Three Possible Causes of Yet Another Downturn

Although I would love it if the market is only headed higher, there are a lot of possible scenarios that would send it lower yet again. The following list isn't necessarily what I think will happen, just things that are possible, some more than others. Many of the things seem inevitable in some economists' eyes, so in today's market, buyer beware.

1) A Crash In the Dollar: Some would say this is inevitable with the government printing money like it's Christmas, but yet others see it as unlikely. The dollar may be strong currently, as it is usually the currency of choice during troubled times, but once confidence resumes, the dollar may fall back to reality. In the process, it could send us down yet again by causing interest rates to rise at an inopportune time.

2) Political Tensions: The main reason this recession is unlike last recessions/depressions is that the government is rushing to help instead of making things worse. They are loosening credit and saving troubled banks. Although I am not a big fan of big government, recent Federal Reserve moves could have saved the US economy from larger problems. If anything gets in the way of US or European governments from saving a large entity such as another Lehman Brothers, it could tip the economy over the breaking point. A small roadblock in fiscal or monetary policy may not make things worse, but it prevents the government from trying to make them better, allowing the economy to deteriorate on its own.

3) Deflation: Although this scenario is becoming less likely with a larger money supply and growing government spending, it is still not out of the question. With key rates almost as low as possible and government spending higher than any other recessions in United States history, if deflation were to creep back up, there may not be much the government could do about it. Deflation would cause lower prices and incomes, all the while making debts harder to pay off. Debtors would be paying off loans with money that is worth more, causing some of the companies on the fringe to default and fail.

Comments

[Tricky]

Other big possibles:
4. Massive losses on Alt-A and prime mortgages (already starting) -- potential for a bigger mess than subprime
5. We need to help bailout UK and/or Eastern Europe
6. Oil supply shock caused by geopolitics

2009 Apr 24 09:37 AM

[ozzy43]

"government is rushing to help instead of making things worse"

This statement betrays a fundamental misunderstanding of, and mistrust in, market forces which cannot be denied. The 'help' government is 'rushing' to supply is, of course, 'making things worse'. Preventing insolvent, corrupt businesses from failing - at gargantuan expense - will only prolong the agony.

2009 Apr 24 10:16 AM

[austrian63]

"The government is rushing in to help instead of making things worse."

Government "help" is causing us to consume capital, the very life blood of growth and progress. How many new technologies and businesses will never start because capital was diverted to "save" corrupt, inefficient and bad businesses? Also, loose credit, artificially low interest rates and an expanding money supply caused the problem in the first place.

2009 Apr 24 01:25 PM

[Ryan Vanzo]

Thanks for the comments.

As to the government aid, I agree with most of you that there are problems with it. Government aid, financed by debt, and keeping uncompetitive companies in business always comes with a price. I was merely pointing out that I would much rather have the Fed of today than the Fed of the past that tightened credit and money supply at the worst of times. Although the system is far from perfect, I think it has improved dramatically. I was trying to compare monetary policy more than fiscal policy, which I think will cost future generations, running us into a path of extreme uncertainty.

2009 Apr 24 01:59 PM

[Whitslack]

I would rather have no Fed at all. :-)

H.R. 1207, the bill to audit the Fed, now has 91 cosponsors and counting. Urge your representative to cosponsor it.

2009 Apr 24 03:44 PM

[jhartz]

As to your second reason, political tensions, would that include a violent US taxpayer revolt? If not, why not?

2009 Apr 24 04:45 PM

[altaman]

Unfortunately "the government is rushing to help" only the politically connected in finance and labor as always. These guys have never run anything actually produced the desired result and always at 5x the predicted cost. Government no-nothings picking winners and losers is failed socialism and is no substitute for millions of people making decisions about what is in their best interests in a relatively free capitalist system. These bloated oligarchs and their political lapdogs are rapidly killing the golden goose of prosperity and freedom that was American capitalism and the bill will come due in the form of crushing taxes, unrest, stagflation and broken promises.

2009 Apr 24 04:58 PM

[Ryan Vanzo]

I do agree with most of everones views on fiscal policy. The economy can usually right itself on its own, but a politician would commit political suicide if they stood up at the podium and said,

"Just sit back and relax, it will all correct itself in time, don't worry."

