy-makers are giving you the incentive  to do so. When they’re not, in the face of all of the these threats to growth, just forget it.

Basically, to my mind, massive coordinated stimulus has engineered a kind of virtual recovery in global growth over the past two years. The removal of that stimulus, combined with some bad luck, means the underlying condition of the global economy is being re-exposed. That condition is fundamentally deflationary as historic debt weighs down private sector demand in the US, the public sector in Europe and plays a part in the ongoing decline of Japan. Emerging markets aren’t big enough to offset that burden and with the chickens coming home to roost from their last attempt at doing so, they’ve worries of their own.

Air is leaking from the reflation. More is needed. More will come. Then the pumps can begin anew.

David Llewellyn-Smith
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Comments

  1. I have a beginners question for you all. The discussion yesterday on the market testing 4200 again in the near future, is it reasonable to theorise that the market showed unfounded exuberance after the GFC. The way I interpret it is that the markets went up on inflows from the various stimulus packages which were meant to allow the economy to sort out its structural problems in a more stable environment. In reality nothing has changed and in fact the stimulus has inadvertently compounded the problem. I refer to bail outs of Greece, Australian property situation and the continued increase in excess capacity in the US through high unemployment. Do you feel that this reaching the true bottom of the cycle? Or given the lack of intent from the political leaders are we headed further into a double dip recession?

    • Sometimes you have to make the ‘least bad’ decision. Unemployment, asset bubbles and recession is nowhere as catastrophic as the complete collapse of the world banking system.

    • The stimulus packages were a way for big business and banks to reposition themselves. Nothing has changed for the everyday chump on the street, he’s still going to get screwed. Everyone knows it but the chump. This is what we call the ‘denial’ stage.

  2. My opinion, based on the likes of Steve Keen and Austrian economics, is that we in Australia have a massive housing bubble that has a lot of deflating left to do. We have a retail and service economy that will contract as the bubble deflates and the negative wealth effect kicks (people feeling poorer due to lower house price).

    We then have the China mirage…the FutureBoom that will save us from everything because nothing could ever go wrong in China could it…I mean communism and socialism has proven itself to be so resilient over the past 100 years!!! They are faking things are ok….they are not. Their economy is a sham

    The US…well I actually think they would be closer to the end of the cycle. As the Austrians have shown…the only way to get rid of a recession caused by specualtive boom and bust is to allow the debts to be written off, economy to tank and then naturally regenerate (creative destruction).

    Although house prices are still falling and have some way to go in some areas, they are a lot closer to the bottom than Europe or Aus.

    Basically…we need to accept this and work out how to live in an environment with less credit. This will require personal sacrifise but something tells me sacrifise wont be accepted and will be imposed (ala Greece)

    • As the Austrians have shown…

      Have they actually shown that or have they theorized it? i.e. can you name an austrian government (apart from austria 🙂 ) that has done this?

      I’m not so sure about things being imposed either. With high unemployment in greece and spain, civil unrest will likely escalate. Both these countries have had military dictatorships in the relatively recent past. It is not too much of a stretch to imagine military takeovers with accompanying withdrawal from the EU and default.

      • Lionel…it is true we have never had a purely free market economy…but I believe a survey of history provides various examples where a recession was allowed to run its course and the economy able to grow again.

        The 1920’s US provides a few examples…as just before the roaring 20s kicked off…the US economy had a downturn. Banks went bust, people lost their jobs and then things started over again.

        Even within economy’s you can see examples where recessions were able to rid themselves of the dodgy businesses and the good ones survive. I would argue the tech crash of 2000-01 is an example.

        Irrational exuberance took off…share prices were way overvalued, bubble popped, people lost a lot, things went on, from the wreckage emerged various online companies that are now powerhouses…none of this required any tinkering byt he Government or bailouts…its the way the market repairs itself.

        The only problem came when Greenspan decided to fuel a housing bubble to replace the tech bubble. So once again, its the meddlers causing the problem and the market sorting it out.

        I dont understand your second point about the imposition of austerity. You seem to disagre, but then suggest the same thing I am suggesting…that the population of Greeece and other PIIGS will not voluntary accept the austerity, but will be forced to accept it through political/military repression

        • don’t think that the first part of your comment addresses an example of austrian theory in practice but that is a difference of opinion.

          On the PIIGS where I think we differ is that in my scenario the military do not take over so as to force austerity they take over because they won’t accept austerity being imposes externally. After they run the show they default and withdraw from the EU thereby minimizing austerity.

          An IMF study from 2007 concluded that default was not that bad but it had negative internal political implications. Those negatives evaporate if you have a military dictatorship.

          • Austrian theory is against the idea that Government should artificually stimulate demand during a recession. They argue the recession just needs to run its course so things can start again and malinvestments made during the boom are written off.

            Maybe not the first part…but the tech bubble is a fine example I believe, because it was a short and sharp recession. Yes rates did drop and help fuel the recovery, but the fundamental lesson to learn is that the economy naturally recovers from a recession.

            Thanks for the info and clarifying the austerity/military/default scenario. I found that very interesting

            Cheers

          • re: military takeover to prevent austerity imposed by others

            I’m talking about Greece and Spain and perhaps Portugal. Not Ireland or Italy.

    • Re China

      The recent burst of locking up critics, artists and minor trouble makers is a sign of a ruling clique that is feeling decidedly nervous.

