Is Recession Unavoidable?

 

“Why did the Fed allow money to tighten like it did this year?  Why were they seemingly intent on driving the economy to the brink of recession?

 

These are the questions that many have been asking in recent months.  With the U.S. economy showing signs of weakness in certain areas, one could be forgiven for concluding that recession is unavoidable.  So let’s look to see whether recession is, in fact, imminent.

 

The following e-mail represents a growing belief that the economy is sliding into recession:

 

“I have worked in the transportation field since 1990.  Currently, I work for Yellow Freight (YRC Worldwide).  I can tell you that volume has dropped drastically over the past year and it is very slow right now considering this is the busy time of year for transportation.  Our volume has dropped down to half of what it was last year at this time. 

 

“I believe we are in a recession because people are not buying.  I also believe the Fed is lying to the general public in regards to the state of the economy.  Earnings are dropping at all transportation carriers.  You know as well as I do that the transportation companies are leading indicators for the state of the economy….

 

“I suspect the next president will be walking into a mess and will be cursing George Bush for years.”

 

This e-mail expresses a concern that many citizens are feeling right now, namely that many segments of the economy are already in recession.  I agree that there have been recessionary conditions in some economic sectors and this summer reminded many business associates of the summer of 2001 (the depths of the last recession).

 

According to the economic numbers, however, the economy hasn’t gone into recession yet.  The reason for this, believe it or not, is partly attributable to the weak U.S. dollar.  Yes, dollar weakness has saved the day as strange as it may seem.  Export growth has been exceptionally strong thanks to the dollar.  This has made U.S. products more competitive internationally. 

 

As Mark Dodson of Hays Advisory recently observed, ““Right now, the surge in exports as a result of the weak dollar is what is saving the US economy from tipping into recession.”  Dr. Joseph Davis, an economist with the Vanguard Group, has observed that dollar weakness “will improve the trade imbalance and benefit the U.S. and global economies.”

 

There’s no denying that in former times the U.S. economy would have already entered into recession with the way the Fed has handled interest rates.  Yet despite a severe housing market downturn and its attendant credit difficulties, the economy continues to muddle along…but for how much longer?

 

According to one well-known economic forecasting service, the number of times the dreaded R-word, recession, has shown up in newspaper headlines has been 103 in just the past few weeks.  This is the highest reading of recession-related news articles since late 2003.

 

Even some high-level government officials have gone on record as predicting recession for the U.S.  “Housing loan head warns of recession” was the big headline for Sept. 28 in the Financial Times.  The article highlighted the remarks made by Richard Syron, chief executive of Freddie Mac.  Syron said that the U.S. economy faces a 40-45 percent risk of a recession induced by the housing market downturn. 

 

In another high-profile warning, Treasury secretary Hank Paulson recently warned of a “period of turbulence [we expect] to go on for a while.”  His comments were in reference to the financial shocks experienced by the “crisis in confidence” in credit markets this summer.

 

Adding her two cents to the recession debate was Janet Yellen, the president of the San Francisco Federal Reserve Bank.  She warned that the housing market weakness could have a negative impact on consumer spending and that it could impact employment and credit lending.

 

By far the most emotionally charged warning of economic weakness was  made by Robert Shiller, the famous Yale university economist.  He went on record as stating that “the collapse of home prices might turn out to be the most severe since the Great Depression.” 

 

He added, “The Federal Reserve will undoubtedly take aggressive actions, which will mitigate its severity.  But if home price deflation persists or intensifies, they may discover that the Achilles’ heel of this resilient economy is the evaporation of confidence that can accompany the end-of-boom psychology.”

 

This naturally leads one to ask the contrarian question, “When have the media ever given us an advance warning of an impending economic recession that actually came to pass?”  We’ll address this point in a moment.

 

Before we do let’s take a look at what some of the economic indicators are saying.  While the economy hasn’t formally entered into recession, it has come close to the edge on more than one occasion.  Check out the retail sales trend chart below.

 

 

 

 

Those aren’t recessionary numbers but they came fairly close earlier this year.  Even now the retail sales trend is in need of dramatic improvement, especially as we’re in the critical fourth quarter – traditionally the most important of the year for the retail sector.

 

Here’s what the highly important ISM Manufacturing Survey Index looks like:

 

 

 

 

The ISM survey Index has shown some improvement from earlier in the year but still has lots more room for improvement. 

 

On this score the Fed could, and should, do a service to this economy by significantly loosening money.  “Mr. Turbulence” Alan Greenspan did an excellent job of tightening the monetary noose and bringing the economy to the brink with his ridiculous tight money policy of 2004-2006.  (As an aside, he had the gall to write about the “Age of Turbulence,” the title of his recent book, which is a turbulence that he created through his policies).

 

The Fed has truly been behind the curve for too long.  The good news is that the financial markets will force them to loosen up and get the money flowing again.  No longer can it ignore the message the bond market has been sending this year.  Even Fed Chairman Bernanke is starting to show signs he is waking up to smell the coffee. 

 

One thing that all recessions since 1974 held in common was a declining trend in bank credit on an annual percentage change basis.  Heading into each one of the recessions of 1974, 1980, 1982, 1990 and 2001, the bank credit rate of change was declining.  This isn’t true in October 2007.  Bank credit growth on annual percentage change basis is above 10% and near its 4-year peak from 2003.  This makes it even less likely that the economy will enter into a recession.

 

Let’s look at some of the indicators that show that the economic softness of 2007 will soon be reversed.  There is a growing gap between personal spending and personal income.  This can be seen in the following chart where spending is shown by the red line and income by the green line. 

 

 

 

 

Historically when spending is declining while income is increasing or remaining unchanged, an improvement is seen in the consumer economy and in consumer sentiment in the months to come.  This indicator is something watched by monetary policymakers.  When the two variables get out of line the monetary noose is loosened.  A change in this trend should begin later this quarter as the retail season begins in earnest.  Further improvements should be seen in 2008.

 

Notice also the chart showing public savings.  After falling into negative territory in 2005, the trend appears to be reversing and the beginnings of an increased trend toward savings can be seen.  It appears that the “get out of debt” campaign we’ve seen over the past 3-4 years has been working.  This holds enormously bullish implications for the 12-18 months ahead.  It shows that consumer sentiment has been shocked into a savings mentality.  This always happens before monetary policy is loosened up and money and credit (the lifeblood of the economy) is allowed to flow once again.

 

 

 

 

Although the Fed has stood back and watched the economy slip to the very edge of recession, there are enough subtle clues to indicate that this has been the intention all along. 

 

Go back and look at similar instances in the past you’ll see what happens when the economy has been pushed this far down while the stock market continues to rise.  The result has been that the economy reverses course and shows gradual and sustained improvement for an amount of time equal to or greater than the preceding period of economic softness.  Fed interest rate policy was instrumental in creating the desired objective in all cases.

 

When the Fed continues to lower rates in the coming months (as it will be forced to do), the somnambulant economy will finally awaken from its slumber and we’ll see higher levels of output in 2008. 

 

As Dodson put it, to experience an economic resurgence, “we only need to encourage growth and get the Fed funds rate down closer to the T-bill rate. In the meantime, we can enjoy the resurgence in US exports.”

 

Clif Droke is the editor of the daily Gold & Silver Stock Report.  Published daily since 2002, the report provides forecasts and analysis of the leading gold, silver, uranium and energy stocks from a short-term technical standpoint.  He is the author of several books on financial markets, including most recently “How to Read Chart Patterns for Greater Profits.”  Visit www.clifdroke.com for more info.

Visit www.clifdroke.com for more info.