	Generational Dynamics
	Forecasting America's Destiny ... and the World's

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Generational Dynamics Web Log for 4-Feb-08
Blogger watch: Mish Shedlock goes gloomy, while John Mauldin gets muddled.

Web Log - February, 2008

Blogger watch: Mish Shedlock goes gloomy, while John Mauldin gets muddled.

The word "Depression" is creeping into mainstream media.

Any regular reader of this web site is aware how critical I am of mainstream pundits, analysts and politicians. Journalists like Greg Ip at the Wall St. Journal have no idea what's going on. Economists like CNBC's Steve Lieseman or the NY Times' Paul Krugman talk pablum from mainstream economics, even though it hasn't predicted or explained anything that's happened in the last 10-15 years -- it doesn't explain why the bubble started in 1995 (as opposed to 1990 or 2000 or at all), it doesn't explain how we got to where we are now, and it provides no clue about what's coming next.

The bloggers -- Nouriel Roubini's blog, Michael ("Mish") Shedlock's blog, the Calculated Risk blog (with Tanta), the Sudden Debt blog, the MinyanVille blog, and others -- often pull the facts together, but fail to draw the right conclusions, for fear of getting people mad at them.

All of these people post analyses of things going on -- the latest jobs reports, the latest currency exchange rates, real estate foreclosure rates, interest rates, housing inventories, etc. They paint dark pictures of what's going on, but they never say what's coming next. Do they believe that we can get out of this mess? They never say that. Do they believe that there's going to be another 1930s style Great Depression? They NEVER say that.

Then you have the Fed chairmen -- Alan Greenspan and Ben Bernanke. They seem to have no idea what's going on either, but there's a suspicion that they're aware of what's coming, but don't want to say anything.

Today's situation is absolutely identical to what happened in 1929, as described by John Kenneth Galbraith in his 1954 book, The Great Crash - 1929, as follows:

"A bubble can easily be punctured. But to incise it with a needle so that it subsides gradually is a task of no small delicacy. Among those who sensed what was happening in early 1929, there was some hope but no confidence that the boom could be made to subside. The real choice was between an immediate and deliberately engineered collapse and a more serious disaster later on. Someone would certainly be blamed for the ultimate collapse when it came. There was no question whatever as to who would be blamed should the boom be deliberately deflated. (For nearly a decade the Federal Reserve authorities had been denying their responsibility for the deflation of 1920-21.) The eventual disaster also had the inestimable advantage of allowing a few more days, weeks, months of life. One may doubt if at any time in early 1929 the problem was ever framed in terms of quite such stark alternatives. But however disguised or evaded, these were the choices which haunted every serious conference on what to do about the market." (p. 25)

This could describe what's happening today as easily as it describes the time prior to October, 1929.

Michael "Mish" Shedlock

And so it's worth noting that one blogger, Michael ("Mish") Shedlock, has apparently decided to throw caution to wind and speak the word that dare not be spoken - "Depression."

Now admittedly he isn't as forthright as we are, choosing instead to make his claims by indirection, but his implications leave no doubt that he's predicting a depression.

He quotes a recent article about a 1929 "fiscal stimulus" package that President Herbert Hoover got passed to save the economy, and concludes, "Like the fiscal stimulus of 1929 the Fiscal 'Stimulus' Of 2008 Is Doomed To Fail."

Shedlock points to the following similarities between 1929 and 2008:

In the 20's, there was a massive overexpansion of manufacturing capacity. Today there is a massive overexpansion of productive capacity in China and a massive overexpansion of retail stores in the US.

In the late 1920s, bank credit propelled a massive real estate boom in New York City, in Florida, and throughout the country. We now have the biggest housing bubble in history.

In late 20’s credit was expanding at a rapid pace but there was no need for additional productive capacity. Today GDP is rapidly falling but credit is still rising (for now).

In 1929 there was no pent up demand for manufactured goods, especially autos. Today there is no pent up demand for homes, restaurants, retail stores, strip malls, autos, trucks, or anything else.

Shedlock adds a quote by Ludwig von Mises: "There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved."

Shedlock refers to an article by Ben Bernanke, in written 2000, called "A crash course for central bankers." In that article, Bernanke explains how the Fed could have avoided the 1930s Great Depression by lowering interest rates faster.

Shedlock says, "Final analysis will show that Bernanke can change interest rates but not attitudes, and attitudes are far more important. Indeed, changes in attitudes will render all of Bernanke's academic theories about the Great Depression meaningless."

