From Kelton To Krugman To Dalio: A Recession Diary

From Kelton To Krugman To Dalio: A Recession Diary

Humans harbor a perverse fascination with calamity.

I revisit this topic from time to time. We like movies about the apocalypse, we can’t resist sensationalized coverage of tragedies and we’d sooner stare at a car accident than help the people involved.

In markets and economics, our affinity for the macabre finds expression in breathless media coverage of stock selloffs and incessant speculation about the proximity of the next recession. The deeper the market malaise and the higher the perceived odds of a downturn, the more hyperbolic the coverage.

This isn’t always an innocent phenomenon. Fear has become the new cognitive principle. And fear is self-reinforcing. If you spread fear, it looks like you have a deep knowledge of things. If you’re calm, it’s like being ignorant.

As JPMorgan’s Nikolaos Panigirtzoglou noted last week, “heightened concerns about the prospect of a US recession,” as manifested in web searches and market pricing, can “become self-fulfilling” if they persist. Robert Shiller recently said the same thing.

Bloomberg

The figure (above) shows the prevalence of the word “recession” in news stories on a weekly basis going back one year.

Currently, America is obsessed with recession risk and while obsession is never healthy, there are plenty of good reasons to be concerned. Unlike Q4 2018, when market participants scared themselves into a short-lived bear market, there’s a clear and present danger of a downturn in the world’s largest economy. That does warrant discussion and, to the extent an informed citizenry is a prepared citizenry, I suppose blanket coverage could be helpful.

The problem is that unlike March of 2020, a recession isn’t, strictly speaking, inevitable. Joe Biden and Janet Yellen are correct in that regard if by “inevitable” they mean a mathematical certainty. I’ve suggested a downturn is basically inevitable, but it’s not the same kind of foregone conclusion as it was when we shut down the entire economy and locked everyone in their homes two years ago. Given that, there’s a non-negligible risk that consumers who were already inclined to pull back on spending in the face of generationally high inflation will retrench further after being inundated with a tidal wave of recession news coverage. Businesses could fall victim to the same psychological trap.

So pervasive is the recession story that it’s virtually impossible to keep track of who said what and when on a daily basis. Literally everyone is talking about it. At the risk of perpetuating the very same self-fulfilling dynamic mentioned above, I thought it might be useful or, at the least, entertaining, to present a compendium of recent recession and bear market banter from notable economists, analysts and executives.

As you read, remember: The only thing we have to fear is fear itself.

A recession is inevitable at some point. As to whether there’s a recession in the near-term, that’s more likely than not. It’s not a certainty, but it appears more likely than not. — Elon Musk, June 21, 2022

We’re not yet in a recession, but we’re getting very close to it. My baseline is a hard landing. If you’re looking at consumer confidence, retail sales, manufacturing activity, housing — they’re all slowing down very sharply. That’s stagflation. It’s not just a recession. — Nouriel Roubini, June 21, 2022

We need five years of unemployment above 5% to contain inflation — in other words, we need two years of 7.5% unemployment or five years of 6% unemployment or one year of 10% unemployment. These are numbers that are remarkably discouraging relative to the Fed view. Is our central bank prepared to do what’s necessary to stabilize inflation if something like what I’ve estimated is necessary? — Larry Summers, June 20, 2022

I thought everyone in the biz knew this, but part of the problem is that “wage-price spiral” is a really bad term for what we’re really worried about. The real concern is self-fulfilling inflation — inflation not driven by demand exceeding supply, but simply everyone raising wages and prices because they expect others to be raising wages and prices. The point is that it matters a lot whether we’re just overheated, needing a cooling off of demand and a modest rise in unemployment, or we need years of punishment until morale improves — sorry, “until expected inflation comes down.” The evidence so far doesn’t point to the latter story, although it sure sounded as if that was what Larry Summers was saying. But I understand that the Fed wants to make sure that we don’t get to that point. — Paul Krugman, June 21, 2022

“We have to dial unemployment up in order to dial inflation down” is some fallacious voodoo. Ask yourself who falls into the “we” category and who falls into the “unemployment” category, and you’ll know everything you need to know about the voodoo. — Stephanie Kelton, June 20, 2022

