Is the party over?
By Daniel M. Ryan
During this last expansion, there has been a curious alliance between the old-style media and the hardcore goldbugs. The mainstreams of both groups have decided that the current boom couldn't be counted on, that it was inherently fragile. For years, both have proven to be wrong on the face of it: the North American economy has kept churning along. Not until recently has there been any serious worry beyond those two groups, as expressed publicly.
Are the good times over? If so, how bad will it be? Is this the end of the multi-decade boom partially engendered by globalization and informational technology?
As far as the investment-market crisis that began and largely ended last week, it was an unusual one based on the timing. According to the Wikipedia article on the "January Effect," January has been the month when the average return has been highest, as of 1992. (If you're interested, October was the second-worst month; the worst was September. The rankings may have changed since then, as the "January Effect" has become less pronounced more recently to the benefit of December.)
The global decline was also unusual in that the American market did not participate in its first day, as last Monday was Martin Luther King Day and the U.S. markets were closed. Also unusual was the Canadian markets' rebound from it, one that anticipated the American markets' rebound. Of course, the immediate decision on the part of the Fed to drop both the Fed funds rate and the discount rate, by 75 basis points each, had a lot to do with the recovery: the announcement of the Bush stimulus plan didn't dissuade the drop all that much.
North American stock markets have recovered, for the nonce, but the larger questions remain: is a bear market upon us? Is a recession? If so, then how bad will either be?
The way things look now, it is indeed a bear market, at least for U.S. stocks. Despite the apparent containment of the subprime-mortgage mess to that sector, there has been a sufficient drop in the averages to warrant a bear-market call. The Fed's expansion of the monetary base over the last twelve months has also been "subprime" in a different way: M2 growth, according to the Fed's most recent historical report, has grown 5.60% over the year 2007 – 5.64% counting seasonal adjustments. Monetary base growth, according to the most recent historical release, was only 1.16% over 2007 (1.29% seasonally adjusted.) I note that seasonally-adjusted M2 shrunk during the second week of January, to a level below its amount as of Dec. 31, 2007, according to the most recent current report on the money supply as of the time I wrote this article. The seasonally-adjusted monetary base as of Jan. 14this also below its Dec. 31st level.
So, from a monetarist standpoint, it's unsurprising that the Fed would have leapt to action given the recent global downdraft. The monetary statistics show a seasonally-adjusted shrinking before the cuts in the two rates. In addition, the leveraging of the money supply at the M2 (but not M1) level, which continued in 2007, shows that the money supply increase during that time did not need a huge addition to the monetary base: as mentioned above, less than 1.3% did the trick. This gives the Fed a lot of expansionary leeway in terms of the monetary base, if it is assumed that both the base and M2 should rise in tandem over the long term.
As far as inflation being on the rise is concerned, the recent ramp-up is also reflective of the end of a boom. From the monetarist perspective, it implies that prices are rising in defiance of the true rate of monetary growth, which further implies that the spurt-up in inflation will be short-lived. From the Austrian standpoint, the recent increase in inflation is symptomatic of the distortion in the capital structure, engendered by previously too-low interest rates, is unwinding as the money hits the consumer markets and thus is being drawn away from the more capital-intensive sectors of the economy. To put it more briefly, and more eclectically, stagflation is upon us. This quick survey of the monetary stats shows that the end of the boom is indeed here.
As is usually the case, though, this quick glance implies nothing about the extent of the reversal. Will it be a recession, or merely a slowdown? The question is still controversial.
My own guess is that it will be a slowdown, particularly in Canada. Stagflation doesn't hit us all that hard because Canada's economy is still partially resource-based. The swiftness of Fed action, and the leeway that it has, suggests further that the Fed will keep the '00s boom going for a couple more years. There really hasn't been any foot-dragging at the policy level so far.
In addition, there have been no warning signs from the economy that's been red-hot all through this decade: China's. As long as the Beijing Olympics are ahead of us, there most probably won't be, either by hook or crook. The PRC government would rather not lose face before, or during, such an auspicious occasion.
In conclusion: the current boom is over, but the spillover from the subprime disaster is being contained. There is a rise in inflation, but this rise has an end-of-boom quality; it's likely to be short-lived. The emergent bear market is likely to be relatively mild. There may very well be a slowdown. Those who are waiting for the wreckage of the Bush economy might as well wait for the next downturn.