Whither now the US?

I’ve been warning for a couple of months that the US economy is in trouble. It’s hasn’t really been that hard to see, so long as you recognise its underlying condition.

The US economy is in a depression. It’s not quite the kind we saw in the 1930s but it’s a depression nonetheless, just slower moving. There’s actually no precise definition for a “depression” in economics so I’m going to take the populist route and rely on that provided by Wikipaedia:

In economics, a depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe downturn than a recession, which is seen by some economists as part of the modern business cycle.

Considered, by some economists, a rare and extreme form of recession, a depression is characterized by its length, by abnormally large increases in unemployment, falls in the availability of credit— often due to some kind of banking or financial crisis, shrinking output—as buyers dry up and suppliers cut back on production, and investment, large number of bankruptcies—including sovereign debt defaults, significantly reduced amounts of trade and commerce—especially international, as well as highly volatile relative currency value fluctuations—most often due to devaluations. Price deflationfinancial crises and bank failures are also common elements of a depression that are not normally a part of a recession.

Anything on that list that is not either a part of the everyday experience of the US economy already, or a plausible threat?

Yes, the US is in a depression but one that has been slowed down by the lessons of the last Great Depression. That is, the last few years have seen huge bank rescues to prevent the kind of calamitous negative feedback loops described by Irving Fisher, as well as huge (though not large enough) Keynesian fiscal stimulus to fill the hole in demand, and enormous monetary stimulus prescribed by Milton Friedman to prevent deflation.

All three of these dead economists are hard at work in treating the US economy, yet it is responding like it shares their grave.

Some excellent charts from Calculated Risk today make the point perfectly. Some four years after the last recession began, real GDP has still not scaled its former peak:

Industrial production is worse still:

Employment is horrible:

And unsurprisingly, real income insuffiicient to boost demand:

When I look at these charts, the only surprise I feel is that others are surprised at the US economy’s ongoing swoon whenever any of the three dead economist’s prescriptions are reversed.

Yet, that is where we are today, with QE2 finished and the new debt-ceiling deal about to rip 1.5% out of GDP over the next twelve months, according to both Dean Baker and J.P.Morgan. And this, for an economy that in the last quarter grew by 0.5% annualised.

So, can we look to new stimulus from monetary policy? According to The Economist, nope:

Mr Bernanke is implicitly asking the government not to place a short-term strain on the economy. In doing so, he is hinting that the Fed can’t be counted on to offset the impact of short-term fiscal tightening, either because 1) he believes the Fed is powerless to do so, 2) he believes the risks to trying to do so outweigh the benefits, or 3) he believes the Fed faces institutional constraints that prevent it from reacting appropriately. Whatever the actual reason, the suggestion is the Fed can’t (or can’t entirely) offset the negative impact of fiscal tightening.

Now, additional easing may well be forthcoming. Last week’s dismal GDP report makes Fed intervention far more likely, if not yet the most likely outcome. But as I’ve written before, the Fed doesn’t appear to respond to employment trends or output trends nearly so much as it reacts to movements of inflation outside its comfort zone. Thanks to recent events, QE3 seems a real possibility, but I’m not going to count on it until the grinding impact of near-zero growth and austerity drive inflation and inflation expectations to levels too low for the Fed’s tastes. That may take a while. In the meantime, the employment situation will grow worse, and the threat of a return to outright recession will rise. It’s an ugly situation, but we can’t say that the Fed didn’t warn us.

Regular readers will recognise the game of chicken I identified months ago between the Fed and commodity prices. The Fed needs commodity prices to fall, especially oil, to give it the deflationary excuse for more stimulus.

Sadly, last night’s action was not encouraging. Despite a thumping 2.5% fall in the S&P500, the CRB index rallied nearly one percent, largely on grains. Oil fell 1% but it’s just not enough. Here’s a one year chart of the CRB:

I have argued that we’ll see QE3 before a cycle ending event. And that still seems possible, although the convergence of weakening Western growth and an imminent Spain/Italy crisis suggests darker possibilities.

But I have one further point to add that is giving me second thoughts. Australian policy-makers are fond of saying that parts of the national economy must shrink if there is to be enough room for commodity boom investment to grow without causing inflation. Could it be that China’s commodity demand is so voracious, so spectacularly large, that the same line of reasoning can be applied to the entire US economy?

That is, Chinese consumption of commodities has so imbalanced the supply and demand equation (such as it, channeled through financialising markets), that the entire US economy must shrink in order to give China the space to grow (on its infrastructure model) without unsustainably spiking the price of the building blocks of the global economy – commodities?

If that’s true, then we’re going to need a cycle ending event to reboot the US economy, or we’re headed for a spectacular inflationary blowoff.

Houses and Holes
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  1. Despite mining boom we are in depression as well. Our GDP growth since late 2006 is driven only by strong population growth while our real GDP per capita is stall. This may not satisfy definitions but in fact this means that our economy is not getting any better

    • Houses and holes.

      I think all our graphs etc etc are interesting but really only account for the last 100 yrs or so, if that, since fiat money rose.

      What I really find intriguing and what I believe requires a deep deep look are your last three paragraphs.

      It harks back to a previous blog some time ago regarding system contraints, ie resources.

      I think we need to step back and look at an even bigger picture of whats going on weith this in mind.

