Monday, March 29, 2010

The case for a very extended recovery

John Mauldin, in this week's Thoughts from the Frontline, rationalizes his impression that recovery, in the US and around the world, will be a long time comin'. Guambat finds it pretty convincing, not the least because he puts the bigger picture in the context of the "fingers of instability" lesson he explained to us years ago.

He relates that theory of order in chaos to Minsky's observation that stability leads to instability, with the corollary that the longer the period of stability, the greater the degree of instability.

He then places those notions up against some economic data, namely, a "60 year debt supercycle", illustrated by this chart (which Guambat doesn't dispute but notes that a very quick google-search to find other such charts was not corroborative):


Finally, he brings in Professors Ken Rogoff and Carmen Reinhart, authors of This Time It's Different, to make the point that we've only begun a recovery process; the return to some form of normalcy is way off, maybe another decade.
We borrowed (and not just in the US) like there was no tomorrow. And because we wereso convinced that all this debt was safe, we leveraged up, borrowing at first 3 and then 5 and then 10 and then as much as 30 times the actual money we had. And we convinced the regulators that it was a good thing. The longer things remained stable, the more convinced we became they would remain that way.

this time is really different from all the other crises we have gone through since the Great Depression

every debt crisis always ends this way, with the debt having to be paid down or written off or defaulted upon. That part is never different. One way or another, we reduce the debt. And that is a painful process. It means that the economy grows much slower, if at all, during the process.

If it were not for the fact that we are coming to the closing innings of the debt supercycle, we would already be in a robust recovery. But we are not. And sadly, we have a long way to go with this deleveraging process. It will take years.

You can't borrow your way out of a debt crisis, whether you are a family or a nation.

We built a very unstable sandpile and it came crashing down and now we have to dig out from the problem. And the problem was too much debt.

And here's where I have to deliver the bad news. It seems we did not learn the lessons of this crisis very well. First, we have not fixed the problems that made the crisis so severe. We have not regulated credit default swaps, for instance.

And this next time, we won't be able to fight the recession with even greater debt and lower interest rates, as we did this last time. Rates are as low as they can go, and this week the bond market is showing that it does not like the massive borrowing the US is engaged in.
Guambat has pared down his list of subscriptions to this last one, but not only because Mauldin's Frontline Thoughts is a free one. It is interesting. Not always agreeable, not always rewarding, but usually interesting enough. (You can subscribe yourself here: http://www.frontlinethoughts.com/learnmore.)

For instance, in his fingers of stability discussion, he mentions the "power law", with its impact on critical mass.
Going back to the sandpile game, you find that as you double the number of grains of sand involved in an avalanche, the likelihood of an avalanche is 2.14 times as unlikely. We find something similar in earthquakes. In terms of energy, the data indicate that earthquakes simply become four times less likely each time you double the energy they release. Mathematicians refer to this as a "power law," or a special mathematical pattern that stands out in contrast to the overall complexity of the earthquake process.
Guambat wonders if there are any implications in that idea to suggest that the market lows we saw back in early 2009 released sufficient "energy" or stress from the system that they will mark the lows for this cycle? He hopes Mr. Mauldin might provide his own conjecture.

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