BEA 4th Quarter GDP 1st Estimate 0.7% Q&A: Why Did GDPNow Rise...

BEA 4th Quarter GDP 1st Estimate 0.7% Q&A: Why Did GDPNow Rise After Durable Goods? When are Construction Revisions Coming? For almost thirty years, count them, for almost thirty years people like you have predicted that our economy will collapse and the end of the consumer. Throughout all of those years, it didn't happen. No matter how many logical arguments the 'gloom and doom' crowd has made, it hasn't happened. Nimesh, I have only been on the deflation bandwagon for a few years, not thirty. However, you are correct about one thing: Some notable people have indeed been calling for a collapse for nearly thirty years. However, that does mean an economic collapse One of the reasons the Fed was created was to manage the economy and prevent further depressions. Guess What? The biggest deflation in history, the great depression, happened 17 years later. At one time economists thought that inflation and recession could not happen at the same time. It happened anyway. A new term was coined for it “Stagflation”. If you asked anyone in Japan if housing prices could fall for 18 straight years, they would have said 'It can't happen'. It did happen. For 30 years people have said US housing prices would never again decline on a national scale. They were wrong. It happened. It is the very nature of the market that it takes the convincing of nearly everyone to believe that something cannot happen, to actually cause it to happen. Consider housing. Everyone became convinced that housing was a one way ticket north, that all housing was local, and housing would not decline nationally. This mass belief in a faulty housing premise in spite of evidence to the contrary in Japan is what helped form the US housing top. Greater fools everywhere who came to believe that faulty theory eventually rushed in to speculate in housing. That made the top. Even the rating agencies got into the act. . As amazing as it might seem now, Fitch disclosed as recently as March 2007 that their model for rating CDOs assumed low to single digit home price appreciation forever into the future. They even admitted their model would break down if home prices were flat for an extended period of time. There is a shocking conference call discussed in the above link where Fitch described those fatally flawed assumptions. Fitch placed so much faith in their models (as did Moody's and the S&P) that the biggest financial speculation in housing history took place. Greenspan and the Fed cheered the miracle of derivatives most of the way. Such foolishness has already cost Citigroup (C) and Merrill Lynch (MER) their CEOs. It may cost Citigroup its entire company. See All of the above are casualties of the bursting of a housing bubble, a bubble that until last year people denied even existed. Instead of looking at Japan for what was about to happen, all we heard was 'It's Different Here. The US is Not Japan'. Housing prices rose three standard deviations above norm in relation rental prices and wages yet excuses were made as to 'Why it's different this time'. Now, in spite of all the evidence to the contrary, most still insist that 'Deflation Can't Happen Here'. The entire argument rests on one or more of the following faulty premises. Belief in the third point above goes well beyond amazing to the point of being nearly universal. Yes, there are a handful of us that see deflation coming, but as Nimesh writes ' That is precisely the sentiment that it takes to make a top (or a bottom). Many predicted the demise too early and are now discredited. Those hopping on the bandwagon near the top are compared to the early visionaries. It becomes guilt by association even though there is no real association. Mocking of the early visionaries is part of the topping process. Group think sets in and is reinforced over the years. Risk premiums drop as the long term trend reaches the peak. That takes time. Memories fade. Does anyone fear another great depression? Heck, does anyone even remember it, let alone fear it? Since everyone knows the early visionary we are talking about, we may as well openly discuss his name. Robert Prechter ignored and/or did not foresee many things that could keep the credit bubble expanding. Let's start with a flashback to conditions of the 70's and 80's. Every one of those things allowed the credit bubble to keep expanding. Many of those factors took years to play out, decades in aggregate. The decline in interest rates alone made housing more affordable for quite some time, at least until things went extremely loony a few years back. And when housing prices went loony, progressively lower credit standards kept the expansion going. The madness ended when there was no one left to buy, and no way to keep that portion of the credit bubble expanding. Sadly, people still give Greenspan credit for his role in keeping the economy expanding. Greenspan deserves absolutely no