Wednesday, October 28, 2009

When Economists Collide


Those who have followed anything I’ve written over the years over at Blah3, or more recently here at the Bonddad Blog, know that I have the utmost respect for former Merrill Lynch economist David Rosenberg (now of Toronto’s Gluskin Sheff). I think Rosie’s one of the best in the business, and has always called it as he’s seen it. To his great credit, he was always unwilling to simply toe the sell-side line and blow bullish smoke up everyone’s behind, despite often catching flak for his bearish posture. He was foretelling the story of our recent catastrophe – particularly as it relates to the housing bubble – long before anyone else (including Roubini or Taleb) was onboard. And, unlike them, he was very specific about what was going to trigger the recession -- he wrote about a housing market bubble forming in August 2004 and articulated very clearly that trouble was brewing as a result of it.

When Rosie left Merrill, there was almost immediately a very subtle, very nuanced shift toward a more bullish posture. And when the announcement was made that Ethan Harris was to replace him, the bullish spin went into overdrive (how could it be otherwise when you’ve now got an economist forecasting 3%+ GDP growth for the next six quarters?).

Lately, it seems as though the rhetoric has been escalating.

Those who have followed Rosie know two things for sure about his work, since he hammered them home every chance he could (almost daily):

1) The U.S. consumer – whose Debt-to-Income ratio rose to the stratosphere in an orgy of consumption – needs to return to a more frugal existence, spending less and saving more. As I detailed recently, a mere return to the long-term trendline of Debt-to-Income implies a shedding of about $1.6 trillion of debt (reversion to the mean implies a shedding of over $5 trillion).

2) Rosie has maintained – and continues to do so – that this will be the mother of all jobless recoveries (it arguably already is given the how far we are from the recession’s starting point and the fact that we’re still bleeding jobs).

Now, Rosie’s taken his shots – broadly speaking – at economists who never saw the recession coming and are now opining about a V-shaped recovery. And he’s referred to them in not-so-glowing terms (e.g. shills, hacks, montebanks, etc.), although he’s rarely mentioned anyone by name (though once in a while he lets one fly). In all fairness, it must be pointed out that Rosie has remained steadfastly bearish in the face of the stock market’s 60% rally, and legitimate criticism could certainly be leveled against him on that front.

Now it appears Merrill has decided to retaliate against what they must perceive as Rosie’s assault against their change in perspective since his departure.

In an Oct. 9 piece that purports to refute Rosie’s view of the consumer -- A balanced view of household rebalancing – the Merrill team argues that the U.S. consumer is in better shape than folks like Rosie think, and adds this zinger for good measure: “However, our results strongly contradict some of the more alarmist views on the consumer.” It continues: “The popular press suggests an extreme deleveraging by U.S. consumers is likely. We think this view is unlikely, as households can restore their net worth in several ways. Households could choose either to pay down debt or to accumulate assets, in
order to restore their net worth.”

Their upshot: “None of this should take away from the bottom line: the extreme deleveraging predictions discussed elsewhere need not occur if households actually care much more about their net worth rather than just their debt ratio. Under what we believe are a reasonable set of assumptions, the household sector can repair its balance sheet by pushing up the saving rate to anywhere from 5 to 10%. This should restrain the growth in consumer spending in the coming years, but only by about ¼ to ¾% per year.”

The gist of the argument is that households are more focused in net worth than on debt or on debt-to-income and that, in any event, they could restore the balance by “accumulating assets in order to restore net worth.” How they could accumulate those assets in the absence of either higher incomes, lower debt, or increased savings remains unexplained. (Last I checked, assets had to be paid for somehow, or am I mistaken about that?)

In another shot across the bow (Oct. 20), they take aim squarely at the “jobless recovery” that most (led by Rosie) are forecasting:

Reasons this recovery can be particularly jobless

Turn to page A3 of today's Wall Street Journal, "Employers Hold Off on Hiring". Even though the profit outlook is improving, many companies are holding off on hiring. The WSJ points out that the situation is so bleak in the labor market that even if the economy was churning out jobs as quickly as the 1990s expansion (2.2 million private sector jobs a year), it would still take the economy until 2017 to reach a 5% unemployment rate. While hiring usually lags the economic recovery, the WSJ highlights several reasons why the outlook may be worse this time around:

1 Many businesses have doubts about the durability of the upturn and attribute much of the recent growth in orders to government stimulus and a temporary inventory rebuild.

2 Businesses face uncertainty over the regulatory outlook and the costs associated with the expansion of health care and climate legislation.

3 Companies have also been able successful at boosting productivity to make up for the sharp declines in headcount.

4 Many companies also have excess labor on hand - after cutting hours to record lows, companies can boost production simply by increasing hours without having to add existing workers.

Reasons we disagree with the jobless recovery view

Of course, the first two factors have some merit at the margin but are unlikely to be major drivers of hiring activity, in our view. The productivity argument arises after each recession and works for a time until the typical lag we normally witness in the relationship between activity and hiring kicks in. The final point is the one that is, in our view, most mistaken. Although it is true that hours have been cut to record lows, that does not mean there is excess labor. Not all labor is fungible and there could be demographic and work rule reasons why firms have chosen to cut hours rather than production in certain industries. Finally, a number of industries work with such a lean workforce that, when the downturn came, these workers saw their hours cut as the alternative was for the plant to shut down - these industries were not likely going to be the drivers of growth in the labor market under any circumstances.

I don’t find either of their arguments particularly compelling.

Yesterday, as a matter of fact, the Merrill team had to contend with what can only be described as a huge setback in consumer confidence. With economic releases looking increasingly mixed, the ML team seems challenged in support of their more optimistic view.

In any event, there most definitely seems to be a very subtle – yet discernible – to and fro taking place between Rosie and his former shop.