KOO: THE GLOBAL SLOWDOWN IS BECOMING MORE PRONOUNCED

Few people have a better grasp on the current economic predicament than Richard Koo. Koo is growing increasingly concerned about the state of the global economy and now believes the slowdown is becoming more pronounced:

“Signs of a slowdown in the global economy have become more prominent over the last two weeks. The deceleration in economic activity was reflected in the US jobs report and new unemployment claims, European industrial output, and Japanese consumer confidence. It was also reported on Monday that Japan’s inflation-adjusted GDP grew only 0.4% y-y in the Apr–Jun quarter, confirming that the recent slowdown actually began this spring.

This string of weak data led to a further correction in equities and pushed bond prices higher (and yields lower). Strong demand for government debt was underlined by yields ofsubstantially less than 3% for the 10-year Treasury note and less than 1% for the 10-year Japanese government bond.

In Ireland and some other countries in the eurozone, meanwhile, marked economic weakness fanned concerns about the future, leading investors to sell bonds and send interest rates higher.

In the currency markets, the narrowing yield differential between Japan and other nations prompted further buying of the yen, which set a new post-Lehman high of 84.72 against the US dollar.”

Koo is quick to note that the recovery we’ve seen since the Lehman collapse was primarily a mean reverting recovery that took us back to where we should have been in the first place had there been no Lehman related panic:

“That means that the rally that started about six months after the Lehman-inspired financial crisis was actually just a recovery from the Lehman crisis and not from the global housing bubble collapse in 2007.

The recovery from the financial crisis of 2008–09 was destined to run out of gas once economic activity rebounded to the (depressed) level where it would have been as a result of the balance sheet problems. I think that is what we are now observing in the US and Europe (Exhibit 1).”

“In other words, the level of economic activity has returned to where it would have been if Lehman Brothers had not been allowed to fail.”

Koo is increasingly concerned that governments have already begun down the wrong path of austerity:

“But governments in the UK, Ireland and Spain have already changed course and are pursuing austerity policies. Even in the US, it remains to be seen whether the Bush tax cuts and the Obama economic stimulus can be extended.

The recovery from the 2008–09 financial crisis has now run its course, clearing the fog surrounding the balance sheet recession. But I suspect that more time and even weaker economic data will be necessary before people understand this and accept the need for further fiscal stimulus.”

In particular he is very worried about Europe and the actions taken by Trichet:

“Against this backdrop, I am particularly concerned by an opinion piece contributed to the 23 July Financial Times by ECB President Jean-Claude Trichet and titled, “Stimulate no more—it is now time for all to tighten.” In the article, Mr. Trichet argues that the economic recovery is already under way and that the fiscal stimulus administered by national governments over the past two years should be quickly withdrawn.

Mr. Trichet also argues that the series of fiscal stimulus packages unveiled by the G20 two years ago was actually a mistake and says it was unfortunate that some countries had administered stimulus without any need for it. Now, he says, it is time for all countries to pursue medium-term fiscal consolidation strategies.”

Koo believes Trichet is wrong because, like Bernanke, he has misunderstood the balance sheet recession.  He believes Trichet is becoming “more German than the Germans” and is directly contributing to the recovery in that single nation while the periphery burns.  Ultimately, he says Trichet is making the same mistakes as Bernanke – believing that austerity and monetary policy should rule the day.  Richard Koo, who has been right thus far, says they still fail to understand the balance sheet recession.   It looks to me like he’ll continue to be right.