The Fundamental Trendline is Still Down (Rosenberg)

Moreover, where were “real” short-term interest rates heading into the unexpected 1937-38 collapse? How about -200bps? What was at play in that recession was not inventories, the curve or real rates — it was the sudden withdrawal of fiscal support after years of massive New Deal stimulus. The deficit-to-GDP ratio receded from 5.5% in 1936, to 2.5% in 1937, to 0.1% by 1937. That represented a huge negative fiscal shock to an economy dependant on government support. Full stop. End of story. Paul Krugman is not sleeping well because he knows that history may repeat itself. Okay, okay — that was over 70 years ago (not really that long ago in the overall context of economic and financial history, that was one retort I got yesterday.

What about Japan? Perhaps an extreme example of a post-bubble credit collapse, but it is still a modern society (for the most part — just avoid the glares if you count your change, forget to drink your green tea at meetings, close the cab door or comment on the white glove, and of course letting women out of the elevator first) and an industrialized tech-led economy. Did Japan not have a recession that seemingly came out of nowhere in 1997 with a steep yield curve, at +170bps, real short-term interest rates at -150 bps and a cycle of modest inventory accumulation? What happened, again, was a negative fiscal shock that took an enormous bite out of aggregate demand as the deficit-to-GDP ratio was cut to 3% from 4.5%.

So, let’s look at the situation from a top-down view. We have seen real U.S. GDP growth average 3.2% at an annual rate during this statistical recovery from the 2009 bottom. Of that, 2.1 percentage points came from the inventory swing — or about two-thirds of the growth. The remaining 1.2% average annual growth rate of GDP excluding inventories — otherwise known as “real final sales” — is the weakest post-recession recovery on record. The weakest ever, despite a 10% deficit-to-GDP ratio, a debt-to-GDP ratio rapidly heading to 100%, a near zero Fed funds rate, record low mortgage rates, an unprecedented tripling in the size of the Fed balance sheet, shifting accounting rules to help rejuvenate profit growth in the financial sector, cheap and easy FHA financing to virtually anyone who wants to buy a home, relentless government pressure on banks to modify defaulted loans, and bailout stimulus galore (Fannie and Freddie are now de facto “Crown Corporations” and their stock still trades!!) — and with all that, all we get for our money is a paltry 1.2% growth rate in final sales. Yuk.

Well, what’s past is past. Where are we going? It's pretty clear from the manufacturing components of the last payroll report and the latest ISM index that the inventory cycle is either reaching its peak or it already has. The inventory plan components of the small business survey for June hardly pointed in the way of more contribution.

We can see from the latest auto sales reports that absent cash-for-clunkers, sales are, at best, stuck in neutral near 11 million annualized units at a time when replacement demand is closer to 14 million. That this is happening with auto loan rates down 40bps year-to-date and down 100bps over the past year attests to the view that motor vehicles, like housing, is working off years of excess consumption. At least the used car market is thriving, but that doesn’t end up adding a whole lot of jobs to the economy outside the car lot.

Speaking of housing, sales and mortgage purchase applications are hitting new lows despite mortgage rates at record lows and this also attests to the degree of excessive demand from the prior bubble that is still being worked off — not to mention the fact that when appropriately measured with the shadow inventory of foreclosed properties held off the market, we are talking about close to a two year backlog of unsold homes overhanging the outlook for residential real estate valuation. Commercial construction is beset by high and still-rising vacancy rates in the office and shopping centre space.

It would be nice to see an export boom but the overseas economies, to varying extents, are tightening either monetary or fiscal policy to rein in growth. China is certainly not going to be in the same position it was back in late 2008 in terms of being a leader on the policy front that could ignite a power surge for the global economy. In fact, we just saw the U.S trade deficit widen quite unexpectedly in May to an 18-month high and trigger a wave of downgrades to second-quarter GDP growth. The consumer is not exactly rolling over, but spending fatigue seems to be setting in, along with a natural rise in the personal savings rate, whenever a quick fix fiscal policy gimmick runs its course and expires.

Perhaps capital spending will be a lynchpin, but at 7% of GDP, at most it will contribute a handful of basis points to headline growth. It certainly doesn’t seem to be generating a whole lot of new jobs; however, corporate spending growth, along with a sharp eye on cost-cutting, you may want to stay long your Intel stock a while longer. But, what it means for the economy beyond tech capex probably isn't very much.

Then we come to the near-20% chunk of the economy, the government sector. Two-thirds of that comes from the beleaguered State and local government sector, which is in a full-fledged retrenchment mode as it cuts services, raises taxes, and lays off 10,000 employees month in and month out, to reverse the flow of red budgetary ink. This will likely persist well through 2011.