Appear to have put the EMU back together again.
I outlined in a previous post (here) what I thought would be necessary to put a (medium-term) end to the European sovereign debt/banking crisis. Overnight announcements out of Europe present a rough draft of what I was looking for: a considerable "voluntary" write-down of Greek debt, plans to recapitalize Europe's banks, and an expanded EFSF. The details are sketchy and need fleshing out, but all of the requisite pieces are there. While this package does nothing to address the longer-term structural issues in the EMU (see previous post here), it seems to be sufficient to give that can a good punt down the road.
Markets appear to agree with my analysis. Credit spreads dropped, and equities rallied fiercely - the Eurostoxx index was up 6%! The marginal moves in short-term European bank funding costs were somewhat unsettling (sorry no imbedded charts, but you can see the one-year EUR-USD basis swap here, couldn't find a chart of the 3-month Euribor-OIS spread), but I expect these to tighten as the mechanics of the bank recapitalizations emerge and are implemented.
Smooth sailing for now. Let's forget the pending European recession and the childish partisan politics being played on the American deficit super-commission - those are concerns for another day.
Thursday, October 27, 2011
Monday, October 24, 2011
The Semantics of Feedback Loops
People who know me well know that I can be a stickler for proper English.
Recently one particularly egregious journalistic oversight has re-emerged. I can remember reading about "negative feedback loops" between the real economy and financial markets back in 2008 (examples here and here) whereby bad economic data were leading to sell-offs in financial markets, which were in turn undermining confidence, and thereby negatively impacting the real economy. Today's "negative feedback loops" are generally between sovereign debt yields and sovereign solvency (here and here).
However, this mechanism, whereby one event causes a second event which in turns reinforces the original event is actually known as a positive feedback loop (here). A system is described as a negative feedback loop when an initial shock is mitigated by its secondary effects - such as the pancreas secreting more insulin in response to elevated glucose levels in the blood.
Journalist, bloggers, and arm-chair philosophers take note.
Recently one particularly egregious journalistic oversight has re-emerged. I can remember reading about "negative feedback loops" between the real economy and financial markets back in 2008 (examples here and here) whereby bad economic data were leading to sell-offs in financial markets, which were in turn undermining confidence, and thereby negatively impacting the real economy. Today's "negative feedback loops" are generally between sovereign debt yields and sovereign solvency (here and here).
However, this mechanism, whereby one event causes a second event which in turns reinforces the original event is actually known as a positive feedback loop (here). A system is described as a negative feedback loop when an initial shock is mitigated by its secondary effects - such as the pancreas secreting more insulin in response to elevated glucose levels in the blood.
Journalist, bloggers, and arm-chair philosophers take note.
Saturday, October 22, 2011
A Few Good Articles
Some of the articles I have read lately that I deem worthy of further consideration.
NY Fed: perhaps we don't need the all-encompassing solution to Europe's soveriegn debt crisis. Lessons from the resolution of the speculative attack on the European exchange rate mechanism in the early 1990s - here.
John Kay weighs in on the state of economics. Probably the most lucid piece I have read on the topic yet. Here.
Some throwback Michael Pettis on the what the PBoC can and can't do with their reserves. Here.
NY Fed: perhaps we don't need the all-encompassing solution to Europe's soveriegn debt crisis. Lessons from the resolution of the speculative attack on the European exchange rate mechanism in the early 1990s - here.
John Kay weighs in on the state of economics. Probably the most lucid piece I have read on the topic yet. Here.
Some throwback Michael Pettis on the what the PBoC can and can't do with their reserves. Here.
Thursday, October 20, 2011
Inflation vs Austerity
When facing unsustainable sovereign debt dynamics, a country which is a currency printer* may response with any of the following three approaches (ranked from most to least common): fiscal austerity, a period of heightened inflation, and default. The conventional wisdom is that default is so devastating that it should be avoided at all costs, and while this may not necessarily be reflective of reality (see Iceland, among others) I do not intend to challenge that assumption here.
I would like to debate inflation versus fiscal austerity as approaches to unsustainable sovereign debt. Once again, conventional wisdom (which weighs in overwhelmingly on the side of austerity) appears to have stifled any real discussion in this direction. I suspect that this is due to policymakers’ memories of the stagflation era, and the extraordinary efforts of Volcker et al required to get inflation under control. This has led to a “don’t let that rabbit out of the hat again” mentality, effectively removing a period of heightened inflation from policymakers’ toolkits.
