Call me goofy, but I am not ready to join the “recession is over” parade just yet. While the economy has hit bottom, it is likely to stay bouncing along that bottom for many months at least. A rapid and sustained recovery beginning this fall is an improbable scenario.
In a spirit of fairness, we will begin by looking at the four main arguments supporting a near-term end to the recession. The first, and strongest, is the healing of the financial markets. The Standard & Poor’s stock index is up 12% for the year and 40% from its March lows. The flow of credit between banks has returned to normal as evidenced by the cost of borrowing. The yield spread between three-month LIBOR, which represents the costs of funds for large banks, and three-month Treasury bill yields has fallen from an astronomical 4.6% in October 2008 to 0.29% last week. Yield spreads between Treasury bonds and bonds issued by corporations and smaller governmental units have narrowed, making it cheaper for these entities to borrow. While there are still exceptions—it’s still next to impossible to securitize mortgages without a government guarantee—the financial markets are back to business as usual.
The second argument is that the $787 billion of stimulus to be provided by the economic recovery act has barely begun to flow. As more projects come on stream, the stimulus package will provide a substantial boost to growth. The stimulus, though, is just that, “something that incites to action or exertion or quickens action.” The question, that only time will answer, is whether stimulus-induced growth will be sustainable, or simply limited to projects whose jobs evaporate when they are completed.
The third argument, put forth cogently by FTN Financial Chief Economist, Chris Low, is that the traditional leader of economic growth—inventory rebuilding—will come to the rescue again. Inventory fluctuations were once a primary lever of economic decline and recovery. In the past, suppliers, caught by surprise, often needed many months to work off excess inventory when bad times hit. Then, equally surprised, they had to rebuild inventories quickly when good times started to return. The process tended to lengthen recessions with longer layoffs, but quicken recoveries with faster re-hiring. “Just-in-time” inventory management, imported from
Japan
in the 1980s, changed all that, and inventory levels played a minimal role in the mild recessions of 1991 and 2001. But, as Low points out, the current recession hit so hard and so fast that businesses had no time to manage inventories; they simply stopped making things. The corollary is that when the economy begins to rebound, inventory rebuilding will also have to be faster and more robust, and, in Low’s words, “slingshot growth.”
The fourth argument is in the interpretation of the data. Several recent government and private sector reports have been widely cited as evidence of an economic rebound.
· Housing starts in June rose by the largest percentage since 2004.
· New home sales increased 11%, the most since 2000.
· Pending sales of existing homes have risen nearly 20% from their January low.
The story on the employment front is similar.
· Initial weekly applications for unemployment insurance have been below 600,000 for the last five weeks, after having been above that level since the last week of January.
· Most importantly, job losses in July were the smallest since August 2008.
Government agencies and private groups pour out an endless stream of economic reports every working day. In each report, one number or percentage, the so-called “headline” number, stands out and seems to tell the whole story. But underneath it are mounds of detailed information that tell a more nuanced tale. Often, their interpretation is not merely a result of honest differences of opinion but of political, ideological, and financial motives. Also, the numbers themselves are far from reliable. They are seasonally adjusted, based on incomplete samples, and subject to frequent revisions. Finally, there’s the question of which data provide insights into the future and which merely offer a look in the rearview mirror.
With all these caveats in mind, let’s take another look at the data noted above.
· Housing starts rose 3.6% in July, but, at an annualized rate of 583,000 units, they are barely a third of the average for the last 10 years and a quarter of the boom period, 2004-2005.
· Pending sales of existing homes have also risen, but they remain down more than 13% from the pre-recession average.
· The four-week average of initial unemployment claims has fallen to 555,000, from a recent high of 659,000, but that’s still terrible by any but the most recent standards. From the end of the last major recession in the early 1980s to the beginning of the current recession, the four-week average of initial claims averaged 354,000 and never hit 500,000, except for one week at the peak of the 1991 recession.
