demandside

But the news is grim and grimmer. Competition with quants is no competition…..Bush II rescues Hoover from the bottom.

Forecast Friday

GDP

Crash

The bad news up front.

Then the good news: On inflation and unemployment, in the ongoing battle of forecasts, Demand Side has beaten the Fed Governors soundly and the consensus of professional forecasters surveyed by the Philadelphia Fed.

With regard to GDP, we have done well, but not as well as we would if the measure reflected reality. The 2.8 percent growth number recorded by the BEA — Bureau of Economic Analysis — for Q2 2008 still sticks in our craw. We note here again, whining if you will, that the GDP deflator necessary to produce this number bears very little relationship to any other measure of inflation.

And after our report on the differences between the others and us, we finish with a carol from Doctor Doom, Nouriel Robini.

Now, the bad news.

Demand Side puts forward forecasts that are optimistic, because our intention here is always to do better than the competition, and in this case, as long as we have leverage to the down side, we will do better. Plus, looking forward, it is always easier to get credibility if you are somewhere near the others. But our real view is grimmer than this. Any optimism needs the boost from aggressive policy measures that to date we just have not seen. We’re hopeful for a new Obama Administration, but it will be very difficult to get done what needs to be done absent a complete collapse and a mobilization of the body politic by virtue of desperation. On Monday we’ll give you the scale of the action that is needed in dollars.

The short form of our success is this:

We anticipated the recession a year ago because we saw that the economy was fundamentally weak, and had floated along for years only on massive debt, household and federal, that was bound to buckle. The collapse of the housing market would mean a reversal of the boom’s employment profile and a reversal of the wealth effect of rising home values.

We anticipated the inflation of the first three quarters of the year because we saw the commodity bubble, from oil to agriculture to metals. Though to be perfectly honest, we anticipated a response to the inflation from the Fed that did not materialize, a response more like what the European Central Bank did. But the Fed was preoccupied in its futile efforts to save the financial sector.

Now we anticipate a near depression because we see the crash. We see that the monetarist remedies dumped on the economy by the Fed and Treasury have not saved the patient. Trade has collapsed, lending has dried up, deflation is upon us, and the financial sector has crashed. We do not have to predict this. It has happened.

The difference from other forecasters, I think, may be that they are extrapolating history from spreadsheets and data points and trend lines. We are extrapolating from historical events.

Be clear, George W Bush will be remembered as the man who rescued Hoover from the dustbin of history. Ben Bernanke will be the last Regent of the Federal Reserve. Henry Paulson? He will join Laurel and Hardy in the slapstick hall of fame. If we have time, we’ll slip in some observations on Bernanke from Brad DeLong, the Berkeley economic historian, and I think we have a list of Paulson pratfalls here somewhere.

So.

On to the numbers. This month we’ve put up inflation numbers that are flat as far as the eye can see, at one percent core and two point five headline. Those are optimistic. The pessimistic is to the downside now, with potential deflation looming.

And when I say we’ve put them up…. No. They are not yet on the website. That comes this weekend.

Then last week we predicted ten percent unemployment for Q2 of next year, again substantially more negative than others, but not as big a number as we might have. This corresponds to 15 percent in the more descriptive U-6 measure.

And today, we see Real GDP declining 3.5 percent in the fourth quarter, 4.5 percent in 2009 Q1 and another negative 3.0 percent in Q2 before recovering to -0.5 and then a positive 2.5 in Q4. To be fair, many forecasters see grim times in 2008 Q4. Ours diverge to the downside in 2009. Again, the post probably outlook is about half again as bad as we’ve put up here, and it is well within the realm of possibility that GDP measured rationally could exceed minus six percent annualized in one or more of the next three quarters.

As it is, our optimistic assessment suggests that before we climb back into positive territory on the back of huge public spending in late 2009, we will have experienced a recession lasting twenty-four months and costing four percent of output and three million jobs.

Our net real GDP number, which takes into account the federal borrowing that is typically ignored in GDP numbers — remember one hundred percent of growth under Republican presidents since 1980 has been borrowed — our net real GDP number is very grim. Minus 7.5 to 9.5 percent through 2009, meaning federal deficits of 6.5 percent of GDP — optimistically.

With that, on to the competition. How do the professional forecasters and the projections from the Fed governors compare to Demand Side?

With regard to GDP, the 16 Fed Governors at their October 28 meeting came in with projections predominantly in the zero to zero point three range for 2008. One lone voice saw minus 0.3 GDP growth and a couple held out for positive 0.4. Rember, this is for 2008, as projected two months before its end. These figures have been migrating downward over the year. I’m not going to go back and look it up today, but if memory serves, they go down about a point every quarter.

Demand Side, on the other hand, predicted a negative 1.75 percent for 2008 in November of 2007. And we keep complaining about the plus 2.8 in Q2, because it keeps our number from coming in right on the money.

If you look at the Fed minutes where they describe the governors’ projections, you see a bar chart illustrating the current projection and a dotted line around the previous projection. The Fed Governors are always moving completely out of their previous area. In this case to the left, downward.

For 2009, one observation remains in the dotted area, while 15 move out and downward. Still, as of the last days of October, all Fed governors came in at minus 1.0 or above for 2009. Demand Side projects a minus 1.75. It’s optimistic.

