Real World vs. Financial World
More and more indicators are highly suggestive of an upcoming recession. I recently talked about capital spending, home sales, GDP, auto sales, and manufacturing in “Capital Spending Suggests Hard Landing.”
This month’s free issue of Contrary Investor, called “Deficit Attention Syndrome,” contains some interesting charts and commentary on still more indicators that are signaling recession. Let’s take a look at a few of the charts:
Nominal Retail Sales
U.S. Imports Annual Rate of Change
Trade Deficit Spread
Trade Deficit 12-Month Moving Average
The trade numbers, auto sales, retail trends, housing conditions, and slowing in corporate capital spending all point directly toward a recession as a very strong possibility, based on historical precedent. But this real world of the U.S. economy is colliding with the global financial markets of the moment — financial markets that are clearly being supported and elevated by acceleration in monetary accommodation as of late. Across the globe, the year-over-year rate of change in monetary aggregates in the major economies is running in the double digits.
Here in the U.S., we know that M3 was bound, tied, and thrown off the side of the ship into the deep blue abyss a year ago. But as a quasi-substitute, MZM (money of zero maturity) is relatively broad in and of itself as a measure of monetary levels and acceleration. As an example of what’s really happening in the land of stateside money/credit creation, the following table lists the annualized growth rates of MZM over the last one, two, three, six, and 12 months. Get the picture?
There is no need for a quasi-M3 substitute. Bart at NowAndFutures.com has reconstructed M3. The only component that is not available is eurodollars, and Bart estimates that based on historical correlations. Still, eurodollars are only about 3% of M3, so unless eurodollars have skyrocketed unbeknownst to anyone, whatever he is off on eurodollar estimates is not likely to be statistically significant. Bart calls his reconstructed numbers M3b. Here is the weekly chart as of April 28:
Is this a start of a pullback in M3? It will be interesting to watch going forward. A couple weeks do not a trend make, but the Fed is having a difficult time defending a 5.25% target (on the high side). There have been several reverse repos recently, so we need to watch and see if this pattern continues.
Excluding Everything, Things Are Fine
Caroline Baum is writing, “Housing? What Housing? I Don’t See Any Housing”:
“Excluding housing, the U.S. economy is doing just fine.
“That’s the latest rationalization of a select group of operators who think that the Bush administration’s 4.6 percentage point cut in the top marginal tax rate and 5 point reduction in the top capital gains rate can protect the economy from any and all ills.
“To say that ex-housing the economy is doing just fine is tantamount to claiming that ex-Iraq, Bush’s Middle East policy is a rousing success.
“How valid is the claim that outside of housing everything is hunky-dory? Let’s go to the videotape to see how housing-centric the U.S. economy’s weakness really is.
“The Commerce Department reported Friday that real gross domestic product rose 1.3% in the first quarter, the slowest pace in four years. The year-over-year growth rate slipped to 2.1%, also a four-year low…
“The first quarter’s sluggish growth wasn’t confined to housing, however. Exports declined, inventories were a small drag, and capital spending (investment in equipment and software) rebounded 1.9% — better than expected based on monthly data on shipments, but nothing to write home about after declines in the second and fourth quarters of last year.
“‘The initial weakness was in housing, but the weakness in capital spending is not a cross-infection from housing,’ says Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, N.Y.
“One year ago, capital spending was growing at a 9% year-over-year rate, he points out. Now it’s zero.
“‘A year ago, people said capital spending was going to rescue us as housing slowed,’ he says. ‘Capital spending is down to zero (year on year). There’s been an unambiguous slowdown’…
“Companies that haul the stuff consumers buy — United Parcel Service, for example — are reporting weakness in their domestic operations. UPS, the world’s largest package-delivery company, said U.S. volume showed no change in the first quarter from a year ago.
“‘I don’t think much of UPS’s business is housing related,’ [Northern Trust’s Paul] Kasriel says. ‘They don’t ship lumber, wallboard, and toilets’…
“Another quarter of growth with a 1% handle is apt to make Fed officials nervous for the simple reason that there is no mandate for a recession with inflation running at 2-something percent. When growth is that slow, all it takes is a big quarterly inventory decline to thrust a negative sign in front of GDP, which in turn leads to a diminution in confidence.
“While Fed Chairman Ben Bernanke’s reaction function is different than Alan Greenspan’s — he’s not a politician, looks uncomfortable at hearings, and keeps his answers short and to the point — he isn’t immune to what’s going on around him.
“Imagine how it would look if Congress were to ask him to explain why the Fed let the economy slip into recession with inflation so low. Would Bernanke be able to keep a straight face when he told them that GDP ex-housing was solid?
“Heck, GDP excluding consumer spending, business investment, housing, and exports was robust in the Great Depression, too.
Things aren’t fine when you have to exclude everything to prove it. Then again, that’s the difference between the real world and a financial world gone crazy with leveraged buyouts, derivatives, and carry trades.
May 4, 2007