The US Economy: How bad will it get?

In the past few years, I have been extremely pessimistic about the US economy. I explained that most pundits seemed to be underestimating the deflationary risks to the economy (A Different Perspective on the Global Economy), that our current account deficit was unsustainable (Macro Perspectives on Global Liquidity: How Chinese Farmers and Oil Sheiks are Subsidizing American Consumption and its Implications), and that real estate prices were out of line with reality (Rent … unless you want to buy).

High commodity, oil and food prices are rightly worrying many. However, I suspect that economists are again massively underestimating the deflationary risks. Most economists are expecting a recovery in the second half of 2009. I fear they may be wrong.

A Great Depression?

Several of my friends are extremely bearish. They expect this downturn to be nothing like what we have experienced in our lifetimes. This is the first time in our history that we are simultaneously being hit by a:

  • A real estate crash
  • A credit crunch
  • An oil crisis

There was no oil crisis during the Great Depression… These three events can effect a self-reinforcing downwards cycle pushing the economy in a deep recession as consumers decrease their spending.

Things don’t “feel” so bad right now – unemployment is still below 6%. People are going on vacation and while the mood is bearish, it’s not terribly so. However, that’s not reason enough to discount the downside risk. In 1930, one year after the stock market crash, it probably “felt” pretty much as it does now. People did not foresee a deep ten year downturn.

Despite the unprecedented downwards pressures on the economy, a Great Depression type recession is unlikely. The Fed has learned the lessons from the Great Depression which was largely caused and exacerbated by incompetent monetary policy (read Monetary History by Friedman and Schwartz for the full explanation). Ben Bernanke is a scholar of the area and is unlikely to make the same mistakes. You can read his summary of Friedman and Schwartz’ analysis at:

A Deep Recession?

Given the downwards pressure on consumer spending and the remaining economic imbalances, a deep recession could be expected. Personal and government saving rates remain negative. Our current account deficit, while lower than the record 6.7% of GDP it hit a year ago, is still around 5% of GDP. House prices remain out of line with fundamentals despite the correction. In addition, boomers are about to retire.

To eliminate the imbalances, consumers are going to have to massively curtail spending and increase their savings. Given how sensitive the US economy is to consumer spending, a significant increase in the consumer savings rate would push it in a deep recession.

Historically Americans were willing to withstand deep recessions that set the stage for a strong recovery. The 1982 recession caused by Paul Volker and the Fed’s monetary tightening saw unemployment jump to over 9.5% with prime lending rates hitting 21.5% and long-term government bond yields topping out at over 15%. There was a deep, temporary economic downturn which lowered inflation for the long run. Inflation went from 13.3% in 1979, 12.5% in 1980, 8.9% in 1981 and 3.5% in 1982. The CPI inflation rate stayed below 4% for most of the next 25 years.

More likely: a shallow recession followed by years of sub-par growth

Given the current policy responses, instead of a short deep recession to remove the economic imbalances, we seem to be opting for a shallow recession followed by years of sub-par growth as Japan had from 1989 until today.

At the first sign of a slowdown we saw both massive easing by the Fed and an unprecedented fiscal stimulus putting cash directly in the pockets of consumers. Once the survival of the banking system was guaranteed, I wonder if the Fed’s action is not somewhat misguided and frankly unfair. The impact of the Fed’s lowering of interest rates is limited by two countervailing forces:

  • Banks have significantly reduced lending activities
  • Any decrease in interest rates increases oil prices

Not only is the impact of lower interest rates more limited than usual, but in addition, it’s essentially bailing out home owners and home lenders at the cost of higher oil prices for everyone else.

Moreover, most of the suggested additional policy response seems misguided – appearing to help on the surface, but in fact not changing the outcome while increasing the regulatory burden on industries or benefiting current homeowners at the expense of future homeowners.