The experience is similar with regard to the unemployment rate. The Fed governors’ projections have consistently migrated out of the dotted area, in this case upward. Demand Side’s November 07 numbers correspond to the Governors June 08 numbers. To be fair, both the Governors and Demand Side have fled upward over the past few months. The 16 governors are now distributed around a 7.3 percent unemployment rate for 2009. Demand Side sees 8.5 in the offing. Optimistically.

In terms of inflation, the Fed’s governors are migrating downward along with the collapsing of demand, though not so dramatically as Demand Side did last time out. Headline comes in very low, both for the remainder of 2008 and for 2009 and out years. This is a deflationary projection and very inconsistent with the positive GDP numbers in those out years.

Core inflation — what we have argued is similar to wage growth — comes into line with headline in the Governors’ assessment in a manner that we have not seen since pre-Bush days. We don’t know what to make of that. We have continued to see deterioration in the labor market contributing to a differential between core and headline inflation, though we may have to revisit that next month.

Now, the competition with the professional forecasters surveyed by the Philadelphia Fed.

The purpose of this exercise is to emphasize that Demand Side’s forecasts have consistently outperformed those of the Fed and the consensus of forecasters. We apologize for not keeping our web site more up-to-date. On one hand, why change if we are still to the good. On the other, why be accurate if you are not relaying that information to people who can use it. Once again, we’ll be up with the new numbers and charts on Saturday.

I guess it has been our preoccupation to prove the Demand Side strategy as being better, not because of any particular brilliance on our part, but because we are using a far superior conceptual description of the economy and we are avoiding the error of applying the tools of thermodynamics to human behavior. On the web site, you’ll see our history of past calls and so on. As I think about it right now, however, it seems that is not very useful.

What I think we’ll do is put up the optimistic forecast along with the policy moves that make that optimistic forecast possible. Then, on a separate page, we’ll put up a baseline forecast, which takes into account only those policy moves that have been enacted or are clearly in the making.

Back to the Philadelphia Fed. Again, the professional forecasters have been migrating toward the Demand Side numbers. For example, in the spring, the consensus called for a positive 2.8 GDP growth in Q4. Demand Side in November 07 saw a minus 2.5. Now in the fourth quarter, the consensus has moved fully 5.7 points to the downside in six months and sees a minus 2.9. I guess since we’re already one month into Q4, the issue is clearer. Make a point that Demand Side has moved down now to minus 3.5.

The average for 2009 growth is forecast by the consensus to be minus 0.2 percent. That is down substantially from their plus 2.8 percent six months earlier. Six months before that, however, Demand Side projected 1.1 percent growth for 2009. In August it became clear that the authorities were blundering around and we revised that down to minus 1.0 for the year. Our current figure is minus 1.75.

Okay, to finish up. The consensus of professional forecasters six months ago predicted an unemployment rate of 5.2 percent for Q4. Now that we’re halfway through it, those forecasters see a 6.6 percent unemployment rate. Again, a year ago we saw 6.0 for Q4. Now we project optimistically 7.5 percent. For 2009, Demand Side sees an average of 8.0 percent. Survey says 7.4 percent. Notably in the second quarter, when we call for a 10.0 percent rate annualized, the survey says only 7.4.

So, enough of that. It’s much better visually. Look for it by Sunday at Demandside dot net.

Now, keep in mind, our divergence will be much more extreme in the baseline because we factor in the crash which has wrecked the financial system, which you might date from the Lehman Brothers bankruptcy in September. We treat as historical fact the ineffectiveness of monetary policy, the compromise of the Fed’s balance sheet, and the ineptness at the Fed.

There’s nobody who knows Wall Street better than Henry Paulson. But Paulson is no Joseph P. Kennedy, who was an operator turned public servant who knew where the bodies were buried and earned the trust and respect of the nation.

Likewise, nobody knows the Depression like Ben Bernanke. Both of these guys were supposed to be the right person forr the job. Bernanke’s save the banks at all costs strategy has now placed monolithic zombie institutions at the center of the financial sector. There are no economies of scale for banks. In fact, there are diseconomies, as the Federal government gets dragged into the pit by insuring them.

Again, it is our view that the banking function can only be saved by returning to the Glass-Steagall system, where nobody was too big to fail and there were no bank holding companies, but businesses that operated in highly segregated markets of commercial banking, insurance, brokerage and investment banking.

We anticipated the recession because we saw that the economy was fundamentally weak under the credit slash housing bubble. We anticipated the commodity inflation because we saw the commodity bubble. Now we are anticipating the depression because we see the crash.

You can see it too, if you look up the Calculated Risk web site and find the chart comparing the major crashes since 1929. You’ll see that as of this 300th day of the bear market, stocks are off more faster than even in the 1929-32 downturn. Thanks in major part to the collapse in the past 45 days.

The chart shows a total 48.5 percent drop to date. The total drop in the 1973 oil crisis market was 48.2. The tech crash of 00-02 took twice as long to get only .6 percent deeper.

It may well be that the 70 percent consumer will need to become the 50 percent consumer, and the 30 percent public sector will need to become the 50 percent public sector to bring us out of this.

But that’s another day.

Taking us out is Nouriel Roubini

ROUBINI

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