The Curious Case of the "Normal Recession"

Nothing much happened in the markets yesterday. Stocks up. Gold up. Oil up. Bonds up. Dollar down.

But listen up…an important announcement:

The bear market/credit crisis/depression is over!

How do we know? Abby Cohen says so. We read this in Bloomberg the other day:

“U.S. financial markets have been moving ‘back towards normal’ since March, said Abby Joseph Cohen, Goldman Sachs Group Inc.’s senior investment strategist, in an interview.

“‘Much of what we can recognize as happening now is really a restoration of where we should be,’ Cohen said ‘This situation is much closer to normal than any place we have been over the last 18 months.’”

Bloomberg does not mention it, but soldiers had more of a fighting chance under George Armstrong Custer than investors following Abbey Joseph Cohen. In August of 2007, she told CNBC that the S&P 500 would rally to 1,600 by December. Then, in December, she predicted the S&P 500 index would reach 1,675 in 2008. In fact, the S&P 500 traded as low as 741.02 by November 2008.

We wonder what they put in the water where Abby Cohen lives. The woman always thinks stocks are going up, of course…but there is nothing odd about that; she’s paid to think stocks are going up.

But why does she think the situation is close to normal? What’s normal in her world? Deficits at 13% of GDP? GM goings bust? US presidents running auto companies and banks? Bailouts…boondoggles…and baloney equal to the entire nation’s output?

If this is ‘normal’…what’s not?

We went to dinner with a group of Americans last night – at one of London’s oldest gentleman’s clubs. Women are not allowed at the bar or in many other parts of the club, but they may come for dinner in the main dining room. Included was a young woman:

“I have a lot of friends who are just getting out of college. None of them has gotten a good job. Instead, they’re all moving back in with mom and dad. And some of them are in their mid-’20s… It’s very depressing.”

It’s a phenomenon known as household compression. Households expand and contract with the credit cycle. The ’80s, ’90s and early ’00s were a time of household expansion. Families broke up. Men and women separated, setting up house in different places. The average house size went up…but the average number of people per household size went down!

Now, those trends are reversing. Children are moving in with parents…spouses are moving back in with each other…old folks are staying put. Multi-generational families are becoming more common.

We don’t have any statistical proof of this. But it makes sense. And it’s not a bad thing. We’ve had a multi-generational household for many years. Grandmother, parents and children all in one house. Everyone seemed to benefit from it.

From around the world comes more evidence that the recession isn’t ending soon.

Bloomberg reports:

“German exports in April were 4.8 per cent lower than in March, and 28.7 per cent down on a year earlier, official figures show – the steepest annual fall since records began in 1950, although officials said that April 2008 had been exceptionally buoyant.”

Meanwhile, from China, comes news that the world’s most dynamic economy has lost some of its old vim and vigor. Chinese exports are down too – 26%:

“China’s exports fall by record after global demand dries up,” reports Bloomberg.

But what’s this? The New York Times says China is on a “commodity buying spree.”

How could China import so much copper and iron ore when it’s not exporting finished products? Iron ore imports into China, for example, are running 27% ahead of 2008. What are they doing with the raw materials?

This story from Maritime Global News helps explain it.

“…could be the fact that domestically produced iron ore in China is of a rather poor quality and quite expensive when compared to spot imported prices. Another explanation could be that of speculators getting into the import market to try and get hold of ‘cheap’ iron [ore] that would possibly be required under the Chinese government’s US$586bn stimulus plan. And a third could be the impending conclusion of the iron ore contract price negotiations.”

Whatever the explanation… China may be importing raw materials, but it is not selling them. Neither is Germany. And neither is Japan, whose economy is shrinking at a 14% rate. So here’s a question for Abby: How can you have a global rebound when the world’s three biggest exporters aren’t exporting?

They’re not selling because the usual buyers aren’t buying. Consider this:

“Hiring Plans Stick at Record Low,” begins a MarketWatch story. Employers’ plans to add jobs were at an all-time low in the second quarter. Now, according to Manpower’s latest survey, they’re still at a record low.

And today comes word that foreclosures topped 300,000 last month – for the third month in a row. At this rate, three and a half million houses will be foreclosed this year.

No jobs, no income. No income, no buying. No buying, no real boom. No real boom, stocks head down. Why complicate it?

Gradually, Americans are waking up. They are rubbing the sleep from their eyes and wondering what they were thinking when they gave the Bush and Obama administrations their credit cards.

“This isn’t a temporary stimulus but a ramp-up in debt followed by a greater explosion in spending and debt,” said Congressman Paul Ryan to Fortune magazine. “The bond markets will come after us with a vengeance. We’re playing with fire.”

Playing with fire? Yes…in a refinery!

Fortune says that over the next 10 years federal deficits will add $90,000 in debt to the average tax-paying household’s burdens, bringing the total to about $155,000 per household.Fortune is underestimating.

Obama may talk about taxing the rich. In fact, there aren’t enough rich people to pay the tab for US spending; the middle class will have to put on the yoke.

