The Upside of Recession?

Upside? Bobbie's been smoking some of "Greenie" Friedman's stuff, apparently.
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The Upside of Recession?

By Robert J. Samuelson
Wednesday, April 25, 2007; A17

It's increasingly clear that much of our standard economic vocabulary needs revising, supplementing or at least explaining. The customary words we use don't fully convey what's happening in the real world. Let me illustrate with two basic economic terms: inflation and recession. There are also larger lessons.

Start with inflation. You may have noticed that last week's release of the March consumer price index (CPI) -- the government's main inflation indicator -- inspired much optimism. "Inflation Fears Relax," headlined the Wall Street Journal. Stock prices jumped on the supposedly good news. But if you actually examined the CPI report, you found that prices in March rose at their highest rate since September 2005 and that, over the past three months, they've increased at a 4.7 percent annual rate. Doesn't sound like retreating inflation, does it?

What explains the discrepancy is "core inflation." That's the CPI minus food and energy prices. In March, core inflation did subside, prompting the upbeat spin. But you might wonder: We must pay for food, gasoline and electricity; why strip them out? The usual answer is: These prices jump around from month to month; they often reverse themselves (oil prices were high in the early 1980s, low in the late 1980s); core inflation better reflects the underlying trend. This is hardly wishful thinking. Since the early 1980s, the two indexes (the CPI and the core CPI) have recorded -- despite many monthly differences -- virtually identical increases.

But suppose that this relationship is breaking down. We all know about oil. Prices are about $60 a barrel. They seem unlikely to return to $28, the 2000 level. The real surprise involves food prices. In the past three months, they've risen at a 7 percent annual rate. We may be seeing the first adverse effects of the ethanol boom. Corn is a main feed grain for poultry, cattle and hogs. Corn is also the main raw material for ethanol, an alternate fuel for gasoline. Competition for grain has pushed up corn prices to about $3.50 or more a bushel, almost double a typical level. High feed prices have discouraged meat producers from expanding. The resulting tight meat supplies raise retail prices.

"Poultry is the best example," says economist Tom Jackson of Global Insight. "In the past 40 years, we almost never have year-to-year decreases in production. In the past few months, we've seen production go down." In March, the decline was 4 percent from a year earlier.

So the government's subsidies for corn-based ethanol are worsening inflation, perhaps permanently. Coupled with precarious global oil supplies -- posing a constant threat of higher energy prices -- that may make core inflation a less useful indicator. Ups and downs may no longer cancel each other. Inevitably, these developments also pose policy questions. Considering ethanol's tiny contribution to our motor fuel supply (about 4 percent), is the program worthwhile? Or is it a giveaway to corn farmers?

Now switch to recession. Since 1982, there have been only two (1990-91 and 2001). That's good. In the previous 13 years, there had been four (1969, 1973-75, 1980 and 1981-82). Almost everyone dreads another one. We've been conditioned to think of recessions as automatically undesirable. The labeling is simplistic.

Hardly anyone likes what happens in a recession. Unemployment rises, production falls, profits weaken, stocks retreat. But the obvious drawbacks blind us to collateral benefits. Downturns check inflation -- it's harder to increase wages and prices -- and low inflation has proved crucial to long-term prosperity. Downturns also punish and deter wasteful speculation. When people begin to believe that an economic boom won't ever end, they start to take foolish risks. Partly, that explains the high-tech and stock bubbles of the late 1990s and, possibly, the recent housing bubble.

Some sort of a recession might also reduce the gargantuan U.S. trade deficit, $836 billion in 2006 (just counting goods). Almost everyone believes that the U.S. and world economies would be healthier if Americans consumed less, imported less, saved more and exported more. The corollary is that Europe, Japan, China and the rest of Asia would rely more on domestic spending -- their own citizens buying more -- and less on exports.

Ideally, this massive switch would occur silently and smoothly. Realistically, the transition might not be so placid. A slowdown in Americans' appetite for imports would involve weaker overall consumer spending, about 70 percent of the U.S. economy. Such a slowdown might also be needed to persuade other countries to stimulate their domestic spending.

Almost no one wishes for a recession, but the consequences might not be all bad. The larger lessons here involve perceptions. Our regular vocabulary often fails to describe the complexities of a changing economy. We must be alert to new possibilities. Things are not always what they seem.

U.S. economy poised for nose dive

By Jerome R. Corsi
© 2007 WorldNetDaily.com

Major recession feared when 'liquidity bubble' bursts

As the dollar sinks to near-record lows against the euro and the British pound, the stock market has returned to record highs, but investors are being advised to anticipate a worldwide downturn and the U.S. economy may have already entered a recession.

An explanation may be found in a private investment letter published by the Carlyle Group to its "professional investors."

WND has obtained a copy of a Jan. 31 letter by the Carlyle Group's founding partner and managing director, William E. Conway, Jr., to the firm's investment professionals worldwide.

In the letter, Conway attributes the continued rise of world stock markets to a glut of liquidity in the world financial system, which he describes as "the availability of enormous amounts of cheap debt.

Conway writes, "This cheap debt has been available for almost all maturities, most industries, infrastructure, real estate and at all levels of the capital structure."

He says there is so much liquidity in world financial systems that "lenders (even 'our' lenders) are making very risky credit decisions."

WND previously reported concern that the decision of the Federal Reserve to quit publishing a traditional index, "M3," a broad measure of the money supply, signaled a decision to pump the economy with excess liquidity.

Since the Fed quit publishing M3 data, economists who have attempted to re-create the index from other available data have estimated M3 data would today be reporting upwards of a 10-percent increase in the money supply, a high level by historical standards.

"Liquidity" is defined by economists as money available in all forms to be given out as debt, ranging from credit card debt to mortgage debt to large quantities of institutional debt typically used in complex financial transactions such as highly leveraged corporate acquisitions.

