Friday, September 4, 2009


The Lehmann Letter ©

It’s become clear over the summer that everyone expects the recession to end shortly. But what does that mean?

Recession over = Economy no longer headed south.

That could signify a sharp recovery or it could signify no growth at all. Keep in mind: The economy only has to stop shrinking for the recession to be over. The recovery could be halting, shallow and disappointing and still count as a recovery.

So it’s worth repeating this blog’s earlier analysis of past recessions and recoveries.

Before the 1990-91 recession the Federal Reserve let interest rates fall whenever inflation subsided. Building activity immediately expanded, stimulating the entire economy. But escalating inflation soon prompted the Fed to raise interest rates and constrict residential construction. That depressed the economy and instigated recession. Inflation soon shrank, leading to a new round of rate cuts and building activity.

Think of that economy the way you’d think of a frisky horse. The economy broke into a gallop (boom) as soon as the rider (the Fed) let the reins dangle (low interest rates). But the economy came to a halt (recession) when the Fed pulled back on the reins (high interest rates), only to shoot forward again when the Fed relaxed its grip. Consequently those recessions were V-shaped, with sharp downturns and equally sharp recoveries.

The 1990-91 and 2001 recessions departed from this stereotype. The 1990-91 recession is associated with the first Persian Gulf War. That downturn came to an end when soaring computer and software expenditures led to the 1990s dot-com boom. The late-1990s boom collapsed when full employment boosted wages and salaries, thereby constricting profit margins and business capital expenditures and leading to the 2001 recession.

The Fed, in a traditional response, depressed interest rates from 2000 through 2003. The consequent real-estate bubble, and that bubble’s demise, led to the current recession. Once again the Fed dangled the reins, hoping the horse would gallop forward. But this horse remains exhausted from its 2002 – 2006 run. It’s barn sour and requires rest. It won’t break into another run for quite a while.

That means we can’t expect another V-shaped recovery. Right now we’re on the horizontal bar of an L, hoping at some point it will turn into a U.

© 2009 Michael B. Lehmann

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