Elizabeth Bailey has recently replaced Martin Feldstein as the chairman of the National Bureau of Economic Research (NBER). The Bush administration and the Republican party live in fear that the NBER will declare a recession. Mr Feldstein, who still serves on the recession dating committee, recently observed:

The U.S. may now be in a “very long” recession that will drive the unemployment rate higher, with little that the Federal Reserve can do to help.

An official recession would be a big negative for the Republicans in the fall elections, which is why every statistical and propaganda effort conceivable is being made to disguise the reality of recession. Paul Kasriel of Northern Trust lays out the evidence and sums up:

After the November elections, the National Bureau of Economic Research will tell us what we and the Fed already know - the U.S. economy currently is in a recession. Industrial commodity prices appear to have peaked, which will begin to moderate the trend in headline U.S. inflation in a couple of months. Businesses have little pricing power at the consumer level. There is no evidence of a wage-price spiral. The inflation-expectations’ anchor does not appear to be dragging. The dollar appears to have stabilized, in large part because of economic growth in the rest of the world appears to be slowing significantly. Losses continue to mount on the books of financial institutions, which will inhibit credit creation. Is the Fed going to raise its funds rate target over the remainder of 2008? Not bloody likely!

Seeking Alpha has done us the service of plotting the GDP estimates for 2008 provided by 63 economists surveyed by Bloomberg. The unanimity is appalling and to me indicates systematic bias.

As one can clearly see, only two are forecasting a recession and a brief, mild one at that. A new Los Angeles Times/Bloomberg poll found that 71% of Americans now believe that a recession is likely. All I can say is let’s review this chart this time next year and see whether the economists are smarter than the man in the street. I’m with the man in the street (surprise!). I don’t know who the surveyed shills economists are; I do know that Paul Kasriel and Nouriel Roubini are both expecting a recession.

“If I had to be bold I’d say we began a recession in December,” Bill Gross of Pimco told the Financial Times. Note that the “Super-SIV” or M-LEC mentioned in the article has been abandoned, according to the WSJ. Apparently the supply of idiots with money was rather smaller than first suspected.

Paul Kasriel of Northern Trust is more tentative, calling for a 65.5% probability of recession in 2008. We need to have a discussion on accuracy versus precision with Paul. For example, “More likely than not”. 65.5%. Economists. You gotta love ‘em.

ECRI, on the other hand, has not rolled over yet. “With Weekly Leading Index growth not far from its lowest reading since the 2001 recession, U.S. growth prospects have clearly darkened, but a recession is still not inevitable,” Achuthan said. Let’s just say I beg to differ. I think your index is giving too much credit to the stock market. Is “not inevitable” the same as “more likely than not?” How about 65.5%? Inquiring minds want to know.

Mish asked Paul Kasriel of Northern Trust about the prospects of inflation versus deflation and got the following email in response (and a follow-up interview). Very succinctly, it describes the situation in which, I believe, we find ourselves:

Japan experienced a deflation in recent years because the bursting of its asset-price bubble in the early 1990s created huge losses in its banking system. The Japanese banks had financed the asset-price bubble. When it burst, the debtors could not keep current on their loans to the banks and therefore were forced to turn back the collateral to the banks. The market value of the collateral, of course, was less than the amount of the loans outstanding, thereby inflicting huge losses of capital to the Japanese banks. With the decline in bank capital, the Japanese banks could not extend new credit to the private sector even though the Bank of Japan was offering credit to the banks at very low nominal rates of interest.Banks are an important transmission mechanism between the central bank and the private economy. If the banks are unable or unwilling to extend the cheap credit being offered to them by the central bank, then the economy grows very slowly, if at all. This happened in the U.S. during the early 1930s.

U.S. banks currently hold record amounts of mortgage-related assets on their books. If the housing market were to go into a deep recession resulting in massive mortgage defaults, the U.S. banking system could sustain huge losses similar to what the Japanese banks experienced in the 1990s. If this were to occur, the Fed could cut interest rates to zero but it would have little positive effect on economic activity or inflation.

Short of the Fed depositing newly-created money directly into private sector accounts, I suspect that a deflation would occur under these circumstances. Again, crippled banking systems tend to bring on deflations. And crippled banking systems seem to result from the bursting of asset bubbles because of the sharp decline in the value of the collateral backing bank loans.

Hope this helps,
Paul

Paul L. Kasriel
Sr. V.P. and Director of Economic Research
The Northern Trust Company
50 South LaSalle Street
Chicago, IL 60603

Paul Kasriel points out that spreads have not come in all that much since the fed’s discount rate cut. Turbulence is still very much out there.

Kasriel certainly thinks that Ben will find a way to rationalize a cut. So do I.