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Two FIRE economy economists duke it out.
2 Top Economists Differ Sharply on Risk of Deflation
Michael Falco for The New York Times
Left, Jan Hatzius of Goldman Sachs; right, Richard Berner of Morgan Stanley.
By NELSON D. SCHWARTZ
Published: August 5, 2010
When the latest unemployment figures are announced on Friday, all of Wall Street will be watching. But for Richard Berner of Morgan Stanley and Jan Hatzius of Goldman Sachs, the results will be more than just another marker in an avalanche of data.
Contrasting Forecasts
Instead, the numbers will be a clue as to which of the two economists is right about where the American economy is headed. Their sharp disagreement over that question adds yet another twist to the fierce rivalry between the two firms, Wall Street’s version of the New York Yankees and the Boston Red Sox.
Mr. Hatzius is arguably Wall Street’s most prominent pessimist. He warns that the American economy is poised for a sharp slowdown in the second half of the year. That would send unemployment higher again and raise the risk of deflation. A rare occurrence, deflation can have a devastating effect on a struggling economy as prices and wages fall. He says he may be compelled to downgrade his already anemic growth predictions for the economy.
For months, Mr. Berner has been sticking to a more optimistic forecast, despite growing evidence in favor of Mr. Hatzius’s view. Last week, Mr. Berner was caught by surprise when the federal government reported that the economy grew at a 2.4 percent pace in the second quarter, well below the 3.8 percent he had forecast a month before. Mr. Hatzius came closer to hitting the mark, having projected a 2 percent growth rate.
Mr. Berner and his deputy, David Greenlaw, still expect a pickup in the second half of the year, which would help gradually bring down unemployment. They play down the danger posed by deflation, the malady of falling prices and wages that deepened the Great Depression and contributed to Japan’s lost decade of the 1990s.
“I’d say at this point the data and the sentiment in the marketplace have certainly gone more Jan’s way than mine,” Mr. Berner said. Some people, he added, “think I’m out of my mind. But I have a conviction in my beliefs that’s based on my analysis.”
Mr. Hatzius, a 41-year-old native of Germany who was 3 when Mr. Berner started out as an economist, is more restrained. He can afford to be, having snagged the top spot in a recent ranking of Wall Street economists as well as an award from Arizona State University honoring his “uncanny economic forecasting that anticipated the global financial crisis.”
On Wall Street, both men were among a very small group that accurately predicted the recent recession. Mr. Berner’s long résumé includes stints at the Federal Reserve in Washington and Mellon Bank in Pittsburgh. “I’ve seen plenty of ups and downs,” said Mr. Berner, 64, sitting in a corner office overlooking the Manhattan skyline at Morgan Stanley’s Midtown headquarters.
Showing not even a hint of doubt, Mr. Hatzius said, “The prospect of substantial inflation seems very remote, but the prospect for deflation is far from remote. A double dip is certainly possible but not likely.”
Mr. Berner does not expect substantial inflation, but he is predicting inflation will run 1 to 2 percent annually rather than the near-zero level Mr. Hatzius sees by the end of next year.
“There is still a one in 10 chance of deflation,” Mr. Berner calculates. “But we already have been much more aggressive and proactive in dealing with the problem than Japan was,” he said, referring to the Federal Reserve’s decision to quickly cut rates and aggressively buy government securities.
The split between the two chief economists, whose work helps inform trading strategies recommended to investors by their firms, echoes a broader and sometimes fiercer debate among academic economists and commentators about the threat posed by deflation and what the government’s response should be.
According to the deflationistas, as they are nicknamed, a new round of stimulus spending by Washington is urgently required to stave off a Depression-like cycle of falling prices and wages that is difficult to reverse once it is set in motion.
Inflationistas, by contrast, worry more about the effect that additional government borrowing could have on the recovery. With the budget deficit expected to hover around $1 trillion a year for the next decade, they say, interest rates could eventually surge, making borrowing — and goods — more expensive. A double dip, they say, is highly unlikely.
Mr. Hatzius’s gloomy outlook is owed centrally to Americans’ slowdown in spending. Recent data suggests that consumers are using any extra cash they have to pay down debt or put into savings. That places a strain on an American economy that has become hugely dependent on consumer spending.
On Tuesday, the Commerce Department reported that Americans saved 6.4 percent of their after-tax income in June, in contrast to the years before the recession, when savings rates stood at 1 to 2 percent.
Last month, the Federal Reserve reported that consumer debt dropped by 4.5 percent in May, a $9 billion decline. It was the 20th consecutive month that figure has dropped. In 2007, consumer debt jumped by 5.7 percent or nearly $40 billion.
