Yip Yap Times

Is the U.S. In A Recession?

No, and we wouldn't be headed for one if Bernanke would keep his hands off the economy.

Even by the newspaper definition of recession, the U.S. is not in one. The media definition of a recession is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters. That has not happened. In fact, the economy is growing. The third quarter GDP for 2007, the latest round of reduced data so far, grew by an annualized 4.9%. This is up from the second quarter annualized growth rate of 3.6%, which is better than the 3.4% growth of 2006. According to my economics book (Economics by McConnell and Brue 2008), a recession is a period of decline in total output, income and employment. The downturn, which lasts 6 months or more, is marked by widespread contraction of business activity in many sectors of the economy.

Some economists prefer to look at individual indicators like manufacturing orders, wages, wholesale inflation rate, supply chain data and employment rate to name a few. Well, the unemployment rate is 5%, which is considered full employment. A rate like the 4.5% that we saw at the end of 2007 is considered a tight labor market--which could also be inflationary as wages rise. As of November 2007, manufacturing and trade inventories were up 1.6% over October, which was up .7% from September. New orders for manufactured goods were up 1.5% from the previous month. New orders for manufactured durable goods were up .1%. Here's the real good news: according to the Bureau of Labor Statistics, non-farm business sector productivity (output per hour) was up 6.3% third quarter 2007. Hourly compensation was up 4.2%. That means labor costs were down 2%. In the manufacturing sector output rose by 5% and wages rose by 1.5%. Now before anybody starts yip yapping about how wages are not keeping up with productivity growth, understand that there are other factors that affect productivity growth. The main one is technology. Others include capital investments and education/training, all of which will make a worker more productive. The bottom line is--economic data is good even if the stock market waffles around wildly.

The stock market would theoretically be one measure of economic performance if it wasn't so driven by emotion and craps shooters. But since this is apparently the only measure Bernanke is looking at as he slashes interest rates, why is the market flapping around so? It all boils down to the subprime credit problem. The subprime defaults were a small, small problem in the overall mortgage market and microscopic in the total debt of the American consumer. The subprime fallout should have been limited to the people involved in this sector and not effect to any appreciable degree the overall economy. But the subprime got its tentacles everywhere because of collateralized debt obligations, or CDOs. The purpose of CDOs, like mortgage backed securities, is 1) to spread the risk around a large pool of investors and get it off the backs of the actual lenders and 2) make more money available for loans. These are good goals, but a variety factors affected their values. Many CDO products are held on a mark to market basis, which is the act of assigning a value to a position held in a financial instrument based on the price of the current instrument. The final value of a futures contract that expires in X months will not be known until it expires. But the failure of risk models used by credit rating agencies and failure to monitor credit performance by institutions that bought these investments paralyzed the credit markets because these futures contracts couldn't be valued. Major loss of confidence in the validity of process used by ratings agencies to assign credit ratings to CDO investments and cash flows led to a collapse of liquidity.

So followed the stock market. But the market was to see even worse thnaks to perosnal debt. Greenspan's monetary policy created the housing bubble. This was highly praised for boosting the housing and construction industry which was in turn credited with keeping the economy afloat after the Clinton years. But a bubble is artificial in that it must be inflated by something and so it was thanks to Greenspan's monetary policy of too loose for too long. Homeowners assumed that the equity in their homes was real so would never fall. They borrowed against the equity in their homes. Consumers maxed out their credit cards because the low interest rate lowered these rates. Sure, the economy could do well excessive consumer spending since 2/3 of the economy is driven by the consumer. But debt for that purpose is foolish. To borrow for investment is generally OK, but to borrow to consume and use up is just plain dumb. It drives the economy in the short term but eventually that money must be paid back. And ballons pop.

So followed the stock market. Bernanke has radically cut the interest rate. News media has reported that the "subprime crisis" has grossly affected overseas markets and investors in this country are losing confidence. The fear is that holders of American dollars will dump them and move to places with better investments. That would further depress the dollare and be extremely inflationary in the U.S. So, true to government bureaucratic thinking, Bernanke "did something." He cut the interest an unheard of 3/4 of a point. This has the effect of weakening the dollar and being inflationary. And it did nothing to help the stock market. Bernanke apparently assumes thought lower credit card rates will encourage more consumer debt and boost housing prices and get people borrowing against the equity in their homes again as prices rise due to demand because of cheaper mortgage rates. But the guy who lives according to his means gets rewarded with smaller earnings thanks to too low fixed income interest rates. So the Fed says let's just spend our way out of recession with even more debt than before that ended in threats of recession. There that ought to work.

We never learn.

posted by Lisa @ 11:08 AM