Macro View: Double Dipping

14 May

Quick Synopsis

  • I expect that the US economy will double dip into a recession in the back half of 2010
  • By 2012, the US will be forced to take drastic austerity measures, including severe cuts to entitlement programs
  • The risk of a debt downgrade for the US increases substantially in the first half of 2011

I have to start off by saying thanks to @Prof_Pinch for the lively macroeconomics discussion last night, it definitely got my mind thinking. He posted a rather interesting chart showing the M3 supply in Europe breaking a historical trend to the downside. Another chart showed Japan’s monetary supply, which subsequently stopped growing and was relatively flat throughout much of the lost decade. That got me thinking about the US’s prospects of a “lost decade”. We face many of the same problems as Greece, mainly the vast amount of entitlement programs that exist. The only difference is that we don’t have (relatively) widespread tax evasion. But, we have a more perplexing issue that has been sorely exposed during this downturn: a large population of people utilizing entitlement programs with a shrinking base of people to pay for said entitlement programs. That is going to force the US to undertake austerity measures eventually that makes the ones that the Greeks are currently undertaking look easy.

The problem is a complex one, but the key risks that I see for the US in the coming 5 years are:

  1. Persistently high unemployment in the population under 50 will result in substantial declines to government tax receipts
  2. Increased risk of a double dip recession as the transfer payments enacted under EUC 08 begin to trail off (i.e. people begin to exhaust unemployment transfer payments at an accelerating rate) resulting in less spending to stimulate the economy
  3. Inflation will begin to skyrocket, further weakening the buying power of those remaining in the population who are the key to pulling us out of a recession
  4. Bank credit will remain extremely tight
  5. Regulatory risk with a detrimental impact on small business innovation and job creation across all sectors of the economy.

More Spending, But Less Economic Growth

Personal Savings

From the chart you can see that while the savings rate experienced a record jump during the crisis vs. previous recessionary periods, I want to draw your attention to the record low savings rates after the 2001 recession and during the housing boom. That spending is what drove the economy out of previous recessions (and also played a part in why the personal balance sheets of many Americans is now obliterated). The rate of change away from saving and back into spending is at the levels that got us out of the 2001 recession, and appear to be well on their way to getting back to the 2004-2006 levels. However, economic growth remains sluggish. The amount of people on unemployment who are receiving transfer payments from the government are, by default not saving that cash. So, we have transfer payments coming into the economy in addition to those who are in the position to spend cash (while sacrificing their savings) but we have sluggish growth. One potential explanation could be that the consumer’s purchasing power has been substantially weakened, so those same amount of dollars from 2001 and 2004-2006 levels are weaker than today. I tend to highly discount the Government’s official measure of “inflation” as you can clearly see the consumer’s dollar has been weakened just by taking a stroll through your local grocery store. For the sake of fairness, high tax municipalities like Chicago (Cook County) and NYC also add to the weakening of consumer purchasing power.

NFP - PSR

This chart offers another perspective on the savings rate by overlaying it with the non-farm payrolls numbers. As the onset of the crisis began, before we witnessed a large number of job losses, the savings rate spiked to over 650 billion. Over the past few recessions, the savings rate has spiked as people initially clamp down on spending over economic uncertainty, but then confidence returns and they begin to spend again. This is economics 101, more demand for products usually means more hiring (except where “productivity gains” play an increasing factor). While I won’t delve into the whole “productivity” scenario, it’s importance in this recent downturn and recovery is pretty significant. Quite simply, the US has maximized productivity so much that we have basically automated ourselves out of entire workforce sectors. That partially explains why the deluge of spending in the economy has failed to produce the growth needed to result in a meaningful increase in payrolls and a significant drop in the headline unemployment rate.

Monetary Supply

This is what we were discussing yesterday evening. Consider the following chart:

US M2 - ROC

While Europe has broken the uptrend in terms of monetary supply, we in the US are fortunate enough that we still have a bit to go in terms of breaking the trend. However, we are close. If that happens, and the rate of change in the deterioration of the monetary supply accelerates to the downside, I believe that a shrinking monetary supply (excluding the printing presses running constantly in DC) puts us at increased odds of a double dip. That assertion may be a stretch, and I must admit that I am straining to really make it “fit”, but when I add this up with what’s discussed above I believe this just shows the strain that we are under. Looking at @Prof_Pinch’s charts out of Europe and Japan further reinforces that – we know that the Eurozone is in trouble, and Japan is also in trouble of seeing slower growth. If they deteriorate further, so will we. China is in the midst of a 2006-type bubble that will pop, so it’s not quite prudent to continue to depend on them to float the consumption lifestyle of the USA.

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One Response to “Macro View: Double Dipping”

Trackbacks/Pingbacks

  1. Closing Notes – August 19, 2008 « Stone Street Advisors - August 19, 2010

    […] refer back to my earlier article from the spring of this year where I laid out my double dip thesis here. While I am less inclined to believe that we are in for sovereign debt downgrades than I previously […]

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