David's Macro Blog

British humor we can all understand.

Somehow this seems to explain the situation better than CNBC. Why is that?

The belief in a recovery from the global economic collapse in 2008 has gained strength as the unemployment rate has leveled off, the stock market has recovered about 70% and real estate prices have stopped falling.

However, do we really have an organically growing economy or something else?

A great description of our recent economic experience comes from Bloomberg’s Caroline Baum:

Here’s a list of things we should expect in a true recovery:

• Increasing bank lending
• Growing credit use by consumers
• Increasing labor participation rate
• Increasing hours worked
• Increasing interest rates
• Decreasing unemployment (yes it is a lagging indicator)

Some far there is “no real muscle” because we don’t see any true signs of rebound in the economic and financial systems. Sure, the stimulus can temporarily bump up retail sales and the stock market, but long term it can’t.

Judge for yourself. Which do we have, an economy on life support or a real recovery?

In my opinion, we’ve been headed for a double dip recession ever since massive amount of stimulus was injected into the economy. Once that stimulus is removed, the double dip will commence. In reality we never left the first dip — we just momentarily suspended the decline.

Jon Stewart, one of the most astute and insightful commentators of our time, explains the May 6th 2010 Flash Crash in this video from the Daily Show: A Nightmare on Wall Street

If you are a day, swing, or momentum trader, how would you trade in this market? Did trading on May 6th blow through all the sell stops on the order books?

Well, I have one friend who is an accomplished trader and he related his strategy regarding this issue. He refrains from trading if the market moves too violently or if there isn’t a clear reason for the market movement (e.g. a war, terrorist attack, major corporate bankruptcy, etc.)

One supposed benefit of an electronic marketplace and program trading by black box algorithms (algos) is market liquidity that would prevent just this type of collapse. The October 19th 1987 Black Monday crash was supposedly caused by computer program trading. It happened again this time — did we learn anything?

Or, as the saying goes:

History is the same events happening to new people who experience it for the first time as though it never happened before.

Are you an expert if you make mistakes? 

Are you an expert if you make BIG mistakes?

Are you still an expert if you miss the biggest financial bubble in world history?

Let’s consider these questions while reviewing some quotes from the so-called “experts” just prior to the 2008 financial collapse and the start of the Great Recession.

“I believe that the general growth in large [financial] institutions have occurred in the context of an underlying structure of markets in which many of the larger risks are dramatically — I should say, fully — hedged.”

“Even though some down payments are borrowed, it would take a large, and historically most unusual, fall in home prices to wipe out a significant part of home equity. Many of those who purchased their residence more than a year ago have equity buffers in their homes adequate to withstand any price decline other than a very deep one.”

Financial innovation means “shocks may be less likely to result in the type of trend amplifying, self-reinforcing dynamic for sustained periods of time that can threaten the stability of the financial system… but it is unlikely to have brought an end to the periodic tendency of markets to experience waves of mania and panic.”

“Improvements in lending practices driven by information technology have enabled lenders to reach out to households with previously unrecognized borrowing capacities.”

“The use of a growing array of derivatives and the related application of more-sophisticated approaches to measuring and managing risk are key factors underpinning the greater resilience of our largest financial institutions …. Derivatives have permitted the unbundling of financial risks.”

“We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though.”

“In the financial system we have today, with less risk concentrated in banks, the probability of systemic financial crises may be lower than in traditional bank-centered financial systems.”

“The Federal Reserve is not currently forecasting a recession.”

“At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”

Final Questions:

• Should an expert still be considered an expert AND be in a position of power and influence to repair the economy/financial systems after they didn’t even see it coming?
• Why do professionals with significant academic training, industry experience, and extensive access to real-time data mis-interpret the fundamentals and say things that look foolish in retrospect?

Perhaps the best quote to summarize the situation:

“The economy depends about as much on economists as the weather does on weather forecasters.”

What do you think? Do you have a favorite expert quote not shown above? Comment below and let me know.

Can good economic times last forever? Is it impossible to have “stable” economic growth?

This is the argument presented in Barry Ritholtz’s post: Galbraith: Financial Stability Creates Instability

Here are the essential points of the article.

• When the economy is good for a long time, people then think the good times will continue indefinitely so they take extra risk (e.g. debt).
• This additional risk eventually sows the seeds of the end of the economic expansionary period.

For example, during the 2000 real estate bubble, housing prices were thought to only go up, therefore the logical conclusion was for everyone to buy as much real estate as possible (by using financial leverage or debt) since this was an easy road to wealth.

Of course this speculation led to massive over construction of residential and commercial real estate. The resulting overcapacity caused falling prices which, as we now know, completely destroyed our financial system and the economy.

Interestingly, classically accepted econimics says that the economy can remain in a steady state – yet it never does, does it?  Ritholtz’s article explains what really happens.

Key Quotes

McCulley was referring to economist Hyman Minsky’s concept that long periods of stability cause people to take on ever more debt and ever more risk, leading to a gigantic meltdown.

Systemically-speaking, the Ponzi phase is one of risky behavior crowding out prudent behavior in a world free of regulatory controls. If risky behavior is temporarily rewarded with profit and this temporary period is long enough, then risky behavior wins and drives out good behavior.

Think we’ll remember this during the next bubble?

Related Posts

• What Bubble Are We In Now?
• Market Cycles: From Euphoria to Despair (and Back Again)