Page 1 of 2 'New normal' will be a painful place By Julian Delasantellis
In Jane Anderson’s made for HBO movie Normal (2003), based on her stage
play, her US husband of 25 years, Roy (Tom Wilkinson), announces to his wife
that he wants to change his gender and become a woman named Ruth. Residents in
his small, semi-rural Midwestern town find out, and don't think very highly of
the idea. Thinking of the most lacerating insult that will cut poor Roy/Ruth to
the quick, "you are not normal" is scribbled in the dirty back window of Roy's
pick-up.
But what is "normal?"
The American Heritage New Dictionary of Cultural Literacy defines "oxymoron" as
"as rhetorical device in which two seemingly contradictory words are used
together for effect"; commonly used
examples for illustration are things like "jumbo shrimp" or "military
intelligence".
A new oxymoron is currently slashing through the lexicon of popular usage -
"the new normal", supposedly, the stasis point the economy is, or soon will
settle in after it finishes reacting to the financial crisis.
Normal, of course, infers customs and practices sufficiently tested by time to
become generally accepted as a sort of bell curve's apex - new, and pretty much
the opposite. Also, in reference to the financial crisis, the phrase implies
that the economy has already reached "new normal"; that very little further
decline can be expected. Indeed. besides being an oxymoron, "new normal" may
be, at most points in time, a logical impossibility, as, instead of resting at
stasis points for extended periods of time, "normal" in the economy and
financial markets more often than not implies movement from one point where
certain customs are accepted to another where another, different set rules.
Indeed, a true "new normal" may be a very rare phenomenon , more so than even
Nassim Nicholas Taleb's famed "black swan" now purportedly seen on most street
corners.
The effort to ascertain as to whether we have reached new normal will be
assisted once we turn back and look at the long, sad road we have just
traversed. No analysis of the present is ever really complete without a look
into the past.
Many times I've written here that the key metric in the ongoing economic
holocaust is not home prices or unemployment, but the ratio of debt, both
public and private, to total US gross domestic product (GDP). Watching this
number climb over the past few years is reminiscent of the 1981 Gabriel Garcia
Marquez short story, Chronicle of a Death Foretold, although in this
case the title would be "Chronicle of the Death of an Economy Foretold".
After being stable at around 1.5 (that is, the economy was carrying $1.50 of
debt for each dollar of GDP) from the end of the Great Depression to the middle
1980s, the ratio then commenced its long, slow, inexorable climb. Passing the
pre-Great Depression highs around 1995, the line just kept on going and going
further up, reaching a ratio of 3.49 just as the recession was commencing in
early 2008.
Where all that money was going, of course, was into real estate, primarily US
real estate, but with British, Irish, Spanish and even Icelandic real estate
seeing its share as well. Wherever the money did slosh ashore, it engendered
huge spikes in real estate prices, as what was then apparently unlimited
streams of money competed with each other to buy, at least in the short term,
the relatively limited and fixed supply of real estate.
Millions were being made every day, and millions more every night, as poets and
schoolteachers came home from their day jobs to flip real estate; even
secondary school dropouts could dream of being a real estate tycoon with their
own cheesy reality show, but the process did carry within it the seeds of its
own destruction. This can be illustrated by an example of a very simple real
estate transaction.
A man wants to buy a house that costs, let's say, a dollar. He needs a loan, a
mortgage for the purchase price. Another man is willing to lend him that
dollar, at say 5% interest.
The buyer purchases the house, and in one year the house's value rises 30% - as
was not at all uncommon during the boom years. He pays $1.05 for a year's worth
of principal and interest to own something worth $1.30, and feels he's doing
fine.
Not the lender. Sometime in the future he wants to buy a house as well; he has
no intention of spending life in a pup tent. He was hoping that, if he deferred
his consumption for a while, the added funds that would accrue to him in
interest would aid him in the process, but it is the exact opposite that seems
to be happening. The $1.05 the lender gets back in interest now only buys $0.81
of house (1.05/1.3)
The same happens the next year, and the year after that. Eventually, the
lender's business becomes more of a philanthropic enterprise, a wealth transfer
machine from him to the borrowers, instead of an actual profit-making
enterprise. Maybe going back to develop a business model better than to lend
cheap and fixed in a high inflation rate environment, the lender withdraws his
funds from the lending marketplace until circumstances more favorable to his
interests are restored in the markets.
