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Let the Year of the Ox begin!

As the Year of the Ox is about to begin (January 26), I hope the anxiety and fear from the Year of the Rat will give way and in its place confidence will re-emerge.  In our complex economic world, theories were tested; experiments were made.  Some of them failed; some were derailed; some still look for validation.  We are traveling in uncharted waters as the magnitude of deleveraging is unprecedented.  To avoid an outright liquidity trap now and to protect the economy’s long-term growth viability after a huge run-up in public debt, a new course has to be mapped based on integrated political, economic, and financial analysis, with human behavior as a key element of the risk structure.  Because an economic outcome is determined by what we (no one else) do as economic participants, it is important to remember there are always two approaches in difficult times - you either give up and give in, or you actively find a solution and work toward it.

Arguably, half the battle for economic recovery is one of confidence.  Negative headlines like those describing the 2.6 million job losses in 2008 as the worst since 1945 without considering six decades of population growth, and others portraying the current economic situation as similar to the 1929-33 Great Depression, work against confidence building.  To be sure, the economy is undergoing a painful adjustment process and the current situation is very challenging.  But we need to recognize that the unemployment rate is some distance from that of the early ‘70s and early ‘80s; the early ‘80s saw a double-digit rate for 10 consecutive months.  December’s 7.2% unemployment rate was still below that registered in 1992 (7.8%), far from that of the Great Depression, when one out of every four people lost their job.

We also need to recognize that, despite the fact that the National Bureau of Economic Research’s Business Cycle Dating Committee has declared that a recession started in December 2007, real GDP actually grew 1.3% in 2008.  It was around September when Lehman’s collapse and the subsequent freezing of the credit market translated a year-long financial crisis into a collapse in economy-wide activities.  Since then panic has been widespread and reinforcing.

It is equally important to recognize that policy actions have been swift and the intention clearly has been toward stimulating the economy.  This has been demonstrated by both the Bush administration and the incoming Obama administration.  This is in sharp contrast to the Great Depression when taxes and tariffs were raised and the FDIC was not in existence to protect depositors.

In the next few months, at least, we will continue to see an uphill battle in finding and implementing the right policy measures and a struggle to communicate both the substantive and inspirational messages.  The first $350 billion of the TARP money used mainly in shoring up banking sector capital ratio, together with the Federal Reserve’s actions, have led to some tentative signs of stabilization as the TED spread, an indicator of perceived credit risk in the economy, has come down and mortgage rates have also come down noticeably.  It is widely expected that more fiscal stimulus will come once the new administration is in office.

On the monetary side, the primary problem we are facing in the economy is a liquidity problem or a money supply problem that directly affects consumption and investment activities.  Despite remarkable efforts by the Fed in increasing the monetary base, liquidity dried up in a matter of a few months when the private portion of it collapsed.  This portion includes various types of typically liquid assets (e.g., mortgage-backed securities) which have a monetary value assigned to them.  When risk aversion increased due to falling home prices, the demand for mortgage-backed securities disappeared and an earlier credit expansion was followed by a credit contraction.

So the question becomes how to lift the total money supply (or loosely speaking “liquidity”) by stabilizing and further revitalizing the availability of private money while, in the meantime, increasing public money.   These are precisely what the government and the Fed are working on through their attempts to limit the downside risks of troubled assets – the foundation of many securitized products – through purchases and guarantees of those assets and directly injecting capital into the private sector.  It is obvious that we are facing a major crisis on a global scale.  It is never a certainty as to how the growth outlook will take shape because no one is in the driver’s seat to change a course, yet everyone is in a driver’s seat to affect a course.  Despite periodic confusion, many policy actions with the right ingredients are already in the pipeline.  It is important to give them a chance to work.

Let’s hope the Year of the Ox will display its desirable characteristics of diligence, reliability, sincerity, strength and sound judgment.  It is important to prevent negative mentality from becoming a self-fulfilling prophesy that impairs rational thinking.  If optimism sounds too off tune these days, then how about a little less pessimism for the New Year.  After all, only when confidence comes back can we realistically expect a recovery.  And we all want to see a recovery.

