"Kee" Points with Jim Kee, Ph.D.

Stocks did well last week (S&P up 1.4%), more because of expectations of global policy easing - particularly in China, Japan, and Europe - than anything in the data. Policy easing is expected because of concerns over slowing China (which I’ll discuss next week), and because of uncertainty regarding Russian actions in Syria and the related European refugee crisis. In the US, the ISM non-manufacturing (i.e. services) index came in strong at 56.9% for September (above 48.7% means expansion; August was 59%). That’s important, because I am seeing expectations for 3rd quarter GDP growth coming down (the first or “advance” estimate will be released October 29th). The current read from the Atlanta Fed’s GDPNow model, which I consider to be a plausible if somewhat conservative starting point, is for 1% growth. Growth based upon the above-mentioned ISM non-manufacturing index would be 3.5% (Institute for Supply Management). Call that the most plausible optimistic case. My concern is that GDP growth in the 1% range increases the odds that any given shock will produce recession (not my forecast, by the way). In fact, former Fed Chairman Ben Bernanke, in his just-released memoir of the financial crisis (The Courage to Act), states that the economy has “never been able to crawl along at a 1% growth rate without lapsing into recession.” Normal growth for the US is 3% or so, not 1%. Of course, Bernanke is talking about a sustained 1% growth rate, not just a quarter or two, and last quarter’s GDP growth rate was 3.9%. I think the broader consensus expectation of a little more than 2% annualized growth is closer to the mark.

 

Bernanke’s book is a great read for anyone wanting to understand the history of central banking and of financial crisis, particularly the 2007-09 global financial meltdown. I don’t really recommend or review books in Kee Points (because I know it probably irks you when people do that as much as it does me), and Bernanke’s book didn’t read particularly well to me (I lost focus during the UT/OU game!). But the insights are important and frequent. I’ll just mention one here, and that is Bernanke’s analogy between the global financial crisis and a hurricane:

 

“If a hurricane knocks down a house, you can blame it on the strength of the hurricane or on the structural deficiencies in the house. Ultimately, both factors matter. A destructive financial crisis is analogous. There are the immediate causal factors or triggers – the hurricane. But the triggers cannot cause extensive damage without structural weakness, the vulnerabilities of the system itself – a house with a weak foundation.”

 

The “triggers” that Bernanke goes on to discuss include the rapid run-up and collapse of housing prices and construction, the breakdown in discipline in mortgage lending (particularly subprime), the risky lending to commercial real estate developers, and the huge global demand for financial assets perceived to be safe. The “structural vulnerabilities” Bernanke discusses include the fact that the American financial system had grown complex and opaque, the financial regulatory system had become obsolete and dangerously fragmented, and the fact that there was an excess reliance on short-term debt that made the system unstable under pressure. It was the interaction of these triggers and structural vulnerabilities that, according to Bernanke, led to the crisis. I hasten to add that both the financial system and the regulatory system are in far better shape now than they were at the time. Anyway, you cannot read this ideology-free insider’s account without being struck by how many commentators on the crisis literally did (do) not know what they were talking about. It also becomes clear that it is somewhat absurd to say anyone “called it” or predicted this crisis in advance. And you get the optimistic sense that, yes, sometimes the system does turn to the right man at the right time. Ever since reading (in graduate school) Friedman and Schwartz’s work on the failure of the Federal Reserve during the Great Depression of the 1920s, Bernanke had “become a Great Depression buff the way that other people are Civil War buffs.” It is truly eerie the way some of the things that Bernanke wrote about academically came to pass, like how the Central Bank might encourage economic activity through asset purchases even if interest rates were “theoretically” zero. I’ll end it there for this week on that relevant note…that Bernanke argued before the crisis that low or zero interest rates certainly would not mean that the Central Bank would be “out of bullets” if a crisis were to strike.