Dr. Richebacher’s Revenge: After the Great Moderation, The Great Disruption Agora Financial Vancouver Conference Robert W. Parenteau, CFA MacroStrategy Edge July 23, 2009

2008 Vancouver Conclusions We were already in a recession We were already in a recession Fed easing would not be enough Fed easing would not be enough Breaking through the “corridor of stability” in markets for durable assets Breaking through the “corridor of stability” in markets for durable assets Fed would be forced to go unconventional Fed would be forced to go unconventional Deflation would present the greater risk Deflation would present the greater risk

Key 2009 Macro Questions What happened to the Great Moderation? What happened to the Great Moderation? What is so different about a balance sheet recession? What is so different about a balance sheet recession? Where does the massive policy response leave us? Where does the massive policy response leave us?

What Ever Happened to the Great Moderation? What Ever Happened to the Great Moderation? Central bankers and Wall Street praised: Central bankers and Wall Street praised: – lower inflation rate – longer economic expansions – lower volatility of growth and inflation That was only part of the story That was only part of the story Household, business, and financial sector leverage all built up at the same time Household, business, and financial sector leverage all built up at the same time Asset prices and profits became more volatile Asset prices and profits became more volatile Job and capital stock growth became shallower Job and capital stock growth became shallower

Household Debt/Income Ratio

Nonfinancial Business Sector Debt/Income Ratio

Financial Sector Debt/Income Ratio

The Great Roller Coast Ride I

The Great Roller Coast Ride II

The Great Moderation I: Job Growth

The Great Moderation II: Productive Capital Stock Growth

After the Great Moderation: The Great Disruption Private sector deleveraging Private sector deleveraging Private sector income deflation Private sector income deflation Price deflation Price deflation Massive policy response to contain debt deflation spiral Massive policy response to contain debt deflation spiral

Sharpest Recession Since WWII

Evidence of Private Debt Reduction

Evidence of Income Deflation

Evidence of Price Deflation

Massive Fiscal Policy Response

Massive Monetary Policy Response

The Oxymoron of a Government Led Recovery Automatic stabilizers will segue into an infrastructure ramp up in 2010 Automatic stabilizers will segue into an infrastructure ramp up in 2010 Headwind of private deleveraging remains Headwind of private deleveraging remains Q2 near zero, 2-2.5% growth into 2010 Q2 near zero, 2-2.5% growth into 2010 Jobless recovery, limited pricing power Jobless recovery, limited pricing power Equities, corporate bonds, inflation hedges outperform Treasuries Equities, corporate bonds, inflation hedges outperform Treasuries

Dealing with the Policy Residue The Hat Trick on Treasury issuance The Hat Trick on Treasury issuance May constrain the Fed mop up operation May constrain the Fed mop up operation Liquidity on ice – Treasury rescue stash? Liquidity on ice – Treasury rescue stash? Super sponge for the Fed? Super sponge for the Fed?

Large Issuance, Lower Interest Expense – Nice One!

Shortening the Fuse on Public Debt

Large Issuance, Low Interest Rate

Liquidity on Ice: Treasury Slush Fund?

After the Great Disruption Private sector flow imbalances are clearing Private sector flow imbalances are clearing But at the price of enormous fiscal and monetary policy intervention But at the price of enormous fiscal and monetary policy intervention The question of placing Treasuries The question of placing Treasuries The challenge of policy exit strategies The challenge of policy exit strategies Need a new global growth model Need a new global growth model Risk of dollar flight: use inflation hedges Risk of dollar flight: use inflation hedges

Never Underestimate Innovation

Adapt…or Die!