State of the Union: Not Good

Nathan's Economic Edge in a post called "The State of the Union - in charts" has compiled a series of charts from the Federal Reserve and the Bureau of Labor Statistics that is quite revealing. See http://economicedge.blogspot.com/2009/12/state-of-union-in-charts.html Read Nathan's post. His comments are instructive. You can scroll through the charts more easily on these pages:  (Banking and Labor).

The state of the Union is not so good.

The stock market apparently believes that we have started a recovery and that the future will be better. But history reveals a pattern that might predict a another downturn in the economy. See the Morgan Stanley article linked by Nathan: "Here comes a brutal 2010" (http://www.businessinsider.com/morgan-stanley-here-comes-a-brutal-2010-2009-11#when-will-tightening-occur-when-jobless-claims-hit-the-350k-400k-level-5) Morgan Stanley's prediction is based on the notion that the Fed, after goosing the economy with low interest rates and easy money to move things out of a recession, always tightens money and credit and raises interest rates once the economy starts to pull out. And that is exactly what Ben Bernanke has signaled that the Fed would do. See, e.g., http://www.forbes.com/2009/08/10/federal-reserve-policy-business-oxford.html

However, this is not a typical recession and recovery and there are some good reasons why the Fed might not tighten any time soon.

The economy is in a very fragile condition. Banks, especially, are in bad shape and it could take years for them to get healthy. (Their balance sheets do not show how bad because the Financial Accounting Standards Board has recanted their proposal to make banks mark their bad loans and securities to market value -- so many banks are hiding insolvency.) The banks consequently are conserving their reserves and are not yet lending, impeding the Fed's plans to print their way out of a deflation. And another wave of defaults in home commercial real estate loans is fast approaching. Consumers have adopted, perhaps permanently, a new, prudent approach to personal finance, reducing their use of credit. Easy money from home equity loans, taken out on constantly rising real estate values, is gone forever. Deflation remains a serious problem for an economy that was based on easy credit. And it will take time for businesses to adjust to a new paradigm in which they will have to fund much of their growth from earnings and what credit they do receive will be based on a higher standard of financial wherewithal.

Businesses will suffer whose sales depend on consumer discretionary spending and spending that can be postponed, which includes almost all businesses. Those businesses which provide essential goods and services will suffer less, but they also will suffer as consumers turn down the heat and shop more carefully for food bargains and otherwise seek ways to economize.

There is also the problem of the politicization of the Federal Reserve System. Ben Bernanke seems to have been more responsive than his predecessors to the political winds that blow and he does not appear to have the will to oppose them. And the passage of a bill that would explicitly make the Fed more politically responsive means that the Fed will not be able to independently act to tighten money and threaten a recovery when the time to make hard decisions comes. Even if the bill does not become law, the mere threat that the Congress can reduce the Fed's independence, is sufficient to make the Fed more politically responsive. And while some predict a robust recovery, that does not mean the Fed will raise interest rates any time soon. See http://www.bloomberg.com/apps/news?pid=20601087&sid=a7yHrrr_Vklo&pos=4 And that is why the stock market has not yet dropped in anticipation of another downturn in the economy. The market believes that the recovery will continue but others do not. See http://globaleconomicanalysis.blogspot.com/2009/12/yield-curve-steepest-since-1980-hard.html.

And all of this ignores the international scene. See http://globaleconomicanalysis.blogspot.com/2009/12/eu-ready-to-bailout-greece-debt.html.

Is there any way out of this mess? Maybe. This fellow thinks that there is no alternative than resurrecting the gold standard: http://www.washingtonexaminer.com/opinion/columns/OpEd-Contributor/Interest-increases-central-to-looming-debt-crisis-8648650-79004147.html

Many say that there is not a practical way to return to the gold standard. But others have plotted a course to do so. The biggest problem is persuading the population that there really isn't a way to have your cake and eat it too. Some day, somehow, everything has to be paid for from real wealth, not printed paper.