Saturday, July 23, 2011

The Economy: A Structural Problem by Will Rahal

For several decades, the consumer, business and government sectors embarked on a journey of increasing debt dependence for consumption and political popularity. This led to unsustainable credit expansion, which ultimately resulted in a financial crisis.

History has shown that many years are needed to unwind the excesses while the economy balances on a tight rope high above ground and financial authorities struggle to provide a safety net below.

The chart above shows the three-year growth rate of nominal GDP over a sixty-year period. The chart clearly illustrates how unusually slow the economy has grown recently; it is currently at one-third the average of the period. The economy has a structural problem.

Nevertheless, there will be some periods of strength as the chart below indicates.

Plotted is the difference between the year-and-a-half annualized growth rate and a three-year annualized growth rate of nominal GDP. Note that it is about to roll over, suggesting a significant deceleration.

So where is the safety net? Bernanke understands the structural problem and has thus engaged in monetary easing. Judging from the deceleration that is coming, however, one can conclude that the timing of QE2 could have been better. Since a third round of quantitative easing is harder to sell than a second round, there may be a tardy response to the economic slowdown.

What about the markets?

Earnings, which are increasingly dependent on a global economy, have done well. The world, however, is plagued with the same malaise as the US. Expect a slowdown.

The injection of liquidity from monetary easing benefits the markets. Commodities compete with financial markets, and have the effect of P/E contraction, which partially explains why, in spite of record earnings, many indexes are still below their lifetime highs.

In summary, sub-par economic performance will continue and it better be viewed as a structural problem that is well understood by financial authorities. This understanding will not guarantee a smooth ride, but will provide a cushion.


  1. Thanks for the update Will.

  2. Will,
    Thank you for the update! Wish you would post more often. Loved your previous work.