We think that nominal GDP is far more important in this cycle than real GDP and the Fed is seemingly starting to agree. It's important because with overall US economy debt/GDP at absurdly high levels, the economy is shock prone for as long as you run such a system. A low level of nominal GDP growth only erodes the burden very slowly leaving us exposed even if real GDP is running at broadly normal post recovery levels. In fact we would argue that nominal GDP needs to be running at higher than average levels due to the argument discussed above and the fact that it fell more than it did in all but one of the previous post-WWII recessions. For us this is why we've always felt that QE will be with us for many years. Until the debt/GDP returns back to more sustainable/normal levels we think the pressure will be on the authorities to effective print money to ease the potentially destabilising deleveraging process. We can't help but think that QE2 won't be the last episode of QE.
Click on charts to enlarge, courtesy of Deutsche Bank.Anyway onto the evidence. The first graph shows every post-WWII recovery in nominal terms from the trough in activity (end June 09 in the latest case). We've rebased the trough at 100 and tracked each subsequent quarter's activity. At the end of the last quarter this current recovery was running pretty much neck and neck with the 2001-02 episode as the weakest of the 13 post-war nominal recoveries. If the number comes in as expected today (2% real, 1.8% price deflator) then the graph shows that we'll move away from it being the worst nominal recovery but it will still be one of the weakest and well below average. The second graph shows the prior drop in nominal activity from the start of each recession to the trough. Of the 13 recessions since WWII, 5 have seen a fall in nominal activity and this latest downturn was the second biggest. So not only was this a big fall relative to history but the subsequent recovery has been one of the weakest. In normal times the more things fall the more they recover. This is why this cycle is different in our opinion. We desperately need more nominal GDP growth to grow out of our problems and this is why the Fed will try to inject fresh impetus into the economy next week. Whether it eventually works is a moot point but this for us is the reason it is being attempted.