What Letter is the Recession? It Depends on Your Time Frame.

Just finished reading an editorial by Nouriel Roubini, professor of economics at the Stern School of Business at NYU, predicting the current recession will be "V" shaped (sharp and deep with a quick reversal and sharp recovery), although he concedes the risks of a "W" are growing. It strikes me that all of these discussions on the "letter" shape of this recession are meaningless without a discussion of the time frame. For example, I would argue that anyone who thinks this recession is a V just has a short time horizon, because something comes after the V.

Stepping back for a moment to look at the big picture, it is clear that the country as a whole got way too leveraged, and now we must unwind that. I don’t think anyone would disagree with that. Households and corporations already started unwinding as fast and hard as they could (many by choice, many forced by their creditors), which is how recessions work. But this time the government is levering up as fast as it can to offset the household & corporate delevering. Eventually, as the Fed knows, they must pull out their leverage. First quant easing must be stopped. Then they must do the opposite (quantitative tightening) to sell all of the stuff on the Fed balance sheet back to the market. Meanwhile, rising interest rates (or the threat of them) will limit the government’s ability for additional deficit spending. So over time, monetary policy will have to become restrictive in the most direct sense (they can do whatever they want with the Fed Funds rate, but quantitative tightening is the most restrictive monetary tool in the Fed’s toolkit) and fiscal policy will also become more restrictive.

It is impossible to predict when this will begin and how long it will take. No one knows, because it will be decided by humans who do not themselves know what they will decide when the future comes. If they do it too fast, it will be a hard double-dip recession – a lower case V followed by an upper case V or L, with the second dip going way lower than the first. If they wait too long it will be an even bigger W, so big people will think it is a really big V, until inflation and reality finally drive the tightening that makes the second V or L look like a trip into the abyss. But I am an optimist, so I think the Fed will thread the needle, which means an “internet recession” – a lower case "www" – we just bounce around with stagflation like the 70’s, except more heavily weighted to stagnation than inflation.