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What Must Happen Before We See Recovery

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Stimulus may take away some pain, but our current excesses remain significant.

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On Wednesday, Tony Dwyer shared a historical chart of consumer credit on the Buzz & Banter, suggesting that the balance declines we've recently seen are bullish, and that they support the notion of a strong V-shaped recovery.

And yesterday, the Financial Times reported that Goldman Sach's economist James O'Neill offered that "deleveraging will pose the greatest drag on growth" in the short run, but there are a number of other positive offsets.

It feels like everywhere I turn, "deleveraging" is the word of the moment, and the range of opinions on its implications is vast.

As I've written many times before, I believe that we're in the midst of a secular deleveraging process where debt will be destroyed either through repayment, default, or shareholder dilution. Put simply, going into this crisis, there was just too much.

I contrast my view with others -- such as Dwyer -- who suggest that the deleveraging process underway is cyclical in nature. Not to bore readers with too much economic mumbo jumbo, but for this to be cyclical versus secular, one must believe that lower interest rates will spur incremental borrowing. To me, that's the key premise behind a monetary response to an economic recession. Make money cheap and people will use it to grow.

For the past year, thanks to the extraordinary actions of the Federal Reserve, we've had about as close to free money as you can find -- and enormous amounts of it no less. But in talking with consumers and corporations, I can find no one who wants to borrow incremental amounts of it. Refinance what they have at lower rates, absolutely -- if they can. But borrow more? No thank you.

Like the kid offered more Halloween candy on November 1, US borrowers know they have already overindulged. And to me, that's a significantly different phenomenon than I've seen in any recession in my lifetime.

Unfortunately for policy makers, it sets the foundation for a failed Field of Dreams. If we build it, they still won't come. In a depression -- which is what I believe we're experiencing -- credit demand won't return until the economy is resized to levels appropriate for a "near-cash" economy where people save and then spend.

Needless to say, I think we're far away from that. And so until our level of debt and industry capacity are reduced, no real recovery will take place.

Now that doesn't mean that fiscal stimulus can't slow the process and potentially take out some of the sting. But we must realize that our current excesses remain significant.
Positions in SPY, SKF and JPM.
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