Vladimir Putin’s speech at Davos last night, Isabelle Oderberg’s fascinating interview with Lacy Hunt of Hoisington Investment Management on Business Spectator this morning, plus a seminal piece of research by David Rosenberg of Merrill Lynch in New York earlier this week (at the time of writing, available here), have taken analysis of the crisis and its solutions to a new level, in my view.
Putin’s speech is generally being reported this morning as the Russian leader attacking capitalism, but it is far more than that.
And, by the way, given the development of a plutocracy in Russia since Putin took over — it might even be called a gangsterocracy — it might be felt that he lacks credibility in lecturing the West about anything at all. But let’s look beyond what’s been going on in Russia.
Putin knows something about the consequences of state ownership and control, and has some credibility when he warns about getting carried away with government rescue packages.
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The urge to rescue is a “natural reaction”, he says, but: “The concentration of surplus assets in the hands of the state is a negative aspect of anti-crisis measures in virtually every nation.
“In the 20th century, the Soviet Union made the state’s role absolute. In the long run, this made the Soviet economy totally uncompetitive. This lesson cost us dearly. I am sure nobody wants to see it repeated.”
His analysis of the cause of the crisis is, I think, pretty sophisticated: he talks about “substandard regulation” and “colossal imbalances” between the scale of financial operations and the value of fundamental assets.
“The entire economic growth system, where one regional centre prints money without respite and consumes material wealth, while another regional centre manufactures inexpensive goods and saves money printed by other governments, has suffered a major setback.”
And finally, on the subject of the causes, he talks interestingly about excessive expectations. “Corporate appetites … swelled unjustifiably. The race between stock market indices and capitalisation began to overshadow rising labour productivity and real-life corporate effectiveness.”
He begins his discussion of the solutions with a call to write off all hopeless debts and “bad” assets. “We must first atone for the past and open our cards, so to speak.”
This, it must be said, is easy for him to say: the banks aren’t based in Russia.
But it’s also true that the attempts by the Bush Administration, and now President Obama to use government funds to cover up the true value of debts and assets by buying them from the banks at inflated values (the “bad bank” solution) will only temporarily paper over the problem.
A lot more write-downs are required than anyone is currently considering. Bank and investment bank shareholders, as well as the greed-merchants they allowed to run their organisations, have not yet been required to wear enough of their own mistakes.
David Rosenberg says that the $US1 trillion in write-downs we have seen so far will have to become $6 trillion.
“…considering that total private sector credit market debt relative to national income is still near a record-high of 140 per cent versus a long-run norm of 80 per cent, the mean-reversion process suggests that before we can even consider embarking on a fresh credit cycle, more than $6 trillion of excess household and corporate debt has to be eliminated.”
Vladimir Putin also talks about the need to get rid of virtual money, exaggerated reports and dubious ratings, as well as the excessive dependence on one reserve currency, and calls for a system of global regulation based on multilateral agreements.
Like Putin, Lacy Hunt is pretty negative about the fiscal proposals being put up by the Obama administration (and, by implication, other governments) — for basically the same reason: it makes the economy uncompetitive. But he expresses it differently and agrees with Malcolm Turnbull that tax cuts would be better.
As he told Isabelle Oderberg:
…the incoming chair of the Council of Economic Advisers has found that every $1 reduction in the marginal tax rates will increase the GDP of total spending by $3. That’s a multiplier of 3 to 1. In the case of government spending, the multiplier is zero.
There’s no net benefit for going along the expenditure route. So in the haste to do something and to show the public that they care about their plight, the politicians are doing something, but in fact they’re doing the wrong thing.
He also makes some pretty telling points about infrastructure spending as economic stimulus, that I should take note of:
If we were to double (it), it would still be infinitesimally small … but we couldn’t double it overnight because you need architectural studies, engineering studies, you have to get environmental approval, you have to buy right of way, you have to satisfy community groups and in the final analysis, road building is not a labour intensive function, it’s a capital intensive process.
The folks that have been laid off in management and insurance and real estate and our young college graduates, they don’t want to go and work alongside the road and there’s not many of those jobs anyway.
He concludes that the process of dealing with debt deflation (where debt actually stays the same value and all asset values decline, so that the debt needs to be written off) will be long and difficult, and that government intervention will not help:
These debt deflationary periods tend to last. They’re very pernicious … really, the only thing that brought the United States out of the post 1929 debt deflation was our participation in World War II. The debt deflation that ensued after the panic of 1873 lasted another 20 to 23 years and the Japanese, they had debt deflation which started in 1989 and is still running for all practical purposes today. They last for a very long time.
David Rosenberg of Merrill Lynch opens his report, called “Some Inconvenient Truths” by coming out and declaring that we are “likely” enduring a Depression today.
His definition of Depressions? “…basically long recessions — they can last anywhere from three to seven years, while historically cyclical recessions last 18 months.”
The CEO of Bank of America, Ken Lewis, might be thinking that it’s a pity Rosenberg didn’t discover earlier that we are in a Depression, so his bank might not have made the mistake of buying Rosenberg’s investment bank, but that’s life in the big city, I guess.
Anyway, Rosenberg says that clearly we have gone past the classic definition of recession when the three-month treasuries yield falls to zero, which has only happened in the US in the 1930s and Japan in 1990.
His prognosis is that the US household sector has to write-off anywhere between $4 and $6 trillion worth of debt, and since we have seen $1 trillion so far “it is truly difficult to believe that we are anywhere but in the early stages of this credit contraction phase.”
He says that a shift from “frivolity to frugality” is a secular (not cyclical) theme. Attitudes towards credit have changed, which raises the question of how banks are going to expand their balance sheets once the credit cycle has turned around if households are focused on paying down debt.
Also, perceptions about residential real estate have changed. It is no longer as a path to greater wealth, at least in the US.
And according to Rosenberg there has been a seminal shift in attitudes towards consumption.
Outlays on discretionary goods and services are contracting at an annualised rate of 15 per cent, “as households shift from veal to chicken and from albacore tuna to Spam”, and in the face of a 60 per cent drop in gasoline prices, auto sales keep declining to fresh 15 year lows.
Yes, these are just three views, and they are post hoc analyses that might also be a signal that the bottom must be getting close – because more and more people are describing the situation as hopeless.
Maybe it is time get optimistic and buy. You go first.