Excess liquidity, as reflected in the rise of highly leveraged hedge fund accounts, has been widely seen as a major factor in the rise of the stock market in the recovery since 9/11.

Conway cautions that "this liquidity environment cannot go on forever." He warns that "the longer it lasts, the worse it will be when it ends."

Looking on the bright side of what could be a major recession when the liquidity bubble bursts, Conway advises, "And of course when [the liquidity bubble] ends the buying opportunity will be once in a lifetime."

He adds, "But I do not know when it will end."

Bob Chapman, who publishes a bi-weekly Internet newsletter, The International Forecaster, has issued his reconstructed M3 estimate to100,000 subscribers.

"The world is awash in money and credit," Chapman said. "My numbers show M3 increasing at about a 10-percent rate right now."

Chapman has spent 45 years in the finance and investment business, including 28 years as a stockbroker specializing in gold and silver shares. He publishes his newsletter from an undisclosed address outside the U.S.

In his April 14 newsletter, Chapman wrote, "The effort to save the American economy, which began in 2001, has finally come full circle and the Ponzi scheme is coming unraveled. The overextension of credit, outrageously low interest rates and loans to the totally unqualified have finally come home to roost."

For months, Chapman has been warning that the U.S. economy entered a downturn in February 2006. Chapman expects it will develop into a prolonged recession caused largely by the bursting of the housing bubble and the weakness in the dollar attributable to the United States' large federal budget deficit and international trade imbalance.

At the same time, Chapman has been predicting for months that the dollar will challenge the technical support point of $USD 80 on the world currency markets.

On Thursday, the dollar index closed at $USD 81.64 in a steady decline that began at the end of February.

The euro late last week was trading as high as $1.3576, near its December 2004 record of $1.3539. At the same time, the pound rose to $1.9938, its highest point since September 1992. The pound last reached the $2 mark 14 years ago, when the UK was ousted from the European Exchange Rate Mechanism.

Chapman has argued the U.S. Treasury and Federal Reserve have been trying to manage a gradual devaluation of the U.S. dollar.

Chapman expects the dollar could lose as much as an additional 20 percent of its value this year alone. In the last five years, the dollar has lost 35 percent of its value against the euro.

Still, until debt defaults force a crisis in the world debt markets, Chapman agrees with the Carlyle Group that excess liquidity will continue to buoy the world stock markets, including the New York Stock Exchange, to new highs.

Chapman also agrees with Conway that when the liquidity bubble bursts, the decline in world stock markets could be sharp and severe, possibly even reaching crash magnitudes on the downside.

"Tens of billions of dollars have already been lost in the U.S. sub-prime lending market and the contagion is spreading as the media tries to cover-up what is really going on," Chapmen wrote in his March 28 newsletter. "We are watching the disintegration to an extent of the entire mortgage market, which encompasses 25 percent of all outstanding credit."

Chapman continued: "We predicted this three years ago and those who believe they are savvy discovered the problem a couple of months ago. This is a general meltdown and do not think it isn't, and it has several years to go until the real estate sector is purged."

The Carlyle Group, a large Washington, D.C., private equity firm headquartered founded in 1987, has close ties to the administration of President George H.W. Bush.

WND also reported the Carlyle Group has established a new team to invest in Mexico. The team includes Mark McLarty, president of Kissinger McLarty Associates and former chief of staff and special envoy to the Americas for President Bill Clinton.

Who will be hardest hit by a US slowdown?

18.04.2007

By Stephen Roach

The global debate is endless (fortunately), but it’s also very simple. The key question is whether the current US slowdown has broader cross-border consequences. For financial markets, which are still discounting relatively sanguine global growth prospects for 2007-08, there is great enthusiasm for the ever-optimistic decoupling scenario – whereby the rest of the world miraculously untethers itself from the US. That remains a real stretch, in my view.

On the surface, the latest global trends seem quite consistent with a decoupling scenario. America has slowed but the rest of the world has picked up. In particular, there seems to have been a meaningful shift in the mix of growth in the industrial world. The US economy has downshifted from 3.4% growth over the 2003-05 period to only about 2% over the past year while trend growth in Europe and Japan has accelerated from around 1.5% to 2.5%.

Never mind that the improved pace in Europe and Japan is only a scant faster than the weakened trend now evident in the US. The decoupling crowd rests its case on the “second derivatives” – the juxtaposition of a deceleration in the US compared with acceleration elsewhere in the industrial world. China and India are the icing on the cake – emblematic of a seemingly open-ended boom in the developing world that remains unscathed by the US slowdown. The case for global decoupling concludes that world GDP growth – which surged at a 30-year high of 4.9% over the past four years – will barely skip a beat in 2007. Little wonder that financial markets are priced for a continuation of what many call the best global economy in a generation.

World economy yet to face a legitimate test

The fly in the ointment in this debate is that it may well be that an increasingly integrated world economy has yet to face a legitimate decoupling test. The US may have slowed but the downshift hardly represents a major derailment of the world’s major growth engine. Moreover, the deceleration has been concentrated in one of the least globalized pieces of the US economy – homebuilding activity.

Over the final three quarters of 2006, a steep contraction in residential construction expenditures knocked an average of 1.0 percentage point off real GDP growth in the US – a swing of -1.5 percentage points from the positive growth contribution of 0.5% over the preceding three years and enough of a drag to have accounted for all the downshift in real GDP growth over the same period. While the housing recession has undoubtedly reduced US demand for foreign sourced construction materials, this is hardly a major challenge to growth elsewhere in the world economy.

