First Roubini lays out his three primary reasons for forecasting this recession/depression drags on into 2010/11:
But while the rate of economic contraction is now lower than the free-fall and near-depression experienced by many economies in the fourth quarter of 2008 and the first of 2009, the recent optimism that "green shoots" of recovery will lead to the recession to bottom out by the middle of this year--and that recovery to potential growth will rapidly occur in 2010--appears grossly misplaced, for three noteworthy reasons.As part of Nouriel's efforts to make his case, he attacks the four pillars of the Green Shooters' case for a second half 2009 recovery:
First, the current deep and protracted U-shaped recession in the U.S. and other advanced economies will continue through all of 2009, rather than reach a trough in the middle of this year as expected by the optimists.
Second, rather than a rapid V-shaped recovery, growth will remain sluggish and sub-par for at least two years into all of 2010 and 2011. A couple of quarters of more rapid growth cannot be ruled out as we get out of this recession toward the end of the year or early next year as firms rebuild inventories and the effects of the monetary and fiscal stimulus reach a delayed peak. But structural weaknesses of the U.S. and the global economy will cause both a below-trend growth and even the risk of a reduction of potential growth itself.
Third, we cannot rule out a double-dip W-shaped recession, with the wings of a tentative recovery of growth in 2010 at risk of being clipped toward the end of that year or in 2011. This will result from a perfect storm of rising oil prices, rising taxes and rising nominal and real interest rates on the public debt of many advanced economies, as concerns rise about medium-term fiscal sustainability and the risk that monetization of fiscal deficits will lead to inflationary pressures after two years of deflationary pressures.
Goldman Sachs--a firm that was more bearish than the consensus in 2008--is the most sophisticated exponent of the "green shoots" hypothesis. In a paper written in mid-March, the research group Goldman pointed out four economic variables/factors/green shoots that were signaling a bottoming out of the recession: (1) initial claims for unemployment benefits; (2) retail sales; (3) industrial production and (4) housing conditions. Out of the four, they recognized that initial claims were still high and ugly, but hoped that they would stabilize and contract soon, while they argued that the other three were already signaling green light. Unfortunately, the U.S. data from the last month have dashed the hope of green shoots and shown them to be yellow weeds.Tu Ne Cede Green Shoots.
First, initial unemployment claims were around 650,000 and fell toward 610,000. Goldman and Robert Gordon (a member of the NBER Business Cycle Dating Committee) even argued that, historically, the peak of the initial claims is always associated with the end of a recession, hinting that the recession was over by May or would be, at the latest, by June. Too bad this is not an ordinary recession--and too bad that bankruptcy/production cut-backs by Chrysler and General Motors over the summer are now likely to lead initial claims to another peak of 700,000 some time this summer, on top of adding another 300,000 job losses to the already mounting ones.
Even the bullishness that job losses will rapidly shrink is altogether misplaced: Yes, in April "only" 540,000 jobs were lost, as opposed to the 650,000 of March; but if you exclude the 70,000 temporary government worked hired by the Census, private sector job losses were still a whopping 611,000 in April, a figure as ugly as ever. Also, note that in the 2001 recession, job losses averaged 150,000 per month (not 650,000 as in recent months), and that while that recession was technically over in November 2001, job losses--being, like the unemployment rate, a lagging indicator--continued all the way through August 2003.
So while one could expect that job losses in the private sector may soon fall from the near-depression levels of 600,000 to 700,000 per month, even a fall of such job losses to a rate of 300,000 to 400,000 per month some time later in the second half of this year would still be massive--and much larger than in the 2001 recession. Even that slowdown in job losses implies that the unemployment rate will be 10% by the end of the summer, well above 10.5% by the end of the year and peaking around 11% some time in 2011. So on the unemployment front, there are no green shoots either in the present or in the likely near future: You can see only yellow or brown weeds.
Second, the optimistic view on retail sales and consumption was based on better-than-expected January and February retail sales. But after the free fall in the holiday season, and given heavy discounts, a temporary rebound was not unlikely. Again, too bad that all the talk about green shoots in consumption and retail sales was soon smashed by an ugly March retail sales report, which showed a sharp contraction, and a similarly ugly April report that showed falling sales and consumption.
The green-shooters forgot about the fundamental forces dragging down the U.S. consumer, who is shopped-out, without savings, debt-burdened and with rising debt-servicing ratios; who lost 50% of equity wealth from the 2007 peak; who has lost 25% of the value of his or her home (and remember, home prices are still free-falling); who cannot use his or her home as an ATM since home equity withdrawal has fallen from $700 billion in 2005 to zero today; whose income is challenged; and whose jobs are disappearing at the rate of 600,000 to 700,000 per month.
It is true that in Q2 of this year, there may be some relief for disposable income via tax cuts, refinancing of mortgages and the lagged effects of the fall in oil prices. But last year, the $100 billion of tax cuts was mostly saved rather than spent, as consumers were worried about jobs, incomes, wealth and running down credit cards and mortgage balances.
This year, those worries are increased by a power of two, and, like last year, at most only 30 cents on the dollar will be spent. Add to this dismal outlook the fact that $20 billion of refinancing savings is spare change, as household disposable income is well over $10 trillion and that gasoline prices are rising again (25 cents in the last month alone, or a 10% increase). So retail sales may recover temporarily in the May to July period--like they did in 2008 after the spring tax rebates--but that effect will fizzle out by Q3.
