The shortest recession ever – unemployment will be below 6% in November

After US unemployment rose to nearly 15% (in April) I wrote a blog post forecasting unemployment would be back below 6% in November.
 
That got me a lot of attention and a lot of suggestions for bets on the numbers (I have accepted a lot of these wagers).
 
Today, we got the US labor market report for May. It is a massive confirmation on my bullish call on the US labor market.
 
US (non-farm) employment rose by 3 million in May and unemployment dropped to 13.3% in May from 14.7% in April. This is much better than the consensus expectation of an increase in unemployment to 19%.
 
The US recovery is well underway. The markets have been right and the-world-is-coming-to-an-end-pundits have been wrong.
 
Meanwhile market inflation expectations continue to rise as well and even though inflation expectations are still below where we where in late February it is clear that the US economy is not heading for deflationary depression.
 
This will in the end will be the shortest US recession on record.
The lockdown of the global economy has been a very bad and unplanned vacation, but particularly the US economy is recovering very fast from it.
In the past 12 years I more or less constantly been calling for further monetary easing both in the US and the euro zone as inflation expectations have remained below the Federal Reserve’s and the ECB’s 2% inflation targets.
However, I am now for the first time in more than a decade beginning to think that the risk is that the Fed could err on the upside in terms of overshooting its inflation target.
I am not too alarmed by this and and I am not overly concerned about a repeat of the mistakes of 1970s (yet), but I am beginning to think that we could see the Fed being forced to reverse cause a lot faster than most commentators are now predicting.
In fact I have over the past week (on Twitter) been arguing that we might even get a rate hike before the end of the year (yes, this year…) from the Federal Reserve.
Markets are of course not yet priced for that, but it is clear that is the direction in, which we have been moving in recent days.
US fiscal policy has been eased aggressively in response to the lock-down crisis and the Fed has at the same time acted decisively to eas monetary conditions. As the US economy is re-opened this easing – both fiscal and monetary will have to be reversed.
Massive government cash transfers have caused a major spike in growth in US personal incomes as the graph below shows.
Historically there has been a fairly strong positive correlation between changes in the Fed’s policy rate and growth in personal income.
However, recently the Fed has been cutting the policy rate and introduced quantitative easing, while personal income growth has spiked.
Obviously, the spike in income growth is a one-off and unemployment remains very high, but if I am right about my call on US unemployment then the Fed very soon will have to hike rates and it could be before the end of the year.
The timing of course will depend both on inflation expectations and on the speed of the recovery in the labor market, but for now I certainly think a rate hike this year is more than likely.
Fed fund target

 ——

Contacts:

Lars Christensen, LC@mamoadvisory.com, +45 52 50 25 06.

See my profile at my Danish speaker agency here.

Why have epidemiological forecasts been so wrong and what to do about it

Why have epidemiological forecasts been so wrong and what to do about it

If we look at the forecasts, we got from epidemiologists initially in the Covid-19 pandemic it has turned out that they have massively wrong. While tragic the number of people who has died in this pandemic has been much lower than forecasted.

The reason given by epidemiologists then is that that is because of interventions – lockdowns. But then you made the wrong kind of forecast – you forgot to forecast what would happen IF lockdowns were implemented.

Furthermore, how do you explain the numbers in South Korea, Taiwan and Japan? There were no lockdowns (until recently) and we haven’t seen a massive death told, which was forecasted by the kind of epidemiological models used for example by the epidemiologists at the Imperial College in the UK.

Similarly, in Sweden with no lockdown, which as the only European country did not have a lockdown. Despite of that the death toll in Sweden has not in general been higher than in other Western European countries. It should of course be mentioned that Sweden’s Covid-death toll has been higher than in the other Nordic countries, but also here government epidemiologists massively overestimated the number of deaths and the need to hospitalizations even after claiming to take the lockdown effects into account.

And the Covid-19 pandemic is not the only pandemic where epidemiologists have been wrong – on the upside.

They were wrong (generally) very wrong on HIV/Aids, Ebola, Swine flu and SARS.

The death toll from these pandemics never reached the levels predicted by leading epidemiologists and there never was the kind of “super spike” in number that standard epidemiological models seem to predict.

We need to take human behavior and technological progress into account

There are probably (at least) two reasons why the standard epidemiological models tend to be wrong in my view.

First, of all as economists have pointed out since the HIV/Aids pandemic standard epidemiological models ignore human behavior. People dislike being sick and hence will change behavior if they know that will reduce the likelihood of being infected with Aids or Covid-19.

The literature on economic-epidemiologic goes back at least to work done by among others University of Chicago economist Tomas Philipson in the 1990s on HIV/Aids and the present pandemic has spurred a lot of new research on this topic. Another example is professor at Cambridge University Flavio Toxsvaerd’s excellent work on what he has termed ‘equilibrium social distancing’.

Furthermore, numerous new studies clearly confirm the thesis that human behavior is very important in terms of mitigating the spread of a virus like Covid-19. American economist William Luther in a recent paper shows that people reacted to the news of the spread of Covid-19 before US States started to implement lockdown.

The same goes for Sweden where there has been no government mandate lockdown and for example school have remained open, but people has nonetheless significantly changed behavior.

