Friday, September 2, 2011

Things look so bad they can only get better



To judge by the level of Treasury yields, the outlook for the U.S. economy has never been so bad. At 0.2% and 0.9%, respectively, 2- and 5-yr Treasury yields are lower today than they have been at any time during my lifetime. Far lower. Lower even than they were at the end of 2008, when the market was priced to years of deflation, a global depression, the default of as many as half the companies in the country within the next 5 years, and a global financial collapse. Wow.

The only thing that makes sense of these extremely gloom-and-doom yields that we are witnessing today is that the market is pricing in a massive default of European sovereign debt that in turn would result in the collapse of the Eurozone banking industry, and such an implosion might bring down the entire global economy. In other words, we have a market that is essentially priced to an end-of-the-world-as-we-know-it scenario.

In order to reach this grimmest of all possible scenarios, the market is making the dangerous assumption that all the bad things going on are going to get much worse: that Obama and the Democrats are never going to triangulate to a real pro-jobs program, that the Fed is going to print us into oblivion, that the economy is headed straight down, that the PIIGS are never going to veer from their big-spending, big-borrowing path, and that Europe is going to eventually implode.

Can things really be this bad and get even worse? Is there no hope for a turn to the better? Yesterday I read an amazing policy piece put out by the progressive think tank Third Way. In it they propose sweeping tax reforms, most of which make perfect sense, and if implemented would very likely usher in a new wave of economic growth and renewal. Art Laffer might have ghost-written most of the piece for all I know. It's a stunning contribution to good public policy, especially coming from the Left. Today Obama bowed to the reality of a weak economy and asked the EPA to withdraw its new stringent air-quality standards. Ireland has already opted to slash spending; maybe the Greeks will figure out that they have no other choice.

With his popularity plunging, and the economy on the ropes, Obama is being forced to change. I can't imagine that he will not adapt further, eventually supporting pro-growth, pro-business policies. The electorate doesn't like what's been happening. Keynesian stimulus policies have been proven not to work, and next week he simply can't reiterate his calls for more stimulus spending and more unemployment benefits. I've never seen so much political, economic and financial tension in the markets. This is not a long-run equilibrium situation; something has to change for the better, and it can't wait until next year's elections.

20 comments:

Jake said...

If things were actually this bad and in fact were getting worse, would you say they would look exactly like they look now?

7b78fdf8-45c5-11e0-99eb-000bcdcb5194 said...

I think there are things happening in the long term cyclical picture that is going to be good for the future. The excess in housing is slowly being worked out, housing prices are slowly building a bottom after many years, and construction spending last month was positive YoY for the first time in what seems like an eternity. Consumers are paying off their debts, state and local govts are becoming more lean, and the personal savings rate is high. All of these things are good for the long future ahead but it makes the short term turbulent. Long term and structural unemployment combined with the gap between trend GDP and present GDP would be my most pressing concern.

Charles said...

Europe is the issue. Unlike the Lehman bankruptcy, Europe is a slow moving train wreck. This means there is plenty of time to avoid injury.

John said...

"Europe is a slow moving train wreck."

If that's true, why is the Euro worth so much more than the US Dollar?

I believe we are in a new normal. There are two big problems:
1. Income stagnation in the middle class reducing condumer demand and
2. Private sector debt.

Focusing too much attention on government debt is like a dog chasing his tail. We're not going anyhere but on the spin cycle, either.

Be patient, fellas. Get out and enjoy the simple things in life.

Benjamin said...

With negative interest rates, this passage from Grannis--- "that the Fed is going to print us into oblivion"---simply does not make sense.

The serious market is not worried about inflation. The serious market is worried we are doing a Japan.

The talk-show carnival barkers are braying about inflation and gold, and they may have scared some people. Fearmongering is profitable.

But institutional bond buyers are certainly not concerned abut inflation.

Benjamin said...

http://macromarketmusings.blogspot.com/

This is a right-wing Texas talking about nominal GDP targeting and QE. Really nice read.

This right-wing Texan is not Rick Perry unfortunately.

honestcreditguy said...

Well, I haven't been around for a little while and things have begun to unravel as forecast....Benjamin will get his benji easing as they will take down market to make it so...

Scott, we still have 2 years for 1/2 the companies to implode..seems like govt. props prevented that from happening already..What will they pull out of the bag now...

The empire is heading to its place in line with other failed empires..

The pan asia commodity exchange will expose the comex BS..Gold and silver have many reasons to explode..The game is over....China will play this out slowly to expose the banker shills of the west....

they are patient and Rothchilds are getting scared, war will come...because greedy pigmen hate to lose....

Junkyard_hawg1985 said...

