The case for a secondary recession rests on several factors: a double-dip decline in the residential real estate market, the accelerating decline in the commercial real estate market, the unresolved losses in bank balance sheets, the narrow focus of the profitability (earnings), which has been limited to bailed-out banks, and the threat of rising long-term interest rates, i.e., a decline in the bond market.
All of these factors are known to the investment community, yet they have not persuaded stock market investors that there is any threat to corporate profits. So, either the negative factors are minor issues or else the optimism of stock market investors is an example of the same sort of stock market boomlet that took place in 1930. It collapsed in 1931.
Then there is the question of the possible responses of the Federal government and the Federal Reserve System if the real estate market resumes its downward path, taking down the economy with it. What is the condition of the government's tool kit of anti-recession policies? I think this question is the crucial one.
A SHOT WAD
Most people have forgotten the series of events from February 2008 to February 2009. This began with President Bush's signing into law the stimulus bill of 2008. It amounted to about $150 billion. The President announced this at the signing:
The bill I'm signing today is large enough to have an impact, amounting to more than $152 billion this year, or about 1 percent of the GDP.
The government hopes the measure, which will send most Americans tax rebate checks by May, will either prevent a recession or make one relatively brief.
The economy was already in a recession, and had been ever since December 2007. This fact had not yet been determined by the National Bureau of Economic Research's committee.
The stimulus had no visible effect on the economy. The recession escalated. In March, Bear Stearns almost went bust. It was saved only by the New York Federal Reserve Bank, which provided a $29 billion loan-guarantee to J. P. Morgan, which then absorbed Bear Stearns.
Then came the collapse of Fannie Mae and Freddie Mac in early September. Treasury Secretary Paulson announced the nationalization of the two busted lending firms.
Lehman Brothers Holdings went bankrupt a week later. Then came October's crisis. Congress in October passed the $700 billion Emergency Economic Stabilization Act, which funded the Troubled Asset Relief Plan (TARP) in order to bail out the largest banks. It did so over the objections of voters.
In February, the new Congress passed the $787 billion American Recovery and Reinvestment Act of 2009. Obama signed it.
The government's three spending packages were traditional Keynesian responses to the recession. They involved massive Federal budget deficits.
From mid-September until mid-November, 2008, the Federal Reserve System pumped in over $1.4 trillion of new money to save the financial markets: from $1.05 trillion to $2.5 trillion. The chart is here.
This kept the capital markets from locking up. This huge increase represented a doubling of the monetary base. This was the largest increase in the monetary base in American history.
This was not specifically a Keynesian policy. It was simply a wild increase in the monetary base as a way to bail out the economy. If you read any textbook account of Keynesian policies, you will find nothing about Keynesian theory and the need to double the monetary base in a period of eight weeks.
RON PAUL AND THE TEA PARTIES
Ron Paul ran in 2007 against the Federal Reserve System and the Federal deficits. This made him a national figure. He had picked the two most visible signs of Federal waste. By the time that Fox News excluded him from the debate for the New Hampshire primary in late December, his positions were already well known. It was too late for the networks to keep his message away from the voters.
His timing could not have been better. In the same month that Fox News closed the door on him, the recession began. His campaign gained momentum as the recession accelerated.
By the time of the election in November 2008, the two stimulus packages were history and the Federal Reserve had more than doubled the monetary base. For the first time since 1914, the Federal Reserve System was under widespread attack by a significant minority of the public.
Then came Obama's stimulus package. We can date the rise of the Tea Party movement from that event. It has continued to grow. Recent polls indicate that at least 25% of the voters identify with the Tea Party movement or express sympathy with it.
The speed of this development is unprecedented in modern American history. No swing voting bloc this large has ever appeared in a one-year period. This is a Congressional election year. The bloc did not exist in November 2008.
This is the wildest political wild card in modern American history. There is no organizational chain of command. Ron Paul represents its main ideas, but he does not give it marching orders. No one does.
Incumbent politicians who are up for election this fall now see what is coming. Their electoral plans have to factor in the Tea Party voters. Even Congressmen in safe districts have to think about what will be the shape of the new Congress in January 2011.
Nancy Pelosi should be making mental plans to turn over her gavel as Speaker of the House.
When Ron Paul got 41% of the vote in the Rasmussen poll a week ago, with Obama at 42%, that sent a message to Congress. No sitting House member has ever matched a sitting President in a public opinion poll. That the member has been the lone wolf in the House on spending bills for three decades indicates a monumental shift of opinion in the public's sentiments.
Pelosi's ramrodding operation of Obamacare was the last straw. She was adamant: the voters be damned. This was the same attitude that Congress displayed in October 2008, when it passed the Paulson-Bush bailout bill. Incumbent Republicans were swept out of office in the House in November 2008. The public got its revenge.
This November, the public is likely to get its revenge again. The dark cloud, no larger than a man's hand — Ron Paul's hand — a year ago has become a thundercloud. It is heading for Washington, D.C.
In non-Presidential election years, the incumbent party usually suffers losses. The hoopla surrounding Presidential campaigns is not operational. This favors the opposition party, whose voters want to get even with the leadership in Congress.
To this add the fury over Obamacare, the fear of the Federal deficits, and the anger over the Federal Reserve. The only thing that may save the Democrats for one more term would be for independents to run against incumbent Republicans who are squishy on spending cuts. What will save them, if anything does, was the unanimous vote against Obamacare.
If Tea Party voters demand from every Republican running for Congress a promise to introduce legislation overturning Obamacare, this will force the Republicans' squishy hand. The Republicans may go for it. They can pass the bill if they gain majorities in both houses. Then they will let Obama veto it, which he will. That would be smart politics for the Republicans.