We now see recession risk as higher and more front-loaded. The main reasons are that our baseline growth path is now lower and that we are increasingly concerned that the Fed will feel compelled to respond forcefully to high headline inflation and consumer inflation expectations if energy prices rise further, even if activity slows sharply. The war and further commodity price shocks have admittedly made the echoes of the 1960s and 1970s ring louder. But we are skeptical that hot wage growth and high inflation expectations are as entrenched today as back then. — Jan Hatzius, David Mericle, Ronnie Walker (Goldman), June 20, 2022

I now hear it commonly said that inflation is the big problem so the Fed needs to tighten to fight inflation, which will make things good again once it gets inflation under control. I believe this is both naïve and inconsistent with how the economic machine works. While tightening reduces inflation because it results in people spending less, it doesn’t make things better because it takes buying power away. It just shifts some of the squeezing of people via inflation to squeezing them via giving them less buying power. The only way to raise living standards over the long- term is to raise productivity and central banks don’t do that. — Ray Dalio, June 21, 2022

For us, the end game remains the same. We see a pretty poor risk reward over the next 3-6 months with recession risk rising in the face of very stubborn inflation readings. Equity valuations are closer to fair at this point but hardly a bargain if earnings are likely to come down and/or a recession is coming. We recognize a lot of pain has already been inflicted during this bear market. Nevertheless, we can’t yet get bullish for more than just a bear market trade until we reach the 200-week moving average of 3,500. Even then, we would only expect an oversold bounce until recession risk falls materially. — Mike Wilson (Morgan Stanley), June 21, 2022

Calls to be on recession watch abound. Between an aggressive global central banking community and headline inflation showing no signs of abating, it follows intuitively that investors are increasingly cautious that the Fed’s actions will ultimately lead to a contraction of real growth. The bulk of the narrative is focused on higher borrowing costs undermining hiring and rate hikes having their intended effect. There just appears to be a collective abandonment of the ‘soft-landing’ scenario — but was that ever really on the table? Moreover, while the prospects for a slowdown are being framed as an early-2023 risk, we’re reminded that with second quarter’s GDP tracking at 0.0% in the wake of Q1’s -1.5% print, the higher headline inflation is in June, the more material the prospects for a technical recession in 2022 become. Alas, this wouldn’t be the type of slowdown monetary policymakers would respond to; however, investors might be more inclined to trade it as such. — Ian Lyngen and Ben Jeffery (BMO Capital Markets), June 21, 2022

The Fed seems to be worried more about its legacy than the economy: It is ignoring deflationary and dangerous signals. Relying on lagging inflation indicators like the CPI, Fed Governor Waller is calling for another hike of 0.75% in July. In our view, the US fell into recession during the first quarter. If massive inventories bloat real GDP in the second quarter, they will unwind and hurt growth for the rest of the year. Alarmingly, in early June consumer sentiment fell to a record low extending back to the 1940s. As measured by the University of Michigan, consumer sentiment is lower today than levels reached during the Global Financial Crisis in 2008-09 and the two recessions in 1980-82 when Fed Chairman Volcker was choking 15%+ inflation with 20% interest rates. Volcker doubled the Fed funds from 10% to 20% in less than a year. Powell’s Fed has increased the funds rate 7-fold in the last year and is pointing to another double from here. Its moves already are more draconian than Volcker’s. If inventories and stock prices are leading indicators for employment and wages, which in this case I believe they are, then fears of cost-push inflation a la 1970’s should disappear during the next six months. — Cathie Wood, June 19, 2022

Clearly from her tweet, Wood does not get the punchline of real Fed funds still being highly negative regardless of how much it has risen from very, very small levels in percentage terms. We are very, very far from Volcker territory. We are nonetheless heading for more crashes, bangs and wallops because of how much more financialized the US economy is now than under Tall Paul. — Michael Every (Rabobank), June 21, 2022

I was talking to Larry Summers this morning, and there’s nothing inevitable about a recession. — Joe Biden, June 20, 2022


11 thoughts on “From Kelton To Krugman To Dalio: A Recession Diary

  1. I ran into burning buildings for a living. If there is smoke there must be fire is very far from the truth. I stopped reading politics and only economics and now I’m having my fill of the chattering class here in the world finance. Everybody but everybody has a soapbox in the Internet age. In hindsight one or two people are bound to be right.
    Young people want a productive and vibrant economy but the older people want a crash so they could buy cheap. That’s how financial people make their money with poor peoples blood on the street.
    Too bad the fallacy that wisdom comes with age is believed by the young.