So far, the rest of the US economy has been relatively resilient in the face of this steep contraction in residential construction activity. That’s especially the case for personal consumption – more than 70% of US GDP and the one sector of aggregate demand that has the tightest linkages to America’s trading partners. During the final three quarters of 2006, when homebuilding activity hit the skids, annualized real consumption growth still averaged 3.2% - down only 0.2 percentage point from the growth pace of the preceding three years and fully 33% faster than overall GDP growth over the final three quarters of last year; moreover, in the first period of 2007, our latest tracking estimates suggest consumption growth held at this same impressive 3.2% pace. Business capital spending has started to weaken a bit in recent months. But the weakening has been concentrated in the equipment piece – only 7% of US GDP, or one-tenth the size of the personal consumption sector. Needless to say, as long as the American consumer continues to hold its own as a source of relative resilience, the US economy can shrug off a capex hit – and the global economy will hardly be tested.

Internal spillovers and external linkages

This outcome underscores a major source of confusion over the global decoupling call – the distinction between internal spillovers and external linkages. The former, in my view, pertain to the interconnectedness within an economy – the relationships between sectors. An obvious case in point is the lack of any spillovers between homebuilding and consumption in the US – at least, so far. I would define linkages as more of a cross-border phenomenon – in effect, the transmission of shifts in one economy to the broader global economy through global trade flows. Internal spillovers are a necessary – but not sufficient – condition for cross-border linkages. But if there have been no internal spillovers, the external linkage debate – and therefore, the global decoupling call – is all but meaningless. That remains very much the case today, in my view.

This same point recently has been made by the research staff of the IMF in the prepublication of one of the chapters in the April 2007 issue of the World Economic Outlook (see Chapter 4 on the IMF website, “Decoupling the Train? Spillovers and Cycles in the Global Economy”). Notwithstanding erroneous press accounts of this research, the IMF staff throws cold water on the notion of a global decoupling from the US. To the contrary, they stress that the “…potential size of spillovers from the United States has increased with greater trade and financial integration.” They underscore the same point I stressed above – that as long as the US slowdown remains confined to sector-specific developments such as housing, the less the chances of a more severe stalling out of the American growth engine and, as a consequence, the lower the probability of a more broadly based global slowdown.

Who has the greatest export exposure the the US?

The IMF research also provides a comprehensive ranking of the cross-border linkages to the US. Based on export exposure to the US, America’s NAFTA partners – Mexico and Canada – are at the top of the vulnerability list; for both of these economies, goods shipped to the US account for around 25% of their GDP.

China’s exposure, while considerably less than the NAFTA bloc, has increased dramatically in the past five years; by IMF estimates, US exports accounted for an average of 5.9% of Chinese GDP over the 2001-05 period – seven times the 0.8% share 20 years earlier from 1981-85. US exposure remains quite high in Asia ex Japan; for the newly industrialized economies of Hong Kong, Korea, Singapore, and Taiwan, in conjunction with the ASEAN-4 (Indonesia, Malaysia, the Philippines, and Thailand), US exports accounted for an average of 10.3% of their combined GDP over the 2001-05 period.

By contrast, Japan has reduced its dependence on America, with US-bound exports averaging just 2.9% of GDP over the 2001-05 interval – well below the 4.0% portion some 20 years earlier. For the Euro area, US dependency ratios remain quite low, although they have inched up from 1.5% in the first half of the 1980s to 2.4% in the first half of 2000s. Similar modest increases in US exposure have been evident in Brazil and Argentina, and because of oil and resource linkages, US dependency ratios have also risen for Sub-Saharan Africa – from 3.0% in 1981-85 to 5.9% in 2001-05.

The results of the IMF staff research are not surprising. They are, in fact, nearly identical with similar conclusions that I and others have stressed in considering the repercussions of a US slowdown on the broader global economy (see my 30 October 2006 dispatch, “The Fallacy of Global Decoupling”). As I noted at the time, the “decouplers” – economies that can stand on their own in the event of a major growth shortfall in the US – must satisfy three conditions: They need to have a broadening base of self-sustaining domestic demand, a diversified export mix, and policy autonomy. In my view, progress is still quite limited on all three counts. Private consumption continues to lag in Europe and Asia. Moreover, the US is still the dominant global export destination; by IMF estimates, the US accounted for 20% of global merchandise exports over the 2001-05 period – a record high for the US and larger than the Euro area as the biggest portion of global trade. Nor is there much leeway for global policy makers to ride to the rescue in the event of a US growth shock; that’s especially the case in developing Asia, which is constrained by currency considerations, but it is also true in Japan, where policy rates are still very close to “zero.”

The outlook for the US consumer

In the end, this debate boils down to the one big call that has always weighed most heavily on the macro outlook – the fate of the American consumer. If US consumption growth remains brisk in the face of pressures building elsewhere in the economy – especially housing, but also business capital spending and autos – then a globalized world will, in effect, have nothing to decouple from. The surprisingly strong March labor market surveys – brisk employment and falling joblessness – underscore the ongoing resilience of labor income generation and consumer purchasing power.

Yet as Dick Berner, our resident consumption bull, recently conceded, consumers will need all the help they can get in the face of higher energy and food costs, decelerating housing wealth creation, adjustable-rate mortgage resets, and a tightening of lending standards in the aftermath of the sub-prime mortgage fiasco (see his 2 April dispatch, “Perfect Storm for the US Consumer?”). But if the US labor market continues to display extraordinary staying power in the face of adversity elsewhere in the economy, the overly-indebted, saving-short American consumer could squeak by once again – and so, too, would the rest of a still-coupled world. I remain highly dubious of such an outcome but concede that the burden of proof remains on me.

I have long been struck by the inherent inconsistency of a macro call that extols the virtues of integration and globalization, on the one hand, while celebrating the resilience of a decoupled world, on the other hand. Don’t kid yourself – if the lead engine of the global growth train goes off the tracks, the rest of the world will be quick to follow. So far, that hasn’t happened – underscoring my basic conclusion that there has yet to be a meaningful test of the global decoupling thesis. It’s up to the American consumer as to whether that test will ever occur.