The change in behavior before government mandate lockdown has also been shown in a very good blog post by Catarina Midões from the research institution Bruegel. She shows that Google searches for ‘restaurants’ was way down in a number of European countries well before lockdowns were imposed by governments around Europe. The graph below from Midões’ blog post illustrates this well.

catarinablogreplace

A second reason why epidemiological models tend to overestimate the death toll from pandemics is that they ignore technological progress – or rather medical progress. The Aids epidemic of course is a prime example of this, but it is also likely to be the case with Covid-19.

Here we have to see medical progress in a broad sense – it could for example be that we become better at protecting the people most at risk – for example the elderly or the obese – and we get better at treatments. This does not have to be major medical breakthrough but gradually nurses and doctors as they learn small things will adjust their treatment of Covid patients and that on its own will gradual reduce mortality.

This is similar to the critique economists have had for centuries against environmental doomsayers like Thomas Malthus, Paul Ehrlich and Greta Thunberg. The world is not coming to an end as humans adapt all the time and are highly innovative.

Concluding, one can say that epidemiological forecasting today is done like weather forecasting, but it should be done a lot more like economic forecasting – you can’t change the weather by carrying an umbrella, but you can change the course of a pandemic by practicing social distancing.

If there are a pandemic people will react to that – during the present pandemic people are practicing social distancing and extra hand washing without government intervention. We just all want to reduce risk – at the lowest cost.

However, there likely is a more fundamental problem – economists would call it a Public Choice problem or a principle-agent problem

Epidemiologists don’t necessarily have the incentives to be right

Most epidemiologists are government employees – either working for the health authorities or government-funded research institutions.

They are generally not paid to be right. They are mostly paid to do reporting and research – not accurate forecasting.

Furthermore, a government-funded epidemiologist will not be rewarded for making a too optimistic forecast, but will likely receive a lot more funding and attention if they are making doomsday forecasts.

I am not claiming this is done on purpose, but incentives work – also in research and economists would make the exact same mistakes if they worked in the same ‘reward-system’.

However, if we compare epidemiological forecasting to macroeconomic forecasting there is one crucial difference and that is competition.

There are not one or two economists making forecasts on the US or Euro zone economies – there are a many. That means that forecasts can be compared.

Furthermore, we have the financial markets to tell a story. In February the global equity markets started telling the story that the global economy would take a major hit.

If macroeconomic forecasters had ignored that information then they would have been too optimistic. Similarly, now – markets are telling us that the recovery will be quite fast.

That is challenging macroeconomic forecasters making very gloomy forecasts – they have to explain their model assumptions and why they believe markets are wrong.

Markets might indeed be wrong from time to time, but they are unbiased and we also know that it is very hard to find anybody who consistently can beat makes – so if you are a professional macroeconomic forecaster forecasting something very different from what markets are “predicting” then your clients and others will surely question whether your forecast is off.

Furthermore, economists argue in public all the time about their forecasts, which means that policy makers and investors get a very good impression of different scenarios for the outlook for the economy. I haven’t seen a lot of debate among epidemiologists – at least not in public – about how we should expect the Covid-19 pandemic to develop.

It is, however, also well-known that government institutions such as Finance Ministries and the IMF make fairly bad forecasts as they often are politicized (see here and here). For that reason, these forecasts are mostly ignored by market participants.

To me it seems like most epidemiological forecasts are quite similar to economic forecasts made by Finance Ministries – and even worse because Finance Ministries’ forecasts will always be compared by the media to independent forecasts.

We don’t see this to nearly the same degree in epidemiological forecasting as there really isn’t a private market for pandemic forecast – at least not yet.

So to repeat:

1) epidemiological forecasting is not done in an institutional framework where precision is rewarded enough and where doomsday forecasts will get more attention and ‘middle-of-the-road’ forecasts.

2) There isn’t enough competition – there are simply too few epidemiological forecasters and too little competition.

If Covid-19 and other pandemics stay with us and continue to shock major parts of the global economic system going forward then this will change as it will become profitable to do good epidemiological forecasting. (In fact, there might be a business idea here and if you are interested in this drop me a mail: LC@mamoadvisory.com)

However, at the present good epidemiological forecasting isn’t especially rewarding for epidemiologist. Alarmist forecasts on the other hand are.

Please note that I am not claiming economists make good forecasts or that macroeconomic forecasting isn’t often very wrong. It is.

However, macroeconomic forecasting continues to develop and adjust in the market place and being right will yield great economic rewards, which pushes forecasters to do a better job.

We need a market for forecasting pandemics

However, we have something a lot better than economists at doing forecasting – and that is markets.

Financial markets being the ‘wisdom of crowds’ is unbiased and generally (weakly) efficient. That means they are a quite good guide for the direction the economy will take.

This is also why I for years have argued that policy makers should utilize so-called prediction markets to make decisions and why I for example have advocated that monetary policy should be focused on market inflation expectations rather than model-based forecasts.

Generally, we need prediction markets to help policy makers make the right decisions based on unbiased market forecasts.

That mean there would be great public benefit from having ‘global warming’ markets and a ‘pandemic market’

This of course also goes for economic policy – we need prediction markets for unemployment and real and nominal GDP. We already have ‘inflation markets’ given the existence of inflation-linked bonds. I have long argued this – see for example here.

Returning to epidemiological forecasting my point is not that ‘epidemiologists are bad” and “economists are good”. My point is that they operate in different incentive structures.

