[For those that have asked:
here is what a real President would do.]
You can date the next recession from yesterday. No, not the contraction, that little bit that starts every text book recession - namely, when the fed makes a decision. oil and gas have surged. The highest price in real dollars, not consumer dollars, for a barrel of oil was approximately $77.60 in today's money, set in 1981, when Iran and Iraq had gone to war, OPECs official policy was not to allow price decreases, and everyone was speculating in commodities, because, "stocks are dead". Gasoline's peak in consumer dollars was around $3.60 - a level that could be broken soon.
Katrina blew away two things. One was the first guazy haze of recession denial. The second is that it put the fed on the horns of a policy bind - it wants to flood the economy with dollars to buffer the
supply squeeze, and it wants to cut dollars out of the economy to deal with the inflationary pressures that dumping roughly
100 billion into the economy is going to do.
Inflation or recession. For an economy marching through its boom, there are no other choices.
What the above graphic shows is that the long end of the bond yield curve is basically flat. That means that money is pouring into lending long, and the economy is filled with peopel making a big bet against inflation. They believe that the Fed will not let inflation happen. The rapidly descending line that says "spread-spread" is the difference between the short end of the yield curve and the long end. This is how much wiggle room the fed has. As of now, it is down to two small quarter point raises, and dropping fast. If that isn't enough to shut down inflation, then there is either an inflationary spike, or a recession in the cards.
The first thing to realize is that we are in, and have been for some months, in the boom phase of an economic expansion - that is, the period where the economy is putting on inflationary growth, but the Fed has not acted, yet, to forcefully stop inflation, because inflation has not, yet, started to reach the consumer sector. Greenspan, in order to slow a recession as much as possible, has been raising rates too slowly, which is why oil prices started to get out of control.
The simple version of the reason is that low real interest rates - that is the interest rate minus inflation - allow more borrowing. More borrowed money sooner or later ends up in the hands of an investor. If investors put their money into equities, and those equities produce more technology, the economy can often keep growing for a while. If, on the other hand, they put their money into loaning, this keeps interest rates down, and allows the economy to continue, with slightly more inflation. However, at a certain point enough investors realize that they will make better returns betting on the inflation itself, rather than on anything else, then prices spike upwards.
And that is what is happening now: enough investors have realized that it is better to bet that oil will go up, than to figure out a way to make more GDP with less oil.
The Phillie Fed announced yesterday that they support a change in interest rate policies. As with the 1998-1999 period, the Fed is going to feed the fever, and hope that they can change course later. This will mean that on the other side of this there will have to be more interest rate increases than before. Since the bond traders were already betting on an inverted yield curve, and trying to tell themselves that this would not mean a recession this time - we are now on a collision course for a late 2006 recession, one that is much deeper than it should be, because of explicit policy choices that America, as a whole has made.
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The business press has been divided into two groups: those who have used pollyana excuses and fraudulent numbers - and everytime a writer adjusts crude oil by CPI, he's simmering the books - and those who have quietly followed arcana such as yield curves and commodity prices, and worried that a disruption could tumble the economy off the tracks.
Katrina is that disruption - right now 1.4 million barrels of oil production is offline - that is the daily output of Iraq. That's right, Katrina had the same effect as shutting Iraq down would have on the world oil market. There is no zero, as in none, nada, nil, zippo, bupkis - zilch - of spare oil production in the world. OPEC can promise to pump more, but what comes out of that well is hot air.
Gasoline is in even worse shape temporarily, because a huge amount of the US refining capacity was also in the area, and was also hit. Currently futures contracts on gasoline - basically the wholesale price - have also soared.
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This disruption, in a healthy economy, would cause pain, but it would be absorbed. The net effect would be to shift a small amount of money from investment - as insurance companies cash out of positions to pay claims - and a small amount of money from other government functions to rebuilding. Or, investment basically. In short, a net wash after a fairly short period of time. It shifts some money and employment, and slows down the accumulation of capital, but disasters are often a kind of "natural emminent domain", where projects that were blocked before can move forward, because stake holders are alot easier to buy out.
However, we did not have a healthy economy - we had one on crank. That is, it was an economy that was using borrowed money to play a trick. It allowed inflation of energy, and kept consumer inflation down by offshoring of manufacturing jobs to china, which produced production deflation. This decision, very similar to the late 1920's economy where America allowed deflation in what we produced, while allowing inflation in the capital sector.
While Republican mouthpieces will pretend that everything was great, and that Katrina "caused the recession", the reality is that this recession has been a long time in coming, indeed, we had barely crawled out of the contraction, when the stage was set for it. The decision to shaft our capital formation system, and to block dissemination over the internet, in effect choking off the next tech boom in its cradle was deliberate. Middle America voted to shackle the coasts, so that the coastal people wouldn't race ahead economically. They got their way, and they are about to have their wish.
The bushconomy rested on housing, health care and homeland security. The current recession is coming because we are about to suck up the excess capacity of all three on rebuilding the Gulf Coast South. The same people who have voted against the Federal government, are now coming to the Federal government to rebuild their cities and towns.
This means that inflation is about to kick into a higher gear, and consumers are going to have to sacrifice the rest of their budgets to pay energy bills. Gasoline will reach consumer dollar levels to match oil's real dollar levels. That means that it will get to $3/gallon by next year, and stay there.
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What should have been done, back in 2001 and 2002, was a more targetted stimulus package, and a reviving of the tech economy. This would have generated GDP without oil imports. Interest rates could have been normalized earlier, and thus, when Katrina hit, the economy would have been in the position where easing would be possible. But in our world, Greenspan effectively treated Bush as a natural disaster, and kept money easy. A second disaster means that the Federal Reserve is going from sluttish behavior, to being open to all comers.
Going forward there are two things to do: work while the money flows, and save every dollar you can get your hands on. Cut expenses mercilessly, and shift to a thriftier lifestyle. Travel less, eat out less, and learn the tactics of eating from bulk - eat what you store, store what you eat, rotate rotate rotate.
That America is sunk in Iraq for two years means that the US cannot retrench into the recession. When tax revenues fall, and they will, the result will be austerity budgets that cut just as the economy is going into recession - making it deeper and longer. Or it wil require high inflation - in the 7% range. This will gut the pensions of Americans. It will also gut the investment people like the most - housing. Housing goes down with inflation. Americans have made a huge bet against inflation, and those that lend to them have as well.
The two results are either a rush to offshore if US wages rise, or US real wages will fall, allowing hiring here, but it will be at the cost of people working two jobs for lower and lower real pay. The pay cut is in the mail.
Finally, because the US debt picture has eroded signficantly during this economic cycle - one that will be very short - it will be hard to recover from. We will owe more money to the outside world, and have no revenue streams to get it from. This heralds a probable currency realignment, as the US will have to keep interest rates here very low. That will mean a depreciation of the dollar, and further increases in the price of imported oil.
And another "jobs drought" recovery. And unlike this one, because of the effects of a burst housing bubble, the consumer will not be able to borrow to prop up the economy.
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Katrina, in short, is not going to cause a recession. However, she does tip the balance and acts like a financial crisis, forcing the Fed to throw gasoline on the fire of inflation.