Tuesday, June 22, 2010
Six reasons to be bearish
I'm still quite bearish on the outlook for US economic growth. Here are my reasons:
1. Monetary PolicyMost of the monetary aggregates are flat, meaning that the spigots at the Fed are either set to "off" or "trickle". The FOMC hawks are still pushing for a contractionary policy, and the compromise is stasis. It is true that the real funds rate is negative, but less than the Taylor Rule or Scott Sumner would suggest.
2. Credit Creation
Bank credit growth is 0%, and C&I loan growth is negative 20% year-on-year. Consumer and small business credit remain restricted. The doubling of the Fed's balance sheet has been accompanied by a contraction in credit. It would appear that Congress' War on Banks is working: they have gone on strike. You can't increase capital standards, tighten accounting and liquidity rules, tax bank balance sheets and expect there to be no real-world impact. The economy simply can't recover without a resumption of credit creation.
3. Nominal GDP Growth
NGDP growth is hovering around 3%, which is the lowest that it has been since Eisenhower. Real GDP is important, but nominal GDP is more important: we spend money, not real money. Bernanke believes that the Fed can target nominal GDP growth, but he isn't doing it because he doesn't have the votes. It will be interesting to see if Obama will nominate a dove to replace Don Kohn (a moderate dove). I nominate Scott Sumner.
4. Fiscal Policy
Next January taxes will go up sharply due to the expiration of the Bush tax cuts. Starting next year we will have a recession trifecta: no monetary stimulus, contractionary fiscal policy, and negative private sector credit growth.
All of the European countries have embarked upon a path of fiscal consolidation (which is worrying Tim Geithner). Greece will be in crisis by this time next year. It's bridge loan will have been consumed, it's debt levels will be higher, and it's NGDP will be lower. Very unlikely that it will have market access under those circumstances. It's only options are a bigger bailout or redenomination and default. This will not restore confidence in the rest of the PIGS or in the eurozone's banks. Global growth will be challenged, as will confidence overall.
China's credit bubble will have to slow or contract. The People's Bank is very worried about the situation. China's growth will slow.
Hard to be bullish, although I am usually wrong and I hope so in this case. Maybe it's already discounted in the markets, but remember that the Dow peaked in Sept '07, after the credit bubble had begun to collapse.