Friday, January 25, 2008

What's So Scary About A Recession?

In 25 years looking at the US economy and global markets, I have never seen such swift action from the Fed and the government, theoretically designed to avert or ease a looming recession. For example, the Fed's 75 bp one-day cut was the largest in its history and the fiscal stimulus bill was approved by Congress in record time. Everything is being done in a great big hurry. Why? And what further conclusions may be drawn from such action?

Part of the reason lies in the people: Mr. Bernanke is an academic who made a career out of blaming the Great Depression on the Fed, and Mr. Bush has never met a tax cut he didn't like. In addition, most of Congress is up for re-election this year and sending cash to voters is as close to hog heaven as a politician will ever get in his/her career.

But from a statistical standpoint, at least, the overall economy hasn't yet weakened appreciably. The medicine being administered seems way out of proportion to the illness. At 3.50% Fed funds are already at the level of late 2001, when the economy was 3/4 of the way out of the recession and much below current inflation, which is running at 5.7% annualized for the three months ended in December.

Fed Funds Target Rate

Because of the Great Depression, American financial and political institutions are terrified of the spectre of deflation. Until perhaps a decade ago, a replay of such a catastrophe was deemed impossible because of the Keynesian social state erected in the intervening decades. But two developments since the 1990's have apparently changed this view:

a) Japan became a glaring example of a modern welfare state suffering from two decades of deflation and zero growth due to the bursting of share and real estate bubbles.

b) Beginning with the Reagan Revolution, the US radically transformed its economy and is now focused on free markets, laissez-faire and individualism, instead of government intervention and social cohesion. Its structure is currently closer to that of the 1920's than at any other time since the end of WWII.

In other words, I think Washington and Wall Street now recognize the danger of a deflationary implosion, even if they don't come out and say it openly, and even if they caused it themselves by unchecked reliance on Adam Smith's invisible hand. This would certainly explain the swiftness and the size of the "insurance policy" currently being taken out by the Fed and the government (i.e. watch what they do, not what they say).

It looks like Bush, Bernanke, Paulson and Co. are scared to death and the recent plunge in global stock markets is giving them the willies. After all, those that live by the sword (the market) are in constant fear of being killed by it.


  1. They act panicked because they are. Every announcment they might as well be saying, "I've got the conch!" and the market just starts sharpening a stick at both ends and screaming, "Sucks to your ass-mar!"

    Can we have Glass-Steagall (and then some) back now?

    Oh, and a book rec: Financing the American Dream: A Cultural History of Consumer Credit by Lendol Calder.

  2. I enjoy reading your blog.
    Just to let you know that Japan is NOT a welfare state.

  3. Japan a welfare state...

    Every modern country in the world is a "welfare" state: they have a large govt., a pension system, unemployment insurance, free public education, etc.

    "Welfare" is more or less a technical economic term, in this usage.


  4. Great post....

    Dubya, Hank and Benny Boy have very good reasons to be scared and if they ain't, they should be.

    It's possible that the inevitable can be extended until mid 2009 although not probable.

    I find the fiscal stimulus package wanting and short sighted, the Fed cut, more of a mental masturbation than a substantially decent screw. These will be short lived at best and far more deleterious over an extended period of time.

    However, these boys have shown their hands and we know how many chips they have on the table. I think that they are going to have to go "ALL IN" with a 5/8 off suit. Not too promising to say the least.

    Best regards,


  5. Still don't understand why they can't they just support every failing enterprise with federal budget money? Federal budget deficit the Final Bubble.

    Its not like they are going to have opposition.

  6. From the Onion, the real stimulus package.

    "Nation's Grandfathers To Receive Annual Shipment Of $2 Bills From U.S. Treasury"

    As you can see, I'm really busy today.


  7. Try to link the obvious together: energy = productive output = stock market valuations. It is more than obvious that a decline in either energy or productive output will result in a decline in stock market valuations.

    The reason we haven't seen this yet is because corruption in the highest levels of gubbemnt and finance is OFF THE CHARTS. I can't imagine what goes through these peoples minds but I'm sure they are busy trying to figure out how to preserve their own wealth and power. I mean, they don't even give us regular people the opportunity to make an informed decision by providing us with real information.

