Economics 101

In my opinion the US Recession started in December 2007. The dynamics of this recession poses some unusual circumstances that create an interesting dilemma for investors and the US Federal Reserve.

The continuing contraction of debt is by definition, deflationary, while the Government Bail Outs of various failed financial institutions is very inflationary. The US Gross Developed Product has not turned negative (yet) due in great part to Export growth. Currently the US Dollar has gained strength which means, US Exports will decline. Our current problem is that no matter what the Fed’s does, we will have a prolonged recession. I have attached some charts to illustrate the point.

This indicator leads the general activity of the US Economy by about six months. The shaded areas on the charts represent recessions. Note that since 1968, Recessions have occurred when the Leading Indicator has turned below -1 (as it has in the July 2008 data). The Coincidence Indicator is coincident with US Economic Activity. Since 1968, when this indicator is below Zero it represents a warning, and when it is below -1 (as it is now), it is in recession.

The Lagging Indicator lags the US Economy by about four to six months. This indicators typically peaks before a recession and then follows the indicators above down. The Lagging Indicator has peaked and starting down.

Ratio of Coincidence Indicators to Lagging Indicators: This ratio is also a very powerful leading indicator that tends to lead general economic activity by about 6 months. Since 1968, a recession has occurred when this Ratio goes below -1 (which is where it is now).

The unemployment rate inverted is a good coincidence indicator that turns below -1 in recessions. Inverted means as unemployment goes up, the indicator turns down.

This indicator is a very strong leading indicator that represents the psychology of the American People regarding the US Economy. If the consumer is worried about the future, he won’t spend money and the Economy will fill his expectations. Note that when this indicator goes below -1 a recession is underway.

This index presumably measures the Consumer Inflation Rate of the US Economy. The basis for this index was changed in the years, and in my opinion does not represent the real inflation rate of our Economy.

John Williams, the President of Shadow Government Statistics (http://www.shadowstats.com), computes the inflation rate under the method that was used prior to the Clinton years and computes the rate at almost 9.00% versus 5.39% of the new “official” rate.

Trade Weighted Dollar: This indicator measures the strength of the US Dollar against our largest trading partners. If this index goes lower, it indicates the purchasing power of the dollar is declining, and vice-versa. Note the large decline in our purchasing power.

S&P 500 Stock Index: This indicator is a leading indicator and when below -1 indicates a recession. In some cases there have been “Bear Markets” (indicator below -1) resulting from investment problems, not necessarily the US Economy. We are in a Bear Market.

Earnings per Share, S&P 500 Stock Index: Currently, there are Earnings Estimates made through December 2009. Stock Prices generally move with estimated earnings (not current earnings). Actually current earnings (reported Quarterly) are a lagging indicator. The accompanying chart shows increasing earnings starting in the 4th Quarter of this year (December 2008). In my opinion, this isn’t going to happen. I expect declining earnings through the 1st half of 2009.

Gold price: Gold represents fear. The more fear in any economy, the higher the price of Gold. Deflations pose a special problem for Gold. In the Depression, the black market price of Gold initially went up, but as the price level collapsed, Gold began to decline. In the current business environment, deflation is considered more likely than inflation and therefore Gold has started to decline. I think our wonderful Federal Reserve Chairman will not let a deflation happen, and therefore will pump up the money supply to save our “credit nation”.

Reuter Commodity Index: This index measures all commodities which includes, Gold, Oil, Foodstuffs, etc. In the beginning of a Business Cycle Expansion, this index normally starts to rise and levels off as the expansion matures. Because of the Global Expansion over the past 5 years, the commodity index has headed higher. Currently commodity prices are declining led by Oil, Gold, Copper, Aluminum etc. Generally in recessions, the Index is declining.

There is overwhelming evidence we are currently in a Recession. Keep in mine the Bureau of Economic Research defines recessions, and always defines them after the fact. I think we are in for a prolonged recession that will try everyone’s patience. Until our Economy recovers, stay liquid and out of debt.