The Elbert Files: The Great Exaggeration
Friday, August 22, 2014 6:00 AM
Economist James Paulsen has a new name for the 2008-09 economic crisis: the Great Economic Exaggeration.
In a recent newsletter, Paulsen explained that from its beginning, the crisis was identified as the worst downturn since the Great Depression.
Commentators tagged it the Great Recession, but six years later, that appears to be a bit of an overstatement. Unemployment was actually worse during the 1982 recession, Paulsen said.
The “character” of the 2008-09 recession was “much closer to that of several other postwar recessions,” he added. And the destruction it caused “was never anywhere remotely close to . . . the Great Depression.”
The textbook definition of a recession is at least two quarters of economic contraction (decline in the gross domestic product). And by that definition, “at least four other recessions in the postwar history suffered almost as large of an annual decline in real GDP growth as was experienced in the aftermath of the 2008 crisis,” Paulsen said. That’s not to say that the crisis was not serious. It was, and we are still recovering from it today, he said.
But, he said, politicians and TV talking heads “exaggerated, early and often, just how close the contemporary era was/is to the Great Depression.”
That’s created a “wall of worry” that has slowed job creation, consumer spending, investment and home purchases, he said.
Paulsen, who is chief investment strategist for Minneapolis-based Wells Capital Management, presents his Great Exaggeration theory in his August newsletter.
It’s one of a dozen “dog days of summer” musings for investors to consider before we head into September, the month when the problems began six years ago.
One of Paulsen’s musings is titled “Shining some light on two labor market fallacies.”
The fallacies are (1) that wages have not kept pace with inflation, and (2) that laborers have not benefited from gains in productivity.
Paulsen cites government stats to show that wages not only kept pace with inflation, but since 1996, they ”outpaced consumer price inflation by an average of 0.6 percent per annum.”
He also plots wage increases against productivity gains on a graph that shows the two pretty much tracked each other except for a period from 2001 until 2008 when a lot of technological advances were being implemented in workplaces.
What makes it feel worse, he said, is the fact that “the share of national income accruing to labor is certainly lower than in earlier decades,” but that is because distribution of non-wage income has become more concentrated.
Many of Paulsen’s musings involved questions about inflation, including “Have deflation fears finally peaked and are inflation fears returning?”
He noted that during normal economic times, which typically include some degree of inflation, stock prices and bond yields typically move in opposite directions, creating a positive correlation – the greater the inflation fear, the greater the separation between the two.
But during periods of deflation or fear of deflation, such as the Great Depression, stock prices and bond yields tend to move in the same direction (a negative correlation), moving mildly up or greatly down, depending on the level of fear.
The dot-com collapse in 2000 and the 2008 crisis “have made deflation the predominant cultural fear,” Paulsen said, and the correlation between stocks and bonds “has been mostly negative since 2000.”
Right now, there is an abnormally high negative correlation, he said. “But it seems highly likely this correlation will diminish in the next few years” as inflation works its way back into the economy. Since World War II, there have been two other periods of negative correlation, and both times stocks did well as deflation fears eased and even better once mild inflation resumed, he said.
Let’s hope that’s what happens now, so we can leave the Great Exaggeration behind us.
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