WHO WILL VOTE FOR A NEW STIMULUS?
If there is a double-dip recession, who in Congress will vote for another stimulus package in 2010? Only Democrats in safe seats.
What will be the investment world's argument for optimism if the U.S. economy runs out of steam? Any support for another $700+ stimulus package is a call for a Federal Deficit over $2 trillion in fiscal 2011.
Does anyone expect Congress to vote for a deficit this large before the November election? If so, that person is politically naïve.
There might be such a package passed by a lame-duck Congress in December. This would be an act of political suicide on the part of the Democrats. The campaign against Obama would escalate on the day he signed such a bill into law. The Democrats would be wise to let the double-dip recession fall into the lap of the new Congress.
Obama will run against a Republican Congress if the Republicans take over either the House or the Senate in 2011. On the other hand, the Republicans can introduce spending cuts, knowing that Obama will veto them. This will produce great political theater for two years.
Bottom line: a hamstrung government will increase uncertainty for the financial markets. This uncertainty will escalate for two years.
If the Democrats still control both houses in 2011, their majority will be slimmer. Pelosi's ramrod will not scare the marginal-district Democrats the way it has over the last year. There will be more marginal districts.
I do not foresee a sufficiently unified Congress from this point on to make likely the passage of another stimulus bill large enough to satisfy the demands of Keynesian economists.
KRUGMAN, THE KEYNESIAN
Paul Krugman is a Nobel Prize winner. He is a New York Times columnist. He was a colleague of Ben Bernanke's at Princeton. He is a Keynesian.
He is convinced that this economy is looking like 1937. Earlier this year, he explained why.
The next G.D.P. report is likely to show solid growth in late 2009. There will be lots of bullish commentary — and the calls we're already hearing for an end to stimulus, for reversing the steps the government and the Federal Reserve took to prop up the economy, will grow even louder.
But if those calls are heeded, we'll be repeating the great mistake of 1937, when the Fed and the Roosevelt administration decided that the Great Depression was over, that it was time for the economy to throw away its crutches. Spending was cut back, monetary policy was tightened — and the economy promptly plunged back into the depths.
We have seen the bullish commentary he predicted in January. Bernanke is talking about an alleged exit strategy for the doubling of the monetary base.
Meanwhile, any talk in Congress of another stimulus package this year is nonexistent. The Tea Party movement has ended that political option.
Krugman went on.
As you read the economic news, it will be important to remember, first of all, that blips — occasional good numbers, signifying nothing — are common even when the economy is, in fact, mired in a prolonged slump. In early 2002, for example, initial reports showed the economy growing at a 5.8 percent annual rate. But the unemployment rate kept rising for another year.
As we know by now, the unemployment rate is stuck in the 9.7% range. Businesses are not hiring.
Such blips are often, in part, statistical illusions. But even more important, they're usually caused by an "inventory bounce." When the economy slumps, companies typically find themselves with large stocks of unsold goods. To work off their excess inventories, they slash production; once the excess has been disposed of, they raise production again, which shows up as a burst of growth in G.D.P. Unfortunately, growth caused by an inventory bounce is a one-shot affair unless underlying sources of demand, such as consumer spending and long-term investment, pick up.
This is exactly what we have seen. Inventories were depleted, so firms are now spending to get them back to normal — a new normal, lower than before.
He saw what is coming: a housing crisis.
During the good years of the last decade, such as they were, growth was driven by a housing boom and a consumer spending surge. Neither is coming back. There can't be a new housing boom while the nation is still strewn with vacant houses and apartments left behind by the previous boom, and consumers — who are $11 trillion poorer than they were before the housing bust — are in no position to return to the buy-now-save-never habits of yore.
This is the new normal. Consumers are not in spending mode. Housing is depressed. It could easily fall into a double-dip mode, as Robert Shiller says. He thinks it's 50—50. Meredith Whitney, who saw the financial crisis coming in early 2008, thinks it will hit.
What's left? A boom in business investment would be really helpful right now. But it's hard to see where such a boom would come from: industry is awash in excess capacity, and commercial rents are plunging in the face of a huge oversupply of office space.
I cannot fault Krugman's assessment so far. Industry does have enormous capacity. Why build a new factory when you already have a spare one?
As a good Keynesian, he thinks the recovery is a statistical illusion.
So the odds are that any good economic news you hear in the near future will be a blip, not an indication that we're on our way to sustained recovery. But will policy makers misinterpret the news and repeat the mistakes of 1937? Actually, they already are.
The Obama fiscal stimulus plan is expected to have its peak effect on G.D.P. and jobs around the middle of this year, then start fading out. That's far too early: why withdraw support in the face of continuing mass unemployment? Congress should have enacted a second round of stimulus months ago, when it became clear that the slump was going to be deeper and longer than originally expected. But nothing was done — and the illusory good numbers we're about to see will probably head off any further possibility of action.
He opposed the FED's talk of an exit strategy. He said that this would be monetary tightening. He was correct.
Will the Fed realize, before it's too late, that the job of fighting the slump isn't finished? Will Congress do the same? If they don't, 2010 will be a year that began in false economic hope and ended in grief.
I see his assessment of the recovery as accurate. The Keynesian prescription is for more Federal deficits and more Federal Reserve inflation. I don't think the former is likely. I don't see Bernanke as soon adopting a policy that is the opposite of what he has told Congress and the public that the FED intends to end.
The Federal government has shot its Keynesian wad. When this economy heads south, it will keep on heading south. It needs tax cuts. It needs spending cuts. It will get neither. The uncertainty of politics will add to the confusion.
April 21, 2010
Copyright © 2010 Gary North