Monday, February 8, 2010

Economic Stress Maximal 9 Months After Bernanke Espied Green Shoots

This is one long horticultural pregnancy. It was March 15, 2009 that Fed Chairman Bernanke lowered himself by going on commercial TV (60 Minutes) and said, among other things:

" . . .And I think as those green shoots begin to appear in different markets and as some confidence begins to come back that will begin the positive dynamic that brings our economy back."

The AP reports that US economic stress hit a peak in Dec.:

Weakness in Western energy-producing states helped raise the average U.S. county's economic stress in December to its highest point since The Associated Press began analyzing conditions in more than 3,100 U.S. counties in October 2007. . .

Economic strains in the final month of last year were evident throughout the nation. Foreclosure and bankruptcy rates rose even as the national unemployment rate held steady. The spillover to Western states was inevitable, some economists say.

"It's hard to stay above water when much of the rest of the country is going down around you," Sean Snaith, an economist at the University of Central Florida, said of those states.

Granted it is now February, but the AP goes on to point out that the prior trough was in fact March 2009, the very month of the green shoots interview:

The AP's Economic Stress Index found that the average county's score in December was 10.8. That's a sharp jump from the 10.2 reading in November. The previous worst reading since the recession began in December 2007 was 10.3 in March 2009.

Leading economic indicators have been pointing upward for quite some time. However, we live in the real world of coincident indicators, which when adjusted for economic Viagra have been slow to join the party.

The U. S. economy appears to be following the post-credit crisis historical pattern of below-trend growth. It is essential to understand that the various forward-looking economic indicators rely heavily on monetary measures such as the steepness of the yield curve (long rates much higher than short rates being historically a good predictor of growth). What has happened here is that short rates have collapsed. Allegedly we are in the 3rd quarter of post-recession recovery, and we see 1-month T-bill rates at around 0.00%. Huh?

On an absolute basis, the 10-year Treasury rate around 3.6% is very low, but I do not think that the forward-looking economic indicators take that into account. Some intelligent institutions and money managers are willing to accept this "low" yield year after year till 2020. Under the deep freeze conditions where instantaneous money carries no cost to borrow, how can we expect the yield curve to tell us much about future growth? Perhaps we really should look at absolute rates, not just spreads between money rates of different durations.

I believe that the administration took its eye off the economic ball last year. It passed a "stimulus" bill that was weighted largely to depression-type relief for the states (Medicaid, unemployment benefits, etc.), a one-off tax cut of the useless type that was tried in 2008, and some roads programs etc., and then went off on its to-date fruitless but distracting efforts on cap and trade and healthcare reform. From a small business perspective, these proposed changes were large enough to further inhibit hiring, and given the poor economy, hunkering down/cutting costs was an easy choice to make.

If policy now focuses on the economy first, second and third from a domestic priority standpoint, the administration will do well to signal that 2010 is a year of incremental change if any at all regarding momentous long-term societal changes of the type that were proposed last year.

It is assumed at EBR that all the money printing, cyclical factors and population growth are likely to lead to significant percentage growth for a while because it is off of a very depressed base, if Washington goes off into a corner on the above-mentioned domestic policy initiatives and sucks its thumb.

However, so many mistakes have been made in economic policy over the past decade that a return to policies that encourage thrift and equity buildup rather than the doubling down (or quadrupling down) on the issuance of debt, the reversal of increasing unfunded liabilities, and the like is an important part of creating a long-term scenario for a virtuous economic cycle. Until then, more stop-start financial market action is a base case (see Jobs Will Grow in 2010, But Then What?), and the markets will reflect that by discounting the growth cycle. This discounting may already have begun even as the real world economic conditions continue to trough rather than peak, as should be the case.

In retrospect it may be clear whether the markets have already done this discounting. What is clear is that the traders and the deficit spenders continue to have excessive power over the real economy. The great economic failure of Barack Obama continues to be that he was elected with Goldman Sachs etc. dollars behind him and had no intention from the start of instituting real change that we could believe in regarding the cause of the economic ills to which he was heir.

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