    None. Zilch. Nada. Figure it out on your own. In fact, here is some totally irrelevant BS to distract you AND we'll use the real information we collected at your expense AND our connections AND your money for leverage to benefit ourselves.

    Oh, wait. It's a new era...

    We interrupt our regularly scheduled programming with this breaking news:

    ENTER THE DRAGON (aka here comes the real world, and not the fantasy land you've been living in the last 40 years, and in case anyone hasn't told you it ain't pretty nor nice nor forgiving)

    - Oil is going
    - High-grade ores going
    - Fisheries going
    - Top soil going
    - Fresh water going
    - Natural gas going
    - Rain forests going
    - Species diversity going

    This is just the tip of the iceburg. We are is SERIOUS TROUBLE with no solutions in sight.

    Yet the people in the most obvious positions to effect change are still fighting over the crumbs of a dying planet or worried about getting elected/re-elected or going to some meeting any place nicer than the one where they live. J6P is worried about getting a pay check so he can pay his bills and feed his dysfunctional family. It is unbelivable.

    Our whole economic growth model should have been pitched in the early 70s and revamped into a sustainable one when the sacrifices would have made a difference in the outcome. Instead we continued on the easy path of resource exploitation/destruction for short term gratification.

    Scared? Of course they're scared. You should be too. This is not going to end well for the vast majority of people on this planet.

  8. H. Adam Smith mentioned the disparity between rich, 'old' nations, which were stationary, and nations which were prospering and in the process of becoming rich. His pet pairings were, respectively, China and India and Great Britian and American Colonies. He observed that although food was plentiful in all the countries, the Money Price of labour was widely divergent; low or absent in the former pair, fair to good in the latter pair. And this advantage in price gave rise to the prosperity.

    Prosperity leads on to riches. Riches on their own provide a stationary economy.

    Something familiar about the current state of the middle and working class in the US of Today - on their way to being poor and stationary? Unlikely - what with all that firepower at their disposal!

    Funny old world!

    Brian P

  9. Thanks for the continual feed of useful information. I feel the need to school myself in economics now that the world is going to hell in a handbasket. I read panic in the faces and worry, too, that they are concerned about the collapse of the financial system, which for a change will hurt the privileged few along with the rest of us chumps.

  10. Thanks for the continual feed of useful information. I feel the need to school myself in economics now that the world is going to hell in a handbasket. I read panic in the faces and worry, too, that they are concerned about the collapse of the financial system, which for a change will hurt the privileged few along with the rest of us chumps.

  11. Hello Hellasious,

    Over the last year, I've promoted you and your blog over at the RGE quite a few times. It seems like the regulars over there have started cross referencing your's and Roubini's site quite a bit. (I don't know if that's because my promotion or not??? ...but i guess that really doesn't matter.)

    Anyway, I'm a huge fan of your work. Many end conclusions that I've come to mirror some of yours (although I generally take a different route to get to my conclusions)

    With all that said, I pose the same question to you that I have to the Prof R:

    What are some of your "REALISTIC" ideas that could be "solutions" to our financial crisis? What's the starting point? What's the gov't role, Wall St's role, our role, fgn country, etc... Who losses? Who losses more?

    The question isn't one I'd expect a quick answer on. ...but as I just appointed you Fed Governor, and Chairman, What is your plan? (Do you get the nickname: "Hellasious-copter Ben" -or- "sudden hell"?)

    Hope to hear back?

    Rich H

  12. J6P is worried about getting a pay check so he can pay his bills and feed his dysfunctional family.

    Not as much as he's worried about who's going to be the next American Idol and who's going to win the Super Bowl.

  13. Can you clarify which part of the FED controlling the money supply you consider "reliance on Adam Smith's invisible hand"?
    Austrian economists make a good case explaining that the money control is one of the root causes of business cycles (bubble/boom then burst).

  14. Dear Rich H and everyone else,

    Thank you for your kind words.

    Realistic solutions.. that's always the rub, isn't it? I consider what I do (identifying the problems) perhaps worth 5%. Proposing solutions is another 5%. But implementing them, i.e. getting them through the legislative, executive and institutional processes and on down to the people is 90% of the work.

    I have thought about this and attempted to post a couple of ideas, which generated considerable - heated - debate. I'll post some more on it in the days to come...


