Next month, the Fed will be winding down its second round of quantitative easing. But will it be for good?
Back in August, at a meeting of global finance officials in Jackson Hole, Wyoming, Fed Chairman Bernanke planted the first seed that QE2 was coming.
At that point, all of the hopes of a sharp 2010 economic recovery evaporated, as the economic data from mid-summer forward had signaled another bout of deflation and recession were coming.
The Fed’s antidote?
Tell the world you’re willing to do whatever is necessary to manufacture growth, period. And then promote higher stock prices to make people and companies feel a little more financially stable and wealthy. Consequently, consumer spending will go up and unemployment will go down.
Well, the perception of “easy money” was enough to induce speculators to make leveraged bets on both stocks and commodities. As such, stocks went higher and commodities went higher. And the jobs data improved a little bit.
Now, QE2 is coming to an end. And this time, as with 2010, so is the perception of a strong 2011 recovery. At the opening of the year, many economists were projecting growth in the U.S. to be as high as 5 percent. And the Fed was thinking 3.4 percent to 3.9 percent — an above average year of economic expansion.
Now the private forecasters polled by Bloomberg are saying 2.7 percent. And the Fed just downgraded its forecast to closer to 3 percent. But as you’ll see below, both of those are likely way too optimistic, again.
After the massive response given to the global financial crisis by all central banks and governments, the world still remains on unstable footing. And that’s exactly how another presenter at the Jackson Hole conference last August saw it then — and foresees it well into the future.
Back then Carmen Reinhart (University of Maryland), a co-author to Kenneth Rogoff (Harvard University) on the most extensive study done on historical global financial crises, presented some very sobering facts.
Her research showed that historically …
Credit Buildups and Deleveraging
of Debt Are Long Cycles
Severe financial crises, like we experienced in 2007-2008, are usually characterized by a buildup of credit for a decade, according to Reinhart. And the unwinding of all of the debt tends to take a decade following the crisis.
Reinhart’s research further suggested that throughout this 10-year deleveraging period …
Economic growth will trend at lower levels than pre-crisis growth.
How it’s playing out: The U.S. has grown at a historical average of 3 percent per year. Even with unprecedented stimulus it’s been growing below trend since 2006. And recent data suggests another dip into recession is coming …
A Bloomberg study shows that since 1948 whenever GDP falls below 2 percent, it normally predicts recession for the U.S. economy. In April, the Bureau of Economic Analysis (BEA) gave their advanced estimate for Q1 2011 growth at 1.8 percent!
Unemployment will hover around 5 percent higher than pre-crisis levels.
How it’s playing out: Even after two rounds of quantitative easing by the Fed and two rounds of fiscal stimulus by the U.S. government, employment still sits about 5 percent over the long run “natural rate” of unemployment.
And housing prices will remain anywhere from 20 percent to 50 percent below peak levels.
How it’s playing out: The government has recapitalized the banks, the Fed has kept mortgage rates historically low, and various failed mortgage programs have been floated. Yet the Case-Schiller housing data shows housing still 32 percent off of 2006 highs.
As for the deleveraging phase: If the credit boom took at least a decade to build and will take as long to unwind, this chart of U.S. consumer credit puts it all in perspective for the world economy.
As you can see, consumer credit peaked in 2008 when Lehman Brothers failed. Given the studies I’ve outlined, it likely means the world is in for another seven years of economic malaise.
With all of this in mind, even though the persistent easy money policies of the Fed have been highly scrutinized, it’s this analysis that exposes a scenario that the Fed fears, yet many others have chosen to ignore: Another violent downturn for the global economy.
Regards,
Bryan
{ 19 comments }
Seven more years – wow.
Um, the quoted remarks were made in 2010. Now there are six years to go, if you think her estimates were that precise. Of course 100% inflation would get us ‘out’ in a much shorter period ;-)
Bloomberg got it wrong about GDP growth and recessions. Since 1950, there have been 10 recessions. We have had during this time, many more slowdowns in our economy. I use anything at 1.3% or less in GDP as a slowdown. By my records, there have been 20 slowdowns since 1950, if you use the 1.3% rule, and five of those slowdowns, there was a minumum of two 1.3% or less GDP figures, with a stronger number in between. I count all five of those as just one slowdown, but if you did not do that, the slowdown figure climbs to 25. And if you use the less then 2.0% figure that Bloomberg is saying, I found 4 more periods of less then 2.0% GDP, but above 1.3%. That would make the figure up now to 29. With figures like that, I just do not see how Bloomberg can say that less then 2.0% GDP means a probable recession. Even if you use my system of identifying slowdowns, a slowdown only has one chance in three of turning into a recession. If you use Bloomberg method, which could mean as much as 29 slowdowns since 1950, then a slowdown has either one chance in four or five of turning into a recession. For the record, I believe another slowdown is coming this summer, but to say this will turn into another recession, it just as this time is to early to say. I am surprised that Bloomberg would come out with such a inaccurate report.