    1. Older people tend to be in charge of businesses, media, and the government. Their concerns drive the news cycle. They get worried when their jobs and retirement savings are threatened, and some get hysterical. Young people have time and should be calm. Young people should be happy when markets decline. They should want them to stay low so that they can invest at lower valuations for longer. And they should hope for massive rallies before they retire. Things don’t work that way, of course. But as long as young people can stay employed and continue investing (admittedly those are big IFs), they should be happy with market downturns.

    2. Even as secluded as I am, I know many old ones who have worried over these “recessions” the past couple years as they tried to retire. Now we will see about cost of living and Ukraine ontop of asset depreciation.

  2. One of the things I remember from the 70’s was that work force union membership was a much larger percentage of the labor pool and by the mid 70’s the union contracts included annual wage adjustments tied to the inflation rate. We haven’t seen this today and union membership is a much smaller part of the work force today.

  3. It feels like our soft-science of economics is trying to now roll alongside our soft-science of politics. Economically speaking, we seem increasingly caught in an academic debate on NAIRU or neutral rates or QE/QT or duration, that are made impossible on the theoretical level because the underlying facts are being called into question. Are the job openings real? Where are inventories exactly? Are shipping rates to be trusted? How much management incompetence is being blamed on supply chain problems? Are the cash balances, both corporate and individual, real?

    But just looking at general indicators of volatility and liquidity, it doesn’t feel like we are in a good place for making any sort of bottom or inflection bet. We keep talking about how all these indicators have “never” — gotten this low or high, risen or fallen so quickly, 3 sigma events eclipsed by 6 sigma events, etc. Everything seems compressed and every trend seems discovered too late and on the verge of reversing by the time it seems actually investable, at least from these wheezy old Graham & Dodd catraract eyes. But no one who’s been paying attention doesn’t feel at least a little tempted by this market (if they’re not busy puking) after 60-80% drawdowns.

    I don’t like it, but I feel like a few decades of investing experience has prepared me for this. But these violent moves and liquidity issues have my spidey sense tingling that someone is going to be caught major-ly offsides. We have our own American suspects of course (Wells Fargo, Microstrategy, ARK, levered decaying ETFS and raft of ez money zombies), but more often than not the trigger is some hedge fund we never heard of or some country we didn’t know we needed to pay so much attention to (Malaysia, Greece).

    If I can be so bold, I’d love to hear your thoughts on specific tail risks. I know prospective is not necessarily your baliwick, though you’ve been an invaluable resource in understanding all of past, pressent and future for me. But all this talk about this or that terminal rate, this or that Fed put level, 3810 on the SPX, 14 or 17 PEs, makes me long for the Heisenberg big picture of what could go really wrong just with the cards we already have, and even ignoring another Russia invading Ukraine on the flop.

    But Turkey and Russia are already deep in the sh–t, as is Ukraine. Europe just ran into a closed door it thought was open. Japan is playing chicken with the private market, perhaps soon to be followed by the Swiss. A 50 bp hike by Powell is now officially dovish. Nurse (Heisenberg)? How did we get here? Actually, wrong question — where the hell are we going?

  4. Lets face facts.We are in deep sh**t. The only real question is how much will it hurt, not if it will hurt.

    Funny though there are still “experts” spewing self-interest nonsense. That somehow all the losses suffered by investors since 2020 are not the result of poor investment decisions and/or poor (or seemingly non-existent) risk management. There will be more attempts (by all experts) to deflect blame if things keep going south!

    Best buckle up. It is going to be a rough ride.

    1. Agreed, Kelton called out that policy impacts people; Summers 10% unemployment is demand destruction without regard to the follow-on consequence.

      If this is all the Democrats fault (nevermind the Trump Tax Cuts, the pandemic, Russia starting a war, etc) then voters could elect the Republicans who don’t believe in raising the debt ceiling and instead prefer trying to default on the US Debt.

  5. I think this post is a fabulous thinking tool for a bulk of readers here. I do think there is a Geopolitical variable here that might be very understated but will reset the Deck that we are being dealt from. Nothing will be as it was before and as it is now. It is an exiting time and as mentioned above the internet gives everyone an opinion and someone ( or a few ) will be correct.

  6. H

    Great post. Putting this stuff together is surely your superpower. One thing I learned was that Ray gets it and Larry has no clue. I’ll bet a hundie that Larry won’t be volunteering for the unemployment line any time soon.

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