That said, forecasting economic growth over the coming 2-3 years is something “we” are used to and macroeconomic forecasting has been around forever. Each new shock is different, but not completely different. We have a lot of experience in forecasting macroeconomics.

On the other hand, forecasting the development in a pandemic means you start from scratch every time. That of course is very different and much harder than observing the same kind of shock over and over again.

But the incentive structures do help. Furthermore, the fact that we have seen a lot of “black box models” during this crisis doesn’t help. We need openness and transparency regarding model assumptions. And we need competition rather than ‘forecasting monopolies’

This is not a critique of epidemiologists, but a critique of the overall way forecasting is done and mostly how it is used to shape policies and it is a critique very similar to things I have said about economic forecasting for years.

Concluding, the world more than ever needs good epidemiologists, but more than that we need good epidemiological forecasts and that means that we as societies need to ensure that we have ‘markets’ for epidemiological forecasting rather than forecasting monopolies.

——

Contacts:

Lars Christensen, LC@mamoadvisory.com, +45 52 50 25 06.

See my profile at my Danish speaker agency here.

 

 

 

Presentation on the US economy and markets (in Danish)

Warning – this is in Danish.

Her til eftermiddag har jeg haft fornøjelsen for første gang at optræde på SpeakerBee. Temaet var markederne og økonomien – primært i USA.

Jeg taler blandt andet om udsigterne for væksten og arbejdsmarkedet i USA – jeg er meget optimistisk – og for det amerikanske aktiemarkeder, hvor jeg er knap så optimistisk. Hør og se, hvordan det hænger sammen her.

Hvis du vil have mig ud til en præsentation eller arrangere et webinar eller lignene, så kontakt mit speaker agency YouandX her.

SpeakerBee

When Americans vote in November unemployment will be below 6%

Friday’s US labour market report rightly got a lot of media attention globally. The spike in US unemployment to 15% surely is historical and tells us quite a bit about just how big a shock has hit the US and the global economy.

However, where most commentators are wrong is assuming that this has to be seen as a normal recession. I on the other hand would argue that this has little to do with a normal recession. In fact I am increasingly thinking that the use of the term ‘recession’ is a misnomer in relation to this crisis.

Back in April I argued in my blog post ‘All set for a fast recovery after the ‘Great Lockdown’ argued that this crisis primarily should be seen as an unplanned and very unpleasant ‘vacation’. 

The IMF has called it the ‘Great Lockdown’ and I find this term very telling. Economies around the world have been locked down – either by governments or by voluntary behaviour by people who want to protect themselves against the coronavirus. 

Most people don’t really think about it, but most industrialised economies in the world every year goes through large “recessions” in the form of a major drop in economic activity. This happens both on the supply side as for example Southern Europeans go on Summer vacation typically in August or with private consumption as it fluctuates wildly before and after Christmas. 

We don’t see articles about this in the financial media and the reason is of course that we know this is happening. It happens every year. So nobody cares – we plan for it so it isn’t an economic problem. 

The lockdowns – boths by government intervention and voluntary social distancing – wasn’t preplanned and that’s why it has created a major economic disruption.

But that said, if we instead of sensationalising it, take a look in our economic textbooks and look at economic history then we will realise that economies return to ‘normal’ very fast after ‘vacations’ (also very unpleasant vacations).

The reason demand shocks take long to ‘disappear’ is that prices and wages are sticky and that economic policy reacts too slowly or insufficiently. But that is not the problem with supply shocks – they very rarely have longer-term effects. 

In fact that was the problem with the entire idea in the so-called Real Business Cycle (RBC) models that became popular (to discuss) in the early 1990s – it simply was impossible to show empirically that supply shocks would have very long-lasting effects on economic activity and certainly no long-lasting impact on labour markets. 

So when I in the headline argues that US unemployment will be back below 6% in November then it is simply because that is what the economic textbook tells us – market economies adjust fast to supply shocks.

This is essentially the point I also was making in my blog post in April, but I am happy to repeat it and I haven’t become more negative since then. The labour report, while it was horrible wasn’t the least surprising. 

We have known for weeks that US unemployment would spike to these levels so I really haven’t become more worried about my forecast for a sharp recovery in economic activity in the US towards the end of the year.

In this blog post I will present three more arguments – other than the purely theoretical arguments I have just repeated – why I believe that unemployment will soon be down to a level close to before the lockdown-shock hit. 

The markets is telling us so

When I back in 2011 coined the term ‘market monetarism’ is was because (now self-declared) market monetarists like Scott Sumner and David Beckworth and myself believe that financial markets tend to be efficient and hence reflect all available information about the outlook for the economy and that markets therefore will be the best available ‘forecast’ for the outlook for the economy and that policy makers should utilize this information when they conduct policy. 

This also means that market monetarist economists to a much larger extent than more traditional macroeconomists tend to look at financial markets when they try to forecast what will happen in the economy going forward.

And if we look at what markets have been telling us since the second half of March it is that this is not a demand shock. Market inflation expectations have first rebounded and then stabilised after the initial first shock and due to the actions of the Federal Reserve. 

And the stock market is telling us the same story. The US stock market is not back at the levels we saw in late February but we have made a significant recovery as markets got better visibility about the outlook for the spread of the coronavirus and the Fed demonstrated that it would not allow a new debt-deflation spiral to set-in. 