More important for 2010-2011, the contraction of consumption and its weak recovery over the medium term--and the need to rebuild depleted savings--will remain a drag on households for a number of years. So expect yellow weeds for consumers both in the short term and medium term.
Third, the argument that industrial production would soon bottom out in the U.S. and other advanced economies was based on the historical relations between the manufacturing ISM or PMIs (Purchasing Managers Index) and industrial production. In previous business cycles, ISM/PMI led industrial production by about a month: So when the ISM bottoms out, industrial production starts to bottom out a month later.
Since the PMIs started to bottom out in all advanced economies--at near depression levels--around March-April, the optimistic consensus predicted a near bottom for industrial production followed by a rapid recovery, as the sharp destocking on unsold inventories of Q4 2008-Q1 2009 would be followed by rapid restocking. But, for reasons we don't fully understand yet (possibly the severity of this recession caused by massive over-leverage), the historical link between PMIs and industrial production has broken down. Industrial production in the U.S. and other advanced economies is still sharply falling--albeit not as quickly as the near-depression rates of the previous six months--in spite of the PMIs having bottomed out and started to recover.
And while the ISM is now considerably above its near-depression level of 32, it is still well below the 50 that signals a continued contraction of the manufacturing sector. So far, the PMI has provided a "fake head"--a misleading indicator rather than a leading indicator--and industrial production is still contracting at painful (though no longer depression) rates in most advanced economies.
Finally, the bullish argument that industrial production will rapidly snap back to rebuild inventories once the recession has bottomed out is predicated on the assumption that final sales of domestic output will rapidly recover once they bottom out. So far, most components of final sales are still falling and have not bottomed out, and once they bottom out, they are unlikely to grow rapidly enough to require a surge in production: Consumption is still falling, residential investment is still free-falling, capital expenditure by the corporate sector is still free-falling and exports are still sharply falling. The only component of final sales that is modestly rising is government consumption.
Thus, the recovery of final sales that would herald a rapid recovery of production is still more in the minds and hopes of the green-shooters than in the reality of the recent data. In summary, there are ugly yellow weeds so far, rather than green shoots, as far as industrial production is concerned.
Fourth, the green-shooters pointed out to the sign of stabilization of the housing recession. Let us leave aside that the optimists, including Ben Bernanke, Alan Greenspan and 80% of sell-side research, have been repeating the refrain that the housing slump will bottom out soon since early 2007 (while totally missing the bust that started in mid-2006)--and have been proved wrong quarter after quarter for all of 2007, 2008 and 2009 to date. The reality is that, in spite of all the talk of green shoots in housing, there is very little evidence for it so far, and home prices need to fall at least another 15% to 20% before they bottom out.
I was the biggest bear on housing in the middle of 2006, when I predicted the worst housing recession since the Great Depression, a fall in housing starts and sales of 50%, and a fall in home prices of 20%. But even the biggest bear on housing turned out to be too optimistic: Annual housing starts did not fall 50% (from 2 million to 1 million) but to 500,000, or 75% from peak--and they are still falling. New-home sales fell even more than starts and are now hovering--for single-family homes--around depression levels of 350,000. Home prices have fallen, based on Case-Shiller, by 25% from the peak, and they are still falling at an annual rate of 20%.
Of course, after three years of the most severe housing depression ever, quantities in the housing markets are so low (75% to 80% from peak) that they may soon bottom out: Both starts and new-home sales are now well below long-term averages. But even quantities may not bottom out until the end of the year for two reasons. One, residential investment was still falling at an annual rate above 30% in Q1 of 2009, and both starts and building permits are still falling. Building permit and starts need to stabilize and start growing again for a while before home completions--the measure of supply of new homes--bottom out a few months later and then start to recover. So, residential investment will be a negative drag on GDP at least until Q4 of 2009, if not later.
Two, some measures of price affordability are better now, but many others are not: Real home prices and price-rental ratios suggest the need for another 15% to 20% fall in home prices; and actual prices are still falling--at an accelerated, not decelerated, rate of 20%.
This is important because today, 0% down-payment mortgages of the housing craze are out. Anyone who wants to buy a home needs to put down 20% of equity. But why would anyone want to buy a house today--even one that he or she could afford--if home prices will fall another 15% to 20% before they bottom out, effectively wiping out any new-home equity by 2010? It is rational to wait until home prices have bottomed out before buying, a behavior that will keep new- and existing-home sales low, even if prices are now more affordable? Note, also, that 50% of existing-home sales are now distressed sales--either short sales or foreclosed properties. Thus both new- and existing-home sales are still showing sharp decreases in prices.
The inventory of new and existing homes is so large--even if marginally smaller than a year ago--that massive downward pressure on home prices will continue through most of 2010. You could stop producing new homes today, and it would take almost a year to clear the inventory of unsold homes. No wonder the Case-Shiller index is still showing home prices falling at a 20% annual rate, with no sign of deceleration.
If anything, the rate of price deflation has accelerated since 2008 from 17% to the current 20%. Even if new-home sales, existing-home sales, housing starts and building permits were to bottom out in the next few months (as they should, as they are close to 80% down from their bubble peak), their recovery would remain so sluggish--and the downward pressure on prices so large--that home prices will have to fall by another 15% to 20% before they bottom out in 2011.
So beware of the nonsense about green shoots in housing: The worst housing recession since the Great Depression is still in full swing, and the yellow weeds have taken over millions of empty housing lots--and are still going.