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This Friday is Yom Kippur, the day when Jews around the world ask
forgiveness for their transgressions from the year past. Rabbis remind the
penitent to dwell on their sins of omission, in which they did nothing when a
more thoughtful and proactive action was needed, and sins of commission, in
which they actively participated in an unjust action. And while not all
economists are Jewish, Gene Epstein the economics editor at Barron's, offered his thoughts on
how this applies to the group.
While Gene is certainly on to something, I think he could have gone much
further in his finger pointing. Increasingly, economists are calling the tune
to which businesses and consumers dance. Since their words and opinions
matter, they may consider seeking forgiveness for what they have said, and
what they have not.
Sins of Omission
Despite clear evidence that elevated prices in stocks, bonds and real
estate remain a direct consequence of zero percent interest rates and
quantitative easing, the crowd has asserted again and again that the prices
are justified by the surging U.S. economy. There is very scant evidence upon
which to base such an opinion.
Most economists have held very tightly to the view that was widely shared
at the end of 2013; that 2014 will be the year that the U.S. economy finally
shakes off the malaise of the Great Recession. And even though the script has
failed to live up to these expectations, the economists haven't seemed to
notice.
During the First Quarter of this year, the economy contracted at an
astounding annual pace of 2.1%. But economists and politicians were very
insistent that the severe miss was solely a result of the difficult winter.
Although severe winters can be a drag on an economy (my research shows that
the 10 roughest winters over the last 50 years knocked about two points off
the normal first quarter GDP), the snow could not fully explain a five point
miss from what had been forecast by the consensus at the end of 2013. But
that's exactly what they did.
This omission was compounded by their reaction to the 2nd quarter
rebound, which showed the economy expanding by 4.6%. But while the crowd was
ready to dismiss the very weak first quarter GDP as being a weather-related
anomaly, they were not willing to acknowledge the role played by the same
anomaly in artificially boosting second quarter GDP. My research, based on figures
from the Bureau of Economic Analysis, has shown that strong second quarter
rebounds almost always follow sub-par weather-related first quarters. This
makes intuitive sense as well. Activity that is delayed in winter gets
unlocked in spring. But economists look at the second quarter as if it
represents the entire year. But already plenty of evidence has emerged that
should sow doubts on the remainder of the year.
Even with the strong second quarter, economists are choosing to gloss over
the fact that growth in the entire first half came in at just 1.25%, far
below the projections that most have for the calendar year. To get to 2.5%
GDP growth, which would be typical of a weak year, not the first year of a
long-awaited recovery breakout, GDP would have to come in at 3.75% for the
entire second half. To hit 3% for the year, second half growth would need to
be 4.75%.
But this will have to occur without the tail winds of Fed QE support and
at a time of heightened geopolitical concerns, and a housing and stock
markets that look increasingly weak and vulnerable to correction. As a
result, economists should take off their rose-colored glasses and ratchet
down their full year estimates to conform more closely to reality. But that
is not happening.
Sins of Commission
Rather than seeing, hearing, and speaking no evil, some leading figures
are much more culpable in spreading bad information. While this list could
prove lengthy, here are the top two offenders.
Fed Chairwoman Janet Yellen - In her September press conference,
Yellen made the stunning assertion that the Fed's balance sheet, which in
recent years has swelled to a gargantuan $4.5 trillion, will likely be
reduced in size to "normal levels" by the end of this decade.
While most accept this statement at face value, Yellen must know the absolute
inability of the Fed to deliver on this promise.
To bring its balance sheet back to pre-crises levels of around $1
trillion, the Fed must sell about $3.5 trillion of debt over the next five
years, or a pace of about $700 billion per year. This is a negative
equivalent of about $58 billion per month in QE. Additionally, Yellen has
claimed that this can be done without actively "selling" assets,
and without tipping the economy back into recession. This claim is so fantastical
that it must be considered active deception, a grave sin indeed.
First, if QE was necessary to inflate asset prices and create a wealth
effect to drive consumer spending and power the recovery, how can the process
be reversed without unwinding its effects and producing an even larger
recession than the last? If the recovery is already stalling with interest
rates still at zero, how can it gather more upward momentum if the Fed raises
rates back to normal levels?
Secondly, if the Fed does not actively sell bonds into the market, it must
hope to draw down the balance sheet by simply allowing older bonds to mature.
This ignores the fact that the maturation process is far too slow to
accomplish the task by the end of the decade, and it assumes that the Fed will
not have to buy any new Treasury or Mortgage-backed bonds over that time. But
in order to provide financing for ongoing Federal budget deficits, or to
stimulate the economy if there were another economic downturn, the Fed would
have no choice but to start buying again with both hands. Since the current
"recovery" is already 15 months longer than the average post-war
recovery, it would be illogical to assume that we can make it through the
next five years without another recession.
Of course, by affirming its intention not to actively sell any of its
holdings, Yellen is attempting to defray any concerns the markets might have
over the impact such sales would have on bond prices. Lost on everyone,
including Yellen herself, is that the impact on the markets is the same
regardless of how the Fed's balance sheet shrinks. Even if the Fed allows
bonds to mature, the Treasury would then be forced to sell an equivalent
amount of bonds into the market to repay the Fed. The fact that a distinction
without a difference reassures anyone shows just how delusional market
participants remain.
World bank President Jim Yong Kim - In an interview at
September's Clinton Global Initiative, the World Bank president urged the
European Central Bank to follow the same "successful" experiments
in quantitative easing that had been pioneered by the Federal Reserve. As
proof of the policy's success, Kim pointed to the stronger GDP growth that
is expected in the US in 2015 and 2016. In other
words, he is attempting to prove his point not by what has happened thus far,
but by what the consensus expects to happen in a year or two. This is no way
to argue a point. Dr. Kim is a smart guy and I suspect he knows this, hence
another sin of commission.
It would be difficult to make the case that six years of Quantitative
Easing has created a healthy US economy. In addition to the subpar first half
of 2014 GDP growth, the labor market, consumer sentiment, and wage growth all
show signs of stagnation. So Dr. Kim has no choice but to hang his hat on a
bright future that he, and most mainstream economists, expect to be right
around the corner. But dressing up a future possibility as a current
certainty is a major foul in the business of economic forecasting. Dr. Kim,
and others who have made similar claims, should fast an extra day.
Best Selling author Peter Schiff is the CEO and Chief Global
Strategist of Euro Pacific Capital. His podcasts are available on The Peter
Schiff Channel on Youtube
Catch Peter's latest thoughts on the U.S. and International markets
in the Euro Pacific Capital Summer 2014 Global Investor
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