Quick Speculative Thoughts about Possible Future Trends

In reading the daily commentary of the American Institute for Economic Research for April 29, 2009, my speculative little crystal ball began to light up. AIER is the only serious business cycle analyst group that points out reality, and reality is that contraction is everywhere in the stats, in spite of the recent "good news" in the stock market. (Desperate exuberance, anyone?)

So let's think it over.

We all agree that the government and the Federal Reserve think they are doing their best to prevent a deflationary spiral, to un-freeze credit, and to save major industry players from precipitating us all into a deep depression. Money supply creation is high, and we can see that the Fed's balance sheet has never been in a more inflated state.

According to some signs, these policies seem on the surface to be taking effect. Sales of existing homes are turning around, and the stock market is maintaining its rally. Meanwhile, the money supply is expanding by an annual 8.1 percent, while at the same time the CPI is stable or falling.

If past experience is any indication, it would seem logical that we are headed for an arrest--and perhaps even a reversal--of price deflation; and if the money creation continues unabated, as would seem inevitable given current Fed policy and the expansionary will of the administration, inflation should be the outcome. Some are even talking about hyperinflation.

But I have a slightly different crystal-ball image (which could of course change tomorrow). Keeping in mind that this is just a game, and that no one's fortune telling is better than anyone else's, just for fun I thought I'd throw this out on a rainy Sunday afternoon.


[Thanks to Crystal-cure.com for the photo.]

Hyperinflation is not in my crystal image. This is not post-WWI Germany or Zimbabwe, in spite of the way things look. What is the reason? It's certainly not because there is no monetary excess going on; it's because, unlike the world of speculative finance, a good part of American industry is too savvy to get caught up in the exuberance.

In fact, American industry has been savvy for a long time, at least one century or more. In pre-1929, over-issued money supply did not all pour into consumers' hands, where it must be before it can create hyperinflation. In the decade leading up to 1929, prices were relatively stable, yet money supply grew. Where did it all go? It flowed into the stock market, for one, which experienced a huge run-up that subsequently burst and started a cyclical downturn.

Why didn't the country experience general price inflation? Economists speak of nominal inflation versus real inflation. Nominal inflation can remain low or non-existent, even as real inflation grows. Prices are stable, whereas they should be falling. This is what happened in the 1920s. And American industry knew this, while the Fed governors pretended not to (or were too inexperienced to realize it).

Later, during the long inflationary run of the second half of the 20th century, industrial market players and their public adjusted to chronic price increases. It's similar to what we do as we grow older (if not wiser): We get used to living with low-grade arthritis pain. This chronic inflating, however, culminated in another stock run-up and the acute crisis of the 1970s, which some say was deeper than that of the 1930s in real terms.

But we got over it and it didn't take too long to get back to our arthritic monetary ways during the 1990s, helped by urgencies in the savings bank industry and in the commercial banking industry's politically motivated foreign investments. This time, the inflationary run popped in 2000 and 2001, having inspired another stock market bubble. By now, we were so good at putting up with pain that we returned immediately to our bad habits, creating the real estate and credit-speculation bubbles that have dropped us to where we are today.

Instead of taking our medicine once and for all, we're off to the races again. Today's crystal ball tells me that we will get a renewed stock market mini-hyperbubble, along with a government stimulus maxi-bubble targeted to specific groups of rent-seekers (special interest groups like financiers, government workers and programs, construction conglomerates, unions, and the like). While this is going on, general prices will remain fairly stable, and banks and investment houses will go right back to their speculative games. Gold and commodities may go through a mini-hyperbubble as well.

But the business cycle really wants to contract. This time, the arthritic pain is too acute. Look at the stats at AIER. It's possible that real industrial GDP may not progress, even though government stimulus money may creep in, pushing up the digits for a while. But keep in mind that government stimulus must be paid back by future capital, depriving us in the coming years of investment in real industrial GDP. The figures will mislead us all. But American industry knows this.

So to conclude, we could get some short-lived hyperbubbles in the stock market and commodities, but they might deflate and run out of exuberance for a while. The maxi-stimulus fake bubble will run out of public support for sure. GDP will eventually dive again and will become chronic stagflation as the increasingly impotent government and Fed blow stimuli through the system like air bubbles in a fish tank. Most of the new air will dissipate through short-lived financial speculation. (Japan, anyone?)

Keep in mind that, having exposed my insights to you today, I'll probably rethink this whole crystal vision by my next blog. But if the deflationary business cycle fights back and ultimately wins this contest between it and our desperate government and Fed efforts, expect bubbly stagnation for a good while, until industry decides it's time to make a come-back. Then we'll probably get the inflation we've been fearing.

Yes Virginia, The Big Recessions and Depressions ARE the Same

Here we go again. Although every recession is unique in the details, this one and those the country has experienced since the 1800s have at least one fundamental underlying similarity: The boom that preceded them.


[Thanks to Themeparks.about.com for this image of Tatsu, a new ride at Magic Mountain.]

Let’s compare what is happening today to what happened during the Great Depression. In the 1920s after World War I inflating of the currency, Florida underwent a damaging real estate boom and bust cycle. Florida’s experience was so violent that one contemporary economist in 1928 called it "the Florida gamble."

