Wednesday, February 4, 2009

Signs Of The Coming Recovery

Unlike with Bob Murphy, I won't be able to make any money off of Brian S. Wesbury and Robert Stein. They see the recession ending, as I do, sooner rather than later. They point out, for example, that

Despite continued problems in financial markets, sensitive commodity and transportation prices--the seismic indicators of economic geology--suggest that the economy may be stirring. For certain, these are very early rumblings. But they are rumblings nonetheless.

The price of gold has increased about $200 per ounce in the past 10 weeks. Some argue that this represents a flight to safety, but Treasury bill, note and bond yields are up sharply in recent weeks, and the new issuance of corporate bonds has accelerated, suggesting otherwise.

Meanwhile, oil prices bottomed in the mid-$30s, but have now moved back up and appear range-bound between $40and $45 per barrel. Another positive sign is that the Baltic Freight Index, a measure of international shipping prices, appears to have bottomed two months ago in early December and is up about 60% since then. This is a small rebound from the massive 94% drop from June to December, but it represents a notable change in direction.

And they understand the power of money printing:

At some point in every recession and recovery since the early 1980s, it has been typical for investors to reach a point where they start to think that "this time around" monetary policy will not work. This happens because there are long lags between when the Fed fires its bullets and when they hit the target. These long lags cause many to lose faith.

But monetary policy always wins and things are no different this time. Monetary policy is extremely loose, and the seismic drums are scratching away. Some early warning signals suggest that despite real GDP weakness, an economic recovery should start taking hold by mid-year.

Another group that sees an end to the recession (although I wonder if they really believe their model), is the New York Fed.

For obvious reasons, a positive yield curve, with long rates higher than short, has been a strong indicator of positive economic activity. This is so because banks, and others like hedge funds, can borrow short, lend long and make the difference. Once the fear works its way out of the markets, this is exactly what will occur.

According to the New York Fed, "Research beginning in the late 1980s documents the empirical regularity that the slope of the yield curve is a reliable predictor of future real economic activity."

Monday, the New York Fed released its latest "Probability of U.S. Recession Predicted by Treasury Spread," with data through January 2009 and its recession probability forecast through 2010. The NY Fed's model uses the difference between 10-year and 3-month Treasury rates to calculate the probability of a recession in the United States twelve months ahead.

The Fed's data show that the recession probability peaked during the October 2007 to April 2008 period at around 35-40%, and has been declining since then to less than 10% for December 2008 and January 2009. Looking forward through 2009, the Fed's model shows a recession probability of only about 1% on average through the next 12 months, and below 1% by the end of the year (.82% by January 2010). The Treasury spread has been above 2% for the last 11 months, a pattern consistent with the economic recoveries after the 1990-1991 and 2001 recessions.



  1. Ah yes, people underestimate the power of monetary policy.

    So do you, Wesbury, et al. not think private sector banks actually perform a service in the market economy? I sorta figure that bank nationalization in 4q 2008 would mess up the economy in 2009. But printing up some paper dollars can patch that up?

    What troubles me is that you guys are writing as if stagflation is impossible. You've been saying, "Yes yes, inflation will go through the roof, but at least we'll get lower unemployment."

    So are the savvy financial analysts all Keynesians now?

  2. I thought this post would get you going :)

    As I continue to say, the money printing will cause the traditional indicators, such as GDP, unemployment to turn positive by the end of the year. Underneath the economy will be a mess. I can't speak for Wesbury and Stein, but it is interesting that W and S also see the uptick in the economy as short term in nature.

    I think our differences are more of timing nature. The inflation will come, but I see that more of a problem in 2010 and beyond.

    Bank nationalization will be very bad in the long term. In the short term, when the nationalized banks start making PC loans to " tree hugging, Spanish-speaking, Afro-Asian, lesbian midgets" the GDP number will tick up when they start spending the money on whatever tree hugging, Spanish-speaking, Afro-Asian, lesbian midgets spend money on.

    Don't forget that even during the Great Depression the stock market, for example, had periods of strong upside action, and where FDR manipulated markets higher, such as, gold, those stocks soared.

    Keynes and Bernard Baruch made a fortune on the manipulated upside price move in gold markets.

    It's not that manipulated markets don't distort the structure of the economy, they do, but the first distortions will look like a recovery.