A few examples include:

  • Federal tax relief on oil for the summer: McCain’s proposal is populist hogwash. In the short term the supply of oil is essentially fixed. Removing the tax would decrease the price of gas which would increase demand for oil and hence its price. In other words, it would essentially be transferring tax revenues to oil producing nations in the form of higher oil prices (and a small portion back to consumers in the form of slightly lower gas prices).
  • Regulatory oversight of oil speculators: Obama’s proposal also makes no sense. Prices are fundamentally determined by supply and demand. Speculators are purely betting on the direction, but in the end they don’t impact supply and demand as they never take delivery of the oil. Moreover, it seems that are current prices there is more short interest on oil than long interest – probably holding prices down by a few dollars per barrel.
  • Anti-gasoline price gouging law: the market for gas is actually extremely competitive – both between producers and between dealers. If anyone was trying to charge more than the market price, they would be driven out of business very rapidly. Introducing price controls as was done in the 1970s would lead to queuing, shortages and an inefficient allocation of gas.

I also fear that this downturn will bring a political bull market where politicians wanting to appear proactive will pass counter-productive policies as those mentioned above hurting our potential long term growth.

I really hope I am wrong, but my instinct is that we are setting ourselves up for at least 5 years of sub-par growth.


  • I am a micro-economist by training. I mostly studied labor economics and econometrics – a field I find much more scientific and exact than macroeconomics.
  • I have been wrong before. I started fretting about excessive house prices in 2002 or 2003. Anyone who listened to me, missed out on 5 years of housing inflation. Moreover, I became extremely bearish on the US economy in 2005/2006. The slowdown only hit the economy in Q4 2007 / Q1 2008.
  • I have repeatedly been surprised by the resilience of the American consumer.
  • My optimistic friends believe that the US will lead a green technology revolution and that innovation will take us out of this recession and will start a new growth phase. They are all eagerly waiting for green tech’s “Netscape IPO” moment. I hope they are right!

Reasons to be Pretty was disappointing

Having enjoyed Fat Pig and The Shape of Things so much, I had high expectations for Reasons to be Pretty. Unfortunately, the play did not live up to my expectations. The characters and setting did not resonate with me. The dialogue is simplistic and crass, reflecting the blue collar setting. I missed the wit from his other plays. I also did not buy the relationships. Greg, the main character, seems too smart to be dating a lunatic like Steph or to be friends with a bully like Kent. I also hated the moralizing monologue at the end of the play. Ah well, I hope I like Neil Labute’s next play more!

The Food Crisis: A Radical Rethink

By Stacie Rabinowitz

I’ve been a bit perturbed lately reading about some of the responses to the global food crisis. I’ve seen a lot of reports that governments and NGOs are donating money to buy more food, which as an economist just doesn’t make sense to me. In the short term, the food supply is almost completely inelastic. By donating more money to buy food, you will only shift the demand curve out and drive prices up (from D1 to D2 in the figure).

In order to truly bring the price of food back in line, you have to either find some way of shifting the supply to the right by increasing the quantity on the market or somehow decreasing the demand.

The international community has begun addressing the supply issue on a long-term basis by providing funding for irrigation, seeds, fertilizers, etc. But there are actually a few shorter-term solutions that could do the trick as well.

To address supply issues:

  1. Sorry, I have to mention it because everyone else is, but since everyone else is I won’t spend too long on it – stop imposing export subsidies/export bans. It is selfish, hurts your farmers, and disincentivizes farming in the long-term (decreasing supply in your own country).
  2. International aid agencies should invest more in storage facilities. In some of the places where the food crisis is hitting the hardest, up to 50% of the food stored in any given month is lost to pests, rotting, and theft. Improvements to storage facilities could be made quickly, and would give the workers hired additional income.
  3. Stop having wars. OK, I’m kidding, I know that won’t happen. But the fact is that one of the biggest contributors to global hunger is man-made strife. It displaces farmers who cannot tend to their crops, and often fields are destroyed in attempts to keep the enemy from getting to them. The international community needs to start thinking very seriously about its role in peacekeeping and peacemaking, and start to consider that protection of food supplies may be a top priority for overall global security. Think about it this way: if oil fields were being destroyed in war with the frequency that food supplies are, would anyone stand for it or would there be a massive intervention to keep prices from skyrocketing?
  4. This has also been said a lot, but governments in the developing world should start accepting genetically-modified crops. Not only do they produce higher yields, but much of the world’s food supply is GMO, and countries that do not allow it are drastically altering the supply curves for their citizens.