Comments (12) 

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Happy New Year Gene. Your summary is indeed eloquent as Sharon stated. You also provide a more balanced view than the majority of your peers. You suggest there are two approaches in difficult times, the easier path is to give up, give in and follow the herd. Your commentary and influence will assist us in moving toward a solution and getting us through what is sure to be a wild ride during this year of the Ox.

I do believe that a positive outlook on 2009 is what we need to promote. I'm not saying that we can make any promises to ourselves or others, but negativity towards the economy is counter-productive. The problem is that people are afraid to take a strong position on anything in the state we are in. Mr. Smith said it best in his letter about corporate tax rates a couple of weeks ago. We as a country can not be afraid of making capital investments and expect growth. Obama needs to cut corporate taxes to promote growth and stop the loss of jobs, and that is something I fear he will be unwilling to do.

I agree in part with Sharron Rose. I can remain confident but the average US citizen probably feels that the very companies that are asking for bailouts are the ones that need to change. The bailouts seem to be a resource of funds to continue there same culture. They are not truly accepting the economy as it is. Change the way they do business. Take notes from those companies that are making the changes. Gain the confidence of the people by not making it harder on them. State governments stop trying to increase the taxes decrease spending on non essentials. The true stimulus will come from people who feel secure with their mortgages and can count on their personal income to comfortably live. And no we don't need regulations, we need common sense.

The core of your message is spot on, however caution is due when using references to historical unemployment measures. A couple years ago I ran into counter intuitive results from trend models that seemed reasonably sound. Much of the variance disappeared when the base metrics were recalculated using a historically consistent method. So, is unemployment 7.2% or 14.6%? The answer depends upon whether one uses the “official” 2008 or the “official” 1978 method. GDP measures are similarly inconsistent across time. It’s a real issue when attempting to interpret events and shape policy.

Although I agree that consumer confidence and positive thinking has a lot to do with recovering from a recession, it is employee condifence that is playing a major role in this recession. Many companies have reduced their workforce and our company, an industry leader, has substantially cut pay to stay in the game. It is hard to have confidence and spend money that you don't have any more. With the loss of incentive, a five percent pay cut and no merit increases for a while, many managers are seeing a year over year loss of twenty percent in annual income. Don't get me wrong, I am proud to work for FedEx and thankful to have a job. I just hope that when the economy recovers, so do our salaries.

Dear Gene:With all due respect how is the average consumer to have confidence again in light of the recent bailout funds squander. Banks have done nothing but take the money and run. Rather than lower the rates on troubled mortgages and leave the balance where they were: Banks left rates high or higher than orginal note Added late fees and extended the fees to the end of the mortgages. Added unpaid monthly payments to the end of the mortgage and gave extended "grace period" to pay up.Used the money to buy up other banks.Paid dividends to stockholder.You cannot have confidence until you get the credit reporting agencies out of the bank's back pockets. Adjust the scoring of credit reports. Bring back usury laws.

This is a very eloquent explanation of the current situation. I believe that we can achieve success with a positive attitude and positive direction.

In your opinion, is it necessary to release the second half of the TARP funds since the primary purpose was to prevent the liquidity trap, or should we keep the money out of circulation to prevent serious inflation down the road?

You state in the 3rd paragraph: We also need to recognize that, despite the fact that the National Bureau of Economic Research’s Business Cycle Dating Committee has declared that a recession started in December 2007, real GDP actually grew 1.3% in 2008. Where did you get your information from? The GDP for year ending 2008 has not been released yet. The (advance) GDP will be released January 30, 2009. However, the 3rd quarter results show a decrease of 0.5% (that is, from the 2nd quarter to the 3rd quarter),according to final estimates released by the Bureau of Economic Analysis. http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm Here's the link. Check the facts for yourself.

I think the most important thing mentioned is the fact that we need to stop the negative advertising.

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Gene provides insight and commentary on the global economy.