By Stephen Roach, global economist at Morgan Stanley, as first published on Morgan Stanley’s Global Economic Forum

Greenspan Is Wrong: Yields Say Recession Risk Higher

(Update1)

By Daniel Kruger

March 12 (Bloomberg) -- Alan Greenspan, who jolted investors by predicting a one-in-three chance of a recession this year, isn't as bearish as the bond market, where the risk of a downturn is even money.

The probability the U.S. economy will shrink for two quarters has risen to 50 percent, according to a model created when Greenspan ran the Board of Governors of the Federal Reserve System. The formula is based on differences in yields on Treasuries.

The economy has gone into recession six of the seven times since 1960 that short-term interest rates topped longer-term bond yields, as they do now. The difference between three-month bills and benchmark 10-year notes is close to the widest since 2001. Investors say the so-called inverted yield curve is a sign the Fed will cut borrowing costs because the economy is decelerating.

``We're going to have slower growth,'' said Barr Segal, a managing director at TCW Group Inc., a Los Angeles-based firm that oversees $80 billion in fixed-income assets. ``The fundamentals of the economy are what you have to watch.''

Investors have used interest rates to predict the economy since 1913, according to a Fed study. Short-term rates have exceeded long-term yields since July, in part because of demand for Treasuries from China and other central banks. The yield difference may now be sending a message about the economy, some investors say.

``The yield curve should not be ignored,'' said Saumil Parikh, who helps manage $688 billion at Pacific Investment Management Co., in Newport Beach, California. ``The fact that the yield curve is inverted gives us a signal that overnight rates are too high. That's what the yield curve is telling the Fed.''

Better Predictor

Treasuries fell last week as the government said the U.S. added more jobs than forecast and stock markets rebounded. The yield on the 4 5/8 percent note maturing in February 2017 rose 9 basis points to 4.59 percent.

A yield-curve model the Fed developed in 2006 is based on research by staff economist Jonathan Wright, as well as analysis from the 1990s by two economists at the Federal Reserve Bank of New York, Arturo Estrella and Frederic Mishkin. Christopher Low, chief economist in New York at FTN Financial, used the model to determine that the 50-basis-point yield gap between three-month bills and 10-year Treasuries would amount to a 50 percent likelihood of a recession over the next year.

Estrella and Mishkin's study said Treasury yields are a better predictor of recessions than stock prices. That's because relatively high short-term rates slow the economy while lower longer-term rates reflect the outlook for weaker growth and inflation, they wrote.

`Imbalances Can Emerge'

Treasury yields may be less of a predictor this time because of demand for U.S. securities from foreign investors, said David Ader, head of government bond strategy in Greenwich, Connecticut, at RBS Greenwich Capital, one of the 21 primary dealers that trade directly with the Fed.

Overseas investors bought $198.6 billion more Treasury notes and bonds than they sold in 2006, up from $18.5 billion in 2001, according to the Treasury Department.

The yield curve has inverted in the past without being followed by recession. In 1966, surging job growth and falling unemployment pushed inflation higher, prompting the Fed to decrease money supply growth and raise the effective funds rate. The flight to Treasuries after Long-Term Capital Management's collapse in 1998 also resulted in an inverted yield curve that failed to be followed by recession.

Economists typically do not consider an inversion of yields significant unless it lasts for three months, Low of FTN said.

`Imbalances Can Emerge'

``We are in the sixth year of a recovery; imbalances can emerge as a result,'' the 81-year-old Greenspan said in a March 5 interview with Bloomberg. ``Ten-year recoveries have been part of a much broader global phenomenon. The historically normal business cycle is much shorter'' and is likely to be this time, he added.

Mishkin, a Columbia University economist, was sworn in as a Fed governor in September. Mishkin and Wright declined to comment. Estrella, a senior vice president in the Research and Statistics Group of the New York Fed, also declined to comment. Greenspan declined to comment.

Three-month bills have exceeded the yield on notes since July 19, three weeks after the central bank raised its overnight lending rate between banks to 5.25 percent, the last of 17 straight increases since 2004. The gap widened to as much as 60 basis points on Feb. 27, the widest since February 2001. A basis point is 0.01 percentage point.

`Severe Monetary Restraint'

``It's an indication monetary policy is biting,'' said Lacy Hunt, chief economist at Hoisington Investment Management Co. in Austin, Texas, which manages $4.8 billion of Treasuries. ``You have fairly severe monetary restraint on the system.''

The Fed's decision to raise rates preceded recessions and contributed to corporate failures including Penn Central Railroad in 1970, Franklin National Bank in 1974, and Continental Illinois National Bank & Trust Co. in 1984, said Hunt, a former senior economist at the Federal Reserve Bank of Dallas.

Greenspan, speaking on a videoconference call to investors in Hong Kong Feb. 26, said slowing growth in profit margins was a sign the expansion might be winding down, according to the Associated Press. Treasuries rose the most since December 2004 and stocks fell the most since 2002 the next day.

Greenspan was ``being cautious,'' said Low of FTN, who expects the economy to grow 1.5 percent to 2 percent in 2007. ``He was saying in a roundabout way that Fed policy is tight.''

`Pace Is Moderating'

On Feb. 28, Fed Chairman Ben S. Bernanke said the central bank expects the economy to pick up. There's little indication that subprime mortgage defaults have spread, Bernanke told the House Budget Committee.

The Fed says the economy to grow 2.5 percent to 3 percent this year and 2.75 percent to 3 percent next year, according to forecasts presented to Congress last month.

``The economy's growth pace is moderating and will probably grow below potential,'' said Tony Rodriguez, who oversees $70 billion as head of fixed income at FAF Advisors in Minneapolis, the asset-management arm of U.S. Bancorp. Treasury yields are ``pointing toward an economy that's moderating.''

