Monday, April 5, 2010

A Sobering View Of Macro Economic Reality (Karl Denninger)

The Market Ticker

Sunday, April 4. 2010

Posted by Karl Denninger in Macro Economics at 14:01

A Sobering View Of Macro Economic Reality

In 2001, we had a recession, right?

We recovered, right?

Are you sure?

Are you curious as to why manufacturing has continued to shift to China, why the only "good jobs" in this country seemed to be centered on ripping someone off in some way (e.g. subprime or "liar loan" mortgage brokers, stock brokers, guys selling bogus CDS against money they didn't have, etc) and why employment never really recovered - with the employment rate of the population failing to move materially higher after the 2000 recession, you might want to read the rest of this missive.

And by the way, the employment trend of the previous month?  Revisions made that worse - here's the previous month's graph:

If you remember last month I said that changes in this data were "encouraging."  This month however the revisions caused some negative impact on the previous month's data; this is what that same chart looks like now:

Oops.  That's still below zero, isn't it?  So despite all the cheerleading in the media about the positive report in point of fact we are, on balance, below where we were last month as that big positive spike got revised away!

Now let's not be too negative - the situation has improved - from the bottom.  For example, the "not in labor force" chart now looks like this:

But last month it looked like this:

You wouldn't know this from the orgasmic response on CNBS Friday.  But the data is what it is, and despite actual improvement this last month the improvement in the situation last month not only revised away all the improvement from this month, it revised away even more!

Leave it to government to report a number that's "good", then is revised away the next month beyond the improvement in the next month in the series, meaning that in point of fact you've moved backward, not forward.

But that's not the reason for this missive.  Oh no.  This Ticker is dedicated to exposing what we did in the 2000-2009 decade at a macro economic level, and why those who are calling "end of recession" need to go drink a bottle of arsenic-laced gin before they wind up really hurting people making real decisions in the economy - that is, you, I, and every business person in America.

If you remember in 2001 we had a recession.  I put forward the following (rather confusing) base graph of federal debt expressed as month-over-month change, going way back to the 1990s.  Click for a big copy, and have a big monitor:

The reason I'm going to confuse you with the above is that I am shortly to bring light to this matter.  That is, I'm going to reduce this raw squiggle to something understandable - that is, the annual rate of change of federal debt (all-in, including on-sheet transfer payments) since the early 1990s.

Notice something: Federal debt additions through the 1990s actually shrunk - that is, the "rate of change" was negative.  But look what happened when we went into the recession in 2001 - The Federal Government began spending a lot more money (on balance sheet) and despite the putative recovery beginning in 2002 they never stopped doing so.  That is, the "Keynesian" stimulus that is allegedly necessary to lift the economy from recession was never retracted from the economy. And, as you can see, in the last two years this "stimulus" has gone nearly-vertical.

How much of the economy did this amount to?  That's easy:

Note that post-recession in 2001 federal spending exceeded the Euro-zone target of 3% continually, hovering between 4-6%.  This is in stark contrast to the years prior to 2001, when it was in fact falling - that is, private industry was supporting the economy.

Also note what has happened during the last two years - Federal Deficit spending was 9.65% and 12.11% of GDP, respectively.

Here's the problem - deficit spending like this produces false final demand, in that it implies the ability to do so forever.  We of course know this not to be true - witness Iceland and Greece, neither of which were able to continue the charade ad-infinitumNor will we be able to; we have survived thus far without "feeling the consequences" because others are willing to loan us ever-increasing amounts of capital at ever-lower rates of interest. 

So what does this look like overlaid?  That's pretty simple too:

Your green line is nominal (as reported) GDP.  Deficits are in blue, and actual private economic GDP - that is, the total output generated by private business activity, is in red.

1990s economic growth was real.  The 2000s economic growth was not - it never exceeded 2% in real terms.  And now?  We're in full-on economic Depression territory - whether you hear it admitted on ToutTV or not.

If you're wondering why your neighbor (and perhaps yourself) managed to go bankrupt playing the Home Equity Withdrawal game, why that new Escalade and boat in your driveway have turned into a noose around your neck, and why despite claims of "recovery!" on ToutTV and in the print media you can't seem to find a good-paying job, now you (should) understand. 

Simply put: You were lied to for ten years and you're still being lied to by all of these clowns, and listening to them now, as it did in 2003, will only lead you to personal financial ruin.

Remember when I said "we will have a Depression" - that given what the government did in 2001-03 timeframe it was inevitable?

We're in one now.

So why has the market rallied so strongly?  For the same reason it did in 2003 - the Federal Government has stepped in to replace final demand by consumers and private enterprise.  That "stabilization" is neither permanent or healthy - indeed, it always causes malinvestment, where capital is put not into productive enterprise but rather tries to "chase" some sort of speculative return because that is the only game left in town.

In the 1990s there was plenty of speculative froth and lies, but at least people were trying to speculate on something that was real - The Internet and the rise of the personal computer in American Business as more than a tool for word processing in lawyers' offices.

But in the 2000s Government interference in what should have been a 10% drop in GDP prevented it - and resulted in massive malinvestment in the speculative froth in housing.  Fact is that the actual economic value of a home does not rise or fall - it is a place to sleep, hang your hat, take a shower and cook dinner.  The "multiplier" beyond that - that is, all alleged "value" beyond shelter, is pure malinvestment.  Government and The Fed encouraged and stoked it with a "free money machine" - not from The Federal Reserve but from the fiscal side of the table - that is, from Treasury and Congress.

Now we're doing it again, writ large.

Consider this - we're spending nearly 12% of GDP in borrowed money that we don't have.  Last month we borrowed and spent $333 billion - that is 28% of GDP!

Got that yet?  Government borrowing was nearly one third of the economy last month!

Now I'm quite sure that next month will show marked improvement - for one month anyway.  It always does, being April (tax day) and all.  But marked improvement for one month doesn't change what's going on here, nor the actual GDP of the economy - not what the BEA reports, but what private supply and demand produces.

If you believe that we can continue to hold GDP at a positive "reported rate" while spending 12% of it via deficits, or even half of that, you're welcome to believe that.  But history says that the crash that comes as a consequence when the imbalances build to the point that something breaks takes the market and economy lower that it would have gone had the intervention not been applied.

What we're doing now is unprecedented, other than during a global war (e.g. WWII) when it was literally "buttholes and elbows" together with the entire nation laboring for one purpose - to avoid obliteration.

To apply such extraordinary "stimulus" via borrowing other people's capital simply to avoid having those who made malinvestments being forced to declare bankruptcy, thereby resetting valuations of all items in the economy to sustainable levels, is both outrageous and doomed to fail.

We can argue time frames, but what can't be argued is the outcome.  We must stop this insanity, as we are building up even greater distortions than we had in 2006 and 2007 - indeed, we have managed to take five years of insanity (2003-2007) and compress it into two!

Does this mean we're due for it all to blow up now?  Not necessarily, although it might.  But it does mean that the damage when it does come apart will be at least as bad as it was in 2008 - and this assumes we stop today.

We will not, of course, which is why one needs to be prepared for what is inevitably to follow when the government's ability to continue this charade is interrupted, whether by forces within or without.

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