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Why Paul Krugman, David Rosenberg fear a looming depression Add to ...

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Shelter in the storm It's a very safe haven kind of day as global markets plunge and bonds rally in the wake of renewed economic jitters. The yield on 10-year U.S. Treasuries have dipped below 3 per cent, and the yield on 2-year paper to below 0.6 per cent.

"The drop in U.S. yields, with the 2-year having fallen to an all time low of 0.59 per cent and the 10-year now trading at a 13-month low of 2.96 per cent, hints that the coming months are going to be difficult ones," said Scotia Capital currency strategist Camilla Sutton.

Ms. Sutton added in a research note that the bond market is signalling important themes likely to lead to heightened volatility and a higher U.S. dollar:

  • A string of disappointing economic indicators suggest the U.S. may be weaker than many believed.
  • A shift in tone among global policy makers, from "supporting growth at all costs to fiscal responsibility," is pressuring estimates for world economic growth. This was a theme of the G20 summit in Toronto on the weekend.
  • Some observers, such as the Bank for International Settlements, believe central banks should hike interest rates "before the macro economic environment fully justifies it."
  • Europe's overhang, now highlighted by the pending expiry of a massive bank lending program, is an ongoing threat.

David Rosenberg, chief economist of Gluskin Sheff + Associates, has a more worrying take, following on comments yesterday by Nobel laureate Paul Krugman. In effect, Mr. Krugman fears global policy makers are making the same mistake as their Depression-era predecessors by pulling back too early on stimulus measures, a move blamed for prolonging the ugliness of the 1930s. "We are now, I fear, in the early stages of a third depression," Mr. Krugman wrote in a New York Times article.

Mr. Rosenberg followed up on this in a research note today: "The bond market is telling a very important story here and it is one of a deflationary depression. We may not agree with Paul Krugman's cure of solving a credit collapse by trying to create even more credit, but his diagnosis is spot on.

"... The stock market bulls who got the 2009 call right were the same ones that got investors whacked hard in 2008 and they again have overstayed their call. Instead of heeding what the bond market is telling them, they are calling it a 'bubble.' In realty, the bond market is sending out an important signal; decelerating nominal GDP growth ahead. This does not dovetail with notions of a V-shaped increase in corporate earnings to new record highs in the coming year and we would be looking for earnings guidance to be rather spotty during the looming reporting season."

Related: G20's plan for deficit cutting draws fire from Paul Krugman


China, economic fears sink markets Global markets are falling sharply today, partly on renewed fears that economic growth in China, one of the few engines driving the global rebound, is slowing. Like Europe, whose debt crisis has wreaked havoc in financial markets, China has been a concern given its rising importance among investors. Europe is still playing into fears today, as are wider economic concerns, such as a disappointing measure of consumer confidence in the United States. In Japan, a new reading showed industrial dipped 0.1 per cent in May and shipments took their biggest drop in more than a year. Oil prices and the Canadian dollar also fell.

The turmoil in the markets began with a reading by the Conference Board, whose leading economic index for China rose just 0.3 per cent in April, a revision from the 1.7 per cent it had earlier reported. It was then fed by other concerns.

"Concern over reduced raw materials demand from China and, on a wider scale, the effect global austerity plans will have on economic growth, are prompting portfolio reshuffles as the outlook for the next few months remains a little uncertain," said IG Index chief market strategist David Jones.

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