To address demand issues:

  1. Get the developed world to stop wasting food. I don’t know how to accomplish this from a policy perspective, but any change is good change, so awareness and marketing is Step 1. When you’re at a restaurant, tell them not to bring the bread basket or the side of rice if you’re not planning on eating it. It will improve the retailer’s margins and help improve the world food supply.
  2. Stop eating meat if you’re eating a lot, and if you’re vegetarian, maybe start to eat some more. According to a Cornell University study published last October, “Even though a moderate-fat plant-based diet with a little meat and dairy . . . uses more land than the all-vegetarian diet . . ., it feeds more people (is more efficient) because it uses more pasture land, which is widely available.” It’s well-established that it takes much more land to raise the animals needed to feed someone than to grow plants to feed that same person. But the Cornell study makes the interesting point that since the quality of land needed to product food for people is higher than the quality of land needed for pasture, a little bit of meat is actually the more efficient choice.

While no one likes high food prices and hungry people, the fact of the matter is that markets work the way they do for a reason. As food prices go up, it makes farming land vs. using it for other things more attractive, increasing supply, lowering prices, and creating a new equilibrium. Additionally, many of the farmers who export their crops are actually in some of the world’s poorest countries, and by trying to lower food prices, you hurt their ability to buy other items necessary for survival. One way to combat this would be to set up hedge contracts between the buyers and sellers so that everyone’s standard of living is consistent and livable for an extended period, but the logistical constraints of this solution are probably insurmountable.

A recent suggestion that has been made about the food crisis is that it is partly due to investment in biofuels. Yes, that has taken supply off the market. BUT, global warming could have just as dire consequences long-term as the food crisis does short-term. While I am a big believer in free markets and in general hate subsidies, unfortunately if you are going to be free market, you have to accept that sometimes short-term sacrifices must be made for the long-term good and the right response is NOT to simply increase farming subsidies so that they are higher than biofuel subsidies.

The Shape of Things is fantastic!

I went to a reading of The Shape of Things by Neil Labute last night. The Shape of Things is Neil’s first play in his trilogy on beauty. I already loved Fat Pig and had high expectations. I was not disappointed. It was fantastic – amoral, irreverent and tons of fun! In fact, I liked it even more than Fat Pig. I am surprised the movie version got mediocre reviews and will be checking out shortly.

I can’t wait to see Reasons to be Pretty this Thursday!

Mongol is fantastic!

I went to see Mongol last night on the early life of Genghis Khan and loved every minute of it. I have to admit I am clearly biased: I read and loved Genghis Khan and the Making of the Modern World and consider Genghis Khan to be one of my role models.

It was beautifully shot with great cinematography. There was great character and plot build up. Most importantly it stayed true to the ethos of the time and did not apply our western values and judgments to the actions of the characters.

There are a number of historical inaccuracies (Mongols hated hand to hand combat), but it captures extremely well the Mongol spirit and shows some of the strategies Genghis is known for: pretending to retreat to break the cohesion of the enemy army and rout it, sharing loot with his troops, etc.

I loved every minute of it and can’t wait to see the next two episodes in the trilogy!

What if the world’s best violinist played the world’s best violin at a subway stop?

Joshua Bell is an internationally acclaimed virtuoso. As part of a fantastic experiment in context, perception, public taste and priorities, Joshua Bell agreed to play his Stradivarius incognito at the L’Enfant Plaza station in DC at 8 am on Friday, January 12 in the middle of the morning rush hour.

In the next 43 minutes, 1,097 people passed by as Joshua performed his classical pieces. Only twenty-seven people gave money, most of them on the run – providing $32.17! The other 1,070 just hurried by, oblivious, few bothering to even look!

I bet he would have received about the same amount of attention in NY. We New Yorkers are more “busy” and “important” than government workers in DC, but that would be compensated by the slightly higher percentage appreciating the music and maybe recognizing Bell 🙂

Read the full article and watch the videos at:

Why I invested in Lab Pixies

A few months ago, I had dinner at Le Colonial with Mark Gerson (the founder of Gerson Lehrman Group and Joe Sigelman (the founder of Office Tiger). As an aside, I was introduced to Mark by Jeremy Levine from Bessemer as they are investors in both Gerson Lehrman and OLX. Joe was the TA in one of my math classes in Princeton!

