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David Rosenberg: Those Complaining of QE Now Will Beg For It Later

Tue, May 17, 2011 - 2:03pm

Editor's Note: The following is a partial transcript of Jim Puplava's interview with David Rosenberg, Chief Economist at Gluskin Sheff. In it, David gives a description of his overall deflationary outlook on the economy for the remainder of the year and why this current post credit-bubble collapse still has much further downside. Audio interview is here.

Jim Puplava: Joining us next on the program is Dave Rosenberg. He’s Chief Economist and Strategist at Gluskin Sheff and Dave, you made a comment the other day about an article that was written by Bill Miller in The Financial Times discussing oil, commodities, and what we call the dollar debasement trade. At some point, it almost becomes counterproductive, meaning that as the dollar falls and if oil goes up high enough, it’s going to impact economic growth. And there’s some price to pay for that cheap money, the bad effects of inflation. Do you subscribe to that view?

Dave Rosenberg: Well, I think there’s quite a bit of truth to it. You know, we had the situation with the Feds’ QE2 program that was ultimately aimed at bolstering risk assets like the equity market but at the same time, other correlated risk assets like commodities and particularly, things that we have to buy—necessities like food and fuels—have skyrocketed and as a result, we’ve had wages in real terms decline now for six months in a row. So it’s almost like Newton’s first law of motion, every reaction has an equal and opposite reaction and in some sense, these QE2 programs, these quantitative easing programs, while they may have ignited animal spirits in investors, have created other distortions as well that have perhaps done more harm than good for the real economy.

Jim Puplava: Yeah. According to Miller, there’s a lot of price or momentum and belief in the system—it’s kind of like a trend that’s once in place keeps going until it bends eventually. How much do you think of, let’s say, the rise that we’ve seen in commodity prices is based on true fundamental demand factors and part based on, let’s say, just cheap money that’s going and looking for a place to park. 

Dave Rosenberg: Well, we knew that commodity prices have been in a well-defined secular up trend for the past ten years. So then the question really is, in those periods where you get these sharp deviations from the trend line. The trend line in commodities is up—if China has some Ponzi scheme that implodes, I imagine that will have a deleterious impact on demand and the secular bull market would be over. Because at least we know what the basic tenets are from the demand side. But what happened—and I think a lot of this is starting late summer with quantitative easing—is that the liquidity or at least the perceived liquidity—if it’s going to influence one asset class like small cap stocks, it’s going to have an impact on correlated assets being commodities. And if you take a look, for example, how you’re going to assess this is just go to the weekly commitment of traders’ reports and just go to the Nymex futures and options to see what the net speculative long position is in a variety of commodities—in this particular instance, let’s look at oil—and we had a situation a couple weeks ago, for example, where the net speculative for a noncommercial interest in oil contracts was triple what it was in the summer of 2008 when oil was $145 a barrel. So there’s no question that whether it’s a ten, twenty or thirty dollar premium that we had in the price of oil, in a sense which that may have been reflecting what was happening in Libya, the reality is that what we had for most of this year that move, I would say, from $90 up towards $115, I treat not as a source of demand in real terms globally, which might be a beneficial increase in the price. But instead, what it really has done is acted as an exogenous tax shock on the American consumer, which is why these consumer confidence indices really, although they’re up off the bottom, the depression bottom, are still at levels that would be consistent with recessions in previous cycles.

James Puplava: Now Dave, your long-term views on all of this have been more in the deflationary camp. Do you still hold those views, given the rise that we’ve seen in, let’s say, PPI, CPI and the basic goods that we have to buy on a daily basis? And if you hold that view still, what are the main reasons behind it?

Dave Rosenberg: Well firstly, let’s go back to the summer of 2008. Once again, we have a massive commodity spasm. And everybody has inflation on the brain. If you actually go to the consumer confidence surveys, people thought we were going to have 6% inflation. Of course, we did get headline inflation at the peak when oil was peaking and other commodities, inflation did get to 5-1/2% at the highs in the summer of 2008. And a year later, we were negative 1% on the inflation rate in a twelve-month span. But something got in the way of that commodity boom and maybe it was credit, maybe it was housing, a combination of the two. As far as I could see, home prices are deflating, commercial real estate is starting to roll over again. We have a situation where there are now more than six Americans in the total pool available labor vying for every job opening out there, and that’s putting downward pressure on nominal wage growth. So the answer is that statistically speaking, if we just take a look at a point of time, your answer is quite right—that we have these visible things we can’t really substitute away from in the family budget, which is food and fuels. And commodities certainly are volatile and they move like a sign wave over time. And that’s where the inflation is. But you see what’s happening at the same time because you can see it in the data. You can see what is happening to pricing in other parts of the economy, especially in the service sector, which is still sensitive to what’s happened in labor market. And that’s what people tend to forget is that, yes, we have goods in place and spending from the commodities. But two-thirds of what we as Americans spend money on out of the budget—well, two-thirds of that is services, not goods. You know, forty years ago it was goods, but we’ve become more of a service-sector economy. And you’ve seen a lot of service sector prices actually still disinflating because they’ve been deregulated and they’re subject to tremendous competition. And at the same time, there’s only so much money right now in the family budget to spend. So you might get more inflation, say, in food and fuels and that means that people have to cut back on other parts of the budget, especially the discretionary items. And I think it’s those areas that will be deflating over the course of the next year.

