Friday, 14 December 2012

"The World's most important chart", courtesy of Goldman Sachs

In an interview for Business Insider, the chief economist of Goldman Sachs, Jan Hatzius, predicts an acceleration of US economic growth in the second quarter of 2013. Business Insider points out that Mr Hatzius had the foresight to predict the housing boom in 2007 (so at least a year after Shiller, Roubini, Schiff and many others), and has a unique framework for analyzing the economy. After all, he is the top economist of Goldman Sachs which is by itself worth (some sort of) admiration. 

He stressed out the following chart depicting the relationship between private sector savings and government budget deficits (click to enlarge): 

Source: Goldman Sachs (2012) "The US Economy in 2013-2016: Moving
Over the Hump" via Business Insider
Here's the logic behind it: 
"The chart demonstrates a critical economic concept: Government deficits (the grey line) are essentially the mirror image of private sector savings (the dark black line). When the private sector tries to save money aggressively (as happened during the crisis) the government deficit will inevitably explode (as happened). Periods associated with small government deficits (such as the late '90s) are associated with extreme private sector leveraging. 
The key to understanding the economy, and forecasting growth, is to think about which sectors are increasing and decreasing their savings."
Basically, Hatzius predicts savings of the private sector to decrease and hence add up to around 1.5 percentage points to real GDP growth in the next year. Residential investments and housing are supposed to be the forefronts of this impulse. 

This actually might prove to be true, since the indicator of new building permits seems to be recovering (as opposed to its previous value in February or July): 

Source: FRED
As I've pointed out earlier in the aforementioned months this indicator of economic activity is a good leading indicator (included in the LEI) that can offer precise insight on the point of recovery of the construction and housing market. 

Even residential and non-residential investments are showing slightly better results than in the previous three years: 

All this could point out to a gradual and 'careful' recovery of the housing market and the construction industry and could justify the confidence of Goldman Sachs's economists on the start of a strong recovery, at least in those two sectors which are supposed to be the drivers of GDP growth next year. 

However all of this is subject to not having the US "fall off the fiscal cliff" and not having the politicians in Washington trigger another global downturn (as it almost happened after August 2011). 

Going back to the balance sheets, Mr Hatzius has this to say: 
"Basically, in order to have above-trend growth – a cyclically strong economy – you need to have some sector that wants to reduce its financial surplus or run a larger deficit in order to provide that sort of cyclical boost, most of the time." 
So basically, reducing a financial surplus (households pushing savings) or running large deficits (governments or households financing consumption) will result in a temporary (or a decade-long) boom on the market. This can coincide well with Bernanke's famous global savings glut story where financial surpluses from Asian households and governments were translated into investments and consumption in the West. The analogous story can be told in Europe, and the 'interaction' between the savings in the "core" and the deficits in the "periphery". 

Read the whole interview, it's very interesting. 


  1. the graph shows a mirror image of the two factors, implying that small gov deficits are good for growth. So they're saying that the pure sign of a decreasing deficit (and hence more spending, even though it's tough to say which factor is driving which) will be enough to ignite the recovery.
    Gee, I wonder why that hasn't worked so far in Europe...

  2. It is interesting but I would not be so sanguine about a recovery. Or rather, I DO think there will be some recovery, but the problem is that the deficits of most nations are so damned high right now they will put a lid on how quickly we can recover.

    Remember that once recovery begins there will be upward pressure on inflation and interest rates. That will make the huge debt service in most nations soar.

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