To me the US stock market, while sometimes wrong, is a fairly reliable indicator of future growth in US nominal income (NGDP) and normally fluctuations in NGDP growth cause fluctuations in US unemployment so we should expect the stock market to be a fairly good indicator of the US labour market as well. 

We can illustrate this with a simple xy-graph with changes (%y/y) in US stock prices (Wilshire 500) versus percentage-point changes (y/y) in the US unemployment rate lagged six months.   

Unemployment stock market

As we see there has historically been a fairly strong inverse relationship between the development in the US stock market and in US unemployment (over the coming 6 months). In the graph I use data going back to 1982. 

It is not hard to spot the outlier – the US stock market “failed” to predict the sharp rise in US unemployment we saw in April. 

One conclusion of course could be that the market is just plain wrong and the situation is much worse than the collective wisdom of the market says it is.

This essentially what a lot of commentators are saying at the moment – the market has become way too optimistic and it is all driven by “Fed liquidity”.

Well, I trust the market where investors have money on the line rather than pundits.

So what is that market telling us? 

Presently the broad US stock market is down around 2% over the past year and given the historical statistical relationship that would (based on a simple linear regression) imply that US unemployment should be up around 0.5%-point in November (compared to November 2019). This would imply US unemployment at 4% in November – somewhat lower than 6%. 

Obviously this is meant as an illustration rather than an actual forecast, but the overall story is nonetheless that judging from the US stock market the sharp increase in unemployment we saw in March and April is going to be temporary and unemployment will soon be back to normal levels. 

Hence, the markets are presently pricing that this will not be a long-last economic downturn and hence the increase in unemployment will be temporary and this naturally brings us to the next topic – most of the increase in unemployment is driven by people who have been laid off temporarily. 

Most layoffs are temporary

Historically around 10% of US unemployment has been made up by workers temporarily laid off from their jobs. 

However, if we look at the US unemployment in April 78% of all unemployed had the status of being temporarily laid off.

This means that essentially the entire increase in US unemployment in April was due to temporary lay-offs. We see that in the graph below. 

What I here call ‘core unemployment’ is unemployment minus the unemployed who has been temporarily laid-off. 

Core unemployment

We see here that ‘core’ unemployment actually has been more or less unchanged over the last couple of months (also in April) around 3.2%

This contrast sharply with the recessions of 2001 and 2008-9 where the number of temporarily laid-off workers didn’t increase at all, but core unemployment rose sharply. Both the recessions of 2001 and 2008-9 were recessions caused by demand shocks. 

If we, however, go back to the recessions of 1973-74, 1979-80 and 1990 we see that the share of temporary laid-off workers increased initially during all of these three recessions. 

What did all of these three recessions have in common? They initially all were triggered by a sharp increase in oil prices – hence, a negative supply shock.

While an oil price shock is something very different from a lockdown both are nonetheless negative shocks to the production (supply) side of the economy. 

This basically means that workers are being laid-off not because they have become too “expensive” relative to output prices (that is what is happening with a demand shock), but because the cost of OTHER inputs have increased. In the case of lockdowns simply because production basically is outlawed in certain sectors. 

Hence, a supply shock is not about prices and wage rigidity as I discussed above and this means that workers have not been ‘priced out of the market’ and should therefore be expected to return to work once production gets up and running again. 

During the first oil crisis the spike in ‘temporary unemployed’ lasted a bit more than a year while it took only around 9-10 months to get back to ‘normal’ during the second oil crisis. 

However, it should be noted that both during the first and the second oil crisis monetary conditions were tightened in response to rising headline (supply-side) inflation, which caused nominal demand growth to slow. Said in another way, on top of the supply shocks we got a negative demand shock. 

This isn’t the case this time around – the Fed has responded to the crisis by moving to ease monetary conditions and even though market inflation expectations are too low (lower the Fed’s 2% inflation target) the Fed nonetheless has stabilized inflation expectations

This means that once the lockdowns come to an end people will be able to return to work – not necessarily to their old jobs and not necessarily in the sectors they used to work in, but the reason they haven’t been working is not that their reservation wage were higher than their productivity so there is little reason why we shouldn’t see the share of temporarily unemployed come down very fast in the coming few months.

Another illustration of this is to look at initial jobless claims in different US states. 

I have looked at some of the hardest hit states where there also have been fairly strict lockdowns and States which have been less hard hit and also a State where there hasn’t been a lockdown (Utah). 

For a comparison I have also included the state of Louisiana, but with the data from 2005 when the state was hard hit by Hurricane Katrina.   

Claims

When we look at the data we see a very different pattern than what we would see normally during a recession where initially jobless claims keep rising months. In fact during the recession in 2008-9 initial jobless claims rose for more than a year. 

This time it is different and as we see the initial jobless claims numbers now behave much more like a shock like Hurricane Katrina in 2005. 

In fact so far the pattern has been very similar for most States – an initial sharp (very sharp) increase in jobless numbers for a couple of weeks followed by a relative sharp drop in initial jobless numbers thereafter. 

So far the numbers more or less have tracked the ‘Katrina pattern’ and if that continues we should expect ‘claims’ to be back to normal levels by the end of June. At that time we should already have seen US unemployment numbers having started to come down significantly. 