(Shedlock reaches the same conclusion that I did last year in my lengthy analysis, "Bernanke's historic experiment takes center stage." Note that Shedlock's "changes in attitudes" are the attitude changes in Boomers and Generation-Xers, as they go from stupidity and nihilism to anxiety and panic.)

Shedlock concludes,

"Greenspan had the wind of consumers' willingness and ability to go deeper in debt at his back. Bernanke has the wind of boomers fearing retirement in the midst of falling home prices and impaired bank balance sheets blowing stiffly in his face. There is no cure for what ails us other than time and price. And with the aforementioned attitude changes, the biggest, most reckless, global credit expansion experiment the world has ever seen is coming to an end. Central banks are powerless to do anything about it."

Shedlock might have mentioned that Gen-Xers are getting even more panicked than Boomers are.

John Mauldin

While Shedlock takes a professorial approach in his blog, John Mauldin runs an investment advisory service. In his newsletters, he likes to brag about enjoying $5-10 cups of coffee from Starbucks, and the fact that his target investor has $2 million or more in assets.

In last week's newsletter, Mauldin he responds to what he says are "lots of questions" about a possible recession and depression.

Now, Mauldin would not have very many $2 million clients if he were saying a depression was coming. On the other hand, he tries to give an analytic answer to his client's question. His conclusion is that the economy will "muddle through" for a couple of years, but since he's being pulled in both these directions, his whole column ends up being just muddled.

I'm actually not critizing Mauldin too much, because his newsletter is actually much more advanced than typical investment advice newsletters.

He responds to the following question:

"What are the differences between the current state of the economy from that of the 1930s that would allow us to have a 'muddle through' instead of a deflationary depression? There seem to be many technical and fundamental similarities. We westerners having been living above our means for a long time and something is going to have to give. If history repeats itself then the cure to our addiction requires us to go 'cold turkey' with a deflationary depression. Is there hope that perhaps we could have room-temp turkey instead?" - Dr. John E.

He begins with this:

"First, I have already lived through 5 recessions. And every one was different in nature and cause. It is likely most of my readers, all except the youngest, have lived through at least 2 recessions, although the last two were rather mild, for reasons we will go into later. And this next recession, if we have one (and I think we are already in one) will be different than the past recessions.

But the operative words are "lived through." The US economy will come through this recession and enter a new period of growth, just as we have in the past. As will, by the way, the European economy, which I also think will encounter a recession. Again, recessions are a normal part of the business cycle. Congress can't repeal them, and central banks can only fight them, but not prevent them entirely."

I don't think Mauldin intended it, but he's captured exactly the reason why Generational Dynamics works the way it does. He's old enough to have lived through 5 recessions, but not old enough to have lived through the Great Depression. So he has no idea what's going on.

What's fascinating though is his section, "It is All About Valuations," where he gets into price/earnings ratios.

I really want to go into Mauldin's arguments, because they're fascinating, and his reasoning, while slippery, appears to be unique to him.

But first, we have to take another look at my own P/E chart that I frequently post:

S&P 500 Price/Earnings Ratio (P/E1) 1871-2007

S&P 500 Price/Earnings Ratio (P/E1) 1871-2007

Now, nobody ever prints a long-term P/E chart like this one (except for that shocking NY Times article that I wrote about last August), because it's way too frightening for the tender intercourse of the mainstream media. Somebody could look at the above graph and actually figure out what's coming, and the mainstream media-ites wouldn't want that.

As this chart shows, the P/E ratio is poised to fall to 5, as it has several times in the last century, most recently in 1982. In order to do that, stock prices will have to fall by a factor of 3, pushing the Dow Industrials down to around 4000. Furthermore, since P/E ratios have been well above average for 12 years, they'll have to stay below average for an equivalent length of time -- that's the Principle of Mean Reversion.

Here's how Mauldin treats all the above points:

"Markets go from high valuations to low valuations back to high valuations, as nauseum. You can measure it in price to book or price to earnings or whatever metric you want. The affect is the same. There has never been a time where markets started out from high valuations that they did not eventually end up with lower valuations. These cycles lasted on average for 17 years, with the shortest being 13 years (so far).

And this is important. There has never been a time when valuations dropped to the mean and then went back up again without visiting a much lower valuation. Never. Not one time. Zip.

We are now back to the mean P/E ratio. Now maybe this time it is different. But those are dangerous words."