By the time they decide to do something, it is usually too late (in the sense that the problem is too large or is already over), is too costly, and is usually not even needed. Government's fiscal policy to solve problems is usually just to show to public they are trying something (over 90% of government proposals are shot down), they are usually never really meant to do anything.

Monetary policy on the other hand is completely different. I believe the Federal Reserve has done a good job at increasing liquidity, but there have been problems with the TARP and TALF plans. It is my opinion that it would have been best to team up with private entities instead of the government taking on the load.

Thanks again for the comments.

2009 Apr 24 05:13 PM

[Moon Kil Woong]

How about a 4th cause: The head of the Federal Reserve goes to jail?

optionarmageddon.ml-im.../

REPORTER: If Henry Paulson and Ben Bernanke really told the CEO of Bank of America to keep quiet about losses at Merrill Lynch, they were probably breaking the law. That’s according to Lynn Turner, former chief accountant at the SEC.

LYNN TURNER: If these allegations are proven true, both Bernanke and Paulson should be prosecuted by the SEC to the fullest extent of the law.

2009 Apr 24 07:07 PM

[Ryan Vanzo]

Although I do believe they tried to keep Ken Lewis quiet, and they may have broken the law doing it, I wouldn't expect any trial and charges. Even if they were charged, they would either be dropped or pardoned immediately, so things can stay smooth. They did not commit a crime against the US, even though it did break some laws. I would not be overly confident about seeing them in jail, it just won't happen.

2009 Apr 24 07:28 PM

[Ryan Vanzo]

Correction to the last comment. When I say they didn't commit a crime to the US, I didn't mean that it was ok. They were wrong and they should face the consequences everyone else would face.

What I meant was that they were not intending to hurt the US, but rather help it.

2009 Apr 24 08:50 PM

[Ryan Vanzo]

jhartz: I do believe this would be included in political tensions. Tea parties around the country have split not only political factions, but also the people themselves. A strong unified people helped bring us out of the Depression. If we are not together, but fighting to worse things, it could hinder a recovery.

Thanks for pointing that out.

2009 Apr 24 08:54 PM

[$OMALIA]

Why another downturn?
This one is enough to last for 30-50 years.

2009 Apr 25 07:50 AM

[CLH]

The downturn may drag on for some time but getting worse--I cant see it.

2009 Apr 25 09:20 AM

[Old Trader]

I wonder if a dropping dollar would cause a market drop. Actually, it might well cause asset values to rise, at least in nominal terms (NOT inflation adjusted ones). During the post 2002 run-up in the market, the dollar, vis a vis the Euro, declined at a steady rate. In fact, at the peak in oil prices, the EU countries were paying roughly some 40% less for their oil by virtue of the fact of Euro strength (since oil is priced in dollars, although that might change at some point in the future).

2009 Apr 25 10:53 AM

[H. T. Love]

On Apr 24 07:07 PM Moon Kil Woong wrote:

> How about a 4th cause: The head of the Federal Reserve goes to jail?
>
>
> optionarmageddon.ml-im.../
>
>
> REPORTER: If Henry Paulson and Ben Bernanke really told the CEO of
> Bank of America to keep quiet about losses at Merrill Lynch, they
> were probably breaking the law. That’s according to Lynn Turner,
> former chief accountant at the SEC.
>
> LYNN TURNER: If these allegations are proven true, both Bernanke
> and Paulson should be prosecuted by the SEC to the fullest extent
> of the law.

Liklihood of that happening? Zilch. SEC did/could not do its job on non-politically-connected entities. Chances they could/would on these "fair-haired boys" seem low to me.

HardToLove

2009 Apr 25 12:07 PM

[Mutual Fund Wealth]

I agree, markets to fluctuate for sure, but hope 8000ish for the Dow will prove to be the low going forward.

Doug T.....The mutual fund guy


On Apr 25 09:20 AM CLH wrote:

> The downturn may drag on for some time but getting worse--I cant
> see it.

2009 Apr 25 08:06 PM

[Old Trader]

Doug,

Not to rain on your parade, but I'm not certain how realistic your hope for 8kish as a low for the Dow going forward is. From purely a technical perspective, there seems to be some fairly strong resistance at 8k.

Just sayin'....


On Apr 25 08:06 PM Mutual Fund Wealth wrote:

> I agree, markets to fluctuate for sure, but hope 8000ish for the
> Dow will prove to be the low going forward.
>
> Doug T.....The mutual fund guy

2009 Apr 25 08:13 PM