· Job losses in July showed major improvement at “only” 247,000 compared to 741,000 in January. But the worst month for job losses in the 2001 recession was October with 325,000, and there were only two other months when losses exceeded 200,000. The worst month in the 1991 recession was February with 306,000 jobs lost, but again job losses exceeded 200,000 in only two other months.
To the extent this data is reassuring, other data is less so. As is well known, our economy runs on consumer spending, which accounts for 70% of Gross Domestic Product. And the consumer is still not spending. The Commerce Department reported recently that retail sales were down 9% between June 2008 and June 2009. On an annualized basis, that’s a difference of about $405 billion. Spending was down in almost all categories:
· Furniture & home furnishings: -12.6%
· Electronics & appliances: -11.5%
· Building materials: -13.0%
· Clothing: - 6.2%
· Department stores: - 9.4%
· Non-store retailers: - 6.7%
Consumer spending is off because consumer income is off. Wages and salaries paid to US workers in June were $6.24 trillion on an annualized basis. They have dropped every month since peaking at $6.58 trillion in August 2008. Had wages and salaries continued to increase at their pre-recession pace, they would have been about $6.69 trillion in June. That difference of $450 billion pretty much accounts for the drop in spending.
There is another dynamic at work too. Americans are paying down debt and saving at record rates. According to Goldman Sachs (and who could question them?) consumer and non-financial company debt fell 0.7% in the first quarter this year, marking the first contraction since 1952. The Federal Reserve reported that total consumer debt excluding debt secured by real estate, after rising steadily for decades, has fallen $80 billion since peaking in July 2008. We still owe more than $2.5 trillion, about where we were in October 2007. As the chart below indicates, we would have to cut another $550 billion more to turn the clock back just five years.
Personal savings has spiked recently as well. The Commerce Department reported that Americans socked more than $500 billion away in June and $680 billion in May. Since May 2008, we have been saving about 4% of our disposable income a month, double what we saved in the boom years.
The increase in savings leads to a key question: Will we go back to our old free-spending ways when the recession finally does end or is our newfound frugality permanent? Retail sales increased every quarter for seventeen years before the recession struck. “Never bet against the American consumer” was economic dogma. But things are different now. Americans have been scared into saving and two powerful forces—one demographic and the other economic—could keep that trend in place for a long time.
The demographic trend is the aging of the Baby Boomer generation. The older people get and begin to contemplate imminent retirement, the more prone they are to save, regardless of economic conditions. A recession can only reinforce this tendency. The economic trend is deflation, or at least the lack of inflation. The most serious previous recession since the 1930s occurred at the beginning of the 1980s. That recession, unlike today’s, was accompanied by double-digit inflation. Inflation discourages saving because it erodes the value of money. Who wants to put $1,000 in a CD if two years later its buying power has been reduced 30%? When the value of money is rising or stable as it is now, savers have a powerful incentive even if interest rates are low. Having been burned by the precipitous fall in stock prices and the even more catastrophic destruction of home equity, simply maintaining the cash you have is appealing.
I hope I am wrong. I hope the recession really is ending and recovery is beginning. If so, dear readers, you will have every right and my cordial permission to call me Mr Goofy from now on.
Why ShoreBank Matters
Dualism, or in its theological aspect, Manichaeism, is the belief that the universe is divided between two starkly opposed but equally matched powers of Good and Evil. Their battle plays out not only cosmologically, but in the life of every individual. Although Manichaeism was declared a heresy by the Roman Emperor Theodosius I in 382 AD, the appeal of dualism remains deeply rooted in Western civilization. (Traditional Eastern thought, with its multi-faceted gods and cycles of death and rebirth, is less prone to dualism.) Dualistic ideas—God and Satan, Catholic and Protestant, North and South, Black and White—have long define the Western and especially American worldview. The 20th century reinforcedAmerica ’s Manichaeism bent. The Nazis and the ultra-militarist regime in Japan that initiated World War II were clearly evil. They were opposed and bested by the Greatest Generation. No sooner were those powers destroyed than another devil substitute, Stalinist totalitarianism, appeared as the avatar of Evil poised against the American Way .
