Ben Bernanke was talking up the economy yet again yesterday, and it appears Floyd Norris got the same memo.
I must digress a tad by giving The Daily Capitalist’s translation of Bernanke’s remarks:
Since August when we began to flood our primary dealers in Wall Street with newly printed money the market went up because they used the money to buy financial products, including stocks. We are trying to cause price inflation because the majority of the FOMC is concerned about price deflation. If we cause price inflation then we will fool everyone into thinking that because prices are going up, such as in the stock markets, that it is real growth even though it’s just price inflation. Even better the national debt can be paid down with cheap dollars. Yields on Treasurys initially went up because the bond vigilantes aren’t stupid: they know it will cause inflation so they wanted higher yields. But, ha, ha, the Euro went into the tank because of the PIIGS and money flooded back in to the US and drove Treasury yields back down, for the time being. Screw the vigilantes. The same thing happened when we tried QE1, but as we all know, that failed and we are desperately trying again because we don’t have too many arrows left in our quiver. Hey, if it had worked, would we be doing QE2? We are desperate because if unemployment doesn’t come down, the Obama Administration will be screwed and I’ll lose my job. We are ready to do QE3 because we don’t have a clue what else to do.
Now to Norris’ truly bizarre column, in which he argues that circumstances now are very much like those of 1983, when forecasters were not optimistic about the odds of unemployment falling quickly, when lo and behold, it did.
The problem is that there are some of us who are old enough to remember 1983, like yours truly. And 1983 has about as much resemblance to today as a merely badly out of shape athlete does to one who is in the hospital and is refusing surgery (or in our case, structural change). Even though I do have the bad habit of reacting strongly to nonsense in the MSM (it’s such a frequent occurrence that I should be used to it by now), I expect more from Norris, who has to know better. I sent a short set of comments to a jaded economist colleague who also remembers 1983 well (and has also analyzed that period), with my message starting, “This is complete horseshit and Norris should be embarrassed.” His reply, “Yup. Totally stupid.”
To the particulars of the Norris piece, “From 1983, Hope for Jobs in 2011“.
Norris makes a simple numerical comparison: In January 1983, unemployment fell from 10.8% to 10.4%. Most economists dismissed the change because unemployment had been stubbornly high for five years; this just looked like noise in the data. Oh, and the stock market had rallied sharply, but a lot of people also discounted that because they didn’t see a big change in the real economy. Norris suggests the fourth quarter GDP release, which showed strong spending growth but not much of a pickup in income, will be revised, as in 1983, to show better results. He also points to evidence that consumer pessimism is falling, which is better than them getting gloomier but a long way from optimistic results.
Now why do I find this so annoying, when on the surface it does not look all that objectionable? Let’s go back to the late 1970s and early 1980s. The country had been mired in persistent high inflation. The stock market had been in firm bear territory since 1973; the famed Business Week “Death of Equities” cover was August 1979.
And why was inflation so bad for the economy? First, it leads to high interest rates, which means high financing costs. That also means high discount rate, which make long-term investments of any sort (capital investments, equities, which in those days were long term investments) look terrible. Second, it means businesses really do not know where they stand on a real economic basis. That point cannot be stressed strongly enough. The US never developed good inflation accounting (I’m told they have in Brazil), and since line items in both the balance sheet and the income statement inflate at different rates, investors and the businesses themselves are a bit fuzzy on where the stand on a real economic basis, which also makes everyone a bit edgy. Worse, capital intensive businesses are punished, since their depreciation is based on historical cost, which means they are not getting a sufficiently high tax break and thus are being overtaxed.
Norris bizarrely completely ignores the big action in the real economy: the punishing wringing out of this inflation by Paul Volcker’s monetary tightening in 1980 to 1982. As a paper by Marvin Goodfriend and Robert King in 2004 observed,
The change in inflation that occurred during 1980 through 1984, when the Federal Reserve System was headed by Paul Volcker, is arguably the most widely discussed and visible macroeconomic event of the last 50 years of U.S. macroeconomic history.
I was on Wall Street during this period. Everything stopped when the weekly money supply numbers came out on Thursdays. It is hard to convey how bad the markets were then. High credit quality companies were paying 14% to 15% to sell bonds. Companies were trading at low prevailing PEs and there was no depth in the market, it was impossible to get companies to issue stock because they hated their stock price. Bank borrowing rates went to 22% and they were hemorrhaging cash, even on their credit card portfolios.
Even though the histories of this period show that the Fed fund peaked in June 1981, it was not at all clear that the drying out process was over. Volcker had wanted to inflict more pain but had been forced to pull back by the Latin American crisis. The Fed funds rate remained over 14% through October 1981, and fell to over 12% in December, but this was not taken seriously because liquidity demands tend to fall at year end. And indeed, the Fed funds rate was back above 14% in February and stayed high through June. It then fell to 10% by early August.
There was a specific day that August, it was the 12th or 13th, when word went out through Goldman that the tide really had turned, that the stock market bottom was in and the Volcker hair shirt days were over. This wasn’t client talk, although it was also conveyed to clients. It was a collective recognition that a big change was now official, much as a big break in a long term pattern of Treasury bond rises in June 2007 was seen as another sea change, that the disinflation that had started in the Volcker era was now over.
The employment gains that Norris points to in 1983 were due SOLELY to the fall in inflation and interest rates. Funding costs fell sharply, business confidence rose, and investment, which had been on hold for years due to economic uncertainty and high funding costs, took off.
The fact pattern could not be more different now. We don’t have massive disinflation under way. We don’t have pent up investment. Even if the economy were to mend a bit more, large corporations are now habitual net savers. And consumers are still under a lot of pressure. The job additions have an unprecedented proportion of temporary hires, hardly a strong sign of business confidence. Housing still has further to fall, and even if we have some short-term reversals, the trend of consumer deleveraging is likely to continue.
So it would be better if I were wrong, but the fact that Norris has to make such a barmy case for optimism does not exactly inspire confidence.