credit. All Greenspan really did was accelerate the existing trend. Furthermore, he did so in a way that was completely reckless. The only reason the economy did not collapse under Greenspan was the ability of consumers and businesses to take on credit had not yet peaked. Greenspan fueled an overall stock market bubble by bailing out banks exposed to Long Term Capital Management. For more on LTCM please see Greenspan fueled a dotcom bubble in 1999-2000 out of irrational fear of a Y2K crash. Greenspan embraced the productivity miracle and was worried about the economy overheating just months before it imploded. The story is documented in FOMC minutes. Greenspan fueled an even bigger bubble between 2003-2006 by embracing ARMs and slashing interest rates to 1% to bail out his banking buddies caught up in bad loans to dotcom companies and bad loans to countries like Argentina. In a sense, Greenspan was the luckiest Fed chair in history. He had a tailwind of productivity at his back that helped keep consumer prices low while he fueled bigger and bigger and bigger credit bubbles when each of several smaller bubbles popped. Greenspan has now left an unsolvable mess for Bernanke to cleanup. This time, there is no bigger credit bubble to be blown. In 2007 many are writing me with reasons why the credit bubble will not bust. It already has. However, just like housing in 2006, the implications have not yet been fully felt. The party is over once the ability and willingness of banks to lend, or ability and willingness of consumers and businesses to borrow is exhausted. Those signs in place today for all but ostriches. have one, but I am inclined (at least right now) to doubt it. Japan went through 18 years of deflation and the world did not end. The US will survive deflation as well. However, we are likely to see something the US has not seen since the great depression: a falling standard of living and a declining middle class. Many things will be One thing I am sure of is the more money we waste in Iraq and the more money we waste attempting to be the world's policeman, the worse off we will be. There is enormous and unwarranted belief in the Fed's ability to 'inflate out of this mess'. It's all an illusion. Greenspan presided over an economy that added enormous numbers of internet jobs followed by enormous numbers of housing related jobs and enormous numbers of jobs related to the buildout of commercial real estate. successful only because the ability and willingness of consumers and businesses to take on more debt was not yet exhausted. Bernanke, on the other hand has no dotcom boom to bail out the economy. Nor does Bernanke have a housing bubble to look forward to that will bail out bad bank lending practices and provide jobs to the economy. Greenspan never had to deal with anything remotely close to that set of problems. It's a lethal combination of things given that solvency issues at banks that will restrict lending. It is also a lethal combination in the face of consumers and businesses that are unwilling to expand because consumers are tapped out. In addition, rising unemployment sure is not going to do anything about consumer's willingness or ability to take on more credit. , many came to believe in the magic of the Fed. The idea was further enhanced by one of the most ridiculous Fed speeches ever in fending off deflation as well. However, near universal belief in a flawed idea is a necessary but insufficient condition for a primary trend exhaustion. The housing boom morphed into merger mania, leveraged buyout speculation, buyout bingo and all sorts of other nonsense including covenant lite deals where debt was paid back not with interest but with more debt. There were not really any more players because there was no one left to convince. Rather the players involved just got greedier and greedier. Even as housing died, credit expansion looniness continued for two more years. When everyone acts as if every risk no matter unsound will go unpunished by the Fed and the market, it fosters the environment where the greedy participants (and even some innocent bystanders) are going to be tremendously punished. Few have stopped to consider that credit conditions only got as insane as they did because of fundamentally unsound belief the Fed cannot fail. Similar beliefs marked the top of the housing boom in the summer of 2005. Yet in spite of the housing implosion, everyone acted (and most still do) as if there is no risk of deflation. Most still fail to see that it was unsustainable credit expansion that fueled not just housing, but the economy in general. Ironically, it is the unvarnished arrogance by Bernanke in conjunction with greater fools who believe in his untested academic wizardry, that fostered the very extreme risk taking attitudes towards credit that makes deflation inevitable. The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. 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