August 28, 2008
The Pause That Depresses: Recession to Begin Within Six Months and Depression Prior to 2008Q2
Note: Please feel free to forward, post and publish.
Clouds are gathering over the US economy and quite a few highly informed people can now see them. What is not understood is that this storm will result in a flashflood and a “the Great Deluge.” Americans are lot less prepared for the coming economic storm than the residents of New Orleans were prepared for Katrina exactly a year ago. While Katrina was only a category 3 hurricane, the next economic hurricane that will hit the US, already gathering strength for a while, would have the force of a category 5 storm, with econ-winds of above 175 mph, when it strikes.
The economic forecasters that we do have, to inform the public, give fortunetellers a bad name. A case in point is economist Diane Swank, a pretty face that frequently appears on financial TV, whom I heard saying, answering a question on what the Yield-Curve was forecasting, “this indicator will crash,” i.e., totally fail this time. If economists, as a group, had any professional integrity, let alone any shame, they will pay for advertorials to inform the public that they are incapable of forecasting recessions and depressions. The stock market might have predicted, “nine out of the past five recessions,” as Nobel economist Samuelson is supposed to have quipped, how many have economists, as a group, predicated? A fat zero. So, please ignore a crank like myself, or any other non-economist prognosticator of the economy, if you must, but don’t hold your breath for an economist to forecast a recession until after the economy is already in a recession. And in many cases until it has already come out of a recession. The best ability to forecast recessions and depressions is to be found among those that dwell into investments and among professional speculators. A degree in economics is a very big hindrance in forecasting recessions and depressions; on that history’s verdict is clear.
Why can’t America have a recession? Because Americans can’t afford it! Especially, not now. There is a book titled, When Wish Becomes a Thought, by an American sociologist that encapsulates the truth about most people’s forecasts. Add to this the most common psychological disease among Americans – Optimitis Americanitis – and you have all the makings of a grand denial and its consequences (this disease has been carried on by many Indians and Chinese to their native lands). As we saw in the case of New Orleans, catastrophes are more likely to hit those who are least prepared. Or, so it would seem.
The proximate cause of the coming recession would be the bursting of the Housing Bubble, existence of which lot less people deny now than a year ago, and one can list more than a dozen indicators to support the case for a recession within the next 12 months. Here are just a few that quickly come to mind:
1. NAHB (National Association of Homebuilders) Index, at a 15-year low and at levels that precede recessions.
2. LEI – Exhibiting a condition of peaking, since Jan’06, which ALWAYS leads to a recession after average of 11 months (thank you David Rosenberg of Merrill Lynch).
3. Yield-Curve that began to invert in Feb’06 and now is very close to the level (10Y-3M-YD = -0.32%) that ALWAYS leads to a recession within 12 months but mostly in 4-8 months.
4. Consumer Confidence – very low, despite the employment holding OK.
5. Break in the Scam Market in May despite very good earnings and huge buying of their own Scam by corporations.
6. The Pause – the main reason is the expectation of a weaker economy, but how much weaker? (More later).
I have been among the leaders of those who saw the Housing Bubble building and predicted a recession once the Housing Bubble bursts. In fall of 2004, I thought that the Housing Bubble was in the process of deflating. Based on that I forecast the recession to begin before the end of 2006Q2. I was wrong about the deflation of the Housing Bubble to begin in the fall of 2004 (which took place exactly a year later) and, hence, wrong on the dates and probabilities of recession I outlined in the fall of 2004. In the forecasting business making mistakes is not uncommon. The important thing is to learn from the failures. I learned two things – gathering historical data on housing, including supply and demand, and to spend lot more time on understanding various leading indicators and gather data on them. The most important part of this process was to accurately quantify the predictive powers of the Yield-Curve. It is the best predictors of the recessions as well as periods of falling inflation, as presented in my editorials over the past six months:
Feb-27-2006 Why Yield Inversion Foretells Recession?
Feb-28-2006 The Best Way to Interpret Yield-Curve’s Ability to Forecast Recessions
Mar-06-2006 Accurate Characterization of Yield-Curve and Recession Probabilities
Jun-17-2006 Yield-Curve, Inflation, and Recessions: Are Recessions Necessary to Control Inflation in the US?