Scott,

I want to thank you for showing the 10-year treasury yields since 1925. It is nice to have the current rates in long term perspective. We have been here before. In fact, the yield curve was very close to where it is today in 1936 shortly before the depression within the depression of 1937. I commend you for showing data prior to 1940 because most blogs and article don't. There wasn't much as much data collected then, but it is still important for long term perspective.

Many blogs and articles are a lot like a man looking for his keys under a street light. When asked where he lost his keys he says "Over in that dark alley, but the lighting is much better here." Using only post WW2 data in the current economy is much like looking for the keys under the lamp post.

Dr William J McKibbin said...

In many ways, a full blow-up of the US and European economies may be the quickest path to a recovery -- a complete wipe-out of all public and private debt may be just what the doctor ordered -- I am not hoping for such a thing, but we all may begin to ponder the advantages of starting over...

John said...

"a complete wipe-out of all public and private debt may be just what the doctor ordered"

If you want to get this party started," that's what you'll need.

Be one hell of a "hair cut" for all those debt security investors, though wouldn't it?

Joe said...

What is the significance of the turning points in direction of the 10-yr yield curve? i.e. up slope from 2009-2010, then down, then up again. Can this have something to do with stimulus economic policies having favorable effects and the conservative advocates austerity hype having unfavorable effects? Also in the long term graph, what is the significance that the downward trend line begins with the introduction of Reagonomics philosophies?

Scott Grannis said...

Joe: Re turning points in 10-yr chart. The ups and downs of 10-yr yields in recent years correspond pretty well to the market's perception of how weak or strong the economy is. The big decline in yields that began in the early 1980s was almost strongly related to the big drop in inflation, thanks to the policies of Fed Chairman Volcker. Jimmy Carter appointed him, so Carter should get some credit for this. Reagan's policies promoted growth and confidence in the economy, and that helped keep inflation low by strengthening the dollar.

Benjamin said...

In Reagan's defense, he reappointed Volcker despite reservations of many Reaganites. But only once.

John said...

"Reagan's policies promoted growth and confidence in the economy, and that helped keep inflation low by strengthening the dollar."

Reagan was helped immensely by falling oil prices driven by new output from Alaskan oil, Pemex, North Sea Oil, and domestic drilling spurred by the high prices of the late seventies.

Jim said...

Some bond managers, and idiotic stock fans tries to pick the bottom in yields and it is hilarious. Forget the 10-year let's look at the 30-year and see how much further we have to go. This curve seems like it will flatten like a pancake.

Is it end of the world? Well, that is impossible unless Martians decided to finance global debt.

On a more serious level, global reflation is required, and the only thing I can think of is the military industrial machine. It will take a lot of electric cars, solar panels, and holding hands singing Kumbayah to get this world economy back on track.

Dr William J McKibbin said...

When countries go broke, those countries typically will cut defense spending -- what Mr Obama should announce to the joint session of Congress should be two things: a) the disbandment (as in a complete unwinding leading to bankruptcy) of Bank of America under the new Dodd-Frank "too big to fail" rules; and b) that he is ordering all US forces to return to the US (from Korea, Europe, Afghanistan, Iraq, Okinawa, Philippines, and everywhere else) for demobilization by summer, 2012 -- these two measures alone would save the US Treasury trillions in the coming years and would free up plenty of capital to be invested into private enterprise in the coming years, decades, and the rest of the century -- small solutions are not going to work at this point.

PS: A long-term goal should be to partition California into two states -- California is just another of those "too big to fail" systemic problems that needs to be dealth with sooner rather than later...

Benjamin said...

Dr. McKibben: Ron Paul, Pat Buchanan, and little ol' me have been advocating a radical downsizing of the military for years.

The idea is gaining some traction in right-wing circles, but you gotta understand: The House and Senate Armed Services Committees, and related appropriation committees, are full of guys who have defense plants and bases in their districts.

Military spending is double of that 10 years ago, and it was bloated and ossified then, like any federal agency.

You will not hear the GOP or Tea Party ever address this issue--too much money flows into rural and GP{ districts through defense, Homeland Security and the VA. And into the hands of defense industry lobbyists (usually former GOP house and Senate members).

Good luck.

septizoniom said...

just as europe did today?

Jim said...

Well it would be money well spent through proven industries - Boeing > more workers > orders for 3rd party part suppliers > more workers > ordering raw materials > more workers - and can sell to foreign countries with the latest technology.

You are not going to get this effect with green technology. Correct me if I am wrong, but people need green technology like they need a hole in their head.

Reality said...

As long as educated employees are available in the rest of the world (India, China) for a lot less than college drop-outs in the U.S. (to say nothing of H.S. drop-outs) The U.S. will have an employment problem.