A Decade Since the Great Recession

Dan Shainberg

September 10, 2018

Everyone wants to know the future catalyst that will pop the current economic expansion. It could come from a political surprise, or an emerging markets crises, or an inflation scare. Or it could come from something totally unexpected, as it usually does. 

It is extremely difficult to read into current economic indicators to foresee the timing of such a reversal in the economy. The economic figures bounced all over CNBC and Wall Street trading floors are not only usually lagging indicators, but they also are the wrong metrics to look at. Metrics like unemployment trends, CPI and GDP are "income statement" data. They account for performance trends over a specific period of time. And that is precisely the problem when using these data points to try to attempt at forecasting the next recession.

The key to this economic expansion du jour is that the likely tailwind propelling the growth is the numerous rounds of quantitative easing ("QE"). Recent political and regulatory changes under the Trump administration may have inflated the outlook causing market multiples to rise. However, the true underlying economic expansion began with QE1 after the great recession of 2008. It is universally accepted that the catalyst for the upturn in the economy and markets was due to the monetary injections of QE and the resulting expansion of the Fed's balance sheet. We are now seeing some uncertainty as to whether or not they can change course to more of a tightening posture without blowing up the economy. The key is the balance sheet. Not the income statement. 

All debt cycles go through stages. We are at an interesting point in the economic cycle as the Fed already swung from a "loosening" to a "tightening." Getting the money supply balance right is paramount for maintaining a growing economy. Capitalist markets always have these cyclical trends. If one can understand the historical cyclical factors and reference the right balance sheet metrics of today's cycle, then it is possible to forecast the next downturn. 

The debt fueled economic downturns of emerging markets caused by inflation have almost always had a levered sovereign government that could not repay foreign denominated debt. Obviously the United States today is not comparable because our debts are denominated in our domestic currency and thus we can print our way out of the debt crises with a loose monetary policy.

In such cases where government's have the debt denominated in their local currency they can avoid catastrophe as long as they do not fail with central banking policies. If you narrow down the problem the U.S. faces, it is a simple leverage issue. We have way too much Debt relative to our GDP. 

The numerator is the debt and the denominator is the GDP. The debts are relatively fixed and unlikely to be the primary catalyst to improve the formula as there's way too much debt per person in the U.S. and even less when factoring in only taxpaying citizens. Reducing debt would help the financial formula although it could also cause more harm if it causes the economy to turn down which is essentially the denominator. 

Like corporations, the easiest way to delever is not through actually paying off the debt, it is through economic expansion. As an example, in California, owners of real estate have seen tremendous wealth generation from real estate ownership over the past decade. In almost all cases, this strong ROI investment was not caused from real estate owners actually paying off transaction related mortgage notes. It came from the value of the property itself appreciating.

Similarly, for the Debt/GDP formula to improve meaningfully, we have to get economic growth moving. The only true path to macroeconomic nirvana comes through a healthy approach to interest rates. If interest rates are tightened too quickly, the economy sputters and leverage increases due to the denominator declining. If interest rate policy is balanced well with inflation, then the GDP can continue to grow thus reducing leverage. But the beauty of keeping inflation and the economy in a healthy growth mode is that inflation also has the effect of reducing the debt in real terms. The U.S. national debt is not adjusted to inflation (CPI). 

If the government can keep inflation and GDP growing at a stable level then we can reduce our balance sheet problem over time to at least a manageable level that would allow for the typical inflationary responses to the next crises.

Dan Shainberg

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#RecessionResister

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