Be Your Own Economist ®

September 20, 2007

Welcome to the second posting of the Be Your Own Economist ® blog. Its purpose is to stimulate your interest in recent economic developments and the investment climate. We’ll go to government and private web sites to retrieve the latest data (see the discussion of today's economic indicator report below). Then we’ll apply the lessons learned in the Be Your Own Economist ® online course to interpret these data. That will help you become your own economist by placing these data in historical perspective for a broader and deeper understanding of current events.

Let's begin.

Yesterday we examined the latest housing-starts data. Residential construction has sagged for over a year and the downward trend continues. We noted that dwindling construction activity pulls other sectors of the economy down with it.

Today the Conference Board, a New York business group, released its index of leading economic indicators. The federal government developed this index years ago and then transferred it to the Conference Board. The index combines ten statistical measures into a single series designed to foretell the economy’s direction. A slumping index can signal a recession ahead.

The most recent report (http://www.conference-board.org/economics/bci/pressRelease_output.cfm?cid=1) puts the index at 137.8 and says the index fell sharply in August. You can see in Chart 1 that the index reached its all-time peak in early 2006 and has fallen slightly since. This stagnant performance and August’s drop is cause for concern. Remember that housing starts also fell from their early 2006 peak.

The question before us is: Will the economy pull out of its recent stall, or is this slowdown an omen of coming events? When you turn to Charts 24 and 25 you notice that interest rates fell sharply at the Fed’s behest during the 2001-2002 slowdown, but the decline in rates was insufficient to stem the economy’s slide. It took a while, after the recession had run its course, for the economy to snap back.

The point is that falling interest rates may not be effective against a residential real-estate collapse. We just don’t know. In the 1970s rising interest rates typically brought an end to real estate booms. Depositors withdrew their funds from savings and loan companies because existing legislation prevented the S&Ls from raising the rates they paid depositors. When the S&Ls ran out of funds, the boom was over. Interest rates fell when recession hit and deposits flooded back into the S&Ls. They could lend once again and housing took off. The recession was over.

Recently interest rates stayed so low for so long that the boom ran its course without impediment. Real estate values rose speculatively in a kind of tulip mania, then began their long slide when the bubble burst. It’s hard to believe housing will recover as long as prices fall. Even if the Fed’s interest rate cut(s) alleviate the sub-prime mortgage crisis and credit-market stringency, that may be insufficient. The housing bubble may take its sweet time to deflate before economic growth can resume. We’ll see.