Reports of Economy's Demise Are Greatly Exaggerated

In this post I'm trying to recap all the things that I think paint a positive picture of the economy, in order to provide some balance for the depressing stuff you encounter in newspapers and television. With the equity market having fallen by 50% from its recent highs, and credit spreads still incredibly high, the market is essentially forecasting that economic conditions will soon prove to be catastrophically bad, on the order of magnitude of the Great Depression or worse. I've outlined this reasoning in greater detail in this post from last November. So the news doesn't necessarily have to be positive to be significant, it just has to be better than distressingly awful.

The TED spread (the difference between 3-mo. LIBOR and 3-mo. T-bill yields, which is a good indication of the market's fear of bank failures) has declined hugely from its all-time high of October 10th. It is still significantly higher than what we would expect to see in normal times, but the market nevertheless does appear to be healing. It took over two and a half years for the TED spread to come back to "normal" levels following the crisis leading up to the Crash of '87. The current crisis hasn't even reached the two-year mark, if you assume it started back in August of 2007. Since this crisis is all about fears of a collapse of the global banking system, progress of this sort is excellent news indeed.

After plunging 60% from July through November, industrial metals prices have been relatively stable for the past 3 months. This same pattern is repeated for the great majority of commodities as well. That prices are no longer falling is an excellent sign that neither the U.S. nor the global economy is going down a black hole. Indeed, activity appears to be stabilizing. Plus, even though the commodity markets have collapsed, prices are still significantly higher today than they were at the tail end of the 2001 recession.

The pessimists argue that we are in the grips of a global deflation driven by weak and declining demand, but I would argue that where commodities are concerned, we've simply seen the popping of another bubble, one that was driven by cheap money and a desire by many institutional investors to add commodity exposure to their portfolios. Things are now back to more reasonable levels, and that can be conducive to growth going forward.

The dollar is not collapsing. It has bounced significantly off its all-time lows of last summer. This chart may overstate the dollar's strength, however, since the dollar as well as most other major currencies have declined significantly relative to gold. Still, it is reassuring to note that the dollar still garners respect among the world's investors, despite the Fed's massive quantitative easing program. I think it also means that the U.S. economy is still considered to be among the world's most dynamic and resilient, and thus the dollar represents access to a safe port in the current economic storm.

Swap spreads have declined significantly. To be sure, they are still higher than would be considered "normal," but they are now back to levels that preceded the current equity disaster. If anything, lower swap spreads are a sign that the fixed-income market has recovered a good measure of the liquidity it had lost at the height of the panic back in October and November. Lower swap spreads also signify an improvement in people's willingness to accept counterparty risk, and that is in turn a key sign of rising confidence.

I've been disappointed that equities haven't rallied in the wake of the improvement in swap spreads, but I've noted before that while swap spreads have been excellent leading indicators of conditions in other markets, that lags can at times be significant. For example, swap spreads started declining just before the onset of the 2001 recession, and credit spreads didn't start declining until late 2002. So I'm willing to be patient.

Shipping rates have bounced solidly off their lows. As markets collapsed and fears of a global banking crisis soared, consumers sharply curtailed discretionary spending and banks all but shut down the issuance of the letters of credit that are essential to global trade. Global trade virtually ground to a halt, with shipping rates, as shown in this chart, falling to levels that most likely marked the point at which shippers would rather leave their ships at the dock rather than sail them for a loss. Shipping activity is now making a comeback, with shipping rates up dramatically from the early December lows.

Doom and gloomers fret that rates will plunge again, as new ships are scheduled to come on line. But that doesn't negate the fact that activity must be up, even if it is only due to China ramping up its stimulus package. Where there's smoke, there's fire.