I'm not sure what 17-year cycles he's talking about; if you look that above graph, you'll see that the major cycles (labeled with bottoms at 5.31, 5.82 and 6.79 on the graph) occurred at roughly 31-year intervals. (The next bottom would thus be in 2012, meaning that it would have to start falling about now.)

Presumably Mauldin is referring to some sub-cycles, but it's confusing that he missed the major cycles.

However, Mauldin does hint at the Principle of Mean Reversion when he says, "There has never been a time when valuations dropped to the mean and then went back up again without visiting a much lower valuation."

That's the crucial point, and he should be applauded for emphasizing it.

"P/Es are now in the 15 range. But I contend they will go lower. How can we get to the low P/E ratios that have prevailed in all previous cycles?

Either one of two ways. The market can drift sideways for a long time while earnings continue to grow, or the market can drop enough to get us to lower valuations. ...

If the stock market were to drop 20%, then the P/E ratio gets to 12, assuming earnings don't fall. Of course, they will, but they are also likely to rebound as quickly as they did after the last recession."

With this, Mauldin begins to go wrong, but since he's trying hard, let's analyze his argument.

He says that there are two ways that P/E ratios can reach their previous lows: (1) A flat stock market, awaiting a return to earnings growth; or (2) A sharp fall in the stock market index. The way he describes it, neither possibility will be particularly bad.

Unfortunately, this argument is completely off the rails. Let's take a look at the problems:

He seems to be saying that the P/E ratio need only make a quick trip down to its 1982 level (6.79), and then it can pop up again, but that's not what the Principle of Mean Reversion says. The P/E ratio has to drop down to a low level, say 5 or even lower, and then STAY THERE FOR A LONG TIME to compensate for the 12 years it was above average. Mauldin completely misses that point.

However, when Mauldin says that there are "two ways," he is making the following point: The bigger the stock market crash (i.e., the lower the P/E ratios go), the shorter its duration.

He says that earnings will fall, but "they will rebound as quickly as they did after the last recession." Boy, this is total wishful thinking. The last recession occurred in 2001-2002, and then the economy got swept up into the housing bubble, the credit bubble, the liquidity bubble and a new stock market bubble. There will NOT be a new bubble. The Principle of Mean Reversion applies to earnings growth as well as P/E ratios. Earnings are going to stay low for a very, very long time.

Now here's an interesting thought:

"Why don't we just hit the mean P/E ratio and just bounce back on up? It is mostly psychology, and I spent a great deal of time in my book and in this letter trying to demonstrate the reasons behind these cycles. But in a nutshell, if you disappoint the market once, you get a small reaction. Disappoint investors again and the reaction is more pronounced, and don't even go there a third or fourth time.

Recessions produce earnings disappointments for a variety of reasons: reduced consumer spending, higher marginal cost of sales ratios, reduced business investment, etc. I think we are in for a few quarters of disappointment."

This is really silly. This is why mainstream economics has been a total failure for so many years at predicting or explaining anything. If you don't understand what's going on, then blame it on investor psychology. Utter nonsense. You might as well blame it on the man in the moon.

The question is: "Why don't we just hit the mean P/E ratio and just bounce back on up?" Well then it wouldn't be the "mean" would it? The word "mean" means the same as "average." The Principle of Mean Reversion says that, over the long haul, the average stays the same. Well, if you always bounced back up when you got to the average, then it would always be above average. This P/E ratio would fit in quite well in Lake Wobegon, where "all the women are strong, all the men are good looking, and all the children are above average."

The Principle of Mean Reversion says that if P/E ratios are above average for a while, then they have to be below average for an equivalent period of time, in order to maintain the long term average.

Mauldin says,

"As I said in my annual forecast, I expect to turn modestly bullish on the stock market when this recession has played its course, and seriously bullish when valuations get lower. I am looking forward to it. It is more fun to be bullish. You get invited to more parties."

I can sympathize with this. I don't get invited to too many parties either.

Carolyn Barber, a woman from the 1930s

People like Shedlock and Mauldin, born after World War II, really have no idea what's coming. Here's are some excerpts from an article in the Red Bluffs (CA) Daily News, written by Carolyn Barber, born in the 1930s, with a wholly different way of looking at things:

Carolyn Barber: The most spoken words of the present, 2/2/2008

Certain words become popular during ongoing generations.

One such word is paradigm. In the 1970s - '80s, every conversation centered on paradigm change. ...

A word being heard frequently these past few weeks is the R word. Sometimes we address words that are uncomfortable with recognition of only the first letter of the word.

