I was quite taken with this post of our occasional guest blogger Cassandra (who holds forth at Cassandra Does Tokyo). I hope you enjoy it as well.
Thumbing through the sell-side research from their multitudes of Strategists, I notice some recurring phrases, small and innocuous as they may be, that trouble me. Time and again, they repeat, in various contexts, the mantras: “when things return to normal”, “when markets return to normal”, and “when x, y or z normalizes” with “normal” implied to be that which has been common over the past decade-or-so in respect of liquidity, leverage, asset prices, equity risk premiums, speculative activity, growth. Mulling this over, I wonder to myself: “is this not just the perfect “recency bias” example, defined by wikipedia as “a cognitive bias that results from disproportionate salience of recent stimuli or observations”? For as I consider what precisely is meant by “normal”, it seems to me that there is a reasonable good chance insofar as this IS “The Big One” (as Bridgewater Associates precsiently termed it nearly a year ago) that all these things – debt, leverage, consumption vs. income, relative asset prices – are ALREADY returning to normal, and the strategists, demonstrating the old poker joke about “if you look around the table and you don’t know who the sucker is, its you….”, simply haven’t yet fathomed the appropriate interval frame of the normality to which things are returning towards.
In Japan, “normal” meant that in 2004 residential real estate prices were roughly 30% of late 1980s or early 1990s prices. In Germany , though nominal prices might be similar in many places to those prevailing two decades ago, the real price destruction would be probably be similar to Japan’s. But what is “normal” for economic growth? Or what is “normal” for aggregate US consumption? Or the amount of debt a typical household can sustain? What is the “normal” leverage for a bank, or the normal return on equity o a listed company? What is a normal share of GDP for corporate profits in an economy experiencing deep recession? What is “normal” for sustainable government budget deficits? What is the normal income multiple of a banker or CEO to a policeman, a professional baseball player to a school-teacher or a doctor to a nurse? What is the normal amount of due diligence a bank should do before extending a loan and what is normal for the amount Honeywell Industries will earn per-share in the coming years?
These may seem disparate and unrelated, but I fear they are not. I fear that the final acceleration towards the denoument of Peak Credit, rooted as it was in poor fiscal policies and lack of regulation & oversight, greased with monetary ease and official foreign mercantile enablement, and driven by parochial and herd-like animal spirits, has distorted what is normal, what should be expected, and of course, what is, and will prove to be reasonably sustainable in the future. But the Strategists, the ones who’ve offended my sense of the normal, seem, in their sanguineness, to be implying that is was normal to extend credit as it was during the last eight years; that gains in asset prices (be they a portrait of Dr Gachet NYC apartments, Chelsea or Notting Hill pied-a-terres ?) are normal at somewhere nearer to the top of their seemingly almost-exponential three-decade rise; that it is normal that US households continue to live with negative rates of savings or consume en masse beyond their means; or cavalierly burn hydrocarbons at the elevated relative per-capita rates that they do presently; that past income-inequality, now rolled-up into massive eddies of wealth discrepancy that approach those which evoke those prevailing during the enclosures in England are normal, and that their sense of normalcy will swiftly return despite the continued pressure to the contrary upon the financial sector, and households to return to a normalcy of a much different mean than those of the recent past, which in their turn directly the impact the corporate sector with body blows from BOTH the cost and availability of their gearing and the ultimate demand for their products.
I do not believe (yet) that we are about to beat each with bones back to the stone-age. But I believe that what we’ve seen in leverage and credit growth during the past 15 years is NOT normal, nor is it sustainable – neither relative to history or in absolute terms. And this return to what is sustainable, and service-able has profound economy-wide, implications, and they are indisputably contractionary: deleveraging, higher savings rates, matching household consumption to income, and government revenues to expenditure. Add to this the impending pull of demographics, the emerging trend towards greater environmental consciousness and sustainability, and “normal” begins to resemble a mean-that is something of a much different magnitude, something still to the south of where we are that – in the big time series – we will continue to revert towards from our presently divergent location rather than – as the Strategists imply – a normal that is something we’ve already overshot.