Agency spreads are down significantly. The difference between the yield on debt issued by Fannie Mae and Treasury debt of comparable maturity is a measure of the degree of trust investors have in the U.S. government's willingness to stand behind Fannie's debt. Although these spread still indicate a degree of doubt on the part of the market, they are nevertheless substantially lower than when the market first realized that Freddie and Fannie's debt, measured in the trillions of dollars, might be worthless. This is very important, since it has calmed the nerves of foreign investors, among others, who held massive amounts of Agency debt.

This is the first appearance of this chart, but it falls under the rubric of "no shortage of money" which has received plenty of attention here over the past several months. We keep hearing and reading that banks are very reluctant to lend money these days, and the economy is suffering as a result. Well, the reality is considerably different from the hype, as this chart demonstrates (data through the end of January '09). Bank lending to consumers has actually accelerated over the course of the past 12-18 months, and currently stands at a new all-time high.

Further to my previous post, Total Bank Credit shows no sign of any significant slowdown in banks' lending activities. If anything, one might argue that the pace of bank lending in recent years has been quite a bit more generous than it was during the 2001 recession.

Comments

[wdhalgren:]

Instead of allowing the most massive private credit expansion on record unwind, politicians around the globe have determined that the best course of action is to convert private debt into public debt. All of the positives that you note are the result of that process.

If governments intended to allow the natural course of over-indebtedness, then they would have permitted bankruptcies to occur and economies to gradually heal through natural selection of prudent actors. Instead, we've taken a less immediately painful course of action, one which thwarts the laws of nature by promoting the welfare of the incautious at the expense of the cautious. Reward the grasshopper, while grinding the ant under our heel.

The end result of this will be the impoverishment of individuals who placed their trust in the US dollar. People who labored their entire lives to accumulate adequate retirement savings will become destitute during their final years due to inflation. Meanwhile, debtors will be handed a free pass and encouraged to have another go at the public expense.

Humans aren't rocket scientists, as a general rule, but if you hit us once between the eyes with a two by four, next time we will duck. Global governments are currently fashioning the most perverse system of financial disincentive imaginable. What follows will make the term "moral hazard" seem quite inadequate.

Feb 25 06:30 AM

[drone:]

Huge amounts of money pours into America and waits for the bottom, hoping to grab a once in a lifetime bargain price on a unique company like Cisco, Harley Davidson, Coach, Dell, whatever.

Feb 25 06:32 AM

[atlasman:]

Sounds like you are channeling Kudlow. The problem is all of these indicators are backward looking and do not mix in future unemployment, inflation, and massive public debt.

Feb 25 07:06 AM

[kelm:]

The Yen was strengthening strongly a couple of weeks ago and then dropped through the floor as the market finally woke up and realized that Japan made no sense as a reserve currency or safe haven. Their economy is a mess (46% contraction in trade released last night), politically anemic, massively indebted ad with an aging population. While the dollar has not yet retested its lows I have to wonder why, if it is the safe haven status and reserve currency of the world everyone says, it is not dramatically higher.

As for Baltic Dry - this needs to be broken down to look at which size ships are causing the rise and why. Capesize are almost all back in use as China has restarted ore purchases, recent articles in the FT indicate the moorings in Britain are still full and getting fuller though ships able to transport cars are being used as floating storage facilities (that is, rented but to store unsold merchandise, not to transport).

Each of these charts tells a story but you have to look under the hood to understand what it really is.

Feb 25 09:17 AM

[jepittman:]

The charts reflect current conditions which are seen from many points of view. Sometimes it helps to see facts instead of subjective fear/gloom people are subjected to in the media.

As for Kudlow, I would suggest the time to be wary of him was six months ago when he was popular. Since the gloom is so widespread it might be more opportunistic to lean the other way now.

America has suffered from high unemployment, high debt, and inflation before and emerged prosperous. IMO we will deal with these problems successfully again if and when they arise. This is not a popular opinion right now as most people expect America's standing in the world to collapse. They will be proven wrong. America's institutions and dynamic, resilient economy will again be the global economic engine it has been in the past. Our markets and economy will recover, possibly sooner than most expect.