To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net

Last Updated: March 12, 2007 10:54 EDT

Greenspan Sees One-Third Chance of Recession in 2007

Related
Chicago Fed chief says recent data has been on the soft side
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(Update2)

By Craig Torres

March 6 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said there's a ``one-third probability'' of a U.S. recession this year and the current expansion won't have the staying power of its decade-long predecessor.

``We are in the sixth year of a recovery; imbalances can emerge as a result,'' Greenspan, 81, said in an interview yesterday at his office in downtown Washington. ``Ten-year recoveries have been part of a much broader global phenomenon. The historically normal business cycle is much shorter'' and is likely to be this time, he added.

Greenspan's outlook contrasts with the prediction of his successor Ben S. Bernanke, who told Congress last week that the economy may strengthen this year. Bernanke's upbeat assessment helped steady stock markets on Feb. 28 after a plunge the day before that some traders attribute partly to Greenspan's musing that a recession couldn't be ruled out.

Financial markets took the comments in stride today. The Standard & Poor's 500 Index was up 1 percent at 12:30 p.m. New York time, following stock-market gains in Asia and Europe. Ten- year U.S. Treasury notes fell 5/32, lifting yields 2 basis points to 4.51 percent. A basis point is 0.01 percentage point.

``It is possible that we can have a recession at the end of this year,'' said Greenspan, who ran the central bank for 18 years until January 2006. Bernanke, 53, declined to comment.

Capturing the Trend

Little more than a year after leaving the central bank, Greenspan is returning to economic forecasting, a role he enjoyed before entering government service in 1974, during the administration of President Gerald R. Ford. He isn't trying to predict a number for gross domestic product or inflation: He's trying to capture the trend and when it might be about to change.

Private-sector economists and policy makers are calling for the expansion, which began in 2001, to continue. The Fed expects the economy to grow between 2.5 percent and 3 percent this year, and 2.75 percent and 3 percent next year, according to forecasts presented to Congress last month.

Greenspan said he has been careful to avoid making life difficult for his successor.

His contracts with clients stipulate that there will be no reporters present and no recordings. He said he tries to have an exchange with an audience, where he often learns something that helps him hone skills he has worked on for 50 years.

Seeking Anonymity

``I was aware of the problem that if I stayed public, I could make it difficult for Ben,'' he said. ``For the most part it has worked. I was beginning to feel quite comfortable that I was fully back to the anonymity I was seeking.''

``I was surprised at this recent episode,'' he added.

Investors may have taken notice of his comments on Feb. 26 because they considered them prescient. The day after he mentioned the risk of a recession to a Hong Kong audience on Feb. 26, a Commerce Department report showed sales of non- military capital goods excluding aircraft dropped 2.7 percent in January, the biggest decline since September 2001. Orders slumped by the most in three years.

Broader capital spending is also weakening. Corporate purchases of equipment and software declined at an annual rate of 3.2 percent last quarter, the biggest decline since the final three months of 2002, according to separate Commerce Department figures.

Greenspan said he doesn't believe that so-called point forecasts, where economists hone their outlook down to decimal points, can be accurately made in the near-term. ``We really can't forecast'' the economy over the next two years, he said.

Investors said financial markets are playing down Greenspan's recession risk message today.

Assuaging the Market

``It's not the message we're getting from the Fed,'' said Bernd Wuebben, senior bond market strategist at BNP Paribas New York. ``All Fed speakers have tried to assuage the market.''

Greenspan worked for what is now the Conference Board, a New York-based business group, as an industrial-metals analyst from 1950 to 1953. Tracking inventories, he was able to come up with a model of final demand. He expanded that model to textiles, aluminum and oil.

He found that large-scale models that used aggregate data averaged out the nuances and changes he could pick up at an industry level. Finally, some of the assumptions of firms' pricing power simply didn't hold as the post-war years unfolded.

``I realized I was trying to see how the world works in the context of individual entities,'' Greenspan said.

Under his chairmanship, the Fed staff began surveying firms directly from the Board of Governors' building in Washington on how their businesses were doing.

Anecdotal Information

``We certainly devoted some resources to our own gathering of anecdotal information,'' said Michael Prell, former head of the Division of Research and Statistics, the central forecasting unit at the Fed. ``Every other week, we would contact some subset of a sizeable group of firms.''

Greenspan's unique discipline both frustrated and amazed Fed colleagues, especially those trained in sophisticated economic modeling.

``His great value is that he has an idiosyncratic approach,'' said Laurence Meyer, a Fed governor from 1996 to 2002 who often sparred with the chairman over the outlook. ``The reason why Greenspan gets and deserves disproportionate weight is that he doesn't get caught up in all the themes that tie together in a consensus forecast. He is looking at all the different strands of data.''

Ingots

Once, Meyer said, he was sitting in a meeting with the Fed staff discussing the inflation implications of import prices. Out of nowhere, he recalled, Greenspan asked about steel-ingot prices. Meyer said he wasn't even sure what an ingot was.

``Why would I ever even ask that?'' Meyer, a founder and vice chairman of the model-based forecasting firm Macroeconomic Advisers LLC in St. Louis, said in an interview.

Macroeconomic Advisers isn't forecasting a recession this year, and Meyer said markets ``over-responded'' to what the former chairman said.

``Who wouldn't agree that it is possible we could have a recession?'' says Meyer. ``I think we are closer to the middle of an expansion than the end of an expansion.''

To contact the reporter on this story: Craig Torres in Washington; or ctorres3@bloomberg.net

Last Updated: March 6, 2007 12:39 EST

Fears of recession spark further turmoil in markets

By David Usborne in New York

Published: 02 March 2007

Fresh anxiety erupted about the health of the world's major economies yesterday after investors in stock markets across Asia, Europe and the United States once again staged significant retreats two days after Tuesday's unexpected global equity sell-off.

