Dr. Richebacher’s Revenge:Dr. Richebacher’s Revenge:After the Great Moderation, After the Great Moderation,

The Great DisruptionThe Great Disruption

Agora Financial Vancouver Agora Financial Vancouver ConferenceConference

Robert W. Parenteau, CFARobert W. Parenteau, CFAMacroStrategy EdgeMacroStrategy Edge

July 23, 2009July 23, 2009

2008 Vancouver 2008 Vancouver ConclusionsConclusions• We were already in a recessionWe were already in a recession

• Fed easing would not be enoughFed easing would not be enough

• Breaking through the “corridor of Breaking through the “corridor of stability” in markets for durable assets stability” in markets for durable assets

• Fed would be forced to go Fed would be forced to go unconventionalunconventional

• Deflation would present the greater riskDeflation would present the greater risk

Key 2009 Macro QuestionsKey 2009 Macro Questions

• What happened to the Great What happened to the Great Moderation? Moderation?

• What is so different about a balance What is so different about a balance sheet recession?sheet recession?

• Where does the massive policy Where does the massive policy response leave us?response leave us?

What Ever Happened to What Ever Happened to the Great Moderation?the Great Moderation? • Central bankers and Wall Street praised:Central bankers and Wall Street praised:

– lower inflation ratelower inflation rate– longer economic expansions longer economic expansions – lower volatility of growth and inflationlower volatility of growth and inflation

• That was only part of the storyThat was only part of the story• Household, business, and financial sector Household, business, and financial sector

leverage all built up at the same timeleverage all built up at the same time• Asset prices and profits became more volatileAsset prices and profits became more volatile• Job and capital stock growth became Job and capital stock growth became

shallowershallower

Household Debt/Income Household Debt/Income RatioRatio

Ratio of Total Household Liabilities to After Tax Income

( in %)

0500959085807570

Source: Haver Analytics

140

120

100

80

60

140

120

100

80

60

Nonfinancial Business Sector Nonfinancial Business Sector Debt/Income RatioDebt/Income Ratio

Nonfinancial Corporate Business Debt/Gross Value Added

( in %)

0500959085807570656055

Source: Haver Analytics

120

100

80

60

40

120

100

80

60

40

Financial Sector Debt/Income Financial Sector Debt/Income RatioRatio

Financial Sector Debt to Gross Value Added

( in %)

0500959085807570656055

Source: Haver Analytics

600

500

400

300

200

100

0

600

500

400

300

200

100

0

The Great Roller Coast Ride The Great Roller Coast Ride II

Household Net Worth to After Tax Income Ratio

( in %)

0500959085807570656055

Source: Haver Analytics

640

600

560

520

480

440

400

640

600

560

520

480

440

400

The Great Roller Coast Ride The Great Roller Coast Ride IIII

US Corporate Profit Margin

(Pre Tax, Quality Adjusted, in %)

050095908580757065605550

Source: Haver Analytics

18

16

14

12

10

8

18

16

14

12

10

8

The Great Moderation I: The Great Moderation I: Job GrowthJob Growth

All Employees: Total Private

120-month %Change-ann SA, Thous

0500959085807570656055

Source: Bureau of Labor Statistics /Haver Analytics

3. 75

3. 00

2. 25

1. 50

0. 75

0. 00

3. 75

3. 00

2. 25

1. 50

0. 75

0. 00

The Great Moderation II: The Great Moderation II: Productive Capital Stock Productive Capital Stock GrowthGrowth

Net Stock: Pvt Nonres Eqpt & Software: Nonfarm Nonmanufacturing 10-year avg %Change Bil. $

Net Stock: Private Fixed Assets: Manufacturing 10-year avg %Change Bil. $

0500959085807570656055

Source: Bureau of Economic Analysis /Haver Analytics

14

12

10

8

6

4

2

14

12

10

8

6

4

2

After the Great Moderation:After the Great Moderation:The Great Disruption The Great Disruption

• Private sector deleveragingPrivate sector deleveraging

• Private sector income deflationPrivate sector income deflation

• Price deflationPrice deflation

• Massive policy response to contain Massive policy response to contain debt deflation spiraldebt deflation spiral

Sharpest Recession Since Sharpest Recession Since WWIIWWII

Capacity Utilization: Manufacturing [SIC]

