Positive Signs 10/20/2008

Barring unforeseen surprises, of which there have been many, there seems to be light at the end of the tunnel of economic crisis. There are several signs of (the overused term) “cautious optimism” showing their heads long before Groundhog’s Day.

First, interbank lending rates are down today to the lowest level since September 30. That does not mean the credit crunch is over; in fact, it is long from ending. However, the lower rate does mean a larger number of banks are willing to lend to other banks – a statement of rising confidence in the viability of the banking industry. Confidence needs to increase even more before the credit crisis ends, but a glimmer of hope is showing.

Second, and quite a surprise, the Conference Board reported today a slight increase in leading indicators. Caution: this does not mean business will be booming soon. Nor, with a one-month increase, does it mean the economy is turning around. Having expected a decrease in the indicators, though, the very slight increase is welcome news. There is little question that the economy will continue to fall for some time; perhaps the slight rise means the fall will not be as severe as some expect. If there is continued rise in the indicators, a turn in the economy could be expected in less than a year.

Third, there is less and less doubt that the government will create another economic stimulus package. The style of the package will depend on the creators: either the current administration or a newly elected one (of either party.) Certainly, the infrastructure needs investment, and along with encouragement to the housing industry, a stimulus package can in short order return thousands of unemployed workers to newly created jobs.

Before dancing in the streets in celebration of an economic recovery, temper all the above with the size of the deficits that will follow, and the enormity of the national debt. The United States will be financially weakened for many years to come. We have put ourselves into a large hole and now face the perhaps impossible task of digging out.

Musings on the Economy

In the spring of this year, it seemed certain the economy was entering a recession. Oddly enough, based on the definition of a recession as two consecutive calendar quarters with shrinking GNP, we still are not in a recession.

Another definition sees a recession as a reduction in the amount of business activity in the economy, based on measures like employment, industrial production, real income and wholesale-retail sales. A recession starts as business activity reaches a peak and starts to fall and ends when business activity bottoms out and begins to rise. Using this definition, recessions last on average about a year.

Now, in the current economic drama, recession seems sure – using either definition. Employment is down; unemployment is up. Industrial production is down; wholesale and retail sales are down. Food and fuel prices have risen sharply, driving down real income.

There are some interesting good signs, though, even during the drama. The dollar is stronger. It has risen some 17% over the last two and a half months. Looking at the economy, that is a surprise. It seems it should have fallen further during that time. Apparently, compared to national economies around the world though, ours is better than most, giving strength to the dollar. If other economies are worse than ours are, they must be very bad. With the weak dollar, exports rose. As the dollar strengthens, they will fall. With a stronger dollar, the real cost of a barrel of petroleum is lower. Fuel costs are lower and may go down even more.

The critical issue in the current economic drama is credit. No one wants to lend money, especially banks to other banks. Without bank-to-bank short-term loans, credit availability dries up. The Fed yesterday intervened by buying commercial paper, never before done. Then the Fed, joined by the larger industrialized nations in the world, reduced interest rates. In the US, the federal funds rate dropped half a point. Mr. Bernake and friends are creative geniuses – he seems to have something new every day. The result, along with interest rate cuts worldwide, may stem the tide of the drama. If only (and how many times have you heard,”if only”) we get a few days of calming, these and other measures will begin to defuse the drama. I personally believe that the many measures and rescues of the Federal Reserve and the US Treasury will keep the economy from falling into a depression - defined as a severe economic downturn lasting several years.

Speaking of depressions, the Great Depression of 1929 lasted ten years, ending only when the outbreak in Europe of World War II began demanding greater output from our mines and factories. We certainly do not want that. Overburdened with a national debt far into the trillions, surviving a depression would become problematic.