Not being old enough to remember the aforementioned era removes leaves me more suited to engage in a measured assessment of inflation as a sovereign debt policy tool. The way I see it, the fear of inflation becoming ingrained is misplaced. I am a subscriber of the balance-sheet recession theory (is there really any debate left here?) which posits that the private-sector deleveraging we are witnessing causes considerable deflationary pressures in the economy. In such an economy, if monetary authorities generate elevated inflation, inflation may be brought back into target ranges simply by scaling down or reversing the inflation-stimulating policy.
Sticking to more conventional economics, concerns over ingrained inflation are still misplaced. Inflation-indexed wages negotiated by unions have been identified as a major driver of the persistence of inflation in the 1970s. Due to the sustained downtrend in union density in developed economies, this simply would not be a factor this time around, implying much less inflation "staying power."
A final argument against persistent inflation is the credibility that policy makers have attained in 15 to 20 years of largely successful inflation targeting. If policy makers were to explicitly target a given level of inflation until government debt fell to a predetermined level (or for a pre-specified period of time), and commit to a reversion to more traditional policy thereafter, I suspect that such commitments would be viewed as credible by the private economy.
Having established the reversibility of heightened inflation in today’s context, let’s consider its effects. With the exception of inflation-linked notes, all debt is denominated in nominal currency units, which means that inflation of say 5% is a very effective method of reducing the national debt burden. Who suffers from such a policy? Two demographics: (1) creditors (ie the rich), who have the real value of their savings eroded, and (2) the poor, who feel the most acute pressure from rising price levels. The middle class also feels the squeeze of rising prices, but not to the same extent as the poor. While no solution to unsustainable government debt is pleasant, these consequences are arguably more efficient than those of austerity.
Furthermore, taking the cynical view, inflation is also arguably more efficient from a social unrest perspective. While inflation leads to a slow burn of discontent (via slow, steady increases in price levels), government austerity has much more recognizable, tangible effects, such as the cutting of wages in the public sector, or a reduction in welfare benefits. Such identifiable consequences may come to represent rallying points for social unrest.
The reasoning above leads me to conclude that elevated inflation should at least enter the policy arena, although admittedly it would have to be precluded by an integration of monetary and fiscal policy, similar to that advocated by Cullen Roche at The Pragmatic Capitalist (here).
*Currency printers (ie the US and UK) differ from currency users (any member of the EMU) in that they determine their own monetary policy, and therefore inflation.
I would like to debate inflation versus fiscal austerity as approaches to unsustainable sovereign debt. Once again, conventional wisdom (which weighs in overwhelmingly on the side of austerity) appears to have stifled any real discussion in this direction. I suspect that this is due to policymakers’ memories of the stagflation era, and the extraordinary efforts of Volcker et al required to get inflation under control. This has led to a “don’t let that rabbit out of the hat again” mentality, effectively removing a period of heightened inflation from policymakers’ toolkits.
Not being old enough to remember the aforementioned era removes leaves me more suited to engage in a measured assessment of inflation as a sovereign debt policy tool. The way I see it, the fear of inflation becoming ingrained is misplaced. I am a subscriber of the balance-sheet recession theory (is there really any debate left here?) which posits that the private-sector deleveraging we are witnessing causes considerable deflationary pressures in the economy. In such an economy, if monetary authorities generate elevated inflation, inflation may be brought back into target ranges simply by scaling down or reversing the inflation-stimulating policy.
Sticking to more conventional economics, concerns over ingrained inflation are still misplaced. Inflation-indexed wages negotiated by unions have been identified as a major driver of the persistence of inflation in the 1970s. Due to the sustained downtrend in union density in developed economies, this simply would not be a factor this time around, implying much less inflation "staying power."
A final argument against persistent inflation is the credibility that policy makers have attained in 15 to 20 years of largely successful inflation targeting. If policy makers were to explicitly target a given level of inflation until government debt fell to a predetermined level (or for a pre-specified period of time), and commit to a reversion to more traditional policy thereafter, I suspect that such commitments would be viewed as credible by the private economy.
Having established the reversibility of heightened inflation in today’s context, let’s consider its effects. With the exception of inflation-linked notes, all debt is denominated in nominal currency units, which means that inflation of say 5% is a very effective method of reducing the national debt burden. Who suffers from such a policy? Two demographics: (1) creditors (ie the rich), who have the real value of their savings eroded, and (2) the poor, who feel the most acute pressure from rising price levels. The middle class also feels the squeeze of rising prices, but not to the same extent as the poor. While no solution to unsustainable government debt is pleasant, these consequences are arguably more efficient than those of austerity.