“The revenues needed are far too big to raise from high earners,” says Alan Auerbach, an economist at the University of California at Berkeley. “The government will have to go where the money is, to the middle class.” The most likely levy, says Fortune: “a European-style value-added tax (VAT) that would substantially raise the price of everything from autos to restaurant meals.”

But wait, there’s more…

The American middle class can’t really pay these debts.

They were living hand to mouth even in the Bubble Epoch. Now, jobs are disappearing and incomes are going down. How would they possibly keep up with the interest, let alone pay down the principal, on an additional $90,000?

We quoted estimates that taxes would have to go up by 60% to balance the budget by 2019. As we said then; that ain’t gonna happen.

Instead, the US is headed for bankruptcy. And that begins with higher interest rates, as lenders try to protect themselves from the risks of default and/or inflation.

Fortune: “The risk that the U.S. will follow Britain, which was warned recently that it could lose its triple-A bond rating, has risen from virtually nil to a real possibility, judging by the sevenfold jump in the cost of insuring Treasury debt in the past year. The big borrowing is already spooking the bond markets. This year rates on 10-year Treasuries have jumped from 2.2% to 3.7%. A further increase in rates would aggravate the situation, raising the interest costs on the debt and increasing its size even more.”

Allan Meltzer, the distinguished monetarist at Carnegie Mellon: “I predict far higher rates over the next few years.”

Fortune continues: “Under George W. Bush, the U.S. experienced a prelude to the crisis before us: Spending rose rapidly, while revenues remained reasonably flat. Bush created an expensive new entitlement, the Medicare drug benefit (cost this year: $63 billion), and let spending on domestic programs from education to veterans’ benefits run wild. Over seven years the wars in Afghanistan and Iraq added a total of some $900 billion to the budget. All told, Bush raised spending from 18.5% to 21% of GDP, setting in motion a chronic budget gap by piling on new spending without paying for it.

“Under Obama the Bush trend keeps going, but this time on steroids…”

Trying to be a responsible pater familias, and having passed the age of 60, we took the rather reasonable decision to put our affairs in order for the benefit of the next generation. The effort quickly became an expensive nightmare of lawyers on three continents.

For your amusement we enclose an actual email message we just received. It is a conversation between five lawyers…each billing at top rates. This is a very private communication, but what difference does it make? As near as we can make out, it is written in code so that neither the client nor the general public can understand it:

“The concept you outline below is workable from US Estate Planning Perspective, and makes sense as the way to meld the various goals, both tax oriented and non tax oriented, together. If Bill confirms that this concept is worth developing further, then I understand that Penny and you will produce a first draft…. Some brief further details:

“(1) The QTIP Marital Trust for Elizabeth MUST distribute all income to her during her lifetime after the demise of Bill, and must have within the text [as you probably know] other tax oriented provisions. The professional trustee having discretion with regard to distribution of income to Elizabeth will not work, but having discretion with regard to capital distributions is ok. Sarah can send sample language for a ‘standard’ QTIP, if you want. Please advise.

“(2) The marital deduction trust in Elizabeth’s Revocable Trust is a QDOT, not a QTIP… It is not a model to be used in Bill’s Trust to provide for Elizabeth if Bill attains his reward…and is survived by Elizabeth.

“(3) Sarah is producing a Summary of US estate, gift and GST tax attributes with regard to Bill. We hope to send that in the next day or so, to serve as a general orientation, and to make sure that we are all reading from the same page.

“(4) It appears, however, as if the ‘applicable exclusion amount’ [the exemption from US federal estate tax] for a person like Bill may be very small…while the exemption from GST tax might be the ‘normal’ $3.5 M. If we confirm this, then the structure that needs to be used [we believe; subject to confirmation] is a QTIP Marital Trust A and a QTIP Marital Trust B. BOTH qualify for the marital deduction; both function to postpone the federal estate tax on Bill’s demise until the assumed subsequent demise of Elizabeth. But ‘A’ captures the amount of the GST exemption in excess of the ‘applicable exclusion amount’, and ‘B’ is funded with all property in excess of (i) the [small] amount of the applicable exclusion [which we agree remains throughout in the main trust; see the fourth sentence of your paragraph 4 immediately below] and (ii) the amount that funds ‘A’. Then upon Elizabeth subsequent demise, ALL US federal estate tax is paid ONLY out of ‘B’ [this is permitted if the document stipulates to this effect], allowing ‘A’ to pass back to the [now irrevocable] main trust [see the third sentence of your paragraph 4 immediately below] wholly protected from all future GST tax.

“(5) The ‘A’ vs. ‘B’ structure preserves the full amount of the GST exemption, and to that extent ‘solves’ the GST issue which you refer to in your paragraph 8 immediately below, and which was identified in jjr email in paragraph 6 and 7 from June 5 at 1:27 pm further below.

“(6) If we confirm (4), then Sarah will send sample language regarding the A vs. B QTIP structure…etc.”

With all this hassle, it is hardly worth dying.