A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Tuesday, January 8, 2008

Forecast Redux -- podcast transcript

Repeating the forecast

As tedious as it may be, today we are reiterating our forecasts, primarily because there has been a full-tilt shuffling of folding chairs over the past few days. The assembled consensus seems to have moved in unison, like a flock of birds into the recession winds. We wanted to remind you we’ve been holding to our call. It seems that the great preponderance of economists were blindsided by last week’s unemployment rate increase and now admit the possibility of recession. It is a bit like admitting it might rain after the water starts pouring in over your boots.

We asserted that the recession was already in progress two months ago. That makes us aggressive. Over the intervening period we’ve moved from being an extreme outlier into being within a couple of standard deviations of the mean.

As far as the unemployment numbers, you may remember we’ve been complaining that the official numbers out of Washington have not been plausible for some time.

I told you this was going to be tedious.

In the last week of September, we made a call of economic weakness, but at the same time strength in stocks, commodity and bond markets. I have yet to see that replicated anywhere. To be clear, by strength in stock markets, I mean the absence of a thirty percent retreat in stocks typical of a recession. By strength in bonds, I mean the strength in bond prices typical in a recession, and a new powering up of commodity markets. The sell-off in stocks after the turn of the year may spook the herd, but we are holding onto the conviction that it will not be for long. We’re sticking with a flat to slightly upward movement in all broad market indexes.

And it was October when we said, it’s not inflation OR recession, it’s inflation AND recession.

The differences between us and the preponderance of economists lies primarily in whether you are Ptolmaic or Copernican, geocentric or heliocentric. That is, supply side or demand side.

Those who believe the supply side drives the economy are reduced to poring over arcane statistics in hopes of detecting a new trend or weakness. Attempting to produce models that are effective statistical trampolines so they can jump high enough to see over the horizon.

Parenthetically, another difference is that the preponderance of economists seem to use equivocation instead of bald assertion. We prefer the latter. If we are wrong, we want to have to explain why. Most prefer to appear not to be wrong, and so they couch their statements in terms of increasing chances, percentage probabilities or slowing economy rather than recession.

The statistical models are less a prediction and more early signs of activity, the smoke of a fire already in progress. This is why you have the ignominious spectacle of forecasters being hit in the back of the head with evidence that doesn’t appear on their charts.

Instead we can simply look at the shape of the economy from the demand side.

The past six years have seen an economy benefitting from interest rates at the bottom of the historic range, a government producing enormous deficits, and a job market that was still pathetic.

The unemployment rate peeked above six percent in 2003 before falling back to near 4.3 in 2006-07. But during that period employment growth stayed below two percent in all quarters except one. In contrast, Bill Clinton inherited an unemployment rate of nearly eight percent from Bush’s father. Growth in employment was above the two percent mark in seven of the next eight years. Net jobs went negative under Bush II in the middle of 2001 and stayed there until the end of 2003. Ten quarters. Longer than any other period of negative growth in jobs in post-war history.

It was this economy that was the scene of the Greenspan housing bubble and the Bush tax cuts for the wealthy. These two forces were the motive force of the last go-round of the so-called business cycle. Wealth, income and employment were all housing- or finance-related. No business investment. No meaningful job growth. The bubble was extended by extremely questionable lending to benefit a voracious appetite for mortgage-backed securities.

So we don’t need to know anything about the future except that it is connected to this past, but without the low interest rates, with a dysfunctional financial sector and in the presence of deflation in housing, the primary component of consumer wealth.

Contrast this with the predominant view among today’s economist that the problem BEGAN in August 2007, and that the previous years were healthy expansion. We were just beset by the, yes, perfect storm.

Our view is that questionable economics from the Fed and White House papered over underlying weakness and now we have the worst of many worlds: inflation, falling dollar, financial sector dysfunction, consumer overextension.

The most talked up prospects for recovery include, improbably, the idea that the Fed will come through with interest rate cuts good enough for housing to recover. This is not going to happen. The Fed cannot go down the Greenspan path because the dollar is on the block and inflation is certain. Even if interest rates could get that low, the housing bubble is over, and housing would not recover in any event because investor appetite is no longer there.

The drop in manufacturing has at least temporarily quieted the notion that export strength from the falling dollar is going to ride to the rescue.

High oil and commodity prices will strangle developed and developing countries alike. If the Fed – as we’ve predicted they will – attempts to keep a tight lid on inflation, then real incomes will be lost to the higher food and fuel prices.