This, of course, is the heart of deleveraging, the credit market contagion that
is starving the world for capital. In essence, like a parent taking away
junior's car keys until he can prove to be able to drive more responsibly,
deleveraging is lenders pulling back from new lending until the system proves
itself responsible enough to lend in such as way to protect the purchasing
power of the old lending. With all the talk about the credit crisis and
deleveraging, with consumers and businesses having their lines of credit cut,
you'd expect this number to be shrinking, right?
Wrong.
As for the first quarter of 2009, the total US debt/GDP ratio was 3.82, up from
about 3.50 the year before. If the United States is being starved for capital,
how can it be going deeper into debt?
Part of this, of course, is the over $2 trillion in new US government debt
being taken onto the federal budget in the past year. Part of it is the fact
that the denominator, GDP, in the debt/GDP equation is shrinking; that would
raise the ratio even if there had been no increase in total debt.
Digging a bit deeper into the data reveals where the problem lies. Total
household financial debt declined $151 billion in the first quarter of 2009,
after declining $271 billion in the financial panic of last year's final
quarter. Still, with total household borrowing still running at an almost $1.4
trillion annual rate, America has hardly become a nation of misers.
That's where all the slashed credit card limits and all the defaulted and
eventually charged off mortgages have gone. The household debt total, at
$1.3679 trillion, is the lowest for this measure, with the exception of 2008's
second quarter, since early 2003.
So is that it - all that lenders will require to open their silk satchels once
again is that $422 billion of private sector deleveraging? That's what the
economy's current cheerleaders, both in the government and out, would like you
to believe.
The essence of the "green shoots" economic recovery argument is essentially
above, that government deficit spending has replaced what the private sector
has taken out of it - and a lot more after that - net, the economy is ready to
rock once more. Conservatives say that the numbers prove that the problem was
not all that substantial to begin with; it was all liberal media hype, and,
yes, the economy is ready to rock again.
If both are advancing the same argument, it should not be surprising if both
are wrong.
For one thing, it is believed that the US Federal Reserve data capture little,
if any, of the so-called "shadow banking" sector, the recent experiment with
wave after wave of leveraged financial instruments that the banks worked hard
to keep separate from their regular balance sheets. As that this market was
totally unregulated, there can be no totally reliable estimates as to what is,
or what was, its size, but many observers estimate that, at its pinnacle last
year, up to 50% of the lendable capital in the system appeared from out of this
financial ether, and has now disappeared right back into it.
At $900 billion, the total quantity of US and European bank writedowns may be a
rough proxy for the status of the entire shadow banking system, but nobody
knows for sure.
Perhaps the Fed numbers, and the ratios and measurements derived from them, are
useful as pointers as to the direction of the debt markets rather than their
absolute level. If that's the case, there are four words that scare the bejesus
out of the "new normal" crowd, those that say that the credit market borrowing
and the actual economy has already reached a level where growth can recommence.
Those words are "reversion to the mean".
At their heart, all economic statistics are just that - statistics. One of the
most common occurrences in statistics is that when numbers in a reportable
series start going out of line with what was previously reported; they may run
away from the area where most previous observations occurred, but eventually
they'll fall back to their moving average, their "central tendency", their
mean.
"Reversion to the mean" is the operating principle behind one of the most
common strategies in chartism, sometimes known as stock technical analysis.
Many savvy investors watch a stock or commodity break out from a recent
extended trading range, wait for it to revert to some mathematical mean, be it
a 12-, 50- or a 200-day moving average, before hazarding a new buy.
So what happens if US debt levels have to revert to a 20-year mean before the
lending spigot opens again? That question produces some very grim results.
As opposed to today's total government and private-sector debt load of almost
$53 trillion, the 20-year period average is down at $43 trillion - that implies
another $10 trillion of debt somehow disappearing, being written off, or (the
most unlikely case) paid off. In the case of the solely "households and
non-profit organizations credit and equity market instruments liability",
another $1.2 trillion, in addition to what has already been vaporized, has to
be written off as well.
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