16 January 2009

Hoisington's 4Q Report: The Great Experiment

Thx to heritage ray of WSE Bearchat.


Presently, major sectors of the U.S. economy are experiencing a debt deflation that is causing a massive destruction of wealth, thereby curtailing jobs, income and spending.


Irving Fisher who, according to Friedman, was the most brilliant of all U.S. economists has noted that when the economy enters a period of "debt and price disturbances", those forces will eventually engulf the economy.

This theory of excessive debt and its pernicious and unrelenting deflationary impulse to the economy has been best chronicled by other notable economists: Charles P. Kindleberger (1910-2003), Hyman Minsky (1919- 1996), Nikolai Kondratieff (1892-1938) and Joseph A. Schumpeter (1883-1950).

The debt level of the U.S. has reached unprecedented proportions

More important than the level, however, is the fact that for the last few years the debt was improperly loaned and financed. In the words of the late economists Minsky and Kindelberger, this type of lending activity implies there is little likelihood of repayment of principal and interest.

Stock prices have plunged, and with home prices plummeting, and commercial and industrial properties losing value, a deflation of assets has clearly begun while the underlying debt remains constant.

Will this deflation overwhelm the best efforts of the Federal Reserve, invalidate Friedman's theory and prove Fisher correct?

Our judgment is that the power of monetary policy revolves around the ability to initiate a new borrowing and lending cycle. This can only happen if lenders are willing to lend and borrowers are wanting and able to borrow. Presently, neither are so inclined.

If price declines in assets continue...a period of very low nominal growth will likely extend for a decade. Fiscal policy actions may not be helpful either and could produce unintended negative consequences

Conventional wisdom is that the current economic contraction is nothing more than a typical post war recession. In the ensuing paragraphs we intend to frame an argument that is contrary to this conventional wisdom.


Our analysis suggests that the Fed will not achieve the desired results of stable velocity.

Fisher also suggested that velocity rises when leverage increases and falls when leverage abates.

So far the evidence at hand suggests that velocity is thwarting the efforts of the Fed. In the fourth quarter velocity plummeted, completely offsetting the increase in M2. Thus, nominal GDP declined at a very rapid rate.

While the historical record indicates that the ultimate low in Treasury yields lies years away, the path to the ultimate low will be anything but smooth or linear as significant volatility continues

As the experience from U.S. and Japanese history indicates, many "false dawns" will occur, with investors assuming that the long-delayed cyclical recovery in economic activity is at hand.

During these pleasant but relatively short interludes, stock prices will probably rise dramatically and bond yields will increase

If history is a guide, however, these episodes will further drain wealth and will be thwarted by the persistent forces of the debt deflation. With yields in the long Treasury market very low in nominal terms, the real return will be greater if deflation sets in.

Moreover, in Japan from 1988 to the present, as well as in the U.S. from 1872 to 1892 and 1928 to 1948, the total return on Treasury bonds exceeded the total return on stocks

Such a condition cannot happen for the long run, but it did happen in these three instances spanning two decades. As a hedge against a recurrence of a prolonged debt deflation, some investors may want to consider even larger positions in high quality, long term Treasury securities.

Van R. Hoisington
Lacy H. Hunt, Ph.D.


In this article, Brian Bloom argues that Hoisington's analysis means an Economic Depression is inevitable.

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