The inaugural Capital Commerce debate between two economist/bloggers, one a bull and the other a bear, moves into its second round. The combatants are Donald Luskin, chief investment officer at Trend Macrolytics, an economics and investing consulting firm, and Barry Ritholtz, proprietor of Ritholtz Research & Analytics.
The bullish Luskin writes a popular blog, The Conspiracy to Keep You Poor and Stupid, while the bearish Ritholtz has an equally popular blog, The Big Picture. Luskin goes first; Ritholtz has the last word:
Donald Luskin: For Now, Don’t WorryBe Happy
I agree with Barry that the biggest threat facing the economy is inflation. That's a very out-of-consensus view, and it doesn’t surprise me that a smart guy like Barry shares it. Longer term, it means trouble. Eventually the Fed will have to act to stop inflation, and the longer the Fed waits, the higher the interest rates will have to be to do it. When the Fed finally acts, the current economic expansion and bull market in stocks will be seriously threatened. So in some sense, longer term, I'm a bear. But for the immediate (and investible) future, I see nothing threatening a continued ascent for the economy and for stocks.
But Barry's wrong about some of the important details of what brought us to where we are. By what evidence can he claim that mortgage-equity extraction has fueled consumer spending, and consequently a boom in Asia? At the same time he says himself that consumer spending is what saw us through the last recession so easily; yet that was well before all the mortgage-equity extraction began. So the spending has been there all along, extraction or no extraction. That takes a major threat off the tablethe consumer isn't going to poop out just because home prices aren't rising anymore.
At the end, predicting a further slowdown, Barry makes what is, in my view, a very incorrect observation. He says, "With housing fading, nothing else has arisen to take its place." As I conclusively showed in my posting yesterday, the fact is that almost everything has arisen to take its place. The numbers don’t lie. As housing has cooled, the economy ex-housing has just gotten hotter and hotter. Fact.
Barry notes that "Business capital expenditure is softening; corporate profits are decelerating." No, the tense of that sentence is wrong. Capital expenditure has softened (past tense) a little, and profits have decelerated (past tense) a little. The real question is: What about the future tense? Are there any preconditions suggested accelerated or even continued softness?
No. Despite Barry's claim that the Fed has executed "a series of tightenings," monetary conditions are still on the accommodative side of normal, not tight at all. Both nominal and real interest rates are normal to low by historical standards. Money is incredibly easy, as evidenced by near-record narrowness in credit spreads.
This expansion is like all the rest. It will end when the Fed ends it, by getting really tight. We're not there yet. Keep watching. I'll let you know when to worry.
Barry Ritholtz: Worry a LotHousing Will Hurt the Economy
Don and I both agree that inflation is too high (and disturbingly sticky, as well). I suspect we have similar views about the Fed and the job Alan Greenspan did. I don't know what Don thinks of Ben Bernanke, but I have empathyhe has to clean up someone else’s monetary mess.
We also both agree that monetary conditions are not terribly restrictive, and with the Fed rate at 5.25 percent, they are not particularly accommodative (at least not like they were!).
Where our views diverge is about housing’s impact on the nature of this recovery, and the overall state of the economy. Over the next few days, I’ll outline my perspectives on housing, corporate profits, job growth, durable goods, gross domestic product, and the consumer.
Since Don shrugged off the housing slowdown, let’s begin our analysis with its impact on GDP and consumer spending, starting with mortgage equity withdrawal (MEW). Here's a related chart from my blog.
For most of the 1990s, net equity withdrawn by homeownersthrough sales or home-equity refinancingwas fairly modest. It accounted for some $25 billion per quarter, and was about 1 percent of disposable personal income.
By the late 1990s, MEW was about $25 to $50 billion per quarterabout 2 percent of disposable income.
Once the Fed slashed rates dramatically, the impact of MEW accelerated. By mid-2002, quarterly average withdrawals were above $100 billion, greater than 4 percent of disposable incomeup nearly 400 percent since 1997. By 2003, it was $150 billion and 6 percent. Things exploded in 2004, as withdrawals were nearly a quarter of a trillion dollars, and MEW hit a new peakover 10 percent of disposable personal income.
That’s a gain of 1,000 percent over 10 years. And, as we will see tomorrow, this was during a post-recession recovery that had below-average GDP, employment gains, residential investment, and equipment/software investment.
The impact of this equity withdrawal on the economy was enormous. Without it, the past five years would have looked very differentthe economy would have been expanding at about a 1 percent rate. Here's another related chart.
Since rates hit their lows in 2003, MEW has been responsible for more than 75 percent of GDP growth. This is a radical change from the past. In the late 1990s, equity extraction was "only" 25 percent of GDP growth. In the current cycle, it is three times that.
Even worse, it continues to fall. As rates have moved up, and lending standards tightened in response to the subprime-lending mess, equity extraction has trended downward (it totaled $113.5 billion in the third quarter of 2006). This is off by some 50 percent from the 2004-05 peaks.
As MEW fell, so did the GDP. This explains why the housing surge was so important to the economyand why its slowdown will also be so significant.
Tomorrow: We will look at why this has been one of the weakest recoveries on record, in terms of GDP and jobs growth.