“We had a housing and credit boom that was unsustainable, and now this boom has turned into a bust,” Mr. Hatzius said. “There was too much debt, and the deleveraging process has still got a ways to go. It’s going to keep private demand weak.”
Another big factor is the amount of slack in the economy. According to a recent report by Nomura, “The U.S. economy continues to operate with a staggering amount of spare capacity — unemployed workers, idle trucks and factories, etc.”
Mr. Hatzius agrees, adding that all this extra capacity will restrict the ability of companies to raise prices, thus raising the risk of deflation. “It’s plain to see there’s a ton of slack in the economy,” he said. “We’re not managing to generate enough demand to absorb all these productive resources in the economy.”
Mr. Berner is also studying the role that slack and deleveraging are playing, but he draws very different conclusions from Mr. Hatzius. Excess capacity is being reduced more quickly than Mr. Hatzius believes, Mr. Berner said. That will help businesses raise prices and improve profits, thus heading off the threat of deflation.
What is more, Mr. Berner argues that the deleveraging process is much further along than Mr. Hatzius believes, which will encourage consumers to start spending again. He expects economic growth in the second half of 2010 to run at more than 3 percent, roughly twice the 1.5 percent rate Mr. Hatzius projects.
If Mr. Hatzius is right, unemployment will still stand at 9.7 percent at the end of next year, slightly higher than it is now. Mr. Berner says he believes unemployment should sink to 8.7 percent by then. As for Friday’s numbers, Mr. Berner is calling for a private sector gain of 145,000 jobs versus Mr. Hatzius’s prediction of 75,000 new jobs.
Either way, both believe unemployment will remain at uncomfortably high levels for several years.
One answer, Mr. Hatzius says, is another round of stimulus spending by Washington to fend off the deflation risk he worries about.
Mr. Berner was skeptical of the stimulus bill passed in 2009, and he still “doubts that traditional fiscal stimulus is the right tool for the job.” Instead, he and his colleague Mr. Greenlaw argue for new mortgage rules that would reduce foreclosures and steady the housing market, payroll tax credits to encourage hiring and a new job training corps for unemployed workers.
“Friday’s number is just one tile in a mosaic,” Mr. Berner said. “From time to time, it’ll be like I’m winning, from time to time Jan will be winning.”
“The truth is that it’s just a crummy moderate recovery,” Mr. Berner added, hedging his bets. “We’ll both testify to that.”
http://www.nytimes.com/2010/08/06/bu...lation.html?hp
Michael Falco for The New York TimesLeft, Jan Hatzius of Goldman Sachs; right, Richard Berner of Morgan Stanley.
Contrasting Forecasts
Instead, the numbers will be a clue as to which of the two economists is right about where the American economy is headed. Their sharp disagreement over that question adds yet another twist to the fierce rivalry between the two firms, Wall Street’s version of the New York Yankees and the Boston Red Sox.
Mr. Hatzius is arguably Wall Street’s most prominent pessimist. He warns that the American economy is poised for a sharp slowdown in the second half of the year. That would send unemployment higher again and raise the risk of deflation. A rare occurrence, deflation can have a devastating effect on a struggling economy as prices and wages fall. He says he may be compelled to downgrade his already anemic growth predictions for the economy.
For months, Mr. Berner has been sticking to a more optimistic forecast, despite growing evidence in favor of Mr. Hatzius’s view. Last week, Mr. Berner was caught by surprise when the federal government reported that the economy grew at a 2.4 percent pace in the second quarter, well below the 3.8 percent he had forecast a month before. Mr. Hatzius came closer to hitting the mark, having projected a 2 percent growth rate.
Mr. Berner and his deputy, David Greenlaw, still expect a pickup in the second half of the year, which would help gradually bring down unemployment. They play down the danger posed by deflation, the malady of falling prices and wages that deepened the Great Depression and contributed to Japan’s lost decade of the 1990s.
“I’d say at this point the data and the sentiment in the marketplace have certainly gone more Jan’s way than mine,” Mr. Berner said. Some people, he added, “think I’m out of my mind. But I have a conviction in my beliefs that’s based on my analysis.”
Mr. Hatzius, a 41-year-old native of Germany who was 3 when Mr. Berner started out as an economist, is more restrained. He can afford to be, having snagged the top spot in a recent ranking of Wall Street economists as well as an award from Arizona State University honoring his “uncanny economic forecasting that anticipated the global financial crisis.”