I am wondering how many of us can readily identify the R word of current repetitive use. No, it isn't a double word like rebel rouser or rat fink.

The word most readily used and somewhat ominous to those who hear it today is recession.

The media use the word daily as do the politicians who are currently seeking possible remedies for the economy in the United States and in the world.

To a multitude of people, old and young, who have been visiting the local grocery stores and other basic needs establishments, the noticeable raise in prices has held their attention for more than a few weeks.

The word recession hit real people over a year ago in the form of challenging already lightly filled pocketbooks. These people already live on a tight budget and are daily faced with hard decisions on what to cut back on or to completely eliminate from their waning budgets. Some have resorted to making their groceries last a little longer, a need to enforced diet or filling their gas tanks for many less miles which means eliminating even short pleasure trips. ...

The dictionary speaks of it as being a short cycle. This recession, sometimes defined as just a little slide back, is hard to accept as small with the large numbers of repossessed homes on auction blocks everywhere.

Those that have lived through previous recessions see the prediction of a short business cycle as a frivolous presumption.

A remnant of the populace remember the economic crisis and the period of low business activity in the U.S. and other countries beginning with the stock market crash in October of 1929 and continuing to the 1930s. What occurred at that time in history was the Great Depression.

Some of us, born in the 1930s can remember stories of the depression (coming after the recession) told by their parents, their grandparents and aunts and uncles.

Thoughts of buying a home in those times was squashed by the fact that many families in the years of depression lost all that they previously owned.

My maternal grandparents had to leave their home and property in Nebraska and Grandpa Field's good job and migrate to the mountains of Colorado to find new employment.

Their young children had to seek jobs of any sort to help maintain the meager income of the total family. Possessions were left behind and were either sold or passed on to neighbors.

My sweet, grandmother, Elsie Fields, mourned over having to leave her precious pump organ, an item that drew the family together as she played and sang the favorite song of each child.

My parents started married life in a two room apartment situated over a pool hall; the residents of these small coal oil heated apartments shared a common bathroom. They also shared food and reused coffee grounds over and over until they could pool their monies to buy additional rations.

I was born in such an apartment, my uncle and aunt's was chosen for the birth, it being better furnished and more presentable to the attending doctor. People helped others through the remaining ravages of the Great Depression. What lesson can we learn from history? Perhaps it is not to take the word recession too lightly. Perhaps it means that we can plan ahead and ward off a full depression. Perhaps by all working together some of the sacrifices will not be those that bring us down to a depression of the mind and soul."

Ms. Barber makes a proposal when she asks: "What lesson can we learn from history? Perhaps it is not to take the word recession too lightly. Perhaps it means that we can plan ahead and ward off a full depression. Perhaps by all working together some of the sacrifices will not be those that bring us down to a depression of the mind and soul."

This is actually a question that I've asked myself many times in the last few years, only I asked it in a different way: Suppose that in 1996, instead of just talking about "irrational exuberance," Alan Greenspan announced that, "I've been studying generational theory, and I've concluded that the current irrational exuberance is the first part of a huge bubble that's going to lead to a new Great Depression. I ask everyone: Please control yourselves."

Or, suppose that around 2001-2002, President Bush learned about generational theory, and concluded that the country was headed for a new Great Recession. What could he have done to prevent the bubble from happening?

Generational Dynamics tells us the answer: Greenspan would have changed nothing, except possibly to get himself fired, and President Bush could have done nothing either.

The power of generational attitudes is too great. You can't stop them any more than you can stop a tsunami. Imagine either Alan Greenspan or George Bush telling Boomers or Gen-Xers that they shouldn't do things that might risk a bubble. You could hear the laughter all the way to the moon.

And so Ms. Barber's plea that we help each other so that a Depression can be avoided will have no effect. It's already in the cards. It's been in the cards for decades. It's 100% certain.

That's why I always tell people on this web site: You can't stop what's coming, but you can prepare for it. Treasure the time you have left, and use the time to prepare yourself, your family, your community and your nation. (4-Feb-08) Permanent Link
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Generational Dynamics Web Log for 4-Feb-08 Blogger watch: Mish Shedlock goes gloomy, while John Mauldin gets muddled.

Michael "Mish" Shedlock

John Mauldin

Carolyn Barber, a woman from the 1930s

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Generational Dynamics Web Log for 4-Feb-08
Blogger watch: Mish Shedlock goes gloomy, while John Mauldin gets muddled.