  2. Milky wilkies on the way…….chart actions look almost identical to pre QE2.

    We may be in for a few months of sideways/falls before The Bernank and the ECB (and BOE and BOJ and Obi Wan) step in…

    Gold shot to new record and is sitting there this morning – $1660 an ounce

  3. Maybe the Tea Party lunatics are actually Chinese agents since their influence guarantees worse times ahead for the USA.

    How anyone could look at the charts you have posted and conclude that their needs to be a fiscal contraction beggars belief.

    • A fiscal contraction can only work if there is widespread debt forgiveness.

      Remove/purge the private debt from the system, eliminate the Fed held public debt, cut the Defence budget 30-50%, retain current entitlement spending (but don’t allow it for future pensioners – i.e grandfather the system) and a fiscal contraction could work.

      So yeah, not much to do there……

      • and thats the only real recipe for recovery in the US. Govt spending must fall, and there will need to be a default of some sort (whether outright or through dollar devaluation).

        Fact is the US economy cannot afford the size of its government, and there will need to be a sizable hit to GDP while the problems are worked out. All they have done so far is avoided fixing anything.

    • Whilst not being a great fan of the Tea Party or their ideology, it could be argued that they have served a useful function.

      They have finally drawn a line in the sand – a line that probably should have been drawn many years ago.

    • John Theodorou

      “The only question is how big will QE3 be?”

      The real question should be, why would it work, when QE’s 1 and 2 have failed?

      • Things might have been a lot worse without QE’s 1 & 2. You can’t measure what you prevent …

        • You can do some pretty good measuring of before and after though. The BoJ analysis of commodities had a good section of QE effects on commodities prices.

          But apart from anything else people need to explain how a QE would stimulate the economy. There are the Pavlovian signals that caused higher commodities and lower dollar but the actual mechanics of QE doesn’t add money to the economy.

          • It is estimated that QE2 was equivalent to -0.75% of additional monetary easing.

            This extra easing pushed ‘risky’ assets like commodities and stocks higher: money looking for higher yields.

            It made it easier for govt and companies to borrow extra money.

            It had nearly zero impact on the real economy, since availability of debt is not the issue, if you do not qualify or do not want to borrow.

            It made commodities more expensive (see oil) which together with the Japanese earthquake slowed the already weak economic growth.

            More QE just like the last one will have very reduced benefits and lots of risks and will make it REALLY hard to unwind when needed.

            The problem is also that govt does not want to increase spending, probably have run out of ideas too. Things like home buyer boosts, car incentives, tax incentives and other economic policies is what actually boosted the economy last year, not QE. US GDP growth in 2001 was very weak, and that’s when QE2 was happening. 2009 / 2010 saw massive incentives in China and Europe too, that’s all gone now.

          • It’s the ‘trickle down’ theory. Hedgefunds and banks will makes an obscene amount of money from cheap credit, and some of it will eventually ‘trickle down’ to the real economy!!

    • IF you’re a US T-Note or T-Bond holder, its worked – yields are back (or close to) pre-QE2 levels. (30 year is below 4% again, 10 year is below 2.6% again)

      The bond market knows what’s going on methinks….

      • The bond market obviously wasn’t concerned about “default” hence an acceleration of price (falling yields) while this lunatic theatre was on.

        This should also put paid to the “no one will buy treasuries when the Fed stops buying” meme.

  4. The FED will have do something and I guess they are figuring that out now with the DJ showing the stress.

    DJA 2.53% down
    DJI 2.19% down
    DJT 3.67% down
    DJU 1.67% down

    • The market previously hadn’t really priced in a possible contraction — certainly not during QE — and now that is not only likely but guaranteed. So expect more of this while the market adjust to the impact on the domestic component of S&P earnings.

      • Definitely more chaos to come. Russell Napier predicted this in March and advised all his clients to sell all their US equities.

  5. I think the MSM definition for a depression is that it doesn’t exist. According to the memo, what US has now is a slow recovery – a job less, wage-less economic “recovery” that is cheered on by the financial markets.

  6. H&H, and here is one for you to ponder. It’s the GAO’s FED inquiry.

    This is a gold mine of proof that the FED had swaps with the RBA during the GFC; that might be normal, but why wasn’t it disclosed?

    Also, it shows Westpac, ANZ, CBA, and NAB had Money Market Investor Funding Facility (MMIFF).

    My question, and “please can somebody answer this” : – why was the MMIFF SPV’s to Australian banks during the GFC not disclosed to the public in either ASX requirements, or by the RBA, etc.?


      • Thanks. But I’m left with the feeling that the FED can’t be named nor can legal process be followed by Australian Banks and regulators.

        The investment community are kept in the dark, and I would expect there has to be a legal issue here?

    • The swap lines were disclosed during the GFC. The Fed and RBA (with other central banks) made joint statements at the time.

      The Feds discount window loans and other emergency loans weren’t disclosed until early this year. From memory the CBA was the biggest borrower. You would think that would have made headlines… but no.

      • Thanks Sweeper, an I appreciate a straight answer. I remember Rudd saying that no Australian banks needed help, and when I heard about the GAO findings I wondered why normal disclosure wasn’t followed. I think I know why (stop a run on the banks), but non banks don’t get ASIC’s blessing to do this; they are prosecuted instead.