We decided to find young, smart aggressive people to find early stage startups for us outside of the beaten path. In Israel, we started working with Yaron Carni who introduced us to Lab Pixies.

Lab Pixies is one of the largest widget companies, and a leader for for iGoogle, Live and Netvibes. They are not as well known as Slide or RockYou given their focus on iGoogle rather than Facebook, but they are a fantastic company. The company has 41 million unique visitors per month and over 750 million monthly gadget views and the gadgets are awesome. The leading gadgets are ToDo List, Sudoku, Weather, Babylon Translation Box, Birthday Reminder and Backjack.

We were impressed by the team of 10 great engineers based in Tel Aviv and decided to invest $1 million in the company.

You can read an overview of the company on TechCrunch:

Ran, Oded, Nir, Udi: make it happen!

Guest Post: Fabrice In Real Life

By Stacie Rabinowitz

So Fabrice has been writing a lot lately about the joys of friendship and how much he enjoys all of the wonderful people who fill his world. In keeping with this theme of warm and fuzzy blog posts, I thought I’d share with all of you who aren’t lucky enough to know Fabrice outside of this space what it’s like to be friends with him.

In some ways, being Fabrice’s friend is exactly like reading his blog. One minute we’re talking about American healthcare policy and I have an important point to make but before I get a chance we’re talking about the cute thing Bagheera did yesterday and then whether COD5 will be better than GTA IV and then we’re on to how long it will be before video games go digital and before I know it my point about healthcare has been lost to the wind. And that’s my favorite thing about being friends with Fabrice – he’s just interested in everything. So not only can we have an interesting conversation on almost any topic, but I can also invite him to almost any activity and know that if he’s in town, he’s probably in. From theater to paintball to physics lectures to just spending a quiet night watching Snakes on a Plane, Fabrice is one of the most fun people I know for just about any activity under the sun. I have never spent even one second bored when he’s around. And he attracts a diverse crowd too – I always look forward to his parties because I meet such varied and interesting people.

The first time I met Fabrice, I got a vision of him that I’m sure a lot of you have in your heads right now – we were having dinner with a mutual friend in Paris, and I got off the Metro to find three people looking for some good wine and good food, and one hopelessly boring nerd jabbering on his cell phone (I was informed by the others that he was trying to buy a company). Four (five? six?) bottles of wine later, I got to see the real Fabrice. OK, yes, he is actually nerdy as hell. But he can also be funny and self-deprecating, silly and playful, and spontaneous and irrational. He is incredibly generous and thinks a lot of others, always trying to introduce friends he thinks would get along, passing along websites of interest, recommending books/movies/TV shows, and (my personal favorite) recommending the best restaurants in Manhattan.

So Fabrice is wonderful, but of course, there are disadvantages. I hate how much I have to share him – with his other friends, with OLX (I hate Buenos Aires!), with all of you. He has horrible taste in music, is a total wuss about being cold, and only skims your e-mails so he misses all the important details. Oh, and that picture of him on this blog is from last summer – he has much less hair now. 😉

In all seriousness, I am very glad that Fabrice has become a part of my life, and I just wanted to let you all know that behind the supersmart, supersuccessful, nerdy entrepreneur, there is also an incredibly fun, incredibly kind, yes still nerdy friend.

Fat Pig is fantastic!

I was considering going to see the play Reasons to Be Pretty by Neil LaBute, which is running until July 5. It has been getting rave reviews for its trenchant commentary on the high value society places on beauty.

Before going to see it, I decided to check out two of Neil LaBute’s prior plays, which with Reasons to Be Pretty, form a sort of trilogy on beauty. I began with a reading last night of Fat Pig, which was fantastic. It tells the story of a good-looking man who starts dating an extremely nice and funny but overweight girl, and his struggle to balance his love for her with the negative reactions of his friends and society as a whole. The play is tragic-comic. It begins on a light, extremely funny note, but keeps getting darker as it progresses and the superficiality of our society begins to manifest itself.

The dialog is extremely true-to-life, and I was both entertained and moved. The play also led to an interesting conversation afterwards. I will definitely go to the reading of his other play on the topic, The Shape of Things (unfortunately sold out), before seeing Reasons to be Pretty.

