“The money hole”

It is hilarious:

The Onion: Should The Government Stop Dumping Money Into A Giant Hole?

Economic outlook: “A tale of two narratives”

This speech summarize pretty well the current debate among economists. It was delivered by Dennis Lockhart, president of the Federal Reserve of Atlanta:

“I see two competing narratives about how this recovery will play out. Growth in the fourth quarter of 2009 was quite strong and raises hope for a robust recovery. In this, the first narrative—that of a traditional sharp bounce-back following a deep recession—growth exceeds the underlying long-term potential of the economy and unemployment declines at an accelerating pace.

In this narrative, businesses rebuild inventory levels and resume capital expenditures in anticipation of growing sales. Consumers regain confidence, and retail spending grows briskly. You can add positive export growth as the economies of our major trading partners—especially in Asia—also show better growth.

Finally, in this narrative the banking system successfully navigates a weak commercial real estate sector and starts expanding credit to both business and consumers.”

This is business as usual, return of the US consumer spending spree, increasing household debt, expanding balance sheet of financial institutions, etc. The optimistic end of the spectrum.

“The alternative narrative entails some fundamental changes in business practices and consumer habits. In this scenario, businesses have learned from the recession that they can operate permanently at leaner inventory levels and flat or lower employee head counts. And the impressive worker productivity gains measured in recent data continue to accumulate.

Consumers, in this narrative, have assumed a quite different mind-set compared to the precrisis, prerecession “normal.” Chastened by the
recession and high unemployment—consumers are simply more frugal and more inclined to save. And even if consumers wanted to resume prerecession spending habits, the consumer finance industry, in this narrative, will not accommodate previous levels of consumption.

In this narrative, growth continues, but at a very modest pace, and unemployment is very slow to recede. The first narrative is a return to something resembling normal as we knew it; the second narrative describes a somewhat new and different world.”

The second narrative describes a New Normal, a term coined by Mohamed El-Erian from Pimco, where growth remains anemic for an extended period of time. After a pretty strong fourth quarter, with a GDP growth revised up to 5.9%, the first camp is having the upper hand. And they could be correct: PCE is has surprised to the upside, as well as most ISM figures, stock market has rebounded strongly, corporate have an historical high level of cash and home prices are up year on year.

However, I tend to be on the side of the second narrative, firm believer that the household debt to GDP ratio can’t continue to increase. (If there has to be only one reason, that would be the one.) That is what the following graph is showing:

(additional graphs on the topic)

Thanks to this increasing debt burden consumption has grown faster than GDP for the last 20 years and now represents more than 71% of GDP. This can’t last forever, consumers have to match their debt growth with their cash-flow and asset growth:

• Because their ability to service their debts depends those cash-flows. Unfortunately they have not been growing as fast…
• Now, it could still work if the asset side of their balance sheet was increasing. But after a stock and a real estate bubble, it is hard to find a new asset class in their balance sheet that a) has not been hammered and b) that could have the potential for double digit annual returns.

So forget the American consumer, at least for now, he has to deleverage.

No big deal, Lockhart mentioned the emerging economies, and especially China, as a “back-up plan”. Great GDP growth, hudge consumer base… Unfortunatly Chinese’s consumer spending is still increasing at a slower pace than GDP. Rebalancing has not even started there… Making it even harder to bet on the business as usual scenario.

Saudi Arabia’s oil exports

That is it, Saudi Arabia now exports more oil to China than the US :

The geopolitical consequences of such a shift are important.  Yes, Saudi Arabia remains under the US military shield, but its biggest customer is now China…