Toni
What do you do use the data you gather for? And what kinds of investing decisions do you make from the data you gather. I am curious about your background and career path as well?
The obvious remains that in a volatile Market, there are opportuinities to do well; you must be able to recognize them and have the disciplined courage to act on Your Plan.
Will QE3 be the final straw that causes the dollar to crash?
Seven bad years? Bryan Rich could have advised Pharoah.
The US banks are really in good shape that’s why without “Mark to Model” they would show Trillions as a negitive worth or capital on all their non performing loans. Each quarter, to show a profit, they reverse loss reserves in the amount they think profits should be at. I guess it’s time to load up the truck with their stock?
Can’t wait for QEIII, like QEII it will add $1 per gallon to gas and heating oil and 1% to the 10 year bond. I guess if your printing money just print little extra to cover the increased interest on the US debt. I doubt that $5 gasoline will kick the US into a love fest. Maybe QEIV will at $6 per gallon. Lets see QEXII should bring in a 15% ten year treasury yield, this should do wonders for housing. Matter of fact I think that Block Buster was really to big to fail, I’ll call them and let them know that there should be some gov’t help coming soon.
I love last months unemployment numbers makes one really want to go out and load up on debt. 62,000 found a $7 per hour job out of 1 million that applied. I see also they added 175,000 birth death to the number to make it come in just right. The most George Bush added in any one month was 12,000 during his whole term. Cant wait for the benefits to start rolling in on health care, wonder if Canada can take our over load?
I guess hes reminding us of the 7 years of fat cows and now 7 years of skinny cows are coming…
Sell the stocks. Buy TZA with one third… GLD with the other third and put the rest in TIPs.
Hats off to Bryan for telling it like it is regarding the pseudo inflation caused by your future taxes being used to run up the markets. If it were true inflation, workers would be demanding more and getting it rather than getting less, with more layoffs. I’ve read similar predictions during the run up prior to ’06. The only thing is there is no guarantee that the deflation will be limited to 7 years with govt and Fed doing the exact wrong things and encouraging the people and biz to do wrong things. Biz should only be working the profitable deals by those they know can pay them. If everyone kept their powder dry this mess could have been already over with. No, you and you grandchildren’s children’s children etc were ripped off to save weasel banksters …only time to grab what they can, since they are still broke with highly leveraged mortgage debt still valued at whatever they decide the value is, rather than the 20 percent that they can actually get for it. Meaning all these cashed up with your money banks will still nose dive as more and more mortgages go belly up from lack of payment. Despite the fiction which is their Accounting Reports. Would the world collapsed had these bubble blowing banksters not been given trillions of your money? Hardly. We’d be better off without them. Their are plenty of Credit Unions to serve the needs of the people. And the banksters aren’t loaning to biz anyway since they know they would never get paid back. Small business is what employs the majority. There are enough smaller banks out there for them as well. From the start, it has been a scam to take your money and put it into a banksters pocket. If govt keeps giving away the store there will be nothing left to recover with!
This is why YOU have to see to it better and moralled people are running for office. Sitting back and voting just doesn’t cut it any more.
Well I am glad someone has the balls to tell it like it is happening before our eyes. It doesn’t take a rocket scientist to figure out we are in serious trouble with no apparent solutions to our ever expanding deficit. Government is so out of control and the Fed has no clue whatsoever what it is doing and continues to try and paper $$$ over this disaster with money that doesn’t really exist. It’s fools gold and not worth a cent and is why we will continue to see rampant inflation and a further eroding of our economic stability worldwide. They are actually trying to spend (inflate) our way out of this mess and by so doing are creating bigger problems that. will further sink our economy. I am afraid to say if we thought this last recessioon was bad, hold on to your hats because it is only going to get far worse.
Two words, “precious metals.” Whether we see inflation or stagflation the best investments will precious metals and commodities. When all this is said and done, gold and silver will be at least three times higher.