In the case of austerity, the brunt of the pain is borne by the lower and middle classes. This is because, when compared with the rich, this area of the income curve is more reliant on government programs than the rich. Naturally, the poor again are the hardest hit, as they are the most reliant on government programs. Given that they are not as reliant on government spending the rich are left relatively unscathed. Additionally, fiscal austerity tends to lead to sustained periods of below-trend growth (or more usually, widens and sustains an existing gap between trend and realized growth), which has serious ramifications across the income spectrum.
Furthermore, taking the cynical view, inflation is also arguably more efficient from a social unrest perspective. While inflation leads to a slow burn of discontent (via slow, steady increases in price levels), government austerity has much more recognizable, tangible effects, such as the cutting of wages in the public sector, or a reduction in welfare benefits. Such identifiable consequences may come to represent rallying points for social unrest.
The reasoning above leads me to conclude that elevated inflation should at least enter the policy arena, although admittedly it would have to be precluded by an integration of monetary and fiscal policy, similar to that advocated by Cullen Roche at The Pragmatic Capitalist (here).
*Currency printers (ie the US and UK) differ from currency users (any member of the EMU) in that they determine their own monetary policy, and therefore inflation.
Monday, October 17, 2011
The High-Yield Freeze
Recently there have been a number of comparisons between financial conditions today and those of Q4 2008. A lot of these parallel that have been drawn are tenuous, but one I do think is relevant is the high-yield primary market.
High yield issuance has been going gangbusters over the last couple of years, setting records in 2009, 2010, and was recently on pace for another record in 2011. However, the latest bout of financial instability has left investors unwilling to allocate fresh money to this sector, reducing the flood of high-yield issuance to a tiny trickle over the last 10 weeks.
Assuming the pace that was observed from January through the end July of this year were sustained, there is approximately $65B in 'missing' issuance. Making the further assumption that high-yield corporations have a marginal propensity to spend which approaches 1, this 'missing' issuance represents as much as .5% of annual GDP. With government expenditure set to contract in 2012, any marginal reduction in private investment is not a welcome sign for the economic recovery. Let's hope this market thaws sooner rather than later.
High yield issuance has been going gangbusters over the last couple of years, setting records in 2009, 2010, and was recently on pace for another record in 2011. However, the latest bout of financial instability has left investors unwilling to allocate fresh money to this sector, reducing the flood of high-yield issuance to a tiny trickle over the last 10 weeks.
Sunday, October 16, 2011
A Europlan that Works
Winston Churchill once remarked that "American can always be counted on to do the right thing... after they have exhausted all other possibilities." While the veracity of this statement is certainly up for debate, it seems to apply to European policymakers in today's context.
Over the last 18 months a litany of ineffective plans have been drafted and implemented to deal with the sovereign debt crisis. Leaving various nuances aside, these plans are pretty effectively summed up by the following: (1) Provide country X with Y billion euros in loans at below-market rates, (2) force austerity on country X, (3) declare that country X is illiquid rather than insolvent and reiterate commitment to no bankruptcies in the euro area (4) on the basis of illiquidity rather than insolvency, have the ECB purchase country X's bonds. Keen minds in financial markets saw through each of these plans (Macro Man has offered a concise analysis of the failings of each plan), and the market disruptions they were designed to end always re-emerged.
The most recent bout of market instability differed from those which preceded it in that it posed an immediate existential threat to the European banking sector. This seems to have finally woken European policy makers up to the scale and severity of the problem. A series of meetings (and subsequent statements/announcements), as well as various leaks have offered observers a glimpse of the plan being negotiated. It appears to include the following:
It is important to point out that the plan, in the form outlined above, would not address the longer-term structural issues I outlined in my earlier post. However, it would mitigate the more immediate threat, giving policy makers time to make the necessary adjustments to the legal structure governing the euro area (I am not particularly optimistic that the necessary changes will be made, however that is a discussion for another day).
Over the last 18 months a litany of ineffective plans have been drafted and implemented to deal with the sovereign debt crisis. Leaving various nuances aside, these plans are pretty effectively summed up by the following: (1) Provide country X with Y billion euros in loans at below-market rates, (2) force austerity on country X, (3) declare that country X is illiquid rather than insolvent and reiterate commitment to no bankruptcies in the euro area (4) on the basis of illiquidity rather than insolvency, have the ECB purchase country X's bonds. Keen minds in financial markets saw through each of these plans (Macro Man has offered a concise analysis of the failings of each plan), and the market disruptions they were designed to end always re-emerged.