  15. "Reliance on the invisible hand" refers to the resurgence of classical, laissez faire economics in recent years, unfortunately to the detriment of regulatory oversight and much of social cohesion. I wasn't referring to the Fed specifically.


  16. I'm reading a new book, MaxedOut...there was a movie by the same name also, you might like it for its insight into credit and its misuse/mismarketing.

  17. If you and I and more than a few others recognize the obvious deflationary environment- and it absolutely screams if one just considers, among other things, the epic housing bust and the amount of debt it now takes to produce a point of GDP, then I think it's likely the case that the higher ups in government have recognized it for even longer.

    Equally clear is their desire to try and counter the effects through massive inflation . All manner of jiggery pokery is being pulled towards that end, from obvious measures such as furiously lowering the short term price of credit as well as enacting unfunded government "stimulus" packages. There are other more sinister and less obvious gambits being planned as indicated in the following minutes of the October meeting of the FOMC:

    "The Chairman noted that the President had recently signed the Financial Services Regulatory Relief Act of 2006, which among its provisions gave the Federal Reserve discretion, beginning October 2011, both to pay interest on reserve balances and to reduce further or eliminate reserve requirements. The Act potentially has important implications for many aspects of the Federal Reserve's operations and the Chairman asked Vincent Reinhart, Director of the Division of Monetary Affairs, to form a committee of Federal Reserve System staff to consider these issues."

    Notional reserves anyone?

    Can they pull off a hyper-inflation? Many people I read are pointing to scenarios that are clearly under girded by the idea that hyper-inflation is in our future. I used to be among their number but I now see this argument as uniformly weak, not for the least of reasons being that the debt markets simply won't stand for it. Witness Thursday's action in the bond pit where rates spiked enormously. Today rates came back a bit from that spike, but not enough to make me think that we are no longer in danger of a full scale bond market revolt against the agents of monetary inflation.

  18. Hell,
    A major factor in any comparisons of the economic state of the US these days has to consider the very dodgy official stats. By this I mean that statistical monitoring of US activity has ben so vastly manipulated/altered/contrived over the last decade or so, it renders statistical comparisons with other historical periods to an extent, irrelevant.

    Measured in pre-Reagan terms, it could well be that US GDP entered a recessionary period during the 3rd qtr 07 when accounted for on an honest inflation adjusted basis. Maybe even earlier if jobs data were also measured in a more factual manner.

    Even with doctored data there comes a point where the negative evidence becomes so overwhelming it cannot be camouflaged. We are at that point now.

    Which begs the question; If this has in fact been the case, why have energy and food prices risen so strongly in a recessioary US environment? Food for thought when contemplating responses to the "defaltionary" scenario.

  19. Enjoy reading your blog.. Thanx for your best and interesting information.. Wow..

  20. Did you EVER heard any official to ever say the name "Kondratieff"?

  21. "Can we have Glass-Steagall (and then some) back now?"

    Aye, aye.

    Paul Volcker, the only honest Fed chairman America has had in the past 50 years, was one of two who voted against overturning Glass-Steagall and was in the minority.

    The fun begins when Bernanke runs out of bullets. At that point, it will be interesting to see how panics such as last Tuesday's will end.

  22. Bottom Line: The average Joe six pack is a baby boomer quickly running out of time. His single largest asset, his primary residence, is deflating rapidly. This single largest asset is also the primary collateral for his single largest liability. His balance sheet is rapidly deflating as all his assets, from his home to his equity portfolio, all simultaneously deflate while his debt outstanding may actually still be increasing. His debt servicing are costs not dropping, despite aggressive rate cuts, and may actually be rising. It has also become damn near impossible to refinance certain mortgages as easy credit evaporates. On top of that, Joe six pack should now be seriously concerned about his job security. So when a cheque for $300 to $1500 arrives in the mail, Joe six pack is not going to spend it on a $200 steak dinner or a new computer or on a vacation. Got it people?

    More on the stimulous package: (


  23. H. Your follow-on comment on the 5+5+90 split in respect of possible solutions is a useful starting point.

    The 'problem' has been at least 12 years in the making, hence it may take about the same time to unravel - if, and only if, specific steps are agreed and put into effect.