So I guess that’s what it comes down to—that is this run-up on commodities really a sustained increase in the overall inflation rate going forward like it was in the 1970s or is it really a relative price shift? And what it’s going to do in the stagnant wage environment is force people to cut back on the other parts of the budget that’s going to force reduced pricing power in those other areas.

James Puplava: Could we, Dave, see a sort of bifurcated pricing mechanism in the economy? In other words, things like housing and maybe even assets would decline? And especially since a lot of these assets or large items like cars, homes, are determined to some extent by credit. But on the other hand, because of, let’s say, emerging market demand, the things that you and I have to buy on a daily basis like groceries, gasoline at the pump, those things go up. So could we see deflation in one sector, inflation in another?

Dave Rosenberg: Absolutely. And that is what we’re seeing and it may well be that’s what we’ll continue to see. I don’t think oil’s going to go from 100 and 200 to 300. Remember, inflation is the whole process. That’s what I mentioned before both just at a point in time. The 1970s was a whole decade of accelerating inflationary pressure. So what we’re talking about here is—you’re right—it’s about relative pricing, you know, with some prices going up, some prices going down. It’s extremely pernicious when the inflation is in a part of the family budget that’s so vital—well, we’ve got to feed our kids and drive to work—and so it’s not something we can substitute away from. You know, like if all of a sudden restaurant prices were to skyrocket, well, you know, maybe we take the family out for dinner one fewer time a month and just eat at home. But when it comes down to the basic fabric in terms of your staples—food and fuels—it’s a different sort of inflation. It eats away at your standard of living and your confidence. And what it does is it forces you to cut back on those other discretionary areas of the economy that you don’t need. And that’s where the deflationary pressure is probably going to come from and the turret is going to wash out. But it does create, I think, social problems. There’s no question about it. When the price of necessities goes up as much as it has and if that doesn’t up reversing course, it is going to be problematic—especially because when you consider what the inflation really was in the 1970s. I mean, you talk about a whole process with everybody had a COLA clause back then. We had a much more unionized regulated and insulated economy protected from global competitive pressures and what was interesting in the 1970s is that the real inflation, people look at commodities. But what happened was that service sector inflation actually went up faster than commodity inflation in the 1970s. And the reason for that is because productivity stagnated for the entire decade and that wages went up 8-1/2% per year. Well, last I saw productivity has not stagnated, but wage growth actually in this country is extremely anemic and if you don’t get the wages playing serious catch-up here, then the inflation that you see in commodities ends up coming out of the pockets, you know, for other producers and retailers out there that are involved in the commodities base.

James Puplava: Let’s talk about what this might mean for the corporate sector because if you take a look at the regional fed surveys, the ISM, we’ve seen higher prices in the prices paid component. If that continues or if it stays as it is without receding, what does that tell us, Dave, about profit margins in the future quarters ahead of us? Because the markets have been elevated because the profits have been good. But what happens when, let’s say, the cost of manufacturing, the input costs are going up faster than, let’s say, what companies can raise their sales price due to competition?

Dave Rosenberg: Well, I think that is a terrific question. And the US economy as a standalone, say, entity, is a net raw material importer. So this is a significant squeeze on consumers, also on producers. And there’s no way that manufacturers or retailers can raise their prices as fast as their input costs are going up as it pertain to what’s happening in the raw materials side, which has gone asymptotic just over the course, say, over the past year. So the choices for corporate sector is that you either continue to make efforts to bolster productivity and productivity growth. Although it’s not gangbusters, it’s certainly decent. And that’s a help for profit margins. On top of that, we’ve got to keep in mind that the biggest expense for any given business is labor. And when you have a U6 unemployment rate of 16%—what I mean for that is that the total level of underemployment and unemployment ,that particular unemployment rate that looks at the whole gamut of the labor market—it’s 16% total unemployment rate in the US. And that’s putting downward pressure on wages, which isn’t so great for the household sector. But that’s the greatest expense for the business sector. So the way out of this for the corporate sector to maintain their margins without radically raising their prices—which I think is very difficult to do in the current environment, although some companies have been successful, but not nearly to the extent that they can offset the raw material price increases into their production process. So what they have to do is maintain solid productivity growth—which, by the way, they are doing—and at the same time, clamp down on labor costs, which is what they’re doing. But again, the phone company’s labor cost is a person’s income. And it’s one of the reasons why wage growth has been so anemic. But that’s really what, you know, outside of that, if we lack the effort to boost productivity and contain or reduce labor costs, what you are going to end up finding in the US equity market and broad corporate sector is a very significant margin squeeze over the course of the next several quarters.