Consumption will rebound sharply – the money is there

I have for some time when talking to the media or with clients been making the argument that this crisis primarily is a supply shock and as long as the Fed (and other central banks) are doing their job of ensuring nominal stability when the economy should rebound very fast once we around the world move out of the ‘lockdown’.

However, most people (even many economists) tend to have a rather rudimentary perspective on economics and what they observe is that since private consumption is down and therefore (they believe) should GDP be – whether nominal or real doesn’t seem to matter. 

So even though I don’t really think it is important how the GDP‘cake’ is sliced in terms of aggregate nominal demand I will nonetheless try to address the issues of private consumption. 

Basically I believe that it makes most sense to think of private consumption on a macro level within Milton Friedman’s permanent income hypothesis. 

Over time private consumption is determined by permanent income expectations. So if our expectations about further permanent income decline we will tend to spend less.

Obviously on a micro-level one can have all kinds of reservations about Friedman’s permanent income hypothesis, but I still think it is the best we got. 

That essentially also means that we can think of how much each of us spends in a given week or month as reflecting the ‘targeted private consumption’ we have, which in turn reflects our expectations about permanent income. 

However, we do also change our spending depending on a lot of other things – we spend more when we are on vacations and during weekends. The same goes for holidays like Christmas. And then we spend less during other periods. 

From time to time we don’t hit our ‘targeted’ consumption. For example if you have planned to buy a new laptop, but it turned out that the model you wanted was sold out and you now have to wait another month. Or the opposite happens – you find something you have been looking for on eBay and simply has to buy it – even though that increases your spending above your targeted spending. 

With this ‘model’ in mind I think we can understand what has been happening with US private consumption, but also what will happen going forward. 

The first question we need to ask is whether there has been a change in the outlook for US permanent income. 

That is essentially whether there has been a drop in the US long-term growth potential. One can of course say that this pandemic will cause all kinds of frictions both as a result of changed behavior and changes in regulation. However, I think it is very hard to say now, but I would also stress that I think commentators in general make far too wild predictions about just how much this really is going to change things. 

Right now it is much easier to say “everything will change – nothing will be the same” in the global ‘media contest’, while the most likely scenario that we will gradually adapt as humanity always does and that this is likely to have an insignificant long-term effect on global growth will not get you either on CNN or Fox TV these days. 

Furthermore, judging from what the financial markets are telling us there is no reason that we should have become significantly more worried about long-term growth in the US or globally because of this pandemic.

This means that it is reasonable to assume that there really hasn’t been a change to permanent income expectations in the US. 

But what we have seen is a shock to private consumption, but not because people have become overly worried about their future income in general (some clearly have), but because people simply haven’t been able to spend. Your favourite restaurant has been closed and so has your hairdresser. 

So what has been happening is that your actual private consumption has been lower than your ‘targeted consumption’. 

A way of illustrating this is by looking at consumption and bank deposits. If private consumption develops as planned then we should expect deposits to grow steadily (with income) over time. However, if there is a shock to private consumption then this should be reflected by a similar shock to bank deposits. 

The graph below shows that the lockdowns and the behavioral reaction to the perception of the risks of the coronavirus in the US have had exactly this effect.

Deposits PCE

We see that prior to the shock bank deposits and private consumption expenditure was growing much in line with a strong positive correlation. However, as the ‘lockdown shock’ hit consumption dropped like a stone while deposits increased sharply. 

It is particularly noteworthy that in dollar terms the increase from February to April bank deposits nearly is exactly the same amount as the decline in private consumption in March. 

We don’t have the April numbers for private consumption yet but given the continued increase in bank deposits we should expect private consumption to have declined a further in April.

This to me is a pretty clear indication that the drop in US private consumption does not primarily reflect worries about the future permanent income of US consumers or a negative shock to income itself (then deposits would have dropped and not increased). But rather this is simply a reflection of the fact that US consumers have been taking temporary ‘vacation’ from spending. 

The question of course is when will consumers start to spend again?

Here history might help us. There are not a lot of examples in US modern economic history of such ‘unplanned spending vacations’, but one example is very similar and that is 911. 

When terror hit the US on September 11 2001 the US economy in many ways also came under a ‘lockdown’ and Americans stopped spending from one day to another. 

It was a shock many at the time said American consumers would never recover from – in the same way many today say that it will take a very long time to return to ‘normal’ consumption patterns. 

The stories at the time were the same as today – people will never fly again, they will not go to restaurants, they will never go to a basketball game again etc. 

We today know that the shock didn’t have a very long-lasting impact on US consumers. 

The graph below shows the consumption-deposit-shock of 2001. 

911 deposits PCE

We see the 911-consumption-deposit-shock is quite similar to what we are seeing now. 911 caused a ‘spending lockdown’ in September-October 2011, which in turn caused bank deposits to increase in parallel. 

However, the cut in spending had not been planned and consumers had not changed their permanent income expectations and consequently consumers quickly got consumption and deposits back on their ‘targeted’ levels  – indicated by the dotted lines. 

In fact, nearly to the dollar the amount US consumers ‘under-spend’ in September 2001 they ‘over-spend’ in October 2001. And they had the money in their accounts to do it. 

After having made up for ‘lost’ consumption consumers got back on track in November and continued on the pre-911 spending path.  

