The Next Great Recession?!
Before you answer, consider this historic episode in the shaky-and-shady world of economic forecasting …
The scene is the annual Fed gathering at Jackson Hole, Wyoming; the time, August 2005.
Conference attendees are invited to honor the outgoing Fed Chairman under the theme "The Greenspan Era: Lessons for the Future."
And they include three brilliant minds at the pinnacle of America’s economics intelligentsia:
Robert Rubin, former Secretary of the Treasury.
Larry Summers, also former Treasury Secretary and President of Harvard University, plus …
Alan Greenspan, himself, appointed Federal Reserve Chairman by Ronald Reagan 18 years earlier, serving almost as long as the longest-tenured Fed chief in history, Bill Martin (1951 to 1970).
On the first day of the conference, giddy optimism is unanimous and palpable.
The financial markets, they all seem to believe, are virtually fine-tuned to perfection.
The global economy, they agree, couldn’t be on a better long-term track.
Even the U.S. housing boom, according to Greenspan, is one of the greatest things that’s happened to average consumers in many decades.
On the second day, however, a jack-in-the box pops up unexpectedly; one lone speaker who dares inject the four-letter R-word into his speech title — risk.
Adding insult to injury, the speaker, University of Chicago’s Raghuram Rajan, pokes a hole in Mr. Greenspan’s pet economic theory by suggesting that maybe, just maybe, the housing boom might actually be a bubble in disguise.
The vicious vibes of the crowd are virtually visible: "How dare you defy and defile this sacred ceremony for the one man who has so prominently promoted the building boom’s benefits and blessings?!" goes the subtext of the audience’s response.
Everyone looks around to see who will rise to the occasion, tell the "truth," and put the rebel in his place.
They’re not surprised when Harvard President (and Pollyanna-in-Chief) Larry Summers steps up, making it obnoxiously obvious that absolutely nothing is abnormal except the speaker himself.
Eventually, however, all three of the most prominent participants admit their blunders and each turns over a new leaf:
|Robert Rubin (top left), Alan Greenspan and Larry Summers.|
Larry Summers sheepishly admits his error four years later, when he takes the podium at the IMF’s annual conference, delivering a speech that shakes the world of economics. The weak recovery, he argues, isn’t just a hangover from the Great Recession. It’s evidence of a chronic sickness that predates the crisis.
His diagnosis: Even in seemingly good times, the U.S. economy is incapable of creating enough demand without bubbles or extraordinary stimulus.
That’s also around the time when Robert Rubin wins what one commentator calls "the gold medal of the economic policy show-no-shame contest." In a Wall Street Journal op-ed, Rubin vigorously argues that "the Fed needs to take the risk of asset bubbles more seriously."
But if you think this story is on the pitiful side, consider these
Pitiful Numbers …15 percent: The probability of a deep recession given by the entire staff of the New York Federal Reserve in the fall of 2008. And this was the number they came up with even after the housing bust, and even after a massive collapse of financial markets.
5.9 percentage points: The New York Fed’s error in its 2008 GDP growth forecast. They predicted it would be a +2.6%. It actually turned out to be a minus 3.3%.
11.4 percent: The proportion of recessions around the world that are predicted by the consensus of economists, even just three months before the recessions begin.
Zero: The confidence establishment economists merit from investors like us, especially when they tell us there are "no recession signs on the horizon," or "no core indicators pointing down."
In a moment, I’ll show you why, as of the latest data, these last two platitudes are verifiably invalid today, based on establishment economists’ own approach.
But first, let’s explore why they have always been, and probably will continue to be, so far off target in times like these.
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Ancient Modern Math
Modern economics is based on calculus, the mathematics developed by Isaac Newton and Gottfried Wilhelm Leibniz. In the 17th century.
It’s also the math which drives the Holy Grail of economic forecasting models: The same model that earned Wharton professor Lawrence Klein the 1980 Nobel Prize in Economics; essentially the same model the Fed still uses today; and almost universally the same forecasting approach relied upon by economists all over the world.
