The Economy Guy

Issue: 11/13/07 Tuesday  

In the midst of chaos, those that stay calm are probably dead.  That’s where the markets are today – in chaos.  So, let’s take a breather from the loud, chaotic daily fun, and talk about something some of you have recently asked me about –– Recession – What is it?

A Recession is a period of general economic decline.  The most popular definition states a recession is a decline in the Gross Domestic Product (GDP) for 2 consecutive quarters.

So, what’s GDP? (I hear you say.)  US GDP is a measure of the value of goods and services produced in the US in any given year, (and is equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports.)  I know, that last part of the definition kind of clouds the understanding by making rather complex.  It’s so much easier to just think about things built and services provided in the US.

Some of you might be asking “So, what’s a depression then??”  Great question.  A depression is the same as a recession.  Some people would have you believe that a depression is a “really bad recession.”  However, the term recession was invented after the Great Depression of the 30’s, so politicians and economists wouldn’t need to be associated with such a disaster.  From a common point of view, the word depression just isn’t used today, so you’ll be hearing the word “recession” instead.  If you remember the analytic definition of recession of a declining GDP for 2 quarters, then it is worthwhile knowing how bad was the negative GDP during the Great Depression.  Here are the numbers: 1930 -8.6%, 1931 -6.4%, 1932 -13%, 1933 -1.3%.  Today, the GDP is somewhere between +2 and 4% each year.  A recession would take it to negative territory, like –0.5% or –1%.  Those numbers aren’t far from the 30’s.  So don’t be fooled by the word “Recession”.

Here’s another tip.  Don’t be fooled with a positive GDP number report.  It is normal in the US to have inflation running between 1% and 2%.   That means we have a built in GDP growth of that much each year anyway.  You must subtract the inflation rate from the GDP growth to get a closer vision of the truth.

The key question most of you have is “What happens to the various markets during a recession?”  A really great question, and I wish it had a straightforward answer.  It doesn’t.  So, let’s start by looking at the US economy today, and try to answer a related question: “What would happen to the various US markets is the US economy tanked next year?”

Here are my guesses.  Please understand that when anyone tries to predict the future, he’s generally a fool.  (I’m not a sexist – women are NOT fools – and have the advantage of intuition.)

Stock Market – probably would go down.  A decline in economic output would mean a decrease in manufacturing and services, so stocks would follow the decrease in company profits.

Bond Market – probably would increase in value.  That means the interest rate would decline.  The reason is that the Fed would be desperately trying to stop the recession by pumping money into the economy, and the US government might help with some big spending programs (kind of easy with today’s Congress.)  How far would interest rates decline?  It depends on how bad the recession really is.  Also, human nature sometimes plays its cruel hand – as the Fed could overreact and drive interest rate too far down, or under-react and prolong the recession.

Dollar Market – probably would go down, providing the rest of the world doesn’t enter a recession with the US.  The US is still the largest market in the world, and has a definite influence on most other economies.  Some of the current weakness in the US Dollar is being caused by the fear that the US might enter a recession.

Gold Market – heaven only knows!!!   Gold would depend on so many other things, like a weakening dollar, and providing a “safe haven” for money in times of danger (think war).  My best guess would be that gold moves sideways.

Oil and Gasoline Markets – in a safe world, the price of oil would decrease during a recession as people and industry would be using less of it.  A wild card of an inflating dollar, or a threat to production (think war), or really bad weather (think Katrina), could cause it to spike very high.

Inflationary Pressures – would probably subside initially, but could grow out of control if too much money is pumped into the economy by the Fed.

I’ve only scratched the surface of this subject.  I truly appreciate hearing from you and telling me what interests you the most.

Here are Tuesday’s closing details:
DJ30 – 13,307 (Up 320 points) – one of the biggest up days in history!!!!!
10 year US Treasury Bond – 4.26%  (Up 0.05%) – moved with stocks, no big deal.
Euro $1.4601  - the dollar returned to its decline today against the Euro.  Other currencies stood still.
Gold closed at $799 per ounce. (Down $9) – gold is below $800 again.  Let’s wait to see what really happens.
Oil Closed at $91.17 (Down $3.45) – a major decline in oil prices.  I think the speculators are unwinding some of their positions.
Gasoline is $2.32  (Down $.10) – a major decline, but not enough yet to reduce those pump prices.