But, a set of new and far more subtle ideas, deeply at variance with dualism, were beginning to appear as the 20th century dawned. Leonard Shlain, in his first-rate book Art and Physics, demonstrates how artists throughout history have anticipated new discoveries about the physical world. Artists are like powerful telescopes, able to reveal faraway and previously undreamt-of galaxies. Schools of non-representative art such as Cubism, dissonant music like Stravinsky’s “Rite of Spring,” and modernist novels like James Joyce’s Ulysses, heralded a non-Newtonian revolution in physics. Relativity and quantum mechanics revealed a universe of discontinuities, non-linearity, and irrationality beyond anything ever before imagined. The universe, instead of being an exquisitely perfect clock as
Ideas so radical would have spread slowly in any case. They literally require a rewiring of the human brain even to think about. The wars, both hot and cold, that consumed the middle three-quarters of the last century, with their clear heroes and villains, undoubtedly delayed the process. But over the past 20 years, which, not coincidently, have been marked with ambiguous and inconclusive conflicts, the dissemination of the probabilistic world view has been exponential. Scores of books about the new physics for non-scientists have been published. The next disciplines to fall in step were finance and economics.
As I wrote in my June 2008 commentary, the economist Hyman Minsky was a prophet ahead of his time. His 1986 book, Stabilizing an Unstable Economy, argues against the ability of markets to be self-regulating. He advanced the theory that capitalist market mechanisms are incapable of creating sustained, stable-price, full-employment equilibrium. Rather, unpredictable and sometimes violent business cycles are inherent in capitalism, and are actually fostered by overlong periods of stability. Ignored at first, Minsky’s ideas are finally moving into the mainstream, as can be seen in the title of Justin Fox’s recent bestseller, The Myth of the Rational Market. Even more telling was Alan Greenspan’s great moment of self-understanding in October 2008 while testifying before a congressional committee.
Greenspan: “I have found a flaw. “I don’t know how significant or permanent it is. But I have been very distressed by the fact.”
Question: “In other words, you found that your view of the world, your ideology, was not right. It was not working?”
Greenspan: “Absolutely. Precisely. You know that’s precisely the reason I was shocked. Because I have been going for forty years or more with very considerable evidence that it was working exceptionally well.”
Another new book, provocatively titled The Age of the Unthinkable, brings the new world view into the realm of international relations and, since international relations are really human relations writ large, into our own daily lives. The author is Joshua Cooper Ramo, a whiz kid who is a managing director at Kissinger Associates and whose hobby is competitive aerobatics. In his own words, “The main argument of the book is not particularly complicated: it is that in a revolutionary era of surprise and innovation, you need to learn to think and act like a revolutionary.” [i] That word “revolutionary” is subject to many interpretations. In the following passage, Ramo explains what he means by it.
