Monday, August 30, 2010

No More Rabbits In The Hat

The Lehmann Letter (SM)

Everyone wonders: Why is this recession so much worse than earlier recessions? Why is it dragging on for so long? Why is the recovery so weak?

To answer that, we must familiarize ourselves with earlier recessions and recoveries.

•Before the 1990s Dot-Com Boom. Household spending on homes and autos led the business cycle after World War II. As borrowing and spending surged, inflation and interest rates rose. That brought an end to the boom, and recession began. When inflation and interest rates fell due to recession, and encouraged renewed borrowing and spending, a new expansion began. That's why recessions were brief, recovery strong and unemployed workers in construction and manufacturing were quickly recalled to work.

•The 1990s Dot-Com Boom. In the early 1980s the Fed brought an end to the earlier boom-bust cycle and its inflationary bias. The economy slumped going into the 1990-91 Gulf War and remained weak for a couple of years after that. But the dot-com boom brought surging recovery and expansion without inflation. This time business, not households, led the charge as industry invested in personal computers, software applications and the Web. The economy and employment recovered and expanded sharply. We had pulled a rabbit out of the hat.

•The 2000-2001 Dot-Com Bust and the 2002-2007 Real-Estate Boom. Shrinking business capital expenditures, not contracting household purchases, generated the 2000-2001 dot-com recession. Once again concerns about a weak recovery and expansion arose, but the 2002-2007 real-estate bubble generated another expansion. That was the second rabbit we pulled from the hat.

•The Present Predicament. The bursting of the 2002-2007 real-estate bubble led to the present doldrums. The economy has passed from asset inflation to asset deflation, and the economy will remain weak as long as asset deflation prevails. We can't snap back quickly the way we did in the 1960s and 1970s when falling interest rates released an economy that had been temporarily stalled by rising inflation and interest rates. Nor is there a high-tech expansion available to rescue the economy; nor will low interest rates produce another asset inflation. There are no more rabbits in the hat.

Once upon a time we were blessed by a self-correcting business cycle that always brought snappy recovery and expansion from each recession. When that failed, the 1990s dot-com boom and the 2002-2007 real-estate bubble rescued us. Now we're in a jam and it could be a long time before we pull out of it. To repeat, there are no more rabbits in the hat.

© 2010 Michael B. Lehmann

Wednesday, August 25, 2010

Housing & Asset Deflation

The Lehmann Letter (SM)

Today the Census Bureau confirmed housing’s predicament:

July sales of new homes fell to a new low of 276,000. This bad news follows directly on the heels of yesterday's word of the drop in existing-home sales.

New Home Sales

Click on chart to enlarge.)

Recessions shaded

And the chart makes clear that new-home sales have been stumbling around the bottom for the past year. To date all hopes of recovery have been premature.

Here's why.

1. We are in the midst of an asset deflation brought on by the reaction to the earlier housing boom. Since high interest rates did not cause the housing bust, low interest rates can't cure it.

2. Today's high unemployment is a consequence of housing's slump, not the cause of it. So don't expect falling unemployment to help any time soon. The causation will run the other way: Rising employment must wait for housing's recovery.

3. Households are busy re-liquefying their balance sheets. That won't permit large down payments and new mortgage-debt obligations.

4. There's a glut of homes on the market and the rising tide of foreclosures will sustain that glut in the near future. This will discourage homebuilders and new-home sales.

Only a massive mortgage write-down, funded by the federal government, could have alleviated this disaster. And that didn't happen.

So now it will take a long, long time to dig our way out.

(The chart was taken from [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of economic indicators.)

© 2010 Michael B. Lehmann

Tuesday, August 24, 2010


The Lehmann Letter (SM)


Today the National Association of Realtors announced a big drop in July existing-home sales. These data can vary sharply from month to month and the expiration of the housing-tax-credit had an effect. But the continued housing slump is cause for concern.

And it's not just existing-home sales that have been hit hard. New-home sales and residential construction are also in the doldrums. Residential real estate is in a slump.

Prevailing rock-bottom interest rates highlight the slump. They should stimulate building and buying, but they can't do the job. Households’ balance sheets are so illiquid and debt burdens so heavy, who can blame them for sitting on the sidelines?

In past business cycles, rising interest rates choked off housing and falling interest rates revived housing. But we've just come off a new post-World War II phenomenon: The housing-asset inflation and deflation. Be prepared for a very slow and weak recovery.

© 2010 Michael B. Lehmann