Friedrich von Blowhard writes:

Dear Blowhards,

I’ve been doing a little light surfing this morning, and have to say that the overall impression is that we’re heading back to those good old days of the 1970s. Not only do we have an unpopular war dragging on in the Third World, but the economy seems to be headed into an unpleasant combination of recession, prolonged slow growth and higher inflation. Remember "stagflation"?

Well, don’t take my word for it. Let’s start with The Economist’s story from November 15, 2007, "America’s vulnerable economy":

More timely signs suggest that the economy could stall in this quarter. By early next year, output and jobs could be shrinking. The main cause is the imploding housing market. Experts said that house prices could never fall nationwide. But fall they have, by 5% in the past 12 months. Residential investment has collapsed, but a glut of unsold homes means that prices have much further to drop. Americans' spending is likely to be dented much more by a fall in house prices than it was in 2001 by the stockmarket's collapse.

Then follows a Bloomberg story by Kabir Chibber on November 16, “Goldman Sees Subprime Cutting $2 Trillion in Lending”:

The slump in global credit markets may force banks, brokerages and hedge funds to cut lending by $2 trillion and trigger a "substantial recession" in the U.S., according to Goldman Sachs Group Inc. Losses related to record home foreclosures using a "back- of-the-envelope" calculation may be as high as $400 billion for financial companies, Jan Hatzius, chief U.S. economist at Goldman in New York wrote in a report dated yesterday. The effects may be amplified tenfold as companies that borrowed to finance their investments scale back lending, the report said. "The likely mortgage credit losses pose a significantly bigger macroeconomic risk than generally recognized," Hatzius wrote. "It is easy to see how such a shock could produce a substantial recession" or "a long period of very sluggish growth," he wrote.

Chiming in, we have Nouriel Roubini (admittedly, a long-time proponent of the hard-landing school of thought) on November 16 on his blog:

But the evidence is now building that an ugly recession is inevitable. Thus, the repeated statements by Fed officials that they may be done with cutting the Fed Funds rate are both hollow and utterly disingenuous. The Fed Funds rate will be down to 4% by January and below 3% by the end of 2008.

I suspect that Mr. Roubini is correct, but if so the inflation rate is likely to rise to unpleasantly high levels. In fact, inflation already seems to have gotten a bit of a head start on our Federal Reserve inflation hawks, oops, I mean, interest rate cutters.

Barry Ritholtz, author of The Big Picture blog, has been a long-time skeptic of official inflation data. On November 14th, he questioned the official line that the Producer Price Index was a benign 0.1 percent in October:

0.1% PPI ? Not according to the BLS year over year data:

"From October 2006 to October 2007, finished goods prices advanced 6.1 percent. Over the same period, the index for finished energy goods climbed 16.6 percent, prices for finished consumer foods rose 7.1 percent, and the index for finished goods other than foods and energy increased 2.5 percent. At the earlier stages of processing, prices received by intermediate goods producers advanced 5.6 percent, while the crude goods index jumped 25.7 percent for the 12 months ended in October."

Perhaps its just me, but I fail to see how that can be considered benign inflation data.

And on November 16, Mr. Ritholtz pointed out that consumer prices in October also suggested a higher-than-acceptable trend:

Headline CPI grew 0.3% over the past month, the same as September. The core index (excluding food and energy), rose 0.2% for the fifth straight month. Annualized, that's 3.7% and 2.2% (ignore the rounding). At 2.2% gains year over year, Core inflation is above the Fed's target rate. Starbucks (SBUX) was the latest company to feel the pinch of inflation: Rising wholesale prices forced the world’s largest chain of coffee shops to raise drink prices. This led to the first ever decline in visits, and a lowered profit and sales forecast. Starbucks, up until recently, very much a stock darling, has seen their share price tumble by a third this year.

As we have repeatedly stated, there is no free lunch. When you drop rates as low as we have, you ignite price increases.

Gee, a tradeoff between slow growth and raging inflation. It brings the sweet smell of my young manhood back to me. Yves Smith of Naked Capitalism points out, in his post "On the Risk of 'Generalized Meltdown of the Financial System'" that the government’s powers may once again not equal to the situation we find ourselves in:

[T]he tools that the powers that be have for ameliorating the damage look woefully inadequate. Lowering interest rates has neither revived the commercial paper market, salvaged overextended mortgage borrowers, nor made banks more generous with credit...no one seems to acknowledge that there are practical limits on what the federal government can do...Japan at least entered its post-bubble-era hangover with a high savings rate. Lacking that, the US has even fewer options if things turn out badly. Policy makers need to think more in terms of triage than broad-based rescue operations.