Fun with Lost

I just finished watching Season 4 of Lost and I have to admit I am impressed. The show has rekindled its magic and has by far the most interesting storyline of any drama on TV currently.

The end of Season 4 is extremely interesting. WARNING: Do not read further if you have not seen Season 4 yet. I expected Ben to be in the coffin, not Locke. Jack really wants to go back to the island. It’s unclear why Sun is working with Charles Widmore. He’s just as responsible for Jin’s death as Ben is. She might be trying to set him up.

Here is my speculation for Season 5. As you may recall Ben tells Jack at the very end that they must all go back to the island together and Jack replies he does not know how that is possible as they no longer listen to him and he does not even know where most of them are. I predict that Ben will either kill Penny or have Sayid kill her – both fulfilling his promise to get revenge for the death of his daughter and uniting all of the Oceanic 6 and Desmond for the funeral – either to mourn or plot revenge. In either case, Desmond will become Ben’s (and potentially Sayid’s mortal enemy), a fight he will eventually lose as the pawns have a tendency of dying in the Charles Widmore / Ben Linus struggle.

Why I invested in Sonico

I first met Sonico at BarCamp in Buenos Aires last September. They were by far the most interesting company. Alec and I met Rodrigo, the CEO, and his team in person a few days later and we were blown away. It’s hard to put my finger on what it was exactly, but they just got it. They were fantastic people – all close friends from San Andres University in the mid to late twenties – and we loved their approach to business

They already had great traction and we were convinced we could do great things together as the things they were struggling with were exactly things we could help them with (structure of the company, fund raising, etc.).

We decided we had to work together and set about fund raising and restructuring the company (making it a Delaware C Corp, etc.). It ended up being much more difficult than expected. The company continued to grow extremely rapidly reaching nearly 17 million users in less than 9 months of operation! However, Argentine politicians seemed bent on making the country less appealing to investors. They increased their agricultural export tax (one of the worst policies possible to begin with) which led to riots by the farmers. They let inflation runaway and it’s now nearing 25% per year! Several American VCs were put off by the macroeconomic environment in Argentina.

In the end, the team and the story were compelling enough and Rod just succeeded in raising $4.3 million from DN Capital and a few investors. The project remains risky given the competitive nature of the market. Facebook effectively enters market through the expat community and sometimes takes off dramatically as it did in Turkey and Columbia in the past few months.

Despite the threat, I bet on Sonico because I believe that they will find a way to succeed given their single mindedness, extreme focus, doggedness and passion!

Rod, Alvaro, Tom, Gustavo, Alejandro and Anton: it’s all in your hands now, go kick some butt!

I am heartbroken :)

As you might have suspected given my prior post on the topic (The Teutonic Viagra), I have been lusting for the Audi R8. It had caught my eye before seeing Ironman, but its role in that movie cemented its position as my infatuation du moment.

Even though I have another year to go before the lease on my Aston Martin ends, I put my faithfulness to the test by checking the R8 out at the local dealership. As I walked in, its seductive lines immediately caught my attention. Its allure further was further increased by its colors – the same ones as the car in Ironman.

Like the hapless sailors called by the sirens, I approached knowing this path would only lead to adultery, powerless to resist. I apprehensively opened the door. My heart was racing. I sat myself into the seat when it happened. I did not fit! I tried every seating position known to man, but my head was firmly stuck on the roof, my eyes only seeing through the top inch of the windshield.

It never occurred to me I might not fit in an Audi! I can understand that Lamborghinis are made by and for short Italian men (the Gallardo had previously spurned my advances), but an Audi? Sports cars should be able to handle guys who are almost 6’3” even if they have a tall torso!

Belatedly, I realized I had fallen for this wretched flirtatious creature, the one that only brings tension to its peak and then leaves you hanging. Clearly because of the strength of my moral resolve, my marriage was saved. Proud of my achievement, I returned home.

As I was about to give up all hope on lust, there it was again … butterflies in my stomach! William had just sent me sent me an in depth preview of the Ferrari California. The longing was back! My faithful Aston got a reprieve: the California won’t be coming out for at least a year and having been jilted by the prancing horse before, I am more guarded, protecting my heart against the potential of being hurt. And yet deep down, I can feel the hope and longing…

California don’t let me down, I know we would be great together!