Re Assessing the Economy

A few weeks back I wrote that I was taking a "contrarian" view on the prospects for the economy. I believed given the strong GDP growth, low unemployment rate, weak dollar, and near record highs on the stock market that all of this hysteria about the state of the economy was over blown. In fact, I went as far as to say that in my view inflation was the worry not recession.

Now, since then the new unemployment numbers came out for the month of December. Those numbers proved to be quite weak. The economy only added 18,000 new jobs well below the estimates of six figures, and as such the unemployment rate rose to 5%. Now, it is important to understand that 150,000 new jobs, roughly, are necessary just to keep up with the new folks entering the work force. Thus, when the economy only adds 18,000 new jobs, it is really losing 120,000. Since July of 2003, the economy has added an average of 170,000 new jobs monthly. I made a careless error in my initial analysis. This latest report is the fourth report in a row of relatively weak jobs growth. Given this, I can say that this is strong evidence of the first signs of a weakening economy.

That said, we still have 3.6% GDP growth, as of the last numbers, the unemployment rate is still 5%, the dollar is still very weak, and even though the stock market has softened it continues to trade close to record highs. On top of this, the fed has lowered the fed funds rate by a full percentage point.

Certain segments of the market anticipate another one point reduction in the fed funds rate.

Expectations are widespread that the Fed's Open Market Committee will announce another 50-basis point cut in the Fed funds target rate at their next scheduled meeting on January 29. Larry said that Fed Chairman Bernanke should have announced a 50 basis point cut in his Congressional testimony this past week, in addition to the 50 we'll get at the end of the month.

If that happens, the fed funds rate would be down to 3.25% (keep in mind the Prime rate, the rate most know, is three percentage points higher). Now, it is important to note that Greenspan dropped the fed funds rate to an obscenely low .75% in the aftermath of 9/11. I also pointed out that the loose money these obscenely low rates created lead directly to the irresponsible lending that produced the current mortgage crisis. Will the Fed cut rates to 3.25%, and will it be enough or too low. At this point, I am reminded of the fond phrase of a late friend of mine,

if if was a fifth we'd all be drunk.

Obviously, there are a lot of variables there. Finally, the President has proposed his own stimulus package. It is unclear if it will pass and certainly when. That said, it is possible that we will have an aggressive expansionary monetary and fiscal policy simultaneously. Now, that is exactly what we had in 2002-2003 when the tax cuts were combined with lower fed funds rates.

I believe the situation in 2002-2003 was a totally different story. We had a stock market crash that caused roughly three trillion dollars in paper losses, followed by 9/11, followed by the accounting scandals. That is three separate events working concurrently to significantly weaken the market.

The situation here is a housing crisis that is either weakening the market or sending it into a recession. While speculative markets, and the housing boon was that, almost always lead to recessions, the situation remains unclear. My concern continues to be that every person in a position of power is jumping over each other to try and provide the market with stimulus.

The situation remains fluid and the next set of important numbers will be January's employment numbers the first Friday of February and then the last quarter's GDP numbers at the end of February.