HedgeTalk: "Output Gap" & the Miracle Landing on the Hudson
By: Johan Rosenberg, Chairman
If you haven’t noticed, I love analogies from the natural world. The green comments are mine, the sarcasm is also mine.
The Federal Reserve and the Federal Government has put so much money into the system that many are swimming in it, like Scrooge McDuck. Never before has the supply of money exceeded the nominal GDP by over $1 trillion. The excess liquidity injected by the Federal Government (in excess of what is produced by actual economic activity) is driving price action in all markets. The inflation that hasn’t taken off like a rocket, can be seen in the difference between aggregate supply and aggregate demand, expressed as percent of GDP. I just got back from the (normally) bustling West Des Moines – however, nearly everything was closed. Folks, like it or not, this is a depression.
According to the CBO, the negative “Output Gap” will not be closed slowly, i.e. aggregate demand will not come back for many years. It’s actually predicted to worsen. Based on this, I hold a deflationary view despite all the stimulus. This bodes well for bonds, along with rates possibly going lower.
Now for the natural analogy… Picture a jumbo jet after a free fall. The jet does a hard correction, and then begins a veering and sputtering approach. It is operating on two or less engines versus the normal four, in attempt to complete a controlled water landing. So, was the Miracle on the Hudson River, really a miracle? What are the chances?
I found this….
Unlike a wheels-up landing on a runway, where the aircraft can skid along and come to a stop, there is no skidding on the water. (Does a massive liquidity event precipitate what amounts to a “water landing”?)
The aircraft will settle in, and then the engines will start to scoop water and create a HUGE drag force, stopping the aircraft almost immediately. (Does the end of stimulus equal massive unemployment, and no demand sound like “drag force”? I think so.) If the plane was landing too fast, the scooping of the water could flip the plane over and break it apart, sinking it immediately. Also, if a wing tip was to dip-on land it would scrape, however, in the water it would cause the plane to cartwheel, break apart and sink immediately. (Sounds scary, but how often does this happen anyhow? This is just way too dramatic. That’s just not going to happen. Right?)
Instead of the tail dragging on the ground, if the aircraft lands with too steep of a pitch angle, it will settle into the water and break off the tail section. This will cause the entire plane to sink immediately. (“Sounds like we have to have a very long unwind of any stimulus”. Short the Dollar.) Of course, any flipping, breaking, etc. will immediately plunge the aircraft underwater, and coupled with the large g-forces, kill the passengers due to drowning (not being able to get away from their seats). (Holy sh*t – this can really get bad! How about some deep out of the money options?)
It’s an amazingly tiny percentage of calm-water "landing" of a commercial jet that would result in no deaths. Very tiny. (Aaaahhh, there’s the reassurance I was looking for. I feel so much better when my emotions are placated with the lifejacket, and escape slide demo / talk. I’m ready to take off! Hah.) If we are discussing the open ocean, with waves and little points of reference for the pilot to adjust the landing, there would be virtually no chance of survival. (Could VIX be an analogy for waves? The root is the Latin volatilis, "fleeting, transitory, flying." I think it’s close enough.)
What does all this mean for our future economy? Looking ahead to when the Fed lands this plane, the conditions will be perfect. They will have a perfect angle and speed because we just practiced this maneuver in 2008. Unlike 2008, now a vessel of gold and metal will float higher and higher on liquidity, to ultimately be safely navigated to shore. Go long metal!