The most recent bout of market instability differed from those which preceded it in that it posed an immediate existential threat to the European banking sector. This seems to have finally woken European policy makers up to the scale and severity of the problem. A series of meetings (and subsequent statements/announcements), as well as various leaks have offered observers a glimpse of the plan being negotiated. It appears to include the following:
- A forced Greek default, with a haircut of 40-50%.
- A commitment that no other countries will be allowed to default (this will require either a larger EFSF or more bond purchases by the ECB to be credible).
- Bank recapitalizations. There is to be a new round of stress tests including a much harsher set of assumptions surrounding sovereign debt valuations. Where the estimated 200 billion euros necessary to get all European banks to the targeted 9% tier 1 capital under the stressed scenario will come from is to be determined, but it seems that there are enough good credits in Europe to raise the money.
It is important to point out that the plan, in the form outlined above, would not address the longer-term structural issues I outlined in my earlier post. However, it would mitigate the more immediate threat, giving policy makers time to make the necessary adjustments to the legal structure governing the euro area (I am not particularly optimistic that the necessary changes will be made, however that is a discussion for another day).
Thursday, October 13, 2011
Chalk One Up for the Good Guys
Raj Rajaratnam (of Galleon Group fame) got what he had coming today.
11 years in federal prison - the longest sentence for insider trading in history. Plus a $10 million fine to boot; pile that on top of his lawyer fees.
He deserves it. He operated a huge network of executives and analysts who routintely exploited insider information for profit. Not that I consider insider trading particularly out of the ordinary, but I like to believe that most shops haven't made it as large a part of their day-to-day business practice as Galleon did.
This is important. The investigation that led to this trial was the first time that wiretaps were used in an insider trading case. Talk about a game changer. The possibility Big Brother listening in on your phone calls will make networks such as Raj's considerably harder to operate moving forward. And that's the really determined people. There will be a lot of others who will simply stop trading on tips for fear of prosecution. This will lead to fairer markets going forward.
Kudos to the investigators and the prosecutors.
11 years in federal prison - the longest sentence for insider trading in history. Plus a $10 million fine to boot; pile that on top of his lawyer fees.
He deserves it. He operated a huge network of executives and analysts who routintely exploited insider information for profit. Not that I consider insider trading particularly out of the ordinary, but I like to believe that most shops haven't made it as large a part of their day-to-day business practice as Galleon did.
This is important. The investigation that led to this trial was the first time that wiretaps were used in an insider trading case. Talk about a game changer. The possibility Big Brother listening in on your phone calls will make networks such as Raj's considerably harder to operate moving forward. And that's the really determined people. There will be a lot of others who will simply stop trading on tips for fear of prosecution. This will lead to fairer markets going forward.
Kudos to the investigators and the prosecutors.
Wednesday, October 12, 2011
Why the Euro Doesn't Work
Currently there are two existential problems in the euro area. The first is a relatively recent development and must be dealt with immediately, while the second has been building for about a decade and requires longer-term solutions:
Before the nations now known rather pejoratively as the European periphery joined the euro area, their workers were kept competitive with those industrious Germans through a regime of flexible exchange rates. For example, if the Portuguese were not innovating as quickly as the Germans, the Portuguese escudo would depreciate against the German mark, making Portuguese products relatively cheaper (all else equal) and thereby allowing the Portuguese to compete with the Germans in international trade.
When the euro was introduced, this mechanism disappeared and the European periphery rapidly lost competitiveness with the core.
Seems like a raw deal right? Well not entirely. The upside for these chronically uncompetitive countries was that, despite all of structural differences between the economies, the bond markets began treating debt issued by any European government as essentially the same credit (assuming an implicit mutual guarantee). This allowed these countries to fill the gap created by the erosion of their domestic private sector with government spending financed by cheap debt issuance.
This was all good until it wasn't. Once people woke up to state of the sovereign finances in these countries (initially just Greece), they rushed for the exits. With European policymakers refusing to take bold action to resolve the crisis, it spread and evolved to the point where we stand now - uncomfortably close to the abyss.
The next post will describe in more detail why policy fixes introduced have been insufficient, and detail the policy prescription necessary for Europe to extricate themselves from the mess they have found themselves in.