“Today the ideal candidates for foreign-policy power should be able to speak and think in revolutionary terms. They should have an expertise in some area of the world—be itChina or the Internet or bioengineering—where fast change and unpredictability are the dominant facts of life. They should have experienced the unforgiving demands for precision and care that characterize real negotiations—as well as the magical effect of risk-taking at the right moments. They should have mastered the essential skill of the next fifty years: crisis management. And they should be inclined toward action, even action at times without too much reflection, since at certain moments instinct and speed are more important than the lovely perfection of academic models.”[ii]
Ramo is talking about foreign diplomacy, but the application of his remarks is much broader. My first reaction to this passage was, “Sounds like the bond markets to me.” Fast and unpredictable changes, risk-taking at the right moments, and especially, the need for action without too much reflection based on instinct and speed. Yup, that’s how the bond markets work; or at least, that’s how I work in the bond markets. But, when I read the passage a second time, I realized that it also reflected how ShoreBank operates. ShoreBank is a revolutionary company, and it’s clear that Ramo uses the word revolutionary in the same way we do. Our motto, “Let’s Change the World,” is said in a joyful tone, as one would say, “Let’s go to a party!” And it’s inclusive. It means, let us work together as peers for changes we agree are beneficial. Like Ramo, we believe that “small things can trigger a big change.”[iii] We also believe that effecting change in this way requires looking at the world through the eyes of the people and communities where we work. In other words, we try to see and then act from the inside out, rather than the outside in. “In a fast-changing world, what really matters is often hidden in corners where the usual ‘experts’ don’t—or can’t—easily look.”[iv]
The first necessary quality for achieving this new way of looking at the world is empathy, the ability to feel as others feel. Ramo uses empathy to mean connecting with the environment, even when it’s uncomfortable or foreign. It means being in a community and working with its values, rather than trying to impose your own. It also means understanding that communities are constantly evolving or “shape-shifting” in Ramo’s words. No matter how they change, they always tend toward greater complexity, in the scientific sense. They become ever less amenable to modeling or anticipating. “Patience,” says Ramo, “not persuasion would be the virtue,” because “no effort truly ends.”[v]
This insight leads to the second necessary quality of resilience, the ability not just to react but to learn. In this view, the more stress you can endure, the stronger you become. Quoting an ecologist named C.S. Holling, Ramo writes, “A management approach based on resilience would emphasize the need to keep options open. Flowing from this would be not the presumption of sufficient knowledge, but the recognition of our ignorance; not the assumption that future events are expected, but that they will be unexpected.”[vi] When people who are trusted and treated as peers, they are empowered will respond with “an explosion of curiosity, innovation, and effort.”[vii] This insight, multiplied in communities around the world has tremendous potential. “The more something lends itself to invention and imagination, the more enduringly useful it becomes. Practically, this means a dramatic, globe-defining effort to touch the lives of billions of people.”[viii]
ShoreBank understands the world as a complex, dynamic system, defying predictability and inherently unstable. We seek to meet these challenges by working empathically, resiliently, and respectfully with ordinary people around the world. We embed ourselves in communities for the long haul. We are learners who have always intuitively understood that the people we serve have more to teach us than we have to teach them, and we have learned from them for decades. Our business model sees the world through the eyes of our customers, whether they are apartment rehabbers on the South Side of Chicago, stall-keepers in Lahore, oystermen in Ilwaco Bay, or machinists in Minsk.
We are risk-takers both by choice and by necessity. Many years ago, at a strategic planning session, our in-house counsel remarked, “If ShoreBank ever woke up one morning and found itself too far from the edge, it would do everything it could to get back there as quickly as possible.” We work at the edge because that’s where so many of our customers are. Sometimes they go over and sometimes so do we. The global recession has been brutal for people and communities with limited financial reserves. Looking ahead, they will need ShoreBank more than ever. Fewer institutions will be able or interested in working in these communities. Their recovery will be slower and their continuing struggles apt to be overlooked. But ShoreBank will be there, providing credit, investment, training, collaboration, empathy, and resilience.
Ramo could have been writing about ShoreBank when he described the revolution necessary for “a sensible international order—one that fits 2009, not 1989”:
It involves accepting that the most important things cannot be predicted with any great accuracy. It involves radically refiguring the balance sheet of power in such a way that the aim isn’t to hoard power but to give away as much of it as possible…It requires harder truth telling than our leaders are used to and experimentation right up to the very edge of collapse.”[ix]
[i] Joshua Cooper Ramo. The Age of the Unthinkable.New York NY : Little, Brown and Company, 2009. p.11.
[ii] 36-7.
[iii] 67.
[iv] 152.
[v] 223
[vi] 178-9.
[vii] 235.
[viii] 244.
[ix] 130-1.
Posted at 02:09 PM in Economic Commentary | Permalink | Comments (0) | TrackBack (0)