|
How to make a the case for
a recession which will last at least for two if not three quarters and
then a slow recovery of at least a year and half where GDP is in the
range of 2% on average.
First, this recession is fundamentally a consumer recession, brought
on by a bursting of the housing bubble and a credit crisis. Consumer
spending is under pressure from several main areas.
First, as the housing market stalled and then began to drop, we saw a
fall in housing related spending, in construction, furniture,
mortgages, etc. Remember when most economists and analysts wrote last
summer that there would not be a recession from the housing crisis
because housing was only 5% of the economy?
Notice that without mortgage equity withdrawals the US economy would have
been in outright recession for two full years in 2001-2, and would
have been quite sluggish for the next two years. That is what you
should expect from the bursting of a major equity market bubble and
9/11. But because the value of the US housing stock was rising and
doing so rapidly, people felt comfortable borrowing against the
ever-rising value of their homes. We borrowed and spent our way out of
that recession. Coupled with the Bush tax cuts a very important
element! and low Fed rates, we bounced backed rather handily.
But now, home values are falling and will likely do so for another year
at the least. As Woody Brock pointed out in this week's Outside the
Box, we are at the beginning of a reversion to the mean on national
wealth. We are getting a reverse wealth effect. People either can't or
won't borrow as much and thus we get negative stimulus from housing
prices. It is likely that people are going to start saving more, which
while a good thing from an individual stand point, it is a drag on
overall consumer spending.
Second, even though core inflation is tame, real inflation that includes
the things you and I actually buy is high and rising. I drove past a
gas station in La Jolla where the price of gas was over $4 a gallon.
Money that is spent on gas and rising energy bills is money that
cannot be spent on discretionary items. Rising food bills means that
there is less money left over to buy entertainment and other modest
luxury items.
Third, rising unemployment clearly means that a small but growing segment
of the population has less money to spend. Unemployment is at 5.1% and
is likely to rise to over 6%. That is clearly bearish of consumer
spending.
All of these factors suggest a recession of at least two quarters if
not three. While lower Fed funds rates and the efforts by Congress to
stimulate lower mortgage rates will eventually help, it will not be an
immediate panacea.
As to a slow and prolonged recovery, the "Muddle Through Recovery," the
reasons to me are clear. The cause for the current recession is the
bursting of the twin bubbles of the housing markets and the credit
crisis. These are problems that are going to take several years to
solve, not matter that the Fed does to interest rates and opening the
discount window to investment banks for all sorts of mortgage and
other asset backed paper. While doing so is a good thing, we still
have to work our way through 3.5 million excess homes, 2 million of
which are vacant. That will take a few years.
Further, we have to develop new sources for the buying of debt. We
vaporized 60% of the market for debt in the implosion of CDOs, SIVs,
CLOs, etc. These buyers are never going to come back. It took 15 years
to create that market. It will take a few years to create its
replacement. (More thoughts on how we do that in a later letter.)
If the Bush tax cuts are not kept largely intact you will see the
recovery that I think will be coming in late 2009 and 2010 evaporate
quickly. If an Obama (probably) or a Clinton (small chance) get their
way, we will see the largest tax increase in history. That is not the
medicine that the economy needs when it is weak already. It could
easily push the economy back into recession as it will make the
consumer even weaker.
So, if things are all that bad, why won't we roll into the soft
Depression that Bill Bonner and others predict? It is quite easy to
make a very bearish case with a falling dollar, rising inflation, a
seemingly never-ending rise in oil and commodity prices, a nasty
housing market crash, a frozen credit market and more.
To establish a basis for my relative optimism, I have to re-visit what is
for me a painful moment in my forecasting life. This is just between
you and me, gentle reader, and I would appreciate you keeping this
just between us.
Back in 1998, I thought the US and the world would drift into a
recession caused by the failure of some large computer programs not
being fixed on time for the Y2K rollover. I did not think it would be
the disaster some thought, but I did see the potential for problems.
Why? Because of one statistic that was very clear. 50% of all major
software projects for 40 years did not finish on time, and a large
percentage of those missed their targets by years. That number had not
changed for decades.
The Y2K software problem was very real. There were thousands of huge
software projects under way by late 1998 to fix the problem. Many
software conferences and talked with the software developers and
management who were quite distressed. Their concern was real.
Could we expect all the projects to be done on time when the clear
record said that software was difficult and managers very poor at
getting things done on time. While I expected most things to be fixed,
it seemed reasonable to think that there would be some problem areas.
And I generally got agreement from very serious managers and
consultants.
Most of the US economy is doing just fine. Businesses have not
overbuilt capacity, have large cash positions and lower debt than is
normal at the end of a business cycle. In the 70's and 80's, we were
much more dependent upon manufacturing for employment, and thus were
subject to large increases in unemployment when too much capacity met
slack demand and businesses cut back as quickly as they could. Even if
we rise to 6 or 7 percent unemployment, that does not rise to the
level of a major recession.
Second, the Fed has responded, if a little late, to the credit crisis,
buying time for banks to find capital. While there will be many more
write-offs from bad debts and mortgage paper in the future, most banks
will survive in some form. The key is that the Fed did buy us time.
The banks and pension funds are still going to have to write off about
twice what they already have, but not all at once. It will be several
years before we are through this mess, but that is why we Muddle
Through and not crash. I still contend that if the Fed had allowed
Bear Stearns to crash that we would experience a soft depression. It
would have been ugly. But they didn't and we won't.
And while the housing crisis is really bad if you are trying to sell a
home, it is also an opportunity if you are a buyer. We will work
through the excess homes that are in the market, as US population is
growing and the natural demand that stems from that growth will help
pick up the slack.
And the credit crisis? It will get solved, because like the Y2K
problem, it must be solved if we are to survive. And the creativity
that infuses this country will rise to the occasion.
We do have very real problems and will suffer a recession. The
problems will not be solved quickly. But they are not fatal problems.
Time is required for the markets to heal themselves. And during that
time, things will be slower than has been the case in recoveries from
"normal" recessions.
|
 |
|