    1. The Financial Mafia. Will not undertake any voluntary reforms. Need mandatory controls imposed by Congress.

    2. The Congressional Mafia. Only have attention spans equal to the time interval to the next election. In addition, there is a low probability of them implementing mandatory controls on their money supporters (Financial Mafia).

    3. Need to have a REAL disaster, one that physically treatens the future well-being of both the Financial and the Congressional Mafia before any reforms will be even contemplated.

    How about some of the following:

    a. Cancel all existing credit and charge cards - re-issue only one Cash Card (with NO backing credit-line) per adult; ie. 21+year old.

    b. Impose immediate import duties on all commodities, services and goods that cannot be sourced in the US. Call it a Green Carbon Tax.

    c. Issue a new internal US currency, backed by gold/silver, which cannot be traded on any currency markets nor exported, and is legal-tender in US territories only. The current, in-use currency is no longer legal-tender in US, is not exchangable for the new currency, except by legal US residents. Non-US citizens or corporations repatriating USD from overseas get 20c on the Dollar - take-it-or-leave-it!

    c. Close ALL overseas US military bases. Bring all the warships back to US territorial waters. Issue a very firm warning that any external attack on any US territory will be met with an immediate, obliterating response. Be warned!!!

    d. Sit tight for a decade and then review the situation. The US is robust enough to live prosperously within its own territorial boundaries, albeit at a much more modest standard of living.

    Brian P

  24. The idea of a Carbon Tariff is really interesting to me. Part of the "Sustainable Future" is that as much as possible should be produced as locally as feasible in order to avoid the energy wasted by transportation. I suspect we may see Brussels lead the way on this concept.

    I think it would be really easy to spin politically even though it might not be anything other than old fashioned protectionism. Think of the steel tariff debacle of a few years ago -- that would have played very differently if it had been framed in terms of environmental impact.

  25. What do you mean Volcker "voted" against the repeal of Glass Steagall? As he has never been a legislator I wonder what "vote" you are speaking of.

  26. What's so scary about this recession is the realization that the limb we've been sawing upon since 1970 is finally snapping. The "permabears" have been pointing to this for decades. Now the time has come.

    On these pages a few days ago, I suggested to Hellasious that the challenge isn't debt, it's not greed, it's not monoline rating fraud. It's the gradual decline in highly productive, innovative behavior that has occurred here in the U.S. over the past 30 years.

    I recently read that MIT grads now go to Wall Street when they graduate. The financial sector moves wealth, it doesn't create wealth. MIT grads used to go to engineering firms, product development, materials basic research...somewhere where actual wealth was created. Why has MIT given up on making things??

    That's a horrific mis-allocation of resources, and it's emblematic of our society's core problem.

    Our minds are figuratively sitting on couches, instead of in the lab struggling to solve the core problems of our day.

    Reversing this recent trend away from production is more political than technical, as Hellasious states. The solution might be top-down, in the form of a leader that's charismatic and technical (e.g. understands how wealth is actually created), or more likely will occur in the form of a bottom-up cultural shift toward creativity and production (actually doing something).

    I'm advocating a tectonic shift from Consumerism to Producerism. Inflation, deflation, falling profits, falling real incomes, etc. are all solved if we vastly increase the rate of wealth creation, and the only way to do that is through innovation.

  27. "What do you mean Volcker "voted" against the repeal of Glass Steagall? As he has never been a legislator I wonder what "vote" you are speaking of." - Edwardo

    I quote from the article entitled "The Long Demise of Glass-Steagall"


    "In the spring of 1987, the Federal Reserve Board votes 3-2 in favor of easing regulations under Glass-Steagall Act, overriding the opposition of Chairman Paul Volcker. The vote comes after the Fed Board hears proposals from Citicorp, J.P. Morgan and Bankers Trust advocating the loosening of Glass-Steagall restrictions to allow banks to handle several underwriting businesses, including commercial paper, municipal revenue bonds, and mortgage-backed securities."

    The article states that attempts to weaken Glass-Steagall go back to the 1960s.

  28. "attempts to weaken Glass-Steagall go back to the 1960s."

    I should have said attempts to kill Glass-Steagall since it has been dead for awhile.

  29. To Edwardo
    If hyperinflation sets in, interest
    rates won't matter that much because the Treasury will no longer
    borrow on the open market and the
    Fed will simply print money to cover federal defecits and redeem
    maturing bonds.