You are being lied to. There is currently more than
sufficient evidence that indicates that we are either in, or about to be in, a
recession. The last time I made that statement was in December of 2007. In
December of 2008 the National Bureau of Economic Research stated that we were
correct. I don't make statements like that lightly and, honestly, I hope I am
wrong as this is a horrible time for the economy to relapse.
However, the reason that I bring this up is that
there have been numerous analysts and economists stating that the economy cannot
be going into recession due to the spread between various sets of interest
rates. (For the purpose of this report we will focus on the spread between
the 1-year Treasury bond and the 10-year Treasury note.) Historically
speaking they would be correct and I will explain why.
The steepness of the yield curve has been an
excellent indicator of a possible future recession for several reasons. First,
the spread is heavily influenced by current monetary policy which has a
significant influence on real activity over the next several quarters. When
there is a rise in the shorter rate this tends to flatten the yield curve as
well as to slow real growth in the near term. This relationship, however, is
only one part of the explanation for the yield curve's usefulness as a
forecasting tool. The steepness of the curve also reflects the expectations of
future inflation. Because economic growth is affected by the level and trend
of both interest rates and inflation it is not surprising that the spread has
historically been a good predictor of future recessions.
This time it could be wrong.
The issues with the spread between interest rates
today are twofold. First, the U.S., via the Federal Reserve, has embarked upon
an unprecedented series of policies to deliberately suppress the yield curve.
Through outright purchases of treasuries through Permanent Open Market
Operations (POMO) and Quantitative Easing (debt monetization) programs have been
implemented to specifically target areas of the interest rate curve. Even the
recent announcement of "Operation Twist" is specifically designed to
flatten the yield curve to "help promote the demand for credit".
Therefore, since abnormal and artificial influences are being applied to the
bond market to manipulate interest rates it removes the usefulness of the yield
curve as a forward indicator of recessions.
Secondly, and most importantly, the economy is
currently not operating under a normal economic environment. As we have
discussed in recent missives the U.S., for the first time since the "Great
Depression", is undergoing a balance sheet recession. During the
"Great Depression" beginning in 1929, the Total Credit Market Debt as a
percentage of GDP rose substantially before eventually collapsing. We saw this
phenomenon begin again in the 1980's as total debt began to expand dramatically
until the Total Credit Market Debt hit 380% of GDP in early 2009. We are now
experiencing the deleveraging of those credit excesses which creates economic
drag as money is diverted from savings and consumption to the repayment of
debt.
Japan has been struggling with the same reality since
the bursting of their real-estate/credit bubble and subsequent balance sheet
recession. The government of Japan has implemented many of the same policies
that Ben Bernanke has been foisting upon the US economy but to no avail. As a
result Japan has been mired in a stagnating/declining economic growth
environment for the last two decades with frequently recurring recessionary
downturns.
The yield spread between Japanese bonds, much
like we expect to happen here in the U.S., has remained positive due to
government interventions since the beginning of their economic malaise some two
decades ago. As far as a recessionary indicator goes - the yield spread has
failed miserably.
Japan has been struggling with the same declining
employment to population ratio, stagnating wages, an overburdened pension system
and weak economic growth enviroment that currently faces the U.S. today. If
that is the case then the economic future that has been laid out before us is
not a bright one. The coming deleveraging of debt which will result in a needed
cleansing of the excesses from the system will result in continued weakness in
economic growth as consumers and businesses remain on the defensive. This
defensive posture leads to deterioration in the demand for credit, stagnation of
wages and lack of productive investment.
If the recent history of Japan is any reflection
of the path that we have been set upon then we will likely enter a recession by
the beginning of 2012. Of course, it will confound, confuse and surprise the
mainstream analysts and media as the yield curve will most likely remain
positive. As I stated before, I sincerely hope I am wrong, and that everything
turns out for the best. Deep down I am an enternal optomist and believe in the
innovation, ingenuity and passion that has made this country great. However,
"hope" and "optimism" are not investment strategies by which
we can successfully navigate the finanical markets today or in the future.
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