"When Florida land first started its upward course there were good substantial reasons for advancing prices ... [but] advancing prices drew those individuals who were speculatively inclined as molasses draws flies. ... Large building projects gave an appearance of substance and worth to the whole affair. In 1924, pessimists were nearly all united that the Florida boom must soon end. But the mass of people, than whom there are no greater gamblers, had Florida fever. ... Then the bubble broke, as they always have and always will. In the wake of the boom followed disaster, defunct banks, and depression."


Hmm. Real estate bubble. Sounds familiar.


In 1925 through 1928 as the Florida gamble unwound, the concomitant US stock market boom was showing foreboding signs of euphoria. The article continues:

"The [stock market] boom has not collapsed, and, from all appearances, is stronger than it has been for some time. That seeming invulnerability and capacity for unlimited progress is a market feature of all such speculative periods as they near an end. It is to be hoped that the Florida bubble will not be completely paralleled [in the stock market]. Banks all over the country have entered on a new experiment in the past few years, the practice of loaning large amounts against securities [italics added]. [Also sound familiar?] A collapse in the stock market would make thousands of banks unwilling investors, very much as the Florida banks found themselves in the real estate business after 1925. Such an experience, with the inevitable blood-letting at the hands of receivers for the least fortunate, would be a blow to our progress that would force upon the country many months of painful convalescence." [Quote from an unpublished paper, "Stock Speculation Versus Florida Memories," E.C. Harwood, 1928.]

As we now know, the Florida real estate bust of 1925 was followed by the stock market crash months after Harwood wrote this prescient article.


Hmmm. Stock market bubble. Again, sounds familiar.

Between 1800 and 2008, Americans have experienced boom and bust cycles; yet economists as a class are known for their disagreement about the cause, with two notable exceptions.

One is the Austrian school of economists, scholars like Von Mises and Hayek, to whom our attention seems to turn cyclically after every recession, but of whom we tend to lose sight as soon as we get another taste of easy credit. They've been warning about credit imbalances and poor banking practices for over a century.

A more scientific thinker, this time from among the empirical economists, is the author of the articles noted above. Through extensive study of banking statistics, Harwood concluded that markets in general, and international markets in particular, work best when unhampered; but that they can only function well when the trading medium is staid. Like the Austrians, he concluded that fluctuating fiat currencies and/or poor banking standards are a catalyst for excessive credit creation, resulting in speculative boom/bust cycles. Using his analysis, he predicted the 1929 crash as evidenced in his articles published in The Annalist of 1928 and early and mid-1929. He also predicted the devaluation and flight from the dollar of the 1970s.

Furthermore, he maintained that the world would continue to suffer damaging speculative peaks and crashes until voters realize that it is our incompetent monetary policymakers who create them. Legislators must acquire enough humility to admit that human agents cannot micromanage the quantity of money—a failing even Milton Friedman feared—and that government’s only role should be to support the natural money-creation process through the establishment and maintenance of sound banking principles and of some form of currency measuring stick.

Both Harwood and the Austrians believe that, to date, the only such device that has succeeded for any length of time is the gold standard in one form or another. The duty of our economic wizards is to find the version of it that fits today’s parameters.

What are the chances our present or future administration will see fit to look for this solution? About zero. Expect more rides in the future.

See more about Edward C. Harwood at the American Institute for Economic Research.

Minneapolis First in Foreclosures - Isolated Incident, or Recession in the Works?

Seeking Alpha points to an article in the Star Tribune about the amazing number of foreclosures in North Minneapolis.

Most impressive is the chart with the red dots, showing how the delinquencies are distributed throughout the county.

Is this just a hot spot of bad sub-prime mortgage lending? Or is it the first in a long string of falling dominoes?

No one really knows, of course. Some say the markets have already taken into account the pretty poor outlook for the housing market. Some say that the dollar's slow demise will help the manufacturing sector and keep the country out of deep recession.


[Thanks to traum-geschenke.de for the image.]

I have no particularly unique crystal ball like Alan Greenspan thinks he does, but my favorite and the only truly scientific economic research institution that I know of is now predicting that business cycle conditions point towards a likely recession.

The institution in question is the American Institute for Economic Research. I like these people. Their news can sometimes be tepid (what truly non-partisan organization issues earth-shattering statements every few days like the IPCC? [Intergovernmental Panel on Climate Change]) But when it's time to rumble, they rumble loud and clear.

Here's an excerpt:

"The yellow caution lights of recent months have now turned red. Conditions have continued to deteriorate: both the percent of leaders expanding and their cyclical score are now at levels that preceded prior recessions. A contraction of general business activity is more probable than continued expansion.

"Last month we were hesitant to assert that recession was imminent because one of our key indexes, the cyclical score, had not weakened sufficiently to confirm the signal from the percentage of leaders expanding. However, new and revised data now indicate that the cyclical score has been considerably weaker and for a longer time than previously thought, confirming the recessionary signals given since January by the percent of leaders expanding. The weakness among our primary leading indicators of business-cycle conditions continues to spread and a recession now appears imminent.

"Very few forecasters share our view. Aside from a few Wall Street 'permabears,' business economists and forecasters seldom, if ever, predict a recession. As many have put it, such pronouncements are 'bad for business.' This is, of course, a disservice to themselves, their employers, and their clients. We, on the other hand, are completely independent and committed to giving our readers our analysis of business-cycle changes, and the evidence behind our conclusions, for better or worse."

[Source: Research Reports, April 23, 2007, AIER, Great Barrington, MA 01230]

Bravo. Keep up the good work. Predicting 24 of the 21 most recent recessions sounds like a good batting average to me.