All still based on 17th century calculus.
It’s very good at calculating rates of change.
Very inadequate for predicting changes in direction.
And downright horrible when it comes to anticipating sudden breaks with the past.
Think of a simple rubber band. It’s easy to predict how far it will stretch with each added unit of force applied. What’s hard to predict is precisely when it will snap. That’s what happened in 2008. That’s what could happen again in the future. And that’s why most economists are as clueless today as they were then.
Prejudice and Pride
I’ve been telling you the sad saga of bias in the world of financial analysis for over thirty years.
How decision-makers at Moody’s, S&P and Fitch were so profoundly riddled by conflicts of interest that they consistently gave "excellent" ratings to the largest soon-to-fail banks and insurers in history, right until the day of failure.
How most Wall Street analysts continued issuing "buy" grades on stocks even after they had lost over 90% of their value, even after the companies filed for Chapter 11.
How many analysts knew their conclusions were dead wrong, but failed to issue downgrades strictly because of the "culture"… the culture in which truth-tellers are terminated; falsifiers, richly rewarded.
What I have not yet discussed in detail is how a similar culture pervades establishment economic forecasting:
To stand before an audience of Greenspan worshipers in 2005 and talk about dangers in the financial system was a sacrilege.
To work at the Federal Reserve of New York in 2008 and dissent from the staff’s consensus GDP forecast would create even greater career risk.
And today, even after years of post-recession repentance, anything more risqué than the usual eco-speak euphemisms still elicits ridicule and ostracism from peers and superiors.
You’d think that, after the biggest credit crisis in nearly a century and the worst blow-ups of derivatives ever, economists would start paying more attention to data in those two categories: Credit and derivatives.
But they’re not. Nor are they recognizing how sensitive these two factors are to the small interest-rate hikes that we know are coming (despite just-announced delays).
Instead, economists are still living in their comfort-food world of data they can digest. Like the "tried-and-tested," "Big Four" indicators heavily relied upon by the National Bureau of Economic Research (NBER), official arbitrators of America’s recession calendar.
For argument’s sake, let’s disregard the official fact that these indicators are not predictors; that they strictly tell us what’s happening now.
Let’s turn a blind eye to recent history — the historical fact that these same indicators (plus many others) failed to detect the Great Recession until it was far too late.
And let’s just look at them objectively to see where we stand …
Two of the Big Four indicators are holding up pretty well so far: Real Retail Sales and Real Personal Income (excluding Transfer Payments). But the two others have been sinking steadily for months.
Industrial Production: The rate of growth has been sinking virtually nonstop for about four years. And the actual level of industrial production has been mostly contracting for nine months.
In fact, as you can see from the red dots in the chart below, the U.S. Industrial Production Index is now below the level that predicted nine of the last ten recessions.
The one exception: The Great Recession, when financial collapse knocked the economy down even before industry stalled badly.
The reason — the plunge you see in the chart below — is pretty obvious.
Thought the Fed’s quantitative easing (QE) was over?
But the facts are the facts:
The Fed’s balance sheet, which reflects its massive money-printing operations, continues to grow at approximately the same pace as it has since the fateful day in September 2008 when we experienced the Big Bang of 21st century financial history: The failure of Lehman Brothers.
But just as Larry Summers lamented at the IMF gathering a couple of years ago, despite all this financial stimulus, the economy is still not generating much new demand … and two of the most-watched core indicators are sinking.
So … now are you ready to venture a guess about the next recession? If so, post your thoughts to Mike Larson’s afternoon edition.
I point you in that direction for three reasons:
That’s where a lot of debate and discussion about recession is now happening.
He’s one of the few that warned of the Great Recession before it began.
And his latest issue of our Safe Money Report, dedicated to this topic, is such a blockbuster, we decided to give it to you here.
The headline title is "RECESSION 2016-2017?" And if you want to download the pdf, go here.)
Good luck and God bless!