Those of us who still in horror remember the terror attacks on that horrible day in September 2001 also remember the fear of flying and the fear of just going out and about. However, life returned and so did consumption – in less than a month. 

I believe this is an important lesson for those who think that ‘we will never be back to how it was before’ in terms of consumption. 

If economic theory (the permanent income hypothesis) and economic history (911) teaches us anything it is that we should expect US consumption to make a very swift recovery.

In fact there is no reason not to believe that private consumption expenditure will be back on track in July after likely overshooting in June as US consumers catch up on what they have ‘lost’ in terms of spending since February.  

Another reason to be optimistic is what we are now seeing in terms of private consumption in the Nordic countries. 

Private consumption has followed a very similar pattern as US consumption in March and April in all of the Nordic countries. We are, however, now beginning to get out of lockdown.

In Denmark schools and kindergartens have been (partly) open since Easter and over the last two weeks certain shops that were closed (by government regulation) during the lockdown have reopened – for example hairdressers. 

My former colleagues at Danske Bank publishes a weekly “Spending Monitor”, which is based on among other things the bank’s clients’ credit card and cellphone payments. The Spending Monitor gives a near-real time update on Danish private consumption. 

It will be very interesting to follow in the coming weeks as Denmark opens up more and more for business and as we return to a more normal life. The ‘re-emergence’ has been under way over the past month. 

A very notable graph in the latest edition of Danske’s “Spending Monitor” is this graph with the turnover at hairdressers.

I particularly note that not only have Danes returned to the hairdressers – they are also making up for lost ground (and long hair) and spending around 20-30% more at the hairdresser than a year ago. 

I believe we will see something very similar overall in the US as the US economy also re-emerges from lockdown in the coming weeks and I see no reason why private consumption shouldn’t recover very fast. 

Yes, US unemployment will drop below 6% by November

So in conclusion, I think that despite the tragedy of the Covid-19 epidemic there is no reason to believe that the US economy – and the global economy for that matter – shouldn’t recover quite fast from this crisis. Much faster than after the 2008-9 crisis. 

Numerous policy mistakes have been made around the world both in combating and containing the pandemic and in terms of the monetary and fiscal response to the crisis and more mistakes are likely to be made, but we should nonetheless remember that market economies emerge much faster from negative supply shocks than from demand shocks. 

That is what I have tried to argue is this blog post and finally let me repeat my forecast – I strongly believe that US unemployment will drop very fast in the coming months and will likely have dropped below 6% when US voters vote at the US presidential elections in November.  

 ——

Contacts:

Lars Christensen, LC@mamoadvisory.com, +45 52 50 25 06.

See my profile at my Danish speaker agency here.

The Corona Crisis – a Scandinavian perspective.

Today Swedish journalist Nathalie Besèr and I have had a talk about the economic and political perspectives on the corona crisis from a Scandinavian perspective.

We among other things talk about the different policies in the Scandinavian countries and look at the economic consequences of the crisis.

ONE factor explains most of the differences in Covid19 deaths across countries

As an economist I am not happy about going into having strong views on the causes of why people die from Covid19, but at least I can have a look at correlations.

It has been very clear for some time that very few people younger than 50 years old die from Covid19.

In fact the average of people dying with Covid19 have been around 80 years in most countries and men are more likely to die than women.

These simple facts made me think – how much of this can explain the different mortality rates we observe across countries?

Why has so many people died in Italy and Spain, while mortality rates have been much lower in for example Scandinavia? Similarly why are mortality rates so low in most developing countries?

Can the age composition explain this? The graph below give us the answer.

Covid19 deaths POP

In the graph I have plotted the number of deads with Covid19 per 1 million population versus the share of the male population older than 80 years (%).

The data was collected on Friday April 17 2020 and I have only looked at countries with at least 100 deaths from Covid19 and excluded very small countries like Andorra.

As we see there is a very strong correlation between the two and it is certainly strong enough for me to argue that the absolut most important variable determining whether or not a country will be hard hit or not by the Covid19 crisis is the the age structure in the country.

Countries with a lot of old men will simply suffer a lot bigger blow than countries with younger populations.

It should of course be noted that I here compare countries, which are in different phases of the Covid19 crisis.

Correcting for that might make the “model” more (or less?) precise and we could of course also add more variables – for example air pollution, which think also is an important factor, but what is notable is that age alone is such an important factor.

From that perspective it also seem amazing to me that countries have introduced more or less draconian curfews and lockdowns around the world basically for everybody rather than focusing on protecting the most fragile parts of the population – the elderly.

In fact, if we look at Sweden which have likely has the most liberal approach to combating the Covid19 we see that Sweden’s mortality rate overall is not much different from other countries and if we put a regression line in the graph then Sweden would be more or less smack on that regression line.

Two nations to worry about – Greece and Japan

When looking at the graph it is very clear that two countries are clear outlier – Greece and Japan. Both countries have a quite high share of males older than 80 years (both above 6% – and higher than in Italy).

However, unlike Italy or Spain both Greece and Japan so far have avoided a large number of deaths. The question is why?

I don’t have a clear cut answer, but the Greek government early on put the entire nation on a very strict curfew – essentially locking up the Greek population in their own home.

The Japanese approach has been very different, but at least so far a major Covid19 outbreak have been avoided.

The question is, however, this will remain the case?