Maybe we should break out the disco balls and the gold jewelry again, no?

Cheers,

Friedrich

P.S. As MB's recent post points out, we're even going back to the Seventies in our movies! Dang, we're jive-talkin' now!

ABBA albums. On vinyl.

Posted by: Fred on November 17, 2007 2:31 PM

Mmmmmmm: stagflation. Now doesn't that word bring back a lot of good memories ...

Posted by: Michael Blowhard on November 17, 2007 2:38 PM

Awwww, geeze, again? Well, I suppose I can handle it as long as they don't bring back harvest gold or avocado-green kitchen appliances.

Posted by: Sgt. Mom on November 17, 2007 3:12 PM

No bellbottoms, please.

Posted by: Lester Hunt on November 17, 2007 5:35 PM

I can hardly wait to hear the Fox spin meisters figure out why this is all Bill Clinton's (or even Jimmy Carter's) fault. It obviously has nothing at all to do with those tax cuts for the ultra-wealthy and the "Don't ask, don't tell" approach to regulating Wall Street.

Posted by: Chris White on November 17, 2007 7:10 PM

Sorry to spoil the fun, this doesn't look very much like the '70's. Some of the big differences:

• Nixon got Fed chief Burns to allow loose monetary policy while he took care of loose fiscal policy, then made it worse with wage and price controls. Hilarity ensued. Bernanke is not Volker or Greenspan, but he's better than Burns, and the federal deficit is not too bad and is getting smaller.


• The '70's happened because one administration was cynical enough to cause the problem and its two successors were unlucky and incompetent enough to make matters worse. Idiocy on that scale almost has to happen on purpose. If either the Fed tightens up, as I believe it will in the next 18 months, and fiscal policy stays within the bounds of reason, things will not get out of hand. Ordinary blundering will not be enough to bring back a 15% misery index.


• Real estate appreciated quickly in the '70's as cash became something to get rid of. Precious metals were all the rage. This time, real estate is falling in value and the upward movement of gold is largely a function of a dropping dollar. Oil, unfortunately, looks like it is putting on its wide lapels.


• Unpopular wars in third-world countries must occasionally be fought. They become a lot more popular, but no more or less necessary, when they are won. This one is still winnable.


• Punk is dead. However, if disco (which still sucks) comes back, punk will have to crawl out of the coffin. You will not necessarily need one of those stupid white suits, but Converse high tops, blue jeans, and leather jackets still look good.

The genius of our system is not that we get things right more often than the rest of the world, but that we are quicker to notice our screw-ups and correct them. That's still the case. It's not completely idiot proof, but it is more idiot resistant than any other system.

Posted by: Mitch on November 17, 2007 9:40 PM

Anyone know what sorts of investments did well in the seventies?

Posted by: Charlton Griffin on November 17, 2007 9:59 PM

[Charlton Griffin said]
"Anyone know what sorts of investments did well in the seventies?"
I'll bite, assuming you weren't asking with tongue in cheek (which I say because I'm old enough to remember it all, though I was too young to be an investor myself).
Precious metals, collectibles, real estate; in other words, tangibles, aka "stuff." Collectibles would seem to be the domain of folks with beaucoup money (unless one wants to put one's entire wad in a painting) and real estate has been blown into a bubble already, rendering it a non-bargain. I went long precious metals (mostly equities of mining companies) at the turn of the millennium and made a big enough killing already to not have to work anymore. And it's still in the early innings as evidenced by the fact that everyone still regards metals as "risky." Volatile, yes, risky, hell no. From '68 to '80 gold went from $35 to over $700. The year is now 1975. In 1975, mainstream advisors were still advising people to steer clear...five years later, they all agreed everyone needed at least 10% in their portfolio. As long as you avoid individual stock-picking, you can make a tremendous amount of money buying a mining stock fund or ETF. The swings will be wild, but if you buy and hold, resisting the temptation to trade in and out (and wait for gold to be a Time Magazine cover item five or ten years from now) you will not be distressed by escalating inflation. I'm here to tell you that sleeping till noon and surfing the internet all day is not a bad life. Buy, buy, buy. Kitco.com has the charts and commentary to get you started (gold-eagle.com too, though that has lots more B.S. to wade through). Also 321gold.com and JSmineset.com Behold, the wisdom of an elder: http://www.321gold.com/editorials/russell/russell111703.html

