Cassandra

“One heart was steadfast, and one soul clear-eyed, Cassandra.
Never her words were unfulfilled; Yet was their utter truth,
by fate’s decree, ever as idle wind in the hearers’ ears…”

—Quintus, “The Fall of Troy, Book XII”

Cassandra Weighs in Again

In Greek mythology, Cassandra was the daughter of King Priam and Queen Hecuba of Troy. Her beauty caused Apollo to grant her the gift of prophecy. But when she did not return his love, Apollo condemned her to never be believed. She warned the Trojans to not bring the massive wooden horse the apparently departed Greeks left as a gift into the city walls. Her people did not listen to her, and the “Trojan Horse” was brought into the city. We all know how that one ended.

We certainly don’t believe economists have the gift of prophecy. We don’t agree with many of them. However, in developing our own views and opinions, we take seriously people who don’t avoid the facts – and who’s positions, although unpopular, at certain critical junctures have been proven correct. And since we consider laughter the response of those who have no substantive response – we pay close attention to those who are mocked. We look at them and ask ourselves, “What do they know?” and “Why does it bother people so much?” And while nobody’s right all the time, when economist Nouriel Roubini speaks we at least listen to what he has to say.

About Roubini:

Fortune Magazine wrote:

“In 2005 Roubini said home prices were riding a speculative wave that would soon sink the economy. Back then the professor was called a Cassandra. Now he’s a sage”.[1]

Per The New York Times:

“On Sept. 7, 2006, Nouriel Roubini, an economics professor at New York University, stood before an audience of economists at the International Monetary Fund and announced that a crisis was brewing. In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks and other major financial institutions like Fannie Mae and Freddie Mac. The audience seemed skeptical, even dismissive. As Roubini stepped down from the lectern after his talk, the moderator of the event quipped, “I think perhaps we will need a stiff drink after that.” People laughed – and not without reason. At the time, unemployment and inflation remained low, and the economy, while weak, was still growing, despite rising oil prices and a softening housing market…

When the economist Anirvan Banerji delivered his response to Roubini’s talk, he noted that Roubini’s predictions did not make use of mathematical models and dismissed his hunches as those of a career naysayer.

But Roubini was soon vindicated. In the year that followed, sub-prime lenders began entering bankruptcy, hedge funds began going under and the stock market plunged. There was declining employment, a deteriorating dollar, ever-increasing evidence of a huge housing bust and a growing air of panic in financial markets as the credit crisis deepened… When Roubini returned to the I.M.F. last September, he delivered a second talk, predicting a growing crisis of solvency that would infect every sector of the financial system. This time, no one laughed. “He sounded like a madman in 2006,” recalls the I.M.F. economist Prakash Loungani, who invited Roubini on both occasions. “He was a prophet when he returned in 2007.”

Over the past year, whenever optimists have declared the worst of the economic crisis behind us, Roubini has countered with steadfast pessimism. In February, when the conventional wisdom held that the venerable investment firms of Wall Street would weather the crisis, Roubini warned that one or more of them would go ‘belly up’ – and six weeks later, Bear Stearns collapsed…”[2]

The Latest

And recently (September 5, 2010) Roubini and others were referred to by Ambrose Evens Pritchard in the Telegraph.co.uk:

“The US has run out of bullets,” said Nouriel Roubini, professor at New York University, and one of a caste of luminaries with grim forecasts at the annual Ambrosetti conference on Lake Como.

“More quantitative easing (bond purchases) by the Federal Reserve is not going to make any difference… Monetary policy can boost liquidity but it can’t deal with solvency problems,” he told Europe’s policy elite. Dr Roubini said the US growth rate was likely to fall below 1pc in the second half of the year, despite the biggest stimulus in history: a cut in interest rates from 5pc to zero, a budget deficit of 10pc of GDP, and $3 trillion to shore up the financial system. The anaemic pace compares with rates of 4pc-6pc at this stage of recovery in normal post-war recoveries.

“We have reached stall speed. Any shock at this point can tip you back into recession… There is a 40pc chance of double-dip recession in the US, and worse in Japan…

Hans-Werner Sinn, head of Germany’s IFO Institute, said the US would have to purge its debt excesses the hard way. “The bitter truth is that there is no way out of this with monetary and fiscal policy. They will just have to see their living standards go down. I see a decade of difficulties for the US,” he said. Dr Sinn said the US the market for mortgage securities (CDOs) had collapsed from $1.9 trillion in 2006 to just $50bn last year, leaving the US property market reliant on federal agencies.

“The world is simply not willing to buy these dubious financial products again. Germany is leaving, China is no longer there, and Japan is pulling away. The US system of mortgage finance is on government life support and that cannot drive a sustainable upswing,” he said.

Harvard Professor Niall Ferguson said… “The fiscal crisis seems to be out of control. The ‘big crossover’ is approaching when the US spends more on debt service costs than on security, and historically that is the tipping point for any global power… China is no longer willing to fund the US Treasury bond market, cutting its share of holdings from 13pc to 10pc of the total debt stock. While China must find ways to recycle its trade surplus and hold down the yuan, it is doing this by stockpiling commodities, buying hard assets around the world, or rotating into Asian bonds.

Dr Roubini said US companies have plenty of cash but are boosting profits by a policy of “slash and burn” on labour costs. “We’ve lost 8.4m jobs and if you include the loss of hours worked it is equivalent to another 3m. We need to generate an extra 450,000 jobs every month for three years to get it back,” he said. The US non-farm payrolls data released on Friday was better then expected but still showed a net loss of 54,000 jobs…

In the US, the fiscal boost has faded… The lift from the inventory cycle is finished. Capex spending by companies has held up well, but this slowed sharply in July. Housing is already in a double dip. The last support for the US economy is consumption, barely growing at 1pc. “All we did was kick the can down the road and stole demand from the future,” he said.”[3]

Planning Accordingly

Dire words indeed. Backed by facts which are disturbing. Are the predictions correct? Time will tell. But we’re listening. And planning for our clients accordingly. And yes, in this we see potential opportunity. But we don’t believe historically “conventional” tactics apply.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD
Vice President
Ernharth Group
www.ernharth.com

Go to www.ernharth.com/economic-commentaries to read past articles from our Economic Commentary series.

1.Fortune; “Eight Who Saw It Coming”; August 2008
2.New York Times; “Dr. Doom”; August 15, 2008
3.Telegraph.co.uk; “No Defence Left Against Double-dip Recession, Says Nouriel Roubini”; September 5, 2010