Note: I have not included Ireland in this discussion because I consider both its path to fiscal ruin and the steps to recovery be considerably different from the nations detailed above.
- The positive feedback loop between insolvency in the European periphery and stresses in the European banking sector.
- The long-term structural divide between unit labour costs in the north and the south of Europe.
Before the nations now known rather pejoratively as the European periphery joined the euro area, their workers were kept competitive with those industrious Germans through a regime of flexible exchange rates. For example, if the Portuguese were not innovating as quickly as the Germans, the Portuguese escudo would depreciate against the German mark, making Portuguese products relatively cheaper (all else equal) and thereby allowing the Portuguese to compete with the Germans in international trade.
When the euro was introduced, this mechanism disappeared and the European periphery rapidly lost competitiveness with the core.
This was all good until it wasn't. Once people woke up to state of the sovereign finances in these countries (initially just Greece), they rushed for the exits. With European policymakers refusing to take bold action to resolve the crisis, it spread and evolved to the point where we stand now - uncomfortably close to the abyss.
The next post will describe in more detail why policy fixes introduced have been insufficient, and detail the policy prescription necessary for Europe to extricate themselves from the mess they have found themselves in.
Note: I have not included Ireland in this discussion because I consider both its path to fiscal ruin and the steps to recovery be considerably different from the nations detailed above.
Friday, October 7, 2011
Bad Asset Allocation (BAA) I
I have been critical of the valuations attached to the .com 2.0 firms since Groupon turned down $6 billion from Google. I said it then, and I’ll say it again Groupon/Google will prove to be the next Yahoo/Microsoft.
Let’s have a look at the biggest name to IPO before markets crashed in August.
Let’s have a look at the biggest name to IPO before markets crashed in August.
This clearly isn’t pets.com (there are real earnings there) but I can’t countenance that P/E. They’re priced for better than perfection.
I’ve heard all of the bull cases:- They’re going to grow exponentially forever!
- Investors are willing to pay a premium for high-growth companies in low-growth environments!
- They are revolutionizing the head-hunting industry!
- Think of all the advertising dollars they can rake in!
Monday, October 3, 2011
The Future of the Renminbi
If there has been one sure bet in financial markets over the last few years, it has been on an appreciation of the Chinese renminbi against the U.S. dollar.
The appreciation has been slow but steady. After a few years of managed appreciation, the renminbi was repegged during the 2008 crisis. In response to considerable pressure from the United States, the peg was removed and the currency was re-'floated' in June 2010. However, the Chinese authorities continue to set the daily closing value and the renminbi has appreciated less than 7% against the U.S. dollar since then. Reputable estimates of the size of the undervaluation are as high as 70% (here), but my read of the 'main-stream' estimate has been about 20-30%.
This intervention has caused considerable furor in the United States. It seems like every six months (or is it a year?) there is a bout of political grandstanding surrounding whether the Treasury will be forced by the Senate to include China on their list of currency manipulators, which would pave the way for the U.S. government to impose trade sanctions. Of course, due to the symbiotic nature of the trade relationship between China and the United States, this never ends up happening, but the posturing appears to have started again (here).
The market however, sees things quite differently. The renminbi forwards market is currently pricing a depreciation of the currency against the U.S. dollar over the coming months.
In other words...
The best explanation I can come up with is that the market consensus is waking up to the Jim Chanos version of the Chinese growth story - economic expansion fueled by unsustainable credit growth which is financing enormous investment in overcapacity (here, starting at the 7 minute mark). While the renminbi forwards have moved in a manner consistent with the recent sell-off in Chinese equities and commodities, I was still quite surprised to see this pricing in the forward markets. Any divergence between these asset classes should be closely monitored moving forward.
The appreciation has been slow but steady. After a few years of managed appreciation, the renminbi was repegged during the 2008 crisis. In response to considerable pressure from the United States, the peg was removed and the currency was re-'floated' in June 2010. However, the Chinese authorities continue to set the daily closing value and the renminbi has appreciated less than 7% against the U.S. dollar since then. Reputable estimates of the size of the undervaluation are as high as 70% (here), but my read of the 'main-stream' estimate has been about 20-30%.
This intervention has caused considerable furor in the United States. It seems like every six months (or is it a year?) there is a bout of political grandstanding surrounding whether the Treasury will be forced by the Senate to include China on their list of currency manipulators, which would pave the way for the U.S. government to impose trade sanctions. Of course, due to the symbiotic nature of the trade relationship between China and the United States, this never ends up happening, but the posturing appears to have started again (here).
