Market musings with David Rosenberg: we’re in a depression
I spoke with David Rosenberg, chief economist at Gluskin Sheff, today to get his take on what’s happening in the markets after Friday’s US credit rating downgrade by the S&P. Here are the highlights of our conversation.
What’s the biggest surprise of the S&P downgrade of the US’s credit rating?
The timing of it. They already had stated their intention, but the timing of it was early.
Why did it come early?
The budget agreement to get the debt ceiling raised is light.
What are the consequences of this?
In a real economic sense, the impact is fairly small. We have to remember it’s a split rating. Moody’s and Fitch have not downgraded the U.S.
What are the global consequences of the US downgrade?
If the U.S. isn’t AAA, it begs the question who is? The real consequences run a lot deeper than the U.S.
What will be more consequential is if France loses their AAA rating. If the U.S. isn’t AAA then I can’t see France having a AAA rating. And if France isn’t AAA you can kiss the European Stability Fund good-bye. Because the ball will then be in Germany’s court and I’m not so sure that the country will be able to bail out the entire euro zone.
So you’re more concerned about the economic situation in Europe than the U.S.?
The crisis of confidence is stemming from the eurozone – not the U.S.
Did bond indices in the U.S. get changed? No. Did banks have to go out and raise capital against bond indices? No. So what is the big deal? It’s a bit of a tempest in a teapot. The U.S. has a split rating. Full stop.
Sounds like the downgrade is not as bad as everyone thinks.
It’s like when Canada got downgraded in 1994. It lit a fire under the seats of the policymakers.
I take it you’re one of many who think policy makers in the U.S. are failing?
The whole point of QE2 was to inflate assets. But QE’s are a bit of a band-aid solution. At best, QE buys you a little bit of time. Once the policy stimulus wears off, the economy sputters. The Bush tax cuts did a better job of stimulating the economy than the tax rebates did from last year.
What can be done now?
On the fiscal side, it’s too late. Nothing on the fiscal side will help the economy.
What should have been done?
What would have helped is a real energy policy combined with a jobs policy.
What happened to real energy policy? If we had a permanent shift to shale gas, that would have helped the economy. We thought we weren’t going to see gas prices go back up into the $100s, but they did. Gas prices and oil prices have gone back up. A permanent decrease in energy costs would be really beneficial and help the bottom line in Washington.
You mentioned a jobs policy as well.
We have a youth unemployment rate of over 20% and a general unemployment rate at 9%. What happened to the war on unemployment from two years ago?
So nothing more can be done in terms of fiscal policy?
The U.S. is a fiscal basket case. We have fiscal deficits that would have made FDR blush.
It’s very limited what can be done in terms of fiscal policy now. We now have double the inventory of unsold homes on the market. How does the Fed address that? The Fed has limited policy capabilities.
What should be done with all the foreclosed homes?
The U.S. should find a way to absorb the huge backlog of foreclosed homes — buy them up and give them to investors to rent.
What would help in the meantime?
What would help is a bipartisan move to eliminate tax expenditures and loopholes. The U.S. has a tax system that doesn’t produce revenues efficiently. It should not have mortgage deductions. Canada did it; the U.S. can do it. The U.S. should also cut its top marginal rates.
When do you think any sort of meaningful reform will happen?
Any real meaningful structural shift won’t happen until after 2012. 2012 is going to be the most critical election of the past three or four decades in terms of fiscal policy.
We have deflation, a credit collapse, an ongoing decline in assets and real estate prices. Along with a global debt crisis. It’s like musical chairs. The debt keeps getting transferred; not expunged.
So what if we had a 12-24 months rally in the equity markets? The same thing happened in the 1930s, when there was a recovery from 1933 to 1936. This is not Japan all over again. What we are in now is probably a modern day depression. The great recession is a polite way of saying a depression – economists are polite people.
So the markets are saying we’re in a depression?
That’s why you have gold at $1700 an ounce. That’s why 10-year Treasury bond yields are lower now. The bond market is saying we are in for weak growth. Gold is saying the government is going to try to reinflate their way out of it.
What can we expect to further happen while riding out the recession/depression?
Growth rates are going to be much weaker globally. There is going to be a prolonged period of very weak activity. Consumer confidence is lower today than after the 1987 crash and after 9/11.
How do we get back to a sustainable bull market and expansion?
In the end, you print money.
When do you think we will come out of this depression?
We are still experiencing aftershocks from the bubble. This is not a plain vanilla recession; this is a balance sheet recession. Balance sheet recessions typically last 5-7 years on average so if this recession started in 2007 then we have until 2012 or 2014 before the recession starts to turnaround. Compound that with rest of the world facing economic downturns as well and it could last even longer.
How are your portfolios fairing?
Things are turning out how we expected them to — we are positioned for this. We’ve been patient all year long. We never bought into the sustainability of QE2. Preserving capital and minimizing our risk on portfolios paid off well.
Lots of portfolio managers are going to have forced selling because they bought at rock bottom. We’re going to be buying what they’re selling. We took advantage of the mispricing in the market. There’s tremendous opportunity when the baby is being thrown out with the bath water. When the markets are at their highs, you can capitalize on that excess supply. When they are at their lows, there’s an excess of worry so there are attractive buying opportunities. We are licking our chops and sharpening our pencils.