In New York, the Dow Jones Industrial Average plunged more than 200 points in the first minutes of trading, seeding fears of a repeat of Tuesday's massacre that saw a 416-point collapse on the index.

With slowdowns emerging, notably in the housing market and car manufacturing in the United States, signs are building that it economy may be at a pivot point, with some observers worrying about decelerating expansion and possibly a recession looming.

The fearful mood was exacerbated by comments from Alan Greenspan, the influential former chairman of the US Federal Reserve, about the possibility of the US entering recession before year's end. He told a conference in Tokyo yesterday: "By the end of the year, there is the possibility but not the probability of the US moving into recession." He has argued this week that corporate profit margins appear to be narrowing, indicating that a recent economic expansion has reached a "mature phase".

Market watchers warned of several more bumpy days to come, pointing to the renewed erosions in stock markets globally yesterday. The Shanghai stock market slippedan additional 2.9 per cent. The London FTSE index closed down 55.5 points or 1.5 per cent. The Dow later recouped most of its early losses as some more encouraging economic data was released and closed down 34.29 points. But fears remain that there may be worse to come. All the markets have fallen significantly during the course of the week.

Senator Hillary Clinton, a candidate for the US presidency, last night called events of recent days a "real wake-up call" for the United States, saying it was "increasingly losing control" of its economic sovereignty because of the globalisation of economies and policy-making, including in China.

"We are in a different environment," she said, noting the $2.2 trillion (£1.1trillion) foreign debt held by the US. "Obviously, the level of public debt that is held by central banks and foreign government is a problem and I don't want our government to ignore this wake-up call."

A degree of calm was restored to the New York market after indicators were released showing better-than-expected manufacturing numbers for the US. The Institute for Supply Management's index of manufacturing activity registered 52.3 for January, stronger than the 50.0 reading analysts had expected. By convention, a recession is considered to be in the offing if that number falls below the 50-point mark.

The US Commerce Department revealed that seasonally adjusted personal income in the US rose by 1.5 per cent in January, which was also a better result than had been anticipated.

Investors have been spooked by this week's gyrations after enjoying 12 months of almost unbroken growth in stocks. No one was more shocked than the new Chinese investors who watched in dismay on Tuesday as the Shanghai index tumbled almost 9 per cent.

US economists are contemplating a change in the balance of power between world markets, where New York can nowadays find itself hostage to foreign market performances.

"It's kind of the tail wagging the dog," said Arthur Hogan, chief market analyst at Jefferies & Co in New York. "There's no stability in Asian markets, and no stability in European markets. We're trading the market as the rest of the globe is."

After the "Shanghai Sneeze", as some called it, officials tried to soothe investors. There was a brief claw-back on Wednesday in New York after Mr Greenspan's successor at the Federal Reserve, Ben Bernanke, said in congressional testimony that "there's a reasonable possibility that we'll see some strengthening of the economy sometime during the middle of the year". He played down a report that showed that a 2006 fourth-quarter expansion of the US economy was slower than previously estimated.

There was no saying how the week would end for world markets today. "The aftermath of Tuesday's major sell-off will linger for the next couple of days," said Peter Cardillo, chief market economist at brokerage house Avalon Partners. He added, however, that "fear of recession is overblown".

That Mr Greenspan is still able to move world markets even in retirement is certain to raise questions about whether he would do better to keep his counsel.

US mortgage crisis goes into meltdown

By Ambrose Evans-Pritchard

Last Updated: 1:15am GMT 24/02/2007

Panic has begun to sweep the sub-prime mortgage sector in the United States after the bankruptcy of 22 lenders over the past two months, setting off mass liquidation of housing loans packaged as securities.

	Analysts say the housing bust is pulling America into recession, citing a 14.4pc drop in housing starts

The rapid deterioration could not come at a worse time for British bank HSBC, which has set aside $10.5bn (£5.4bn) to cover bad loans in the US.

The cost of insuring against default on these loans has rocketed in recent weeks, from 50 basis points over Libor to 1,200, raising fears that a credit crunch could spread to the rest of the property market.

Low-grade BBB-rated securities - measured by the ABX index - have crashed from near par of 100 in early November to 72.5 this week.

Peter Schiff, head of Euro Pacific Capital, said the sector was in an unstoppable meltdown. "It's a self-perpetuating spiral: as sub-prime companies tighten lending they create even more defaults," he said.

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California's ResMae Mortgage filed for bankruptcy last week as it struggled to cope with defaults on a $7.7bn book of sub-prime loans issued last year, while Accredited Home Lenders in San Diego warned that bad debts had reached 7.18pc of its portfolio.

HSBC chief executive Michael Geoghegan, who stepped in to take control of the US division earlier this month claiming "The buck stops at my door", has ousted top executives. But the worst may not be over for Household International, the property arm it acquired for $14.4bn in 2003 to capitalise on the housing boom.

Rating agency Standard & Poor's is shifting its focus to the tier of debt above sub-prime, eyeing loans covering people viewed as better credit risks but who lack the steady income needed for prime status.

S&P has placed 11 loan packages worth $146m on watch for a possible downgrade this week, saying it was most worried about "piggyback" second mortgages. "There is a potential danger of default on these deals," said credit strategist Robert Pollson.

For now, the US Federal Reserve believes the damage can be contained. "I don't think there'll be a large impact on prime mortgages from the sub-prime market," said governor Susan Schmidt Bies.

However, she warned of a "hidden" problem caused by sellers pulling property off the market. " The percentage of homes where nobody is living in them is at a record level. So the potential for inventory correction is still very high," she said.