Bryan,
Could you copy a link to the speech from Caren Reinhart, I bet I’m not the only one here who would enjoy hearing what she said about the unwinding of credit post a major economic crisis. It’s always hard to predict the future, but history is helpful in sheading some light into the dark corners to add some guidance.
Typically how has the US$ acted as an investment in these type of events, or are we in such un charted waters that its irrelevant?
Good article, Bryan. However, you have missed two very significant aspects of the current situation:
1) The effects of massive government intervention in the economic cycles.
2) Where the trillions of dollars in bailouts are being spent/consumed.
While there has been government stimulation in every major economic meltdown, our current situation is different. Not only is the scale of intervention much larger by the US (the world’s largest economy by far), but unusually large-scale interventions are simultaneously happening in every major industrial nation. What happens when countries compete to devalue their currencies through inflation (i.e. increasing the money supply)? How does the introduction of trillions of dollars affect the 10-year cycle that was uncovered by the study quoted? If the public is increasingly-knowledgeable and skeptical, what impact do government interventions have on the economic cycles?
With regard to the trillions of dollars being thrown at the situation, where the money is spent makes a difference. It is obvious that the money is NOT going to resolve the mortgage issue, nor is it going toward making loans to consumers or businesses. So, where is all that money going? Are we lining the pockets of the bailout recipients? If so, what are they doing with the money? Are they investing in commodities, real estate and other hard assets? If so, is the government intervention creating new bubbles in different industries? What impact will these bubbles have on the 10-year cycles mentioned in the study?
In short, your article was good with respect to the information offered, but the analysis was lacking. As a result, I am not sure what conclusion to draw from the new information that you provided. I look forward to more of your insights, and more detailed insights, into the unfolding events.
Thanks.
This economy is going to go into the ground, called ground zero,. There will never be a recovery. This is the end of civilization as we have known it for the last three hundred years. I keep wondering why anyone would buy precious metals when you will have seven billion people on this planet plundering everything from every one else for food. We are headed for the greatest bloodbath in history, and the elites will not escape. In the bible this is called the great tribulation. It says that unless those days were shortened (by angelic intervention) there would be no flesh saved. But on account of the chosen ones, those days will be cut short. (thank God)
This is it folks. Get right with your “God”, prepare yourselves to meet your God., because this economic catastrophe leads inexhorably to judgement..
Oh I finally got it, “Why” Q-3 will follow. Then I reflect on the remarks of the Speaker o/H,”We’ve got to fix these deficits or.. the markets are eventually going to fix them for us”. Maybe there will be a QE-3 but it is going to have to be done more with a slieght of the hand than by just intervening in the US Treasury bond market with phoney manfactured money. Anyway this scenario plays out that in a year from now it will be generally accepted that Obama is a gonner and by extention the Bernank is either “let go”, resigns, or is asked to resign by the next President and then hounded out of office by the Congeress and their becoming brazenly contemptuous of the toad at the 2013 Humphrey Hawkins hearings. If it is clear that 5-6 years of this destruction in savings and the formation of capital has been of only marginal benefit and the continuing bank bail outs using ZIRP are not getting credit and loans made available to qualified consumers and busineses at these low rates that only exist for the 20 largest US banks and not borrowers, then something else will be implemented. Maybe there will be new banks formed that are banks and not fee generating businesses that lay off 100% of their intrerest rate risk on the taxpayers. Savings and capital formation could return. Besides increasingly worthless less than 1% yielding +3 year Treasury bonds the US is rich in coal, forest products, grains, and natural gas. We will have to at some point under take to offer these as substitutes for less desirable Treasury debt . Once that happens the coincident inflation and the new government direction will have the Gov’t stepping aside from the maniopulations in monetary policy and an endless QE policy. Interest rates can rise savings will increase and private sources of loan capital will become available. As it is for now what is wrong with CPL,EIDO, MCQPF, SDRL, CFPUF, RAP, and any other commodities or commodities currency investment with yield. What next as unions are destroyed and pension trusts de-funded, Americans who are trying to save for their eventual retirement will have even further restrictions beyond which are just recently being proposed imposed on their IRA savings to prohibit owning foreign corporations?
Hi Brian
There seems to be a new boom industry of litigation in the housing industry with among other things house holders suing banks. We have not fixed the problems in the system. We are just paying to prolong the agony. We need a strong and fair assessment of our current situation and active and robust direction, not just rearranging the deck chairs with further debt. Howard Dimond
We think the QE is done, moreover, FED could start tightening its monetary policy and it is going to be a very good opportunity to buy dollars specially versus latin american currencies.