Is Jim Grant the Latest To Be Drinking the Kool-Aid?

David Rosenberg of Gluskin Sheff comments on Jim Grant’s WSJ column:

The Weekend Journal ran with an article by James Grant, which admittedly took us by surprise (he is a true giant in the industry, as an aside) — From Bear to Bull and in the article, he relies mostly on the thought process from two economic think-tanks — Michael Darda from MKM Partners and the folks over at the Economic Cycle Research Institute.

We highly recommend this article for everyone to read to understand the other side of the debate. But we have some major problems with the points being made.

1. Mr. Grant starts off by saying that “as if they really knew, leading economists predict that recovery from our Great Recession will be plodding, gray and jobless.” Well, frankly, it doesn’t really matter what “leading economists” are saying because Mr. Market has already moved to the bullish side of the debate having expanded valuation metrics to a point that is consistent with 4% real GDP growth and a doubling in earnings, to $83 EPS, which even the consensus does not expect to see until we are into 2012. We are more than fully priced as it is for mid-cycle earnings.
2. Nowhere in Mr. Grant’s synopsis do the words “deleveraging” or “credit contraction” show up. Yet, this is the cornerstone of the bearish viewpoint. Attitudes towards homeownership, discretionary spending and credit have changed, and the change is secular, not merely cyclical. After all, didn’t consumers just see a record $20 billion of outstanding credit evaporate in August?
3. Mr. Grant emphasizes (the Darda argument) how we had a huge bounce in the economy after the worst point of the Great Depression (in fact, the subtitle of the article contains: “The deeper the slump, the zippier the recovery”). Well, we didn’t have the Great Depression this time around — real GDP did not contract 25% but rather by 3.7%. We probably have to go now and redefine what a massive slump is. But all we had in the mid-part of the 1930s — between the worst point in 1932 to the 1937-38 relapse — was a statistical recovery, and nothing more than that. Nobody from that era will recall that any year was particularly good — each one was just different shades of pain and sacrifice. By the end of the decade, the unemployment rate was still 15%, the CPI was deflating at a 2% annual rate and the level of nominal GDP, as well as industrial production, still had yet to re-attain its 1929 peak. The equity market in 1941 was no higher than it was in 1933 (and long bond yields were heading below 2%) and even a child knows that it was WWII that brought the economy out of its malaise, not the seven years of New Deal stimulus.

So, to concentrate on the wiggles in the GDP data in the 1930s, no matter how large, totally misses the point about what the decade was really about, which was social change, a focus on family, less discretionary spending, and a trend towards frugality that few market pundits seem to comprehend. But the 1930s were the antithesis of the 1920s — not unlike what we are witnessing today. To concentrate on a bungee jump that wasn’t even sustained is akin to focusing on the noise around the trend-line as opposed to the trend-line itself.

4. The very sexy argument about how all the government stimulus is going to give the economy a really big lift — combined monetary and fiscal measures are worth 19.5% of GDP. This is viewed as a good thing, of course, but nowhere in the analysis is there a comment about how this “stimulus” is just there to cushion the blow and smooth the transition as wide swaths of private sector credit vanish. We are at the point where 85% of housing activity is still being supported by government interventions. Is this really desirable? According to BusinessWeek, it’s not just the FHA financing 40% of new mortgage originations but the USDA is also allowing builders and lenders to take advantage of rural mortgages that require no-money down and with 100% financing through “a little-known loan program”.

Well, as with most bulls, this new era of state capitalism is a reason to rejoice. But from our lens, what would be more noteworthy would be an article explaining that the massive government incursion with all this “stimulus” is actually more a reason to be concerned than be jubilant — what it really symbolizes is an economy that is so sick that it continues to require massive doses of medication.

It’s not what all the stimulus does that matters — of course, it is there to act as a cushion — but it is what all the stimulus has come to symbolize. A fundamentally weak economic backdrop and a precarious banking system that has government guarantees to thank for its survival.

Rothbard Vindicated on Analysis of Great Depression

Joseph Salerno from Mises.org reports on a National Bureau of Economic Research working paper written by a prominent macroeconomist — and accepted for publication by the influential Journal of Economic Theory — which challenges the Friedman-Schwartz view and lends ample evidence to the Rothbardian position on the genesis of the Great Depression.

In America’s Great Depression, originally published in 1963, Murray Rothbard argued that the recession-adjustment that began in 1929 was greatly worsened and turned into a full-blown depression by the policies implemented by Herbert Hoover. Among the Hooverite policies that stifled the adjustment process, Rothbard identified public-works programs, increases in taxes, the imposition of the Smoot-Hawley tariff, but especially Hoover’s efforts to prevent the downward adjustment of nominal wages by exerting pressure on big industrialists not to cut (and even to raise) their employees’ wage rates.

Rothbard’s explanation of how the temporary and benign recession-adjustment process was impeded and diverted into the Great Depression ran counter to the view that Milton Friedman and Anna Schwartz put forth in their classic work A Monetary History of the United States, 1867–1960, also published in 1963. According to Friedman-Schwartz, it was the collapse of the money supply due to the negligence of the Fed that turned what should have been a “garden-variety recession” into the Great Depression. The Friedman-Schwartz view came to dominate mainstream macroeconomics after the collapse of the Keynesian consensus in the 1970s. Indeed, it is today the conventional explanation of the Great Depression, which Bernanke holds to and which governs the policy response of the Fed to the current financial crisis.

Thus, for decades Rothbard and a handful of Misesian economists were virtually alone in maintaining that Hoover’s interventionist policies, particularly as they impacted the industrial labor market, were mainly responsible for transforming what should have been a short and sharp recession into the economic catastrophe of epic proportions that we now know as the “Great Depression.” Now comes a National Bureau of Economic Research working paper written by a prominent macroeconomist with impeccable academic credentials — and accepted for publication by the influential Journal of Economic Theory — which challenges the Friedman-Schwartz view and lends ample evidence to the Rothbardian position on the genesis of the Great Depression. In writing his article, “Who — or What — Started the Great Depression,” UCLA economist Lee E. Ohanian spent four years poring over wage data and culling information from sources related to Hoover and his administration.

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Krugman: How Did Economists Get It So Wrong?

Paul Krugman wrote a lengthy piece in the New York Times Magazine today. It is a very hard critique and analysis of the failure of current macro and financial economic thought, which didn’t even come close to predicting the current financial malaise. I don’t agree with all of it, particularly his love affair with Keynesian economics. But it is still very worthy of your time and a recommended read. A point where I agree with Krugman: the failure of EMH.

Below is an excerpt:

As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn’t sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealized market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives. But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.

Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.

It’s much harder to say where the economics profession goes from here. But what’s almost certain is that economists will have to learn to live with messiness. That is, they will have to acknowledge the importance of irrational and often unpredictable behavior, face up to the often idiosyncratic imperfections of markets and accept that an elegant economic “theory of everything” is a long way off. In practical terms, this will translate into more cautious policy advice — and a reduced willingness to dismantle economic safeguards in the faith that markets will solve all problems.

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