It is pretty clear that sooner or later Greek government will have to open up society and at that point there obviously is a risk of a Covid19-Tsunami hitting the country. Greece in that sense seems stuck between a rock and a hard place. Either the country goes bankrupt or the number of Covid19 death will likely increase sharply.

Japan has had a much less draconian approach than Greece or Spain and Italy for that matter and despite of that Japan has been able to avoid the Covid19 Tsunami. So maybe Japan’s approach should be copied by other countries – or maybe Japan so far has just been lucky. I don’t the answer to this.

The purpose of this post is to highlight the very clear relationship between share of the male population older than 80 years and the mortality across countries, but I must say that developments over the past week or so in terms of people being infected with Covid19 in Japan and the number of deaths and my fear clearly is that Japan could catch up with the “pattern” in the rest of the world. I certainly hope that that will not happen.

All set for a fast recovery after the ‘Great Lockdown’

In 2005, Hurricane Katrina hit New Orleans in the US state of Louisiana. The hurricane caused enormous material destruction and about 2,000 people perished.

While Katrina obviously cannot be compared to Covid19 in terms material devastation and death it nonetheless is comparable in terms of the sudden the “shutdown” of the economy.

Katrina was a very clear case of a supply shock. Production facilities were simply shut down. And in the same way as today, it happened from one day to the next.

But nothing really had happened to the fundamentals of the economy – this to a large extent is also the case in terms of the Covid19 around the world.

Katrina was a huge, but very short-lived economic shock

If we look at how things were going for Louisiana’s economy in 2005-6, then you will see that in economic terms, it was a huge negative shock, but the shock was also very short-lived.

We can see that by looking at various indicators of the labor market.

Recently, there has been a lot of focus on US initial jobless claims figures, which have spiked in recent weeks and US unemployment is like to soon hit double digit-figures. This clearly is deeply worrying, but if we look at what we saw in Louisiana in 2005 it might be that we should be less concerned for the longer-term consequences.

When the shock (the hurricane) hit, there was a strong spike in initial claims that is very similar to what we have seen recently – both in speed and scale.

But as the graph below shows, it was a very short-lived shock, and after a few weeks, claims began to subside, and after 3-4 months we were back to normal.

Katrina 1

In this context, we must keep in mind that there was enormous material damage in New Orleans, which greatly affected production in the area affected by the hurricane.

There is no material damage to Covid19. When the lockdowns around the world comes to an end, production can be re-started immediately. Yes, there will of course be a prolonged shock to relative demand for e.g. restaurants and air travel, but it does not change the overall nominal demand in the economy – only the composition of demand. And remember here – nominal demand in the economy is essentially determined by the demand and supply for money. More on that below.

If we look at unemployment in New Orleans, we see that unemployment from one month to another (August to September 2005) rose to more than 15% (more or less what is expected in the US now). But it was a very short-lived shock. 4-5 months later, unemployment had fallen back to the pre-shock level. A similar picture can also be found in employment.

These figures should make you optimistic that the shutdown shock will generally have a very short-term effect on economic activity in the United States – and in the world in general.

So yes, US unemployment is rising sharply right now, but if the lesson from Katrina tells us something, then we should not be surprised if unemployment has dropped back to levels not far from pre-corona levels when Americans vote at the US presidential elections in November.

Katrina 2

That being said, there is a loss of production and activity in the economy, no matter what, it will take time to recover. So, if we look at the economic activity in Louisiana, it took just over a year to get back to “normal”.

But again, it must be remembered that there was very extensive material damage that made production difficult for many months. We do not have that challenge today.

Therefore, when some claim that it will “take years” to get through the Lockdown crisis, I actually think we have to be a lot more optimistic.

Katrina 3

The Corona shock is primarily a lockdown shock to the economy – in the same way as Katrina was in Louisiana in 2005. And as soon as we move out of the lockdowns around world economic activity very will quickly pickup and return to pre-crisis levels.

Market economies – when allowed to – adjust very clearly to supply shocks – whether it is a hurricane or a pandemic.

It looks like we will avoid a major demand shock

It should, however, be remembered that for the price system to work well so the economy swiftly adjusts to changes in relative prices (as demand in certain sector maybe more permanently drops – for example tourism, restaurants and major sports events) it is necessary that nominal demand is kept on track. It is primary a task for central banks to ensure this.

I must, however, admit that I was very worried about this in the beginning of this crisis, as inflation expectations (in the bond markets) dropped very sharply both in the US and the euro zone and that financial distress increased sharply.

Fortunately, however, the Federal Reserve (and partly also the ECB) was quick to respond and although US inflation expectations are still a little too low (way below Fed’s 2% inflation target), the situation has largely stabilized.

Katrina 4

At the same time, major fiscal easing has been adopted in both the US and Europe. So, the risk of a negative demand shock in my opinion now is quite small.

The risk of premature monetary tightening is still there but I believe the risk of that is substantially lower today than in aftermath of the 2008 shock.

Say Law’s and the Fed will ensure a swift recovery

The IMF has dubbed this crisis the Great Lockdown. I think this very well captures the nature of this crisis. It’s primarily a negative supply shock, which at some point also partly looked to developed into a demand shock.

One could illustrate this in a simple AS-AD framework, but I actually think it more fitting to think of this as Say’s Law in action.