Nouriel Roubini, economics professor at New York University, says the housing bust is slowly pulling America into recession. He cites a 14.4pc drop in housing starts last month; an expected loss of 600,000 real estate jobs in 2007; a sharp fall in home equity withdrawals - down from 6pc of GDP at the top of the boom; and a squeeze as $1,000bn of mortgages are adjusted upwards this year to higher interest rates.

Mr Roubini said: "America faces a 'reverse cycle' where a credit crunch has hit before the slowdown, a rare pattern. Normally, recession comes first, setting off credit troubles in its wake. We have a housing recession, an auto recession, a manufacturing recession, and a real investment recession already present. If all this happening in what the consensus terms as a 'Goldilocks economy', what would happen if the economy slows down?"

Sluggish services sector growth points to economic slowdown

Sluggish services sector growth points to economic slowdown

The Boston Globe, 05-Jan-2007

"Growth has slowed, but it hasn't collapsed," said Jim O'Sullivan, senior economist at UBS Securities LLC in Stamford, Conn.

The nonmanufacturing index was expected to fall to 57, the median forecast in a Bloomberg News survey of 61 economists. Estimates ranged from 54 to 60.

The Treasury's benchmark 10-year note rose almost a half point, pushing the yield down to 4.60 percent at 5:05 p.m. yesterday in New York.

The National Association of Realtors reported yesterday that contracts to buy previously owned homes fell 0.5 percent in November after a 1.5 percent decline the prior month. Economists had forecast a 0.7 percent increase, according to the median estimate in a Bloomberg survey.

Is Copper Signaling a Recession?

Jan 6, 2006

By Bonddad
bonddad@prodigy.net


From CBS MarketWatch

A sell-off in commodities -- from copper to crude oil -- over the past few sessions is telling some veteran market watchers that a slowdown in economic growth, likely one of considerable magnitude, is already underway.

In the last two days alone, commodity prices seem to have fallen off a cliff. Copper futures, which tumbled 7.7% on Wednesday, fell another 1.8% on Thursday -- and have dropped 27% from their December highs.

Crude-oil prices fell nearly 5%, following a 4% drop in the previous session. The front-month futures contract was trading at its lowest level since June 2005. See Futures Movers.

Here's a daily copper chart. The price has gapped down and continued downward last week:

The reason copper is predictive?

Most commodities are used in the production of industrial goods. When producers start demanding fewer raw materials, it becomes noticeable in commodities prices much earlier than in official economic statistics, explained Barry Ritholtz, chief market strategist at Ritholtz Research & Analytics.

Copper, in particular, is often used as a reliable economic indicator because of its widespread use in production.

"Copper is the metal with a Ph. D. in economics," Ritholtz said. "It's used in the wiring of homes and offices, in plumbing in construction, and it's also a key component in electronic goods.

High stockpiles are one of the reason for the drop in copper prices:

Stockpiles of copper monitored by the LME have doubled since the start of last year. The exchange said earlier today copper stocks held in its warehouses had risen another 1,700 tonnes to total 194,875 tonnes

However it also reported that cancelled warrants, which represent warehouse stocks booked and due for delivery, have climbed to just over 17,000 tonnes, suggesting copper might soon start leaving LME warehouses

"With the large inflows of metal believed to be nearing an end, net falls in LME stocks could start to resume, which would support prices," said UBS Investment Bank analyst Robin Bhar

Simple supply and demand comes into play here. Higher supply = lower price.

Bloomberg has a bit more to flesh out the story:

Copper prices in New York had the biggest weekly decline in 10 years as slower U.S. economic growth and a building slump reduced demand for the metal used in homes, appliances and cars.

Global stockpiles are at the highest since June 2004. The U.S. economy grew at the slowest pace of 2006 in the third quarter, led by a decline in homebuilding. Builders are the biggest consumers of copper. Prices tumbled 12 percent this week, touching a nine-month low.

``I don't think anybody has predicted it would go this low,'' said Karen Poniachik, Chile's mining and energy minister and chairwoman of state-owned Codelco, the world's biggest copper producer.

According to Bloomberg, the slowdown in the US housing market is a prime reason for the drop:

Construction spending fell for a third month in November as homebuilding fell by 1.6 percent, the eighth-straight drop, the Commerce Department said this week. Fewer Americans signed contracts to buy previously owned homes in November, suggesting continuing weakness in the real estate, an industry group said yesterday.

``If overall housing sales stay slow, you could easily pare another 30 or 40 cents off of copper,'' Frank McGhee, head metals trader at Intergrated Brokerage Services Inc., said yesterday. ``Copper is a leading indicator. It's very sensitive to perceived economic conditions.''

Something to keep in mind is the futures markets have become the high tech market of the late 1990s. A ton of money flooded into the futures markets over the last 6 years. This is one of the reasons for the huge price run-ups over the same period. Increased demand = higher prices. Some of this selling may simply be people taking profits. In other words -- this could be speculators leaving the market.

However, the fundamentals indicates there may simply be weaker demand. Housing construction in the US is down. Overall stockpiles are up. This indicates copper production may be too high right now, anticipating a level of demand not warranted by the underlying economic fundamentals.

For market and economic commentary, go to the Bonddad Blog

The Recession of 2007

December 02, 2006

by John Mauldin

One of my favorite cartoons of all time is that of a very scrawny mouse caught out in an open field with a rather large hawk swooping down on it. There is no place to run, no place to hide. All the mouse can do is face the hawk and give him the bird, so to speak. The caption runs something like, "In the face of total disaster the only appropriate response is utter defiance."

And while the economic data is not a total disaster, it has not been good this week. Yet the response of investors everywhere is defiance, or at the very least serious nonchalance.

Recession possibilities? "What recession? I spit on your talk of recession." They continue to assume that things will turn out much better than merely OK. All manner of investments are priced for perfection, perfection being defined as growth slowing enough to take out inflation risk yet not enough to hurt the ever upward rise of corporate profits. Goldilocks is the name of the game.

