"The Sum of All Fears," UCLA Anderson Forecast March 2020 Interim Forecast

As we noted in our quarterly March report, the forecast represented an “attempt to distill incomplete and rapidly evolving information into a framework about the future course of the economy.” We now have new information that has confirmed the coronavirus is spreading rapidly, the travel and recreation sectors of the economy are shutting down, oil prices continued to plunge in response to the Russian war on the American fracking industry, credit spreads have widened dramatically thereby tightening financial conditions and stocks remain volatile with a downward bias.

As a result we have changed our forecast. Simply put we believe that when the business cycle dating committee of the National Bureau of Economic Research meets they will note that the 2020 recession began this month. Significant increases in Federal spending to support individuals and industries damaged by the coronavirus and a new program of quantitative easing by the Fed will limit, but not avert the decline in economic activity that we foresee. In summary our new forecast is as follows:

·        Real GDP declines by 6.5% and 1.9% in 2Q and 3Q, respectively. Growth rebounds in the 4Q a 4% clip.  (Figure 1)

·        Social distancing causes real consumption to fall by 7.8% in 2Q. (Figure 2)

·        Real Business Fixed Investment declines throughout the year. (Figure 3)

·        Two million jobs are lost between 1Q20 to 1Q21. (Figure 4) 

·        The unemployment rate rises from 3.6% to 5.0%. (Figure 5)

·        The Fed responds with a zero interest rate policy and QE. (Figure 6)

·        Inflation remains muted. (Figure 7)

Note: No Figures in this post.

Monetary Policy on the Eve of Destruction

The world’s central bankers will meet later this week at their annual confab in beautiful Jackson Hole, Wyoming. The meeting’s topic is “Designing a Resilient Monetary Policy.” All of that is well and good, except monetary policy has reached a dead end. Simply put after eight years of QE, zero interest rates, negative interest rates, corporate bond buying and forward guidance all the central bankers have succeeded in placing the entire financial system on the eve of destruction.

To be sure their policies likely avoided The Great Depression 2.0, but that that was six years ago and along the way asset values were boosted to levels unimaginable only a few years ago. But not only does a low interest rate policy increase asset values; it also increases liabilities and undermines the profitability of the banking system. Simply put there is very little margin left in bank lending thereby jamming the monetary policy transmission mechanism through the banking channel.

More important the decline in interest rates exploded the explicit unfunded liabilities associated with public and private pension plans which now stand at $3.4 trillion (using private sector accounting rules) and $560 billion, respectively. In Europe the situation is far worse. The fundamental issue is that plan sponsors never contemplated a sustained period of extraordinarily low interest rates. Where once an 8% rate of return on plan assets was viewed as conservative, now a 6.5% return can rightly be viewed as aggressive. Similarly discount rates have dropped from around 6% to the 3-4% range. Remember bond math the lower the discount rate, the higher the liability. As a result under the current regime most plans are effectively bankrupt which will require either a cut in future benefits or a substantial increase in contributions/taxes. How can that be conducive to growth? Similarly the same dynamics apply to life insurance and annuities.

Moreover implicit retirement liabilities have also exploded. How so? In a low interest rate regime individuals have to put more money away in their 401k’s and IRA’s to meet their retirement goals. Thus instead of low interest rates working to reduce savings, the real world result yields higher savings, thus turning on its head microeconomic time preference theory. This phenomenon of higher savings in the face of lower interest rates and higher asset prices is one of the reasons that monetary policy has not ignited a consumption boom.

Thus when the central bankers meet later this week they had better recognize they are at the end of their rope. By excessively using monetary policy over the past eight years the bankers have destroyed its efficacy. As Fed Vice Chairman Stanley Fischer noted last week, perhaps it is time for fiscal policy and regulatory reform.

My Amazon Review of Ben S. Bernanke's "The Courage to Act: A Memoir of a Crisis and its Aftermath"

Only in America*

This is an American story about the rise of the son of a Jewish druggist from the backwater town to Dillon, South Carolina to the commanding heights of the global economy. When he is writing about his boyhood and personal life Bernanke writing shows the benefits of the creative writing course he took in his freshman year at Harvard. Unfortunately when he writes about policy making the writing becomes more guarded and academic. Nevertheless it remains a very lucid account of the financial crisis and its aftermath.

He chronicles his early life in the segregated South to his working construction and as waiter at the very touristy South of the Border rest stop off I-95 to his arrival at Harvard and graduate school at MIT. From there he goes on to teach at Stanford and Princeton establishing his reputation as a leading scholar of the depression (See his “Essays on the Great Depression”)

He leaves academia first to become appointed a Governor on the Federal Reserve Board by President George W. Bush, to the chairmanship of the Council of Economic and then in early 2006 to the chairmanship of the Federal Reserve Board. To my mind the Fed including Bernanke and other regulators flunked in failing to see the onset of the financial crisis brought about by reckless lending not only in the housing markets but through the creation of an array of toxic financial products. However with the onset of the financial crisis in August 2007 through mid-2009 the Fed and others did indeed have the courage to act. Here Bernanke and crew get an A in throwing everything but the kitchen sink at the crisis. In my mind their actions avoided the Great Depression 2.0.

Bernanke argues, correctly in my opinion, that Lehman Brothers, my former employer, could not have been saved. At the time it looked Lehman’s balance sheet was too toxic for any private sector party to handle. It is easy to second guess, but you have to put yourself in the shoes of the decision makers when they made the decision. However, while spending quite a bit of time on Lehman, Bernanke gives short shrift to the two wards of the Fed, Citi and Bank of America/Merrill Lynch. Were they just as insolvent as Lehman, who knows, but Bernanke doesn’t tell.

With the high drama of the financial over Bernanke covers his defense of the Fed in the writing of the Dodd-Frank Financial Reform Act and his growing friendship with Democrat Barney Frank, the Chair of the House Financial Services Committee. He also highlights his growing dislike of what I call the “wrecker caucus” within the Republican Party. This animosity causes him to leave the Republican Party. Who can blame him?

He then goes on to discuss the very sluggish recovery and the very low rate of inflation. He brings the reader into the internal Fed debate involving the policy choices to expand the Fed’s balance sheet with QE2 and QE3 and the continuation of the Zero Interest Rate Policy throughout his entire term and beyond.  As a result the Fed’s balance sheet quintuples during his tenure in office. He gives himself high marks in promulgating these policies. Further he contrasts the relative success of the U.S. economy when compared to Europe and Japan where more orthodox monetary and fiscal policies were followed.

In this judgement Bernanke is premature. It is far too early to judge how the 8 year policy of zero rates and the explosion of the Fed’s balance sheet will look to a future Ben Bernanke writing in 2025. Remember in 2005 Alan Greenspan looked like a genius and three years later not so much.

*-With apologies to another Jewish South Carolinian, Harry Golden.

See the full Amazon URL at:

https://www.amazon.com/review/R7ZC3ZWS1XY65/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv