Thursday, October 1, 2009

[Société Générale's] Albert Edwards On The Upcoming Economic "Abyss"

We are fans* of M. Edwards. From ZeroHedge:

As always, Albert Edwards provides a solid dose of economic observations based on facts, not hope. And, as always, he is one of the few in his attempts at deductive logic: why bother with causal relationships when there is a scent of "change you can (almost) believe in" permeating the airwaves. Never mind that the next administration will have to deal with the massive fallout of this "change" once it realizes America is bankrupt: we hope they have their catchy slogan writers already on damage control. After all "debt repudiation you can really believe in" just lacks that certain pizzazz that may prevent the next president from being on TV 24/7.

Back to Albert, who shares his thoughts on the liquidity driven asset bubble:

Many clients believe it is inevitable that "excess" liquidity will continue to drive risk assets higher. The broken nature of the banking intermediation means that surplus reserves are not being funnelled into the real economy and therefore must, it is believed, inevitably cascade foaming and invigorating over risk assets. And all the while interest rates remain close to zero this process is expected by many to continue apace, driving risk assets higher.

This is wrong. It is the cyclical upturn that is sucking money into risk assets. This is exactly what happened in Japan in the 1990's. Japan enjoyed many decent economic and profit recoveries which regularly pushed equities and other risk assets substantially higher. But the underlying fragility of any cyclical recovery amid a secular balance sheet recession meant there were frequent lapses back into recession. This eventually drained hope away from zombie investors who then became sellers-on-rallies, rather than buyers-on-dips.

Additionally, Edwards presents the case for balance sheet-based deflation. In essence, even as the government tries to inflate its way out of all its problems, it is, even by printing trillion in new treasuries, unable to catch up with the non-governmental balance sheet collapse.

The US Federal Reserve recently published their comprehensive flow of funds data for the US. This showed that the household sector continued to pay down debt for the fourth consecutive quarter. Corporates also started to pay down debt sharply in Q2 at a similar $200bn pace. The non-financial private sector paid down debt at a $435bn pace in Q2. This compares to a $2,116bn pace of expansion in 2007 (see chart below). Add to that the financial sector unwind and the total private sector is unwinding debt faster than the government is able to pile it up (hence the red line is still negative)! The lesson from the balance sheet recession in Japan is that the massive private sector headwind to growth has a long, long way to run.

If that is the case, we can expect, just like Japan, frequent relapses back into recession. The market now understands how an end of inventory de-stocking can boost GDP, i.e. it is the change in the change that matters. Similarly as Dylan Grice points out - link, it is the change in the fiscal deficit that is a net stimulus or drag to GDP. A massive 6pp stimulus last year is likely to turn into a 2pp drag on growth next year (see chart below). With continued private sector de-leveraging likely next year and beyond, how can one seriously not expect the global economy to relapse back into recession next year taking nominal GDP deep into an abyss?...MORE

*Possibly related posts:
"Eat your heart out Albert Edwards": Royal Bank of Scotland Calls for 550 S&P (and: "South Sea Bubble Redux")

The Shape of Things to Come: "V Defies Economic Pessimists Seeing L, U, W"

Société Générale's Albert Edwards "A Full Blown Deflationary Episode"

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