It is easy today to be confused, for this is a remarkably complex time. I argued two years ago that we were all part of an elaborate experiment, the inputs to which were completely new. We had an unprecedentedly low risk premium on every asset class and a stew of new and badly understood nancial instruments. That was bad enough, but isn’t the picture even more complicated and without precedent now? We have never in our lifetime seen a nancial and economic bust such as the one we just had. We have never had two great asset bubbles break in the same decade. We have never wiped out so much wealth in all asset classes as we have this time: $20 trillion at its worst point, on our reckoning. We have never experienced such rapid deterioration in the government’s budget and in the balance sheet of the Fed, nor witnessed such moral hazard, with bailouts flying around like this. What hope do we really have in making accurate predictions of how the world will recover from all of this, and in what ways it will be changed? Very little.
My view of the economy’s future is boringly unchanged: “Seven Lean Years.” I still believe that after the initial kick of the stimulus, we will move into a multi-year headwind as we sort out our extreme imbalances. This is likely to give us below-average GDP growth over seven years and more than our share of below-average pro t margins and P/E ratios, so that it would feel more like the bumpy (bumpy, but not so disastrous) 1970s than the economically lucky 1990s and early 2000s.
Playing with Fire
Whenever the Fed attempts to stimulate the economy by facilitating low rates and rapid money growth, the economy responds. But it does so reluctantly, whereas asset prices respond with enthusiasm.
Fed has been reckless in facilitating rapid asset booms in the tech and housing bubbles. As we know, the of cial policy remains to avoid trying to contain asset bubbles, but to ameliorate the pain of any setbacks should asset prices reverse course and collapse. Indeed, the Fed claims never to have been sure that bubbles even exist. Non- nancial corporations and the Treasury were lucky that they went into the tech bubble in good nancial shape and into the housing bubble in reasonable shape, except for the overstretched consumer. Now, though, after our massive stimulus efforts, the Fed’s balance sheet is unrecognizably bad, and the government debt literally looks as if we have had a replay of World War II. The consumer, meanwhile, is approximately as badly leveraged as ever, which is to say the worst in history. Given this, we would be well advised to avoid a third go-
around in the bubble forming and breaking business. Up until the last few months, I was counting on the Fed and the Administration to begin to get the point that low rates held too long promote asset bubbles, which are extremely dangerous to the economy and nancial system. Now, however, the penny is dropping, and I realize the Fed is unwittingly willing to risk a third speculative phase, which is supremely dangerous this time because its arsenal now is almost empty.
Investors, traditionally reluctant to burn their ngers badly twice in a generation, line up to buy risk and bid down spreads as if eager to suffer for a third time in a decade. Scientists believe that some wild animals that are threatened constantly by predators quickly forget the worst episodes lest they become so completely traumatized that they dare not return to nibbling grass. Normally, investors appear to have longer memories than rabbits, but not this time! And the Fed, having learned nothing, still worships at the Greenspan altar. Overstimulus was painful in the 2000 break and extremely painful in 2008, but the Fed soldiers on with its failed strategy like Field Marshal Haig in World War I (“The machine gun is a much over-rated weapon.”).
Full note here:
Quarterly Letter
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