Posted by: Yakking Guy on November 18, 2007 12:44 AM

Yakking Guy notes "Collectibles would seem to be the domain of folks with beaucoup money (unless one wants to put one's entire wad in a painting)"

Here's a quote from the Mei Moses Art Index site:
http://www.artasanasset.com/

"In general arts relative performance is based on the historical time period under consideration. For example over the last fifty years the Mei Moses® all art index has slightly underperformed stocks. It has significantly underperformed stocks for the last 25 years and has slightly outperformed stocks for the last ten years and significantly outperformed stocks over the last five years. However for all these time periods art has higher volatility and lower liquidity than most other financial assets. However art has low correlation with other assets and thus may play a role in portfolio diversification."

One interesting caveat is that "Masterpieces" are more likely to under perform when compared with the overall art market. Should someone be looking at art as a possible investment they would be better off NOT putting their 'entire wad into a [single, masterpiece] painting', but rather to acquire a group of works that may seem somewhat undervalued.

Given the various postings on 2Blowhards about less recognized talents from various pre-modernist movements perhaps Donald and Michael should consider becoming art investment advisors. My own tastes are more skewed toward abstraction where there are similarly undervalued artists to be discovered ... as there are in almost any genre. Stay away from those Thomas Kincade 'limited editions' however.

Posted by: Chris White on November 18, 2007 8:57 AM

Thanks to everyone for their comments.

Mitch: I'm not suggesting that the comparison to the Seventies will hold up in every detail, but the unpleasant dilemma facing the Fed of choosing on the one hand to raise rates to stifle rapidly rising inflation and on the other hand to cut rates to prevent a recession suggests, to me, that they won't do either vigorously and we may endure both the highest inflation of the post-Volker era and a significant recession. That inflation, I grant you, is unlikely to reach the actual heights experienced in the 1970s. I notice that there's a Bloomberg story up that suggests that the financial futures market shows that investors are expecting not one but repeated interest rate cuts to bail them, um, I mean the economy, out, despite the various noises that the Fed has been making that it's more or less through with cutting and it's starting to get really worried about inflation.

Charlton: You raise a good point, and one I hadn't really pondered. I'll have to give that some thought. My only investment idea at the moment is to assume that the dollar will continue to fall. As for Chris White's idea, I've never seen data on what happens to art investments in recessions, but it's a thought. Another thought is that you should do whatever it takes to become the head of an investment bank, because then you will be guaranteed a multi-million dollar income no matter how bad your performance is. Hey, it worked for Mssrs. Prince and O'Neal!

Posted by: Friedrich von Blowhard on November 19, 2007 1:22 AM

Not saying the gloom and doomers are wrong, but how do you square g & d with full employment (historically, it's been harder to get to lower unemployment) and the evidence all around (at least I see it) of incredibly widespread prosperity?

Posted by: ricpic on November 19, 2007 10:32 AM

Ricpic:

Well, how "full" is our "full employment"? Remember, the government's employment numbers are massaged by removing people who are no longer looking for work, a group that has risen by over a million people in the relatively recent past. When you look at the number of people actually employed today as a percentage of the total population, that number has been falling for a while and is well below historical peaks.

Check out these links for a fuller discussion:

http://bigpicture.typepad.com/comments/2007/11/cyclical-jobs-r.html

http://bigpicture.typepad.com/comments/2007/09/a-closer-look-a.html

Not to seem paranoid, or anything, but it is a little odd how many government statistics, widely and uncritically reported in the press, seem to be massaged to look more optimistic. Those include "core inflation" numbers, "unemployment" numbers and "jobs added" numbers. You wouldn't think they're trying to finesse things a bit, would you?

Posted by: Friedrich von Blowhard on November 19, 2007 11:47 AM

ricpic and FvB,

If you look at the official statistics from the BLS, they have different categories (U3-U6) which give different numbers for the unemployment rate. The broadest measure is U6. You'll see that it is approximately twice the official rate. And since the official rate is massaged, one can only guess what the real rate is, but it is much, much higher than the official rate.

Unemployment here is just as bad as it is in Europe.

Posted by: BIOH on November 19, 2007 2:54 PM






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