James Puplava: You know, one thing that we’ve seen, Dave, in the last month we’ve seen a number of softening in the LEIs—I think five out of the seven were down in April. Are we headed for another slowdown or will we see a bit of stag-flation?

Dave Rosenberg: Well, you know, as I said before, we’re certainly going to get something called “flation.’ I just don’t think it’s going to be stagger in. I still think we have, overall in the aggregate, an overall deflationary backdrop, I think as it pertains to real wages, as it pertains to credit, as it pertains to real estate. There’s still significant pockets of deflation. I don’t have a big inflation view. I know it’s very tempting to have that as you drive by the gas station, but just remember that we all had that view in the summer of ’08 and the inflation view back then didn’t really materialize. We ended up getting a recession and inflation came down. It wasn’t a recession with inflation going up, which is what the stag-flationary environment would imply. I think that the, you know, to view that the economy is going to slow down is appropriate. In fact, it’s not even a forecast—it’s actually a fact on the ground—because we know that we had this QE2 euphoric lift in GDP growth in the fourth quarter of last year when we had 3.1%. I mean, think about it—we went from 2.6% GDP growth in the third quarter of last year to 3.1 in the fourth. Lo and behold in the first quarter, we’re at 1.8 and half of that is inventory accumulation and I’m not really noticing that we’re getting any sort of meaningful impetus into the current quarter. So the economy has already slowed down. I think that’s being reflected in the fact that bank stocks are down 12% in the past two months and ten-year treasury yields are down 60 basis points in the past two months and we usually get bank stocks and bond yields going down in tandem. That is not usually a development that is foreshadowing very good things to happen on the macro front. So the answer is yes, I think that second half of the year with the dramatic withdrawal of monetary, and especially fiscal support—I think we’re going to have a very sluggish economy between now and December.

James Puplava: This bring up a question, especially since 2012 is presidential election cycle. Dave, if the economy slows down, much in the way it was sort of doing so in the second and third quarter of last year—and let’s say we start to see the employment numbers begin to rise—would we see, in your opinion, another round of quantitative easing or some new stimulus from Congress, especially given the fact that the greatest unemployment that worries politicians is their own?

Dave Rosenberg: Well, I think that at some point in 2012, there’s a strong likelihood that we will see another round of quantitative easing—you know, how it manifests itself, what shape it takes—it might not be a case of expanding the balance sheet. It could be a case of targeting ten-year treasury yields to really give a push to the housing markets. But all that said, it’s that the bar for the next round of quantitative easing is very high. I mean, last year—it’s one thing to talk about a double dip—but don’t forget that the S&P 500 was on its way, seemingly below the thousand mark a couple of times. We’re at 1350 in the S&P. I mean, I’ll just tell you that. There is no QE with a S&P at 1350. But I would say that by the time we get the next round of quantitative easing—whatever shape or form it takes—the levels on everything, from the unemployment rate to inflation to home prices to the S&P are going to be materially different than they are today. And I would hazard to say that, especially now that Bernanke and the Fed have come under such close scrutiny—and actually disdain—from so many people that probably by the time we get to QE3, the same people that are lamenting and complaining about it today will be begging for it at that particular point in time. My belief is that we’re, in a very large book, probably a 600-page book called The Post-Bubble Credit Collapse. And people think that just because you complete a chapter or you double the stock market from the lows, but the book is not over. There’s several chapters. People thought that the book was over in 1930, in 1931 as well, and then they got whacked in the head with 1932. This is going to be a long and drawn-out affair, as usually is the aftermath of a post-double credit collapse. So to say that QE is off the table, well, it probably is for the next six months but if you go back to the opening month of 2010, the Fed was supposedly going to embark on the deficit strategy and lo and behold, by August, the Fed is crying uncle and, oh, we had QE II. And that was not supposed to be in the cards for the opening month of last year.

So we all know that Ben Bernanke is willing to be extremely aggressive, but when the time is right—it’s certainly not going to be in July—but I do think that will we see, at some point, another round of monetary easing? I think it’ll be necessary but maybe not until next year.

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