      And why wouldnt they be – their massive make work schemes are being financed by a rigged banking system and stealing money and property from households.

      While the ‘big picture’ crowd get turned on by massive infrastructure projects, there are lot of little people who get squished in the process.

      300 million mobile phones are hard to silence

      • 850 million mobile phone users – and the means to control.
        http://www.freedomhouse.org/images/File/FotN/China2011.pdf

        And for anyone with a real interest in China’s future: politically, demographically, economically along China’s evolving relationship with the West – this talk/Q&A with Niall Ferguson at London’s Chatham House. Well worth the listen even if you don’t agree.

        He does indeed see a bumpy road for China, but also that essentially the juggernaut will continue (with bumps) for 15-20 years, and explains why. Suspects that as China faces issues including the very real demographic problem in years ahead, it is likely that India will be further developed and better positioned to make significant economic strides.

        http://www.polycapitalist.com/2011/06/video-niall-ferguson-west-and-rest.html

        Long term quarry Australia?

        • 850M!

          Thanks for the freedom house link – the obsessive attention to ‘control’ in China is fascinating but only confirms that the authorities clearly perceive they face a huge threat.

          Despite the enormous economic growth over the last 30 years the government clearly understands that it is highly vulnerable to questions concerning its legitimacy.

          The China Story in the medium to long term depends on whether China can develop a model of governance that doesn’t involve a paranoid suspicion of its own people.

          That may prove hard and possibly very disruptive to the economic growth story.

    • The problem with the ‘Austrian’ model is this : people live in a society, not an economy, and people needs to eat. Solving unemployment via starvation of the unemployed is simply not an acceptable solution.

  3. Iceland is the only example I can think of re a semi austrian respone, let the bankers fail and start again. endure a couple of years of pain but get on with it.

    • stand corrected cause its a while since I’ve read about iceland, but my recollection was that they let foreign bankers fail but guaranteed the savings of locals.

  4. Sandgroper Sceptic

    Australia is in the grip of a recession which will be severe. If the government tries the US solutions: delay, kick the can, bail out banks, lower interest rates, more stimulus etc it will delay the recession or soften it and you could look at a Japanese style strangulation.

    If the Government does few of these or is paralysed by other issues then our recession will be severe. But it will be over much faster. This would be the best result we could hope for.

    If China slows right down for whatever reason, we are headed for a full blown depression. A whole generation has not felt the harsh winds of recession but this will totally shape their future behaviour as it did to the people who lived through the 1930s. My Great Grandfather made a living selling bush cots to displaced persons who set up humpy camps near the beach in the 1930s as they had no work and no home, they traded anything of value they had for a decent bed. My Grandfather used to go out into the bush (on foot) and hack off/dig up grass tree stumps and make some money from selling them to richer households who burned them. The people that lived through the 1930s and then the war knew all about sacrifice, making do, recycling, saving etc.

    • The problem in Japan is deflation. Their inflation rate is NEGATIVE. Japan’s ‘stimulus package’ were rather small, and it’s handed out to politically connected businesses. It made some people fabulously rich paving concrete on riverbeds to make the water flow faster. If they followed the Australian model of ‘go early, go hard, go household’, Japan would not be in this mess right now.

      The believe that the ‘market’ can fix itself is somewhat curious as the ‘market’ created the problem in the first place!! Like it or not, Australia only has a limited control over its destiny.

      • Sandgroper Sceptic

        Is deflation so bad for the individual? Geez cheaper prices on everything is great. It also stops people buying crap as they know it will be cheaper in the future so they save more, even with low interest rates your money is actually gaining in purchasing power parity. Inflation is hideous it robs savers, those that do the right thing and rewards borrowers.

        Deflation is bad for people with debt as it gets harder to pay it off, but is that such a bad thing? Surely a society with less debt, less pressure to make the monthly mortgage nut, cheaper items, a culture of saving and investing in productive assets is better than our go-go fast consumption debt borrowing binge of today? Banks of course hate it and will fight it tooth and nail but few are going to cry about them.

        • I agree SS, deflation is great for those with lots of savings. Whereas rampant inflation such as in Australia barely makes it worth saving.
          It is about time the Government stopped punishing those who don’t spend beyond there means.

    • SS, you are so right there, however, can you imagine the current iGen (I want Gen), having to do without the essentials like smart phone’s, gaming consols, computers, TV’s, latte’s etc. It would never happen, they would just vote in a soft celebrity govement that would give them what they want.

  5. One of the Japanese banks solutions was to sell their bad loans to Yakusa who upped the rate to 20%. This could be how it plays out here. New series of underbelly.
    Speaking of Rabbit, i cooked a stew fed it to my Y generation kids, they loved it right up until I told them what it was. Mind you Rabbit is expensive, unless you shoot it.

  6. HH wrote:

    “Basically, to my mind, massive coordinated stimulus has engineered a kind of virtual recovery in global growth over the past two years. The removal of that stimulus, combined with some bad luck, means the underlying condition of the global economy is being re-exposed.”

    I agree with this, but not the gentle manner in which the idea is presented. The US has been running a deficit that is 12% of GDP to produce GDP growth of 2 or 3%. The term “double dip recession” is laughable because the end of the first recession was merely a wonder of financial engineering. IMO, the US private sector has been in clear depression for 3 years. The only major economic indicators that dispute this are GDP and the stock market indices, both of which have been entirely goosed by QE and deficit spending. It is all illusion.