The stock market did close down somewhat today, yet as trading came to the end of the session, it rose over 100 points from its low of the previous few hours. All you can do is just marvel at the amazing capacity of investors to embrace risk in the face of this week's economic data, which we will look at in some detail today.

And after we dissect the parade of bad news, I will tell you why it is not all that bad. I continue to believe we will see a recession next year, but not a major one. Let's jump into the data.

Housing: The Roof Leak Gets Worse

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Economic Storm Signals: PAUL KRUGMAN - Tough 2007

THE COMPLETE ARTICLE
The New York Times

OP-ED COLUMNIST
By PAUL KRUGMAN

Economic Storm Signals

Published: December 1, 2006

The odds are very good that 2007 will be a very tough year.

"It's tough to make predictions," Yogi Berra is supposed to have said, "especially about the future." Actually, his remark makes perfect sense to economists, who sometimes have trouble making predictions about the present. And this is one of those times.

We're now two-thirds of the way through the fourth quarter of 2006, so you might think we'd already know how the quarter is going. Yet, economists' assessments of the current state of the U.S. economy, never mind the future, are all over the place.

And here's the bad news: this kind of confusion about what's going on is what typically happens when the economy is at a turning point, when an economic expansion is about to turn into a recession (or vice versa). At turning points, the various indicators that usually tell us which way the economic wind is blowing often point in different directions, so that both optimists and pessimists can find data to support their position.

The last time things were this confused was early in 2001, when most economists failed to realize that the United States was sliding into recession. If that sounds ominous, it should: the bond market, which has a pretty good record of forecasting recessions, is pointing toward a serious economic slowdown next year.

Before I explain what the bond market is telling us, let's talk about why the economy may be at a turning point.

Between mid-2003 and mid-2006, economic growth in the United States was fueled mainly by a huge housing boom, which created jobs directly and made it easy for consumers to spend freely by borrowing against their rising home equity.....

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Bonds Say Recession; Stocks Say Soft-Landing. Who's Right? : Bonddad

Related

Schiff: Worse Than Holding Dollars Is Holding Bonds
http://www.safehaven.com/article-6367.htm
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Nov 30, 2006

By Bonddad, bonddad@prodigy.net

The bond market and the stock market are sending contradictory signals about the next 12 months. The stock market is essentially buying into the Goldilocks scenario – that the economy will slow gradually but will not fall into a recession. The bond market is saying a recession has a higher probability of occurring. There is enough information for both markets to maintain their respective viewpoints for now. Only time will tell which outlook is fundamentally correct.

First, here is a chart from the MarketGuage website – which is a great site for basic market information.

The top line outlines the difference between the ten-year Treasury bond and the 3-month treasury bone. This is called the "spread". Before we get into what this spread says, let’s go over some yield curve basics.

A "normal" yield curve (if there really is such a thing) slops from the lower left to the upper right of a bond yield chart. Here is an example from yesterday’s chart of the Japanese bond market from Bloomberg.

This graph says a couple of things to an economist. First, the risk associated with longer-term investments is greater than shorter-term investments. This is the natural state of yield curves because there are more things that could go wrong in the long-term in the short-term. Suppose you lent someone money for 6-months and assume they are a good credit risk. There are fewer bad things that can happen to that person to prevent them from paying you back your money. However, if you lent them money for 30-years, there is higher chance that something will happen to prevent them from paying you back. The time horizon is simply too long to calculate all of the negative possibilities. Therefore, you charge a higher interest rate to compensate for the increased risk.

Secondly, this graph says that inflation expectations are higher. It’s important to remember the real rate of return on a bond is the bond’s interest rate minus the prevailing rate of inflation. If traders think inflation is headed higher, they will demand a higher interest rate so they can make more money. Here it’s important to remember that a bond’s price and yield are inversely related: as prices decrease, the interest rate increases and visa verse. So, on the Japanese chart investors are selling the long bond (or at least not buying it), driving longer-term interest rates higher.

Finally, this graph says bond market traders are expecting an increase in interest rates – or, more generally, that the probability of interest rate increases is higher than interest rate decreases. Here’s the reason. If interest rates increase in this environment, people who hold longer-debt will lose money because interest rates across the board will probably increase in one degree or another.

Now, let’s literally reverse everything that’s been said above, with a few changes. First, let’s make the possibility of a rate decrease the most important factor when buying a bond, followed closely by decreased inflation expectations (or reverse them). That would describe the current US yield chart which looked like this at about 3PM EST.

The above mentioned factors – a decrease in inflation and a decrease in interest rates – are two important factors that happen in an economic slowdown. The central bank lowers interest rates to stimulate borrowing and thereby increase economic activity. Inflation decreases (usually) because there is less demand for products, which lowers the possibility of demand-pull inflation. The general decrease in economic activity lowers the amount of goods business produces, which lowers the purchase of raw materials, which lowers cost-push inflation pressures. Anyway, that is the basic line of thinking involved with the current US yield chart.

Now, let’s turn to the stock markets, which have all enjoyed a rally starting in July of this year (this chart is from the Martindale Capital Website which has some great charts.)

All three averages have increased since July. Stocks increase when business conditions are good and stocks decrease when business conditions are bad. The latest earnings season was good for stocks. While GDP has slowed it has not gone negative. The latest inflation gauges have shown a decrease in inflation, meaning the Fed doesn’t have to increase interest rates (at least right now). Basically, traders think the economy will have a soft-landing. This means that growth will slow, inflation will slow, but the economy will not contract. In the words of most Federal Reserve bankers, the US economy will not operate at full capacity, but operate below full capacity.

So – who is right? We won’t know until the economy gives a firm set of signals in either direction. However, it’s important to note there is enough evidence for both markets to take their respective positions.