SA, % of Capacity

050095908580757065605550

Source: Federal Reserve Board /Haver Analytics

97. 5

90. 0

82. 5

75. 0

67. 5

60. 0

97. 5

90. 0

82. 5

75. 0

67. 5

60. 0

Sharpest Recession Since Sharpest Recession Since WWIIWWII

Final Sales to Domestic Purchasers 2-qtr Change SAAR, Bil. $

Gross Domestic Product 2-qtr Change SAAR, Bil. $

0500959085807570656055

Source: Bureau of Economic Analysis /Haver Analytics

750

500

250

0

-250

-500

-750

750

500

250

0

-250

-500

-750

Evidence of Private Debt Evidence of Private Debt ReductionReduction

Nonfinancial Business: Liabilities: Credit Market Instruments

Difference - Period to Period NSA, Bil $

0500959085807570656055

Source: Federal Reserve Board /Haver Analytics

375

300

225

150

75

0

-75

375

300

225

150

75

0

-75

Evidence of Private Debt Evidence of Private Debt ReductionReduction

Households: Liabilities: Credit Market Debt

Difference - Period to Period NSA, Bil. $

0500959085807570656055

Source: Federal Reserve Board /Haver Analytics

400

300

200

100

0

-100

400

300

200

100

0

-100

Evidence of Income DeflationEvidence of Income Deflation

Personal Income ex Transfers

% Change - Year to Year

050095908580

Source: Haver Analytics

16

12

8

4

0

-4

16

12

8

4

0

-4

Evidence of Income DeflationEvidence of Income Deflation

Corporate Profits with IVA and CCAdj

% Change - Year to Year SAAR, Bil. $

050095908580

Source: Bureau of Economic Analysis /Haver Analytics

40

20

0

-20

-40

40

20

0

-20

-40

Evidence of Price DeflationEvidence of Price Deflation

Final Sales to Domestic Purchasers: Chain Price Index

1-qtr %Change-ann SA, 2000=100

050095908580757065605550

Source: Bureau of Economic Analysis /Haver Analytics

15

10

5

0

-5

15

10

5

0

-5

Evidence of Price DeflationEvidence of Price Deflation

CPI-U: All Items

% Change - Year to Year SA, 1982-84=100

050095908580757065605550

Source: Bureau of Labor Statistics /Haver Analytics

16

12

8

4

0

-4

16

12

8

4

0

-4

Massive Fiscal Policy ResponseMassive Fiscal Policy Response

Total Government Fiscal Balance as a Share of GDP

( in %)

0500959085807570656055

Source: Haver Analytics

4

2

0

-2

-4

-6

-8

4

2

0

-2

-4

-6

-8

Massive Monetary Policy Massive Monetary Policy ResponseResponse

Monetary Authority: Financial AssetsNSA, Bil. $

Security Brokers & Dealers: Financial AssetsNSA, Bil $

05009590

Source: Federal Reserve Board /Haver Analytics

3750

3000

2250

1500

750

0

3750

3000

2250

1500

750

0

The Oxymoron of a The Oxymoron of a Government Led RecoveryGovernment Led Recovery

• Automatic stabilizers will segue into an Automatic stabilizers will segue into an infrastructure ramp up in 2010 infrastructure ramp up in 2010

• Headwind of private deleveraging Headwind of private deleveraging remainsremains

• Q2 near zero, 2-2.5% growth into 2010Q2 near zero, 2-2.5% growth into 2010

• Jobless recovery, limited pricing powerJobless recovery, limited pricing power

• Equities, corporate bonds, inflation Equities, corporate bonds, inflation hedges outperform Treasurieshedges outperform Treasuries

Dealing with the Policy Residue Dealing with the Policy Residue

• The Hat Trick on Treasury issuanceThe Hat Trick on Treasury issuance

• May constrain the Fed mop up May constrain the Fed mop up operationoperation

• Liquidity on ice – Treasury rescue Liquidity on ice – Treasury rescue stash?stash?

• Super sponge for the Fed?Super sponge for the Fed?

Large Issuance, Lower Interest Large Issuance, Lower Interest Expense – Nice One!Expense – Nice One!

Federal Outlays: Interest

12-month MovingTotal Mil. $

05009590

Source: U. S. Treasury /Haver Analytics

260000

240000

220000

200000

180000

160000

140000

260000

240000

220000

200000

180000

160000

140000

Shortening the Fuse on Public Shortening the Fuse on Public DebtDebt

Share of Privately Held Marketable Treasury Debt < 1 Year to Maturity

( in %)

050095908580

Source: Haver Analytics

60

55

50

45

40

35

30

60

55

50

45

40

35

30

Large Issuance, Low Interest Large Issuance, Low Interest RateRate

Implied Average Interest Rate on Federal Government Debt

( in %)

0500959085807570656055

Source: Haver Analytics

14

12

10

8

6

4

2

14

12

10

8

6

4

2

Liquidity on Ice: Liquidity on Ice: Treasury Slush Fund?Treasury Slush Fund?

Treasury Securities as a Share of Commercial Bank Financial Assets( in %)

Cash plus Reserves as a Share of Commercial Bank Financial Assets( in %)

0500959085807570656055

Source: Haver Analytics

40

30

20

10

0

15. 0

12. 5

10. 0

7. 5

5. 0

2. 5

0. 0

After the Great DisruptionAfter the Great Disruption

• Private sector flow imbalances are Private sector flow imbalances are clearingclearing

• But at the price of enormous fiscal and But at the price of enormous fiscal and monetary policy interventionmonetary policy intervention

• The question of placing Treasuries The question of placing Treasuries

• The challenge of policy exit strategiesThe challenge of policy exit strategies

• Need a new global growth modelNeed a new global growth model

• Risk of dollar flight: use inflation hedgesRisk of dollar flight: use inflation hedges

Never Underestimate Never Underestimate InnovationInnovation

Adapt…or Die!Adapt…or Die!