John Maynard Keynes formulated Say’s Law to mean that “supply creates its own demand”. Or rather production creates demand.

The Great Lockdown happened because households around the world more or less simultaneously decided to redraw from the labour market – either because of their own voluntary actions or because of government curfews or a combination of these.

In that sense on can also think of this as the first global Real Business Cycle (RBC) recession. But there has always been one problem with RBC models – it is hard to generate year-long recessions in these kinds of models. Recessions are not a result of people of going on vacation – except this time it is actually is. This is an unplanned and partly involuntary “vacation”.

But one can actually question whether this is a recession in the way we normally think about it. Nick Rowe has defined a recession as a situation where there is a general glut (excess supply) of newly-produced goods.

A negative demand shock creates such a general glut, but that is not the case with a negative supply shock – and it not the case with the Great Lockdown.

In the Great Lockdown the problem is not general lack of demand, but lack of production. Changes in relative demand also create problem for certain sector (air travel, restaurants, sport events etc.), but that is not the reason for the crisis – specific sectoral problems is no the reason for the overall decline in economic activity.

Therefore, once we emerge from the “lockdown” phase production­ will pick-up fast and then Say’s Law will take care of demand.

However, as uncertainty might remain heightened for a longer period, we should not rule out that there also will remain a heightened demand for money and safe assets. This could cause money-velocity to decline and push down nominal demand growth.

To avoid this, it is the task of central banks to offset this velocity shock by expanding the money base. Luckily the Federal Reserve seems to have gotten the message and has responded well during this crisis and so far, have succeed in stabilizing market inflation expectations.

The Fed has not done a perfect job, but certainly good enough in my view to ensure that this is not about to turn into a major negative demand shock.

So, in conclusion as long as the Fed keeps nominal demand on track and keep inflation expectations stable then we should expect that Say’s Law will ensure a fast recovery in the US economy (and likely the world economy).

As Hurricane Katrina shows us natural disasters can hit an economy very hard and send economic activity down very sharply and unemployment up extremely quickly, but economic activity also returns fairly quickly.

The imitate contraction in GDP in most countries in the world during this crisis is likely to be larger than during the Great Recession in 2008-9, but duration of the crisis is likely be much shorter – likely months rather than years.

So, let me stick my neck out and give you a forecast on US unemployment – unemployment will rise sharply in April maybe above 15% and is likely to remain elevated in June and July, thereafter unemployment will drop fast and will likely be back to the ‘structural’ level around 5-6% in November. The only conditions I have for this forecast is that the Fed ensures that market inflation expectations does not drop below present levels.

PS I believe that we could best understand the Great Recession by reading Milton Friedman, but to we should rather read F. A. Hayek to understand the mechanism in play during the Great Lockdown – that goes both for his warnings against totalitarianism (“Road to Selfdom“), his opposition to economic planning (The Socialist-calculation debate) and his deep understanding of the The Price System as a Mechanism for Using Knowledge.  2008 was primarily about monetary policy failure – today’s crisis is mostly about regulatory overkill.

A talk with the Icelandic Minister of Finance on the corona crisis

Everyday at 1000 CET I do a Facebook Live Update on the economic and financial consequences of the corona shock.

It is normally in Danish but today I did it in English because I had invited the Icelandic Minister of Finance Bjarni Benediktsson to join me for a talk about Iceland’s response to the corona shock.

You can watch the talk here and you can follow me on Facebook here.

Well done! Decisive actions from global central banks

Sunday night European time global central banks under the leadership of the Federal Reserve moved decisively to calm down market fears of eroding global dollar liquidity and to ease global monetary conditions.

See my comments on the this decisive and positive policy action here.

A (Keynesian-Monetarist) proposal to shock the euro zone out of the crisis

Fundamentally I think central banks have full control of nominal spending and therefore also inflation. Therefore, to me there is no liquidity trap.

However, there can be a mental or an institutional liquidity trap if for example a central bank refuses to take the necessary steps to permanently increase the money base.

I believe we are now in such a situation in the euro zone and therefore I think it is now time to suggest something I never thought I would have suggested – significant keynesian style (with quite a bit of market monetarist influence) fiscal “stimulus”.

So have a look at what I wrote on Twitter earlier today:

tweet 1

tweet 2

tweet 3

I know this is radical and maybe not expected from me, but the seriousness of the global ‘corona shock’ and the ECB’s refusal to act appropriately necessitate policy proposals like this.

Furthermore, proposals like this will not permanently expand the role of government in the economy and it will have an imitate and transparent impact.

Some might argue that this will not work as the Germans would just increase savings. This, however, really doesn’t matter. What is important is that this would decrease net savings in the euro area – through “weaker” public finances in German. This in turn would push up the “real natural interest rate” in the euro area. In line with what we have seen with the Trump tax cuts.

My “guesstimate” is that such measures likely would increase the real natural interest by at least 100bp in the euro zone and hence if the ECB keeps its key policy rate unchanged this would cause an “automatic” easing of monetary conditions in the euro zone. Hence, this proposal is really away to get monetary easing without the ECB actually doing anything (directly and on its own).

It is highly imperfect and not something I am happy about suggesting, but it is certainly better than the deepening of the deflationary pressures in the euro area and potential re-ignition of the euro crisis that we now might be facing.


Remember to have a look at my speaker agency’s web site here and follow me on Twitter here.

 

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