By Lance Roberts, CEO, StreetTalk Advisors
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.
good article.
Good post. It is ironic that Uncle Ben is attempting to flatten the yield curve, which of course tends to signal a slowing economy. If he wanted to boost confidence, perhaps he should try to steepen the curve instead!
Can’t. Short term at 0 , significantly higher long term will destroy the mortgage market.
Only quick way out is inflation.
It could be argued that monetary policy is backward. Lowering rates could actually be deflationary for two main reasons. First, it reduces the amount of income in the economy. Secondly, interest rates are a cost of doing business. Lowering costs is deflationary.
sure, if you ignore income distribution as a factor.
If imagination is the prelude to lifes coming attractions (Einstein) then it is not too difficult to imagine the challenges for a “deleveraging” world economy. My only limitations in using my imagination is what Sovereign Central Bank responses will be – their responses will determine whether we have significant inflation (kicking the can down the road – no real solutions), stagflation (continued negative real interest rates) or deflation (across the board asset class depreciation) – all three will not end well!
Imagine if “all debt” oth personal and Sovereign debt was absolved!
Mr. Roberts,
A CEO telling us were being lied to supported by facts. The future looks better every day on this site.
Good Stuff Mr. Roberts!
I don’t support everything that Bernanke has been doing, but it is clear to me that he is trying to reduce rates for long-term loans like the 30-yr mortgage and business loans in order to stimulate the economy, especially the housing sector. I saw a forecast that within 3 weeks we should have a 30-yr mortgage rate down to 3.62%, it was on Bloomberg news. I doubt it will help much, but should help a little.
ya, it should help perpetuate more asset bubbles.
http://www.kansascityfed.org/publicat/econrev/pdf/4q97kozi.pdf Predicting Real Growth and Inflation With the Yield Spread via the Kansas City Fed.
I agree with Lance Roberts on his post that the Fed has completely distorted the markets. The million dollar investment question is how do they restore it?
“The million dollar question is how to restore it”
How do we restore the markets? How do we restore confidence in the markets? How do we restore confidence in the Fed, Policy Makers and the FIRE sectors of the economy?
You don’t need a million dollars to answer this you just need to know how to type http://www.pragcap.com or http://www.ritholtz.com or http://www.hussmanfunds.com I could go on. It’s free and it ain’t hard to do. You could go to other sites and get maybe not the best restoration project you wanted to answer the questions but better than what we have now.
If I lie to you consistantly about a little, most things or everything. There are only two ways to restore confidence. 1. I stop trying to control the outcome with lies and start telling the truth. It doesn’t matter how bad I think you will react to the truth. The TRUTH is the key to the restoration of markets, prosperity, freedom, good policy decisions and a Real honest life. Good or Bad we can set our sails in a direction based on the truth. I did not say it would be easy. “it feels so good because it was F$$$ing hard”- Awolnation
But stay focused on solutions and action. Based on Truth.
2. If I keep lying and manipulating for my benefit, my constinuents or my own selfish political agenda or simply because I am covering up for poor policy than like any business owner must do. You must get rid of me. Some here would do it by force if they must or by legal and peaceful means.
At this point…legal and peaceful is the way to go. For now.
The Pragmatic Capitalist who read this site must figure a way to collectively help the unpragmatic capitalists to see why it’s important to know what the real problem is and the solutions to fix it.
If the unpragmatic capitalists are unwilling to be honest and stop making the problems bigger than we pragmatic have an obligation to remove the unpragmatic. It is our responsibility to cut off the limb before it kills the body.
Many of us here said the same thing when it was a finger 20 years ago. Then in 2000 it was a hand now in 2011 it’s the entire arm.
How hard is it to do the right thing…it doesn’t take a million dollars..it’s quite simple actually.
Agreed, great post. Challenges the conventional thinking from the perspective of a balance sheet recession. Wish we had more analysis like this.
Cullen, wanted to point you toward Krugman today, who had an interesting post showing how the Euro crisis has hit those countries with CA deficits rather than fiscal deficits. (Spain and Ireland were running surpluses before the crisis hit.) Seems to support the MMT & sectoral balance approach, doesn’t it?
Yeah, good piece by PK. We’ve been saying that for years. It’s directly out of the sectoral balances. His post on Ireland should also point out that their “recovery” is largely because of their trade surplus – again SB approach. PK should be onboard with us. I am a bit stunned that he can’t fully mesh MMT into his work….
Why the U.S. is not Japan:
http://pragcap.com/why-the-balance-sheet-recession-will-not-last-as-long-as-japans
Interest rates would be irrelevant if we did not have a government enforced private money monopoly. Why? Because if interest rates got too high then new money supplies would be created to drive them down.
But let’s continue to think we have a “free market economy” while the most important part of it, money creation, is a government backed and enforced cartel?
I think the issue in the US is not with government money monopoly (is there an advanced or emerging economy without a central bank? ), but with the public/private nature of the Fed. It should be all government and serve to national interests.
It should be all government and serve to national interests. dimm
What is the “national interest”? Is it not what the public would freely choose? Would the Soviet Union have invented the “I-Pod”?
I see you chose to ignore my question, so I’ll ask again. Is there an advanced or emerging economy without a central bank? That is what you are suggesting, right ?
Is there an advanced or emerging economy without a central bank? dimm
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