Pests in the Garden of Green Shoots


Nouriel Roubini must be reading up on Green Lantern spectragnosis: "Green shoots or yellow weeds?" Roubini asks in a long article (free reg. req.) describing "double dip W-shaped recession" and other potential dipsy doodles. The chairman of Roubini Global Economics, whose mid-decade bearishness on real estate and credit was ignored at the time but has since earned him honors as the second greatest public intellectual on Planet Earth, refers to a "trifecta of risks," then lists a quadrafecta and a decafecta of support for that trifecta.

These days some folks are seeing the light at the end of the bottom that is turning the corner, and Roubini acknowledges that some signs look positive. But like the teen math geek in a Hollywood film who can't get the Air Force to believe his crackpot theory about global-warming aliens, Roubini says they caught a shark, not the shark. Some red meat:

Let us leave aside that the optimists – including Bernanke, Greenspan and 80% of sell side research—has been repeating the refrain that the housing slump will bottom out soon since early 2007 (while totally missing its bust that started in mid-2006) and have been proven wrong quarter after quarters for all of 2007, all of 2008 and all of the current 2009.  The reality is that, in spite of all the talk of green shoots in housing there is very little evidence for it so far and home prices need to fall at least another 15 to 20% before they bottom out.

Also plenty of complex carbs for monetary policy buffs:

Sixth, the rapid and massive monetization of fiscal deficits—that has been pursued by central banks this year—is not yet inflationary in the short run as there are massive deflationary forces in the world given the slack in goods markets and labor markets; also the collapse in the velocity of money implies that the excess liquidity has been so far hoarded by banks in the form of excess reserves.  But if central banks don't find a clear exit strategy from  very easy monetary policies—that have led to the doubling or tripling of monetary base in the US alone—eventually either goods prices inflation and/or another dangerous asset and credit bubble will ensue when the global economy gets out of this severe recession. And some of the recent rise in equity prices, commodity prices and other risky assets prices is already clearly liquidity driven rather than being fully justified by the improving economic fundamentals.

Inflation may indeed become the path of least resistance for policy makers as it is easier to run the printing presses and cause inflation rather than pass politically difficult tax increases or spending cuts in Congress or other legislative bodies. But inflation is not a cheap solution to high public debts and the debt deflation problems of the private sector. If central banks were to allow the inflation genie out of the bottle allowing expected inflation and actual inflation to rise from low single digits to high single digits to double digits at some point a painful Volcker-style recessionary disinflation policy (like the one in 1980-82) would have to be implemented to break the back of inflation expectations and bring back the inflation genie expectation into the bottle.

Odd as it sounds, fear of higher interest rates right now makes you an optimist—because higher interest rates imply that there is actually demand for something. That's not always the case: As the reference to 1980-1982 (ably discussed in this Reason piece by Robert Samuelson) makes clear, recession, inflation and high interest rates can go hand in hand in hand. But at the moment, deflation expectations are so high that harebrained schemes like this one are being publicly discussed. I'd like to see some ultra-sophistical economist make the case that the smart move right now would be to let interest rates rise. This article doesn't do that, but it's got 9,700 grim words to kick off your three-day weekend.