My big break in being on the top of the Housing Bubble Watch came with the historical data on the Fundamental Demand for housing (as in a place to live, including second homes, or for a dwelling, i.e., number of households) and the supply. It is true that the prices were going up so rapidly because of the market demand outstripping the market supply, but what if the market demand were to be Speculative Demand, as I suspected and claimed? The data settled that question as well as repudiated all the arguments by the bulls who claimed that Fundamental Demand for house-dwellings (a term from Adam Smith) was leading to the rapid increase in prices. Just a few days ago, Paul Kasriel, an economist I respect along with David Rosenberg of Merrill Lynch, wrote an article on the Supply-Demand question:
August 25, 2006 New Homes Market: Worst Supply-Demand Situation Since Early 1970s by Paul Kasriel
Well, I foresaw this coming more than a year ago:
07/31/2005 The US Housing Supply-Demand: Countering Lies with the Facts
In July of 2005 I became convinced that when this Speculative Demand driven bubble bursts it would be ugly. Thus far, even though the burst has barely begun, it has not disappointed. It will make all the previous bubbles and crashes look mild by comparison.
Connecting the Dots
Few weeks ago, Ron Insana, one of the better commentators on CNBC, said, during a debate on inflation, “Inflation peaks during the first year of a recession (you can see for yourself in Fig 1. of http://www.safehaven.com/article-5390.htm). How many people know this fact even today?
How many of you believe that Bernanke will let inflation keep rising for another six months, let alone a year? If inflation does not start going down, and continues going down, in another six months he will be forced to apply the brakes if for no other reasons than to establish his credibility. Assuming that it takes up to nine months for inflation to start to fall, we will already be in a recession in nine months. I personally think that inflation will start to come down lot sooner than nine months. Why? The Pause!
One risk that Bernanke will not take is that of letting the inflation going out-of-control. Even the current level is way outside the 1-2% declared target zone by Bernanke and various Fed officials who have bought into that. The Pause is a clear signal of expectation by the Fed of weakening economy, led by Housing Bubble bursting, and once the economy starts to weaken due to Asset Deflation, the Fed can’t control its slipping into a recession, as we already learned, once again, in 2000-01. The fact is that bursting of an asset bubble is a psychological phenomenon and there isn’t much the Fed can do in a short period. By the time the Fed knows that the economy has weakened into a recession, usually it is late by several quarters. The Fed will have to use terms like slowdown, soft landing, orderly retreat, etc., until we are well into a recession.
I have already indicated, earlier, that the Yield-Curve is now at the point where the recession is highly likely to occur in 4-8 months.
Two Most Important Economic Reports
Existing Home Sales reports for the months of August and September. I have been waiting for the August report for some nine months. What is so special about that report? The housing broadly peaked in August 2005 and the YoY comparisons will look plain ugly. Here is what I see between the August and the September reports:
1. The YoY nominal median prices of homes, nationwide, will be negative.
2. The YoY nominal median prices of homes for the state of California will be negative.
3. Sales volume will be down 20-50% across most of the areas in the US.
The first hasn’t happened for some 53 years and it will get the attention of all the bulls in denial of how serious the housing problem is going to be for the economy – a hard landing and the beginning of the first depression since the Great Depression.
Why the Depression?
It Is the Debt, Stupid!
All asset bubbles are “Credit Bubbles.” Well, Debt is just the other side of Credit. I think that Americans are running out of bubbles. No? Also, the Fed and its constituency, Bankrupters and Fraudsters of New York City (BFNYC), are running out of “options” to push more Consumption Debt (yes, mortgage is consumption debt) and Scams. And it was the unprecedented push of Consumption Debt, mostly via “reckless mortgage lending,” that has kept the US economy out of a recession for the past four years. I think that the “Bush recovery” has been pushed as far as it could be pushed already. Nicht mehr, nicht mehr, nicht mehr. (No more, no more, no more).
Now, about the Deflation case. Most people misjudge the powers of the Fed. Almost all its power, long-term, is a matter of The Confidence Game (title of a book on the Fed). Fed is in no position to inflate as most inflationists think. Deflation will come so suddenly, as a result of the Demand Destruction leading to inflation falling very fast and going from +1.0%, YoY, to below zero within months, that Fed will not be able to pre-empt it. Once Deflation takes root for few months it would be very hard to get rid of. The proverbial Pushing On the String (not being able to Pushing ON More Debt!) will become a reality. It would be good for Americans to learn about the limits of Fed’s power in being able to manipulate the economy. Americans will also learn a thing or two about what wealth is and what an investment is.
Jas Jain, Ph. D.
Prophet of Doom and Gloom