The Great Recession Debate

Some bad economic numbers out this week, a rise in jobless claims, and also the Federal Reserve said economic growth has slowed in 75% or nine of its 12 districts since February, up from two-thirds in its last report.

So is the US economy headed for a national nervous breakdown? And when will we see the end of the Stygian gloom in the financial sector? Have we seen the worst of it?

Before we get to the answers, don't get lost in the weeds. A broad-zoom perspective is needed.

The US economy has been growing at breakneck speed for five years. We've added the equivalent of the GDP of Great Britain and something like two Canadas and five Saudi Arabias since 2003, though Congress has put virtually the same amount in spending on the backs of taxpayers and entrepreneurs, proving it still has no more sense than a flock of geese. The world is only in the first stages of true globalization, evident by the growing share of profits from overseas at multinationals.

And a slowdown will bring much needed rationality, especially with heedless back-to-back bubbles, the housing and credit mania being the biggest of all, which we are still in the thick of, having come fast on the heels of the dotcom and telecom implosion.

Yes we are in a downturn, but economists and analysts I talk to say it will be short and shallow, similar to the last two recessions which were relatively quick and not so deep. The '90-'91 recession and the 2000 to 2001 downturn lasted eight months.

These pros say that the growing consensus of a turnaround by the end of the year is right. Inflation though is running at a dangerously high 4% annual rate, even higher in food, energy, tuition and health care costs, hurting consumers. The Fed faces a growing chorus of criticism to do more to bolster the weak dollar.

Also we are still in the middle of the financial sector writedowns. Some good news here: The bond market has been in a blackout since late last summer due to the housing and credit market crisis, but the lights are just starting to slowly come back on, notes economist John Rutledge, though, post-bubble, the snap has long gone out of the yellow suspenders down on Wall Street.

A word of caution: Despite what you may hear, a recession is not necessarily defined by two back-to-back quarters of negative growth.

The National Bureau of Economic Research (NBER), the nonprofit organization of mostly academic economists that calls a recession, does not use that definition of two consecutive quarters of negative growth. Also, the late 2000 to 2001 recession did not have two back-to-back quarters of negative growth.

Instead, NEBRA gets to call a recession based on its take on a wide range of data, including things like income growth, industrial production and jobless claims. Problem is, we won't know for some time whether we were in a recession. NEBRA has called recessions often nine months or more after they have ended.

Watch the labor data, which NEBRA scrutinizes closely and says provide the broadest monthly indicators for the economy. Jobless claims this past week on a rolling four-week average basis came in at 376,000, far below the number seen in prior recessions.

Can the jobless numbers though signal an upswing in economic activity? Dennis Gartman of the closely followed, must-read Gartman Letter says yes, that's been true in the past. He says investors should watch for that spike in the rolling four-week jobless claims, as a sharp rise has historically preceded an upswing within a month or two in every recession in the US since the late ‘50s. He now says that jobless claims could rise toward 500,000 to 550,000, before the economy sees an upswing.

By Gartman's estimates, jobless claims are still low compared to prior recessions. Also, in the 2000 to 2001 downturn, jobless claims spiked to about 405,000, says Fox Business's senior economist Mark Lieberman, before turning down several months later, which is when the economy started to resurface. In the '90-'91 downturn, jobless claims rose relentlessly from less than 300,000 to 429,000, Lieberman says. But that then marked a turning point, and the recession ended in early '91.

Similarly, Gartman says that in the '81-'82 downturn, initial jobless claims spiked at 660,000, then came the turnaround soon after. Same for the '73-'75 recession, 660,000 came late in the game then the upturn quickly followed.

Clearly we are no where near those numbers yet and maybe the spike won't be that bad. Also, since December the economy has shed on average almost 80,000 jobs a month. In most recessions a rate of 150,000 to 200,000 is normal.

And watch this: Historically recessions have been caused by the Fed tightening monetary policy to battle inflation, price hikes exacerbated by oil shocks, says economist Edward Yardeni. However, the Fed now is clearly opening a gushing hydrant with historic liquidity measures, but its interest rate cuts, which cause the dollar to drop in value, of course is helping to cause oil to hit record highs, since oil is priced in dollars.