On Wall Street, both men were among a very small group that accurately predicted the recent recession. Mr. Berner’s long résumé includes stints at the Federal Reserve in Washington and Mellon Bank in Pittsburgh. “I’ve seen plenty of ups and downs,” said Mr. Berner, 64, sitting in a corner office overlooking the Manhattan skyline at Morgan Stanley’s Midtown headquarters.
Showing not even a hint of doubt, Mr. Hatzius said, “The prospect of substantial inflation seems very remote, but the prospect for deflation is far from remote. A double dip is certainly possible but not likely.”
Mr. Berner does not expect substantial inflation, but he is predicting inflation will run 1 to 2 percent annually rather than the near-zero level Mr. Hatzius sees by the end of next year.
“There is still a one in 10 chance of deflation,” Mr. Berner calculates. “But we already have been much more aggressive and proactive in dealing with the problem than Japan was,” he said, referring to the Federal Reserve’s decision to quickly cut rates and aggressively buy government securities.
The split between the two chief economists, whose work helps inform trading strategies recommended to investors by their firms, echoes a broader and sometimes fiercer debate among academic economists and commentators about the threat posed by deflation and what the government’s response should be.
According to the deflationistas, as they are nicknamed, a new round of stimulus spending by Washington is urgently required to stave off a Depression-like cycle of falling prices and wages that is difficult to reverse once it is set in motion.
Inflationistas, by contrast, worry more about the effect that additional government borrowing could have on the recovery. With the budget deficit expected to hover around $1 trillion a year for the next decade, they say, interest rates could eventually surge, making borrowing — and goods — more expensive. A double dip, they say, is highly unlikely.
Mr. Hatzius’s gloomy outlook is owed centrally to Americans’ slowdown in spending. Recent data suggests that consumers are using any extra cash they have to pay down debt or put into savings. That places a strain on an American economy that has become hugely dependent on consumer spending.
On Tuesday, the Commerce Department reported that Americans saved 6.4 percent of their after-tax income in June, in contrast to the years before the recession, when savings rates stood at 1 to 2 percent.
Last month, the Federal Reserve reported that consumer debt dropped by 4.5 percent in May, a $9 billion decline. It was the 20th consecutive month that figure has dropped. In 2007, consumer debt jumped by 5.7 percent or nearly $40 billion.
“We had a housing and credit boom that was unsustainable, and now this boom has turned into a bust,” Mr. Hatzius said. “There was too much debt, and the deleveraging process has still got a ways to go. It’s going to keep private demand weak.”
Another big factor is the amount of slack in the economy. According to a recent report by Nomura, “The U.S. economy continues to operate with a staggering amount of spare capacity — unemployed workers, idle trucks and factories, etc.”
Mr. Hatzius agrees, adding that all this extra capacity will restrict the ability of companies to raise prices, thus raising the risk of deflation. “It’s plain to see there’s a ton of slack in the economy,” he said. “We’re not managing to generate enough demand to absorb all these productive resources in the economy.”
Mr. Berner is also studying the role that slack and deleveraging are playing, but he draws very different conclusions from Mr. Hatzius. Excess capacity is being reduced more quickly than Mr. Hatzius believes, Mr. Berner said. That will help businesses raise prices and improve profits, thus heading off the threat of deflation.
What is more, Mr. Berner argues that the deleveraging process is much further along than Mr. Hatzius believes, which will encourage consumers to start spending again. He expects economic growth in the second half of 2010 to run at more than 3 percent, roughly twice the 1.5 percent rate Mr. Hatzius projects.
If Mr. Hatzius is right, unemployment will still stand at 9.7 percent at the end of next year, slightly higher than it is now. Mr. Berner says he believes unemployment should sink to 8.7 percent by then. As for Friday’s numbers, Mr. Berner is calling for a private sector gain of 145,000 jobs versus Mr. Hatzius’s prediction of 75,000 new jobs.
Either way, both believe unemployment will remain at uncomfortably high levels for several years.
One answer, Mr. Hatzius says, is another round of stimulus spending by Washington to fend off the deflation risk he worries about.
Mr. Berner was skeptical of the stimulus bill passed in 2009, and he still “doubts that traditional fiscal stimulus is the right tool for the job.” Instead, he and his colleague Mr. Greenlaw argue for new mortgage rules that would reduce foreclosures and steady the housing market, payroll tax credits to encourage hiring and a new job training corps for unemployed workers.
“Friday’s number is just one tile in a mosaic,” Mr. Berner said. “From time to time, it’ll be like I’m winning, from time to time Jan will be winning.”
“The truth is that it’s just a crummy moderate recovery,” Mr. Berner added, hedging his bets. “We’ll both testify to that.”
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