Derail the Recovery
May 3, 2011
Die-hard deflationists – those who foresee a continued bull market in bonds – are so few in number these days they could all share an elevator, according to Gary Shilling. One is Gluskin Sheff’s David Rosenberg, whose views are considered elsewhere in this issue. But the loudest such voice belongs to Shilling himself, who has advocated for a long position in Treasury bonds continuously since 1980, a stance that has always proved prescient so far.
Shilling runs the New Jersey-based economic consulting firm the bears his name, A. Gary Shilling & Company, and he is the author of the recently-released book, The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation. He spoke last week in San Diego at the Strategic Investment Conference, sponsored by Altegris Investments and John Mauldin
Continued deleveraging was the overarching theme of Shilling’s forecast, and I’ll review why he believes that will keep inflation at bay.
Shilling’s forecast came with five important caveats, and I’ll also consider how those factors might upset the US recovery.
The age of deleveraging
The leveraging that took place in the US financial sector beginning in the 1970s and among consumers beginning in the 1980s ended with the financial crisis in 2008, Shilling said. But deleveraging since the crisis has so far been “minimal.”
His long-term view is that it will still take “a number of years” to work off this leverage. This drawn out process may frustrate investors, but if this process were to accelerate the economy would fall into a depression that “would make the 1930s look mild by comparison,” Shilling said.
Shilling called the current economic recovery “very slow” and said that US GDP is barely back to where it was 13 quarters ago, prior to the last recession.
That tepid growth came at the expense of trillion-dollar deficits, which Shilling expects to continue for many years to come, in the face of continuing unemployment. Historically, real GDP must grow at 3.3% annually to keep employment constant. Shilling, however, forecasted growth of only 2% in the near term, slightly better than the preliminary announcement for the first quarter of this year but still not enough to keep unemployment from rising.
“No government, left, right or center, can stand for persistently rising unemployment,” Shilling said. “There's going to be immense pressure to do whatever it takes to create jobs. And that's why I think the deficit is going to remain high.”
Shilling said he does not advocate deficit spending, but he predicted that nothing substantial would happen to curtail it until at least 2013, after the next presidential election.
While deleveraging and deficits provide the backdrop, Shilling said the key to his forecast is the consumer savings rate, which declined from nearly 12% in the early 1980s to almost zero prior to the financial crisis. Today it is nearly 6%.
The drop in savings, he said, fueled growth in the US and most of the rest of the world; the global economy ultimately depended on spending by the US consumer.
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