Bernanke, a student of The Great Depression, knows full well that the Fed's monetary contraction during the early '30s helped trigger that collapse (on top of the disastrous Smoot-Hawley tariffs).

The Fed tightened in the '70s to fight inflation arising from LBJ's guns and butter fiscal policies. Inflation also arose after LBJ strong-armed the Fed to get it to print money to pay for the Viet Nam War. The tightening wasn't enough, inflation soared to 11.5% by March 1980, and the Fed hiked rates to 20% in December 1980, and a recession arose.

Oil shocks also helped trigger inflation and ignited recessions in '73 and '79. Remember the Arab oil embargo of October 1973, which came about due to the US, western Europe and Japan's support of Israel during the Yom Kippur war of the late '60s? That embargo hastened the recession in the early '70s, which saw the rise in power of the oil cartel known as OPEC (founded in Iraq in 1965, Venezuela first moved toward establishing the cartel in 1949).

The '79 oil shock, Yardeni notes, was brought on by the revolution in Iran which deposed the Shah and saw Ayatollah Khomeini gain power.

The last two recessions were caused by the S&L crisis and the Internet and telecom bubbles, and again lasted about eight months each.

Today's downturn is a housing and credit crunch exacerbated by record oil prices. The Federal Reserve and the government are intent on keeping this one as short and shallow as possible, with an unprecedented package of both fiscal and monetary stimulus actions as well as liquidity injections for Wall Street.

That has some churlishly wondering whether the central bank is now in danger of becoming a government-sponsored enterprise for Wall Street, sort of like a Fannie Mae or Freddie Mac for the traders.

How long will the housing downturn last? Goldman Sachs looked at 24 house price busts with declines of more than 15% since the '70s across 15 countries. On average, real house prices tended to fall around 30% and only bottomed out after six years, the investment house says.

Look at it this way. Standard & Poor's/Case-Shiller widely followed 20-city composite index of home prices fell 10.7% in January from a year ago. Average house prices dropped 23% on an annualized basis over the three months ending in January. Since analysts say house prices will likely fall 30% or more from their peak, we've got a ways to go. However, housing starts in March fell a bruising 11.9% to 947,000, on the heels of February's revised 1.065m. And housing permits fell 5.8% to 927,000, the lowest level since sometime in '91.

All of this is a rational cleaning out of the excess in housing, and it is a good thing. Gartman has a target to which housing starts must drop to before a turnaround is evident: below 750,000 on an annualized basis.

But no way are we in a Depression, despite what you hear, of course, from many despairing traders and officials on Wall Street saying it sure feels like one. Plenty of Wall Street executives now appear to be walking around in a stark awake coma of despair, or as if they are clothed in the sack and ash of wisdom, (more like Triple Sec and cigar ash).

In the '30s unemployment got as high as 30%. Unemployment today is still around 5.1%. Setting aside the Stygian gloom at the financials, earnings in other sectors remain well above where they stood at the last market peak in 2000.

So sit back and watch in this political season the furious search for scapegoats, they being the oil and Wall Street fat cats, the overpaid reprobates of colossal riches whom many want to see headed for the tumbrel.

And watch how the new US president taking office next January will face a hot domestic debate over whether to create bigger budget deficits to deal with a downturn--if we're still in it by then--or to curtail spending, or to rescind Bush's tax cuts.

Remember, the US was a creditor nation up until the '80s, but no longer, as red ink swamps the country's books.

We can forget government-backed reforms of health care for now, the country can't afford it, especially given that both S&P and Moody's now threaten to downgrade the entire US government. S&P's threat is due to Fannie and Freddie's dangerously leveraged condition, with a potential taxpayer bailout of the two costing 10% of GDP or $1.4t. Also, like Thelma and Louise, Social Security and Medicare are both headed for a cliff with taxpayers in the back seat, as Pat Buchanan rightfully says.