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Tuesday, September 01, 2009


twenty years of the new normal

via ed harrison, bill gross' latest missive.

[T]here’s been a significant break in that growth pattern, because of delevering, deglobalization, and reregulation. All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it’s time to grow up and become a chastened adult; it’s time to recognize that things have changed and that they will continue to change for the next – yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.

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Mr. Gross, like many others, still cannot fathom that US consumers are spending less not because they are saving, but because they have less money and less ability to borrow it. Being a saver is like being thin--one does not suddenly begin doing it in middle age. Plenty of people go on diets, but most of them wind up gaining the weight back.

This is why the consensus view that we will become like Japan is mistaken--it presumes that people make "rational" economic choices (rational meaning choices that economists would make.)--that the baby boomers will begin saving money as they suddenly discover that they are getting old, that debtors will delever, etc. It is much more likely that someone who has made it into their fifties spending more money than they earned will realize that $50K or $100K isn't going to do squat for them in retirement.

I don't know what the future holds, but I'm willing to bet it will be unlike what happened in Japan.

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i don't know either, bwdik. i do think there will be a great panic push by the large segment of boomers who were saving on some level but overexposed to risk markets in 2007-9. they want to save and are accustomed to saving, but have sustained pretty severe balance sheet damage between risk markets and the housing collapse.

the segment that has never saved is likely relying on working until they drop dead. as it happens many of this lot are also in parlous employment and are being shed as industry downsizes to meet the new demand level. for my money, as of now these folks represent the belated return of the elderly poverty that SSA was supposed to wipe out. many face a future of household consolidation and reliance on children, et al.

i would postulate that households will almost always take whatever financial rope you give them to hang themselves with, in large part because they aren't very bright. so the bid is nearly always there; the huge leveraging of the household was a result of banks and shadow banks lowering their offering standards. now those standards have tightened, and households will be compelled to delever in an environment of bank balance sheet reduction. some will pay down debt; others will default.

it will be unlike japan, i agree. deposit-poor banks here are likely to be compelled to use earnings to delever as cheap wholesale funding dries up -- that never happened in the deposit-rich japan of zombie banking. japan's household savings position has gradually deteriorated throughout its corporate-leverage crisis; america has a household-leverage crisis and household savings efforts really cannot get much worse. so where delevering japan saw zero interest rates, zombie banks, a decline in household savings and increasing real domestic consumption -- the delevering US will likely see nonzero interest rates, forced (and perhaps rapid) downsizing of banks, increasing household savings and declining real domestic consumption. in other words, i think the US situation will probably be more traumatic, central bank machinations notwithstanding.

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I agree, GM, that your scenario would probably play out absent government action--but there's the rub, isn't it? What keeps the government from issuing debit cards to everyone which they can reload with money at will (done already for unemployment and the $200 back-to-school fiasco in NY). I mean, if we're going to run $2 trillion deficits each year (OK, we probably won't quite get there this FY) why not just give every adult in the country $10K to "keep them going until things improve" or some such rhetoric. I know it sounds far-fetched right now, but things really haven't gotten bad yet.

Currency debasement is also an option. Saying that the government can't create inflation is wrong--perhaps they can't create it through conventional means and the banking system, but they can create it. Of course, the cure would be worse than the disease, but desperate people don't always think long or even medium term.

The put it in the metaphor of Dune, we are approaching a nexus.

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