Well, Bob Wenzel has already been knighted due to his remarks at the NY Fed, so in the interests of keeping Sir Bob humble, I want to recall something back from November.
Some of you may remember that Tom Landstreet and I had a piece run on Nov. 7 on Forbes, in which we said the following:
Many analysts have been surprised lately by the strength in certain economic indicators, such as the growth in business investment in the third-quarter GDP report, particularly in equipment & software. The hopes for a general rebound are misplaced, however, because temporary depreciation rules may be driving the apparent upswing. The generous bonus depreciation and small business deduction rules begin to drastically phase out in January 2012, which will likely cause a dramatic reversal in investment and other indicators.
Wenzel didn’t think too highly of our view. In a post titled, “Bob Murphy: It’s Not Austrian Business Cycle Theory That Counts, It’s Depreciation Rates,” Wenzel wrote:
Bob Murphy, along with Thomas F. Landstreet, have an odd column out at Forbes, which seems to diss Austrian Business Cycle Theory and promote depreciation rates as the key to the economy…
Say what? Depreciation is driving the upswing? I have been one of those forecasting a general (manipulated) rebound because of Fed money printing, based on ABCT. I don’t see anyway that depreciation is the major driver in this economy.
ABCT holds that central banks print money which generally first goes to the capital goods sector. This flow of funds results in a (manipulated) boom in the capital goods sector. Federal Reserve Chairman Bernanke is now printing money (M2) at a rate of 15% plus. That is a lot of money to be hitting the system. In fact, over the last 12 months, it is nearly a trillion dollars. M and L apparently want to ignore this trillion dollars and hang their hat on depreciation changes.
…In other words, businesses are going to be hit with a big new tax burden.What does this have to do with a general rebound? If you know that you are getting business because of a depreciation law that is about to expire, are you going to crank up your business for a demand that is not going to be there in a year? Of course, not. Do glove makers continue to crank up sales for the summer months? Should we send out an alarm saying, “Hey glove makers, coat makers and sweater makers are going to get smacked when summer hits. The economy is going to tank.” ? Of course not. Expected changes are planned for.
The depreciation change is not fooling anyone. … Do M and R think that the businessmen on the sell side of these transactions aren’t aware of this? Do they think the sellers are idiots?
Needless to say, Wenzel wasn’t convinced of the cogency of our analysis.
Back to our Forbes article, Landstreet and I looked at the last time such a drastic change in depreciation rules occurred:
Note that if the accelerated depreciation rules are temporary, then the long-term impact may be muted. As the expiration deadline for a particular benefit approaches, we might see businesses simply pull forward their routine replacement of equipment. Thus the surge in investment during the period of eligibility might be matched by a collapse in investment after the expiration.
For historical evidence, we can look at what happened when the bonus depreciation rate dropped from 50% in 2004 down to 0% in 2005. Even though investment in equipment and software jumped 21% over the two-year period, the growth was not spread uniformly.
Instead, there was strong growth through 2004 (with fourth-quarter 2004 equipment & software investment up 12.1% from the prior quarter), but then an abrupt slowdown going into first quarter 2005, when this investment category only rose 2.4%. Businesses likely pulled forward much of their planned equipment amd software purchases—which normally would have occurred in early 2005—into 2004, to take advantage of the expiring 50% bonus depreciation.
We face a similar situation today, except that the stakes are higher. To reiterate, the bonus depreciation rate drops from 100% to 50% in January, and at the same time the Section 179 maximum deduction drops from $500,000 to $125,000. Anecdotally, we know many businesses have been rushing to get their capital purchases “placed in service” before the 2011 deadline passes. This has given an artificial boost to business investment and other measures thus far, but investors should be ready for a sudden reversal come 2012.
Now in the actual paper that we put out for Landstreet’s investment clients, we were more specific, and focused on Nonresidential Fixed Investment, as well as Equipment & Software. (The latter is a component of the former.) We showed how, over the period from 2004-2005, average growth in both categories was strong, but that it was unevenly distributed. Specifically, quarterly growth was high in these categories in 3q2004 and then slowed into 4q2004, then fell sharply in 1q2005 before starting to recover in 2q2005. We specifically predicted that we would see a similar pattern, though more pronounced, this time around in both those categories, with reference to the 2011 and 2012 numbers.
Lo and behold, the advance estimates from the BEA released last week show the following (you have to click on the Tables to get these details):
Nonresidential Fixed Investment
3q 2011: +15.7%
4q 2011: +5.2%
1q 2012: -2.1%
Equipment & Software
3q 2011: +16.2%
4q 2011: +7.5%
1q 2012: +1.7%
So, Landstreet and I are declaring Miller Time on this one. Not only did we say that GDP growth was going to be lower from 4q –> 1q (which it was: 3.0% down to 2.2%), but we specifically called one of the components of the slowdown. This is from the BEA’s press release: “The deceleration in real GDP in the first quarter primarily reflected a deceleration in private inventory investment and a downturn in nonresidential fixed investment that were partly offset by accelerations in PCE and in exports.”
In contrast, Wenzel has been pushing a “Keynesians are idiots, they don’t see the boom caused by Bernanke’s mad money printing spree” story. Every time a decent economic indicator has popped up, Wenzel has reiterated this line. So if he wants to say Bernanke has slowed his money-printing from when Wenzel bit my head off back in November, OK, but then he can’t at the same time mock Keynesians for being so pessimistic about the “manipulated recovery.” Bernanke can’t be simultaneously spiking and slamming the economy.
If anything I think 1q 2012 showed the exact opposite of Wenzel’s take: Business investment decelerated (or actually declined, depending on the category), while consumer spending and foreigner spending were up. If you were doing a standard ABCT explanation, isn’t that backwards?
Don’t get me wrong, I am fully aware that people can get lucky when throwing out predictions. But Wenzel bit our heads off when our piece came up, so I think it’s not too cheeky for me to mention that at least as far as the crude BEA numbers go, we hit that out of the park. Landstreet’s clients are telling him on the phone, “Huh, you called that one, Tom.”
UPDATE on May 3, 2012: Wenzel has responded here. He makes some good points, especially about the fact that the stock market definitely didn’t move in accordance with the Landsburg/Murphy perspective (though technically we didn’t say, “Short the market!”).
On another matter, Richard Peach of the NY Fed has a different version of how things unfolded that fateful day.