The market however, sees things quite differently. The renminbi forwards market is currently pricing a depreciation of the currency against the U.S. dollar over the coming months.
In other words...
The best explanation I can come up with is that the market consensus is waking up to the Jim Chanos version of the Chinese growth story - economic expansion fueled by unsustainable credit growth which is financing enormous investment in overcapacity (here, starting at the 7 minute mark). While the renminbi forwards have moved in a manner consistent with the recent sell-off in Chinese equities and commodities, I was still quite surprised to see this pricing in the forward markets. Any divergence between these asset classes should be closely monitored moving forward.
Saturday, October 1, 2011
Rececssion Ahoy!
On Friday, the ECRI publicized their call that the U.S. economy was headed for a recession (here). This firm has a respectable track record of forecasting turns in the business cycle, so this is a particularly noteworthy call.
Most of the financial commentary I have read so far has been forecasting a garden-variety recession (should one even occur), with corporate earnings falling 10-15%. While I have yet to be able to quantify the effect on corporate earnings, I take issue with comparisons to historical recessions for a number of reasons.
Starting with the C in Y = C + I + G + X, the consumer is still balance-sheet constrained. Historically, when consumer income fell, consumers would borrow money to smooth their consumption. With the American consumer leverage sitting as high as it is, it is likely that consumer spending will fall more than in historical recessions (higher flow through from falling consumer income).
Moving on to investment, while I am not expecting a total credit market freeze for highly-rated corporates, the high-yield primary market has been effectively closed for nearly three months. Historically, high-yield names have not been a meaningful proportion of total corporate issuance, but in the last two years, we have seen $600B in high-yield issuance, which I suspect has significantly inflated business capital expenditures (admittedly some of this issuance was debt-for-loan swaps). With this group of firms locked out of the primary market (and higher-rated firms behaving in line with historical experience) I expect there to be a larger decline in business investment than has been seen in historical recessions.
Government. Given the hysterical obsession with cutting spending (and taxes) in the House, I cannot see the U.S. passing any marginal stimulus until after the 2012 elections. If this is the case, government expenditures will actually contract relative to 2011. This is in direct contrast to historical recessions, wherein the government traditionally inflates expenditure in an attempt to stimulate the economy.
I do not have any strong feelings on net exports and feel that it is probably a wash.
Throw in European and Chinese tail risks, and the risks to the consensus recession forecast are clearly overweighted on the downside.
I should clarify that I am not saying with 100% certainty that teh U.S. is headed for a recession (although I do believe that a recession is more probable than not), but rather detailing my thoughts on the nature of the recession, should it occur. I will flesh out these thoughts in upcoming posts.
Most of the financial commentary I have read so far has been forecasting a garden-variety recession (should one even occur), with corporate earnings falling 10-15%. While I have yet to be able to quantify the effect on corporate earnings, I take issue with comparisons to historical recessions for a number of reasons.
Starting with the C in Y = C + I + G + X, the consumer is still balance-sheet constrained. Historically, when consumer income fell, consumers would borrow money to smooth their consumption. With the American consumer leverage sitting as high as it is, it is likely that consumer spending will fall more than in historical recessions (higher flow through from falling consumer income).
Moving on to investment, while I am not expecting a total credit market freeze for highly-rated corporates, the high-yield primary market has been effectively closed for nearly three months. Historically, high-yield names have not been a meaningful proportion of total corporate issuance, but in the last two years, we have seen $600B in high-yield issuance, which I suspect has significantly inflated business capital expenditures (admittedly some of this issuance was debt-for-loan swaps). With this group of firms locked out of the primary market (and higher-rated firms behaving in line with historical experience) I expect there to be a larger decline in business investment than has been seen in historical recessions.
Government. Given the hysterical obsession with cutting spending (and taxes) in the House, I cannot see the U.S. passing any marginal stimulus until after the 2012 elections. If this is the case, government expenditures will actually contract relative to 2011. This is in direct contrast to historical recessions, wherein the government traditionally inflates expenditure in an attempt to stimulate the economy.
I do not have any strong feelings on net exports and feel that it is probably a wash.
Throw in European and Chinese tail risks, and the risks to the consensus recession forecast are clearly overweighted on the downside.
I should clarify that I am not saying with 100% certainty that teh U.S. is headed for a recession (although I do believe that a recession is more probable than not), but rather detailing my thoughts on the nature of the recession, should it occur. I will flesh out these thoughts in upcoming posts.
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