On Feb 25 07:06 AM atlasman wrote:

> Sounds like you are channeling Kudlow. The problem is all of these
> indicators are backward looking and do not mix in future unemployment,
> inflation, and massive public debt.

Feb 25 09:23 AM

[Stock Marke...:]

A nicely done piece, whether you agree or disagree...

Feb 25 09:45 AM

[mrresponsible:]

I agree, a thorough, concise, and well written article.

Wdhalgren, whoever you are - I think the gov't is attempting to juggle a place between the ravages of large debt and hyperinflation. Won't hyperinflation be moderated by temporarily bringing some of the private debt into the public realm to smooth out the curve? By the way, if you are not writing and publishing, you should consider it.

Feb 25 10:31 AM

[Dave Shafer:]

Very informative. Although it "proves" nothing about the future, it allows us to look beyond the "doom and gloom" being offered to us on a gold platter!

Feb 25 01:50 PM

[Aristophanes:]

A high US$ hinders the employment picture. You want to sell to the past savers in Asia and elsewhere and narrow the trade deficit, but the dollar curtails exports.

There's a lot less buyers out there for pretty much everything, therefore a steep, sudden, and unprecedented drop in world trade (without protectionist laws this time).

As a result "domestic demand" is will be the next rallying phrase in order to sop up productive over-capacity. Start at home and then trade with surpluses. Until that happens, unemployment will be a severe drag on the economy.

Feb 25 02:05 PM

[DiracMan:]

Tell me what your explanation is about NAKED Credit Default Swaps as a legitimate economic function from your derivatives buddies? Government regulation was withdrawn ten years ago and financial markets were turned into gambling casinos just like bingo night down at the VFW. You accusing Obama trying to "seize power" is right out of Michael Savage's incessant drumbeat.

I played Division I major college football. I would not walk on a football field that had no referees. In high school maybe. But not in college. The talent is so fierce you could get killed without referees.

Government has a legitimate function as referee doesn't it?

You have been listening to Rush Limbaugh, Shaun Hannity, Glenn Beck, and Michael Savage too long. It is all Johnny-One-Note broomstick-up-the-ass RepubliCON yammering. Get something more original ideas.

And since you love your economic politics so much, thanks for your military service to our country. You did serve, right? You did put your lily white yuppie ass on the line, right?

Yawn.


On Feb 25 10:01 AM know nothing wrote:

> If you had financial trouble at home, you'd cut spending right away.
> You wouldn't borrow another penny, and you'd make it a high priority
> to pay down all existing debts as fast as possible. And yet, Obama
> thinks saddling us with another $800 billion of pure pork will somehow
> mysteriously "stimulate" the economy. It's not true. It doesn't work
> that way.
>
> The economy doesn't depend on spending and credit. Spending and credit
> depend on the economy, the productivity of you and me, which in turn
> depends on politicians like Obama getting the hell out of our way.
> I think Obama knows this, too. He knows his $800 billion package
> is no damn good. He's dishonest enough to go through the motions,
> no matter how destructive, to give the appearance of taking action.
> He really just wants power. He wants to tell you what to do and for
> you to worship him in return.
>
> No one seems to understand government is the problem. Most people
> say, "The government ought to do this" or "the government ought to
> do that." Nobody ever says, "The government ought to leave us alone
> and stay home, while we the people work this out amongst ourselves."
>
>
> I think it was Elbert Hubbard who wrote, "Grown men don't need leaders."
> I don't know about other types of leaders, but we sure don't need
> political leaders like Obama, not during tough times like this. At
> times like this, we need to be left alone to work out our problems,
> without the busybodies inside the Beltway making it even worse than
> they have already.

Feb 25 06:37 PM

[Fred Voetsch:]

It's good that you post this data but none of it indicates a recovery when compared to all the other economic data and as everyone, including propably you, have pointed out, a real recoverly simply can't happen until housing at least bottoms yet housing is getting worse.

Feb 26 01:33 PM