My Cruise Blues

Sorry about the delay.  I haven't been on the Canadian border arbitraging books in U.S. and Canadian dollars as I had threatened to do.  Instead, I participated in a Forbes/NCPA Investor Cruise through the Panama Canal.  Very nice.  Good folks; interesting program.

But the program left me in a bit of a funk.  I had friends on opposite ends of the optimism/pessimism spectrum speaking with passion and absolute certainty about current and future economic prospects.  At one end, my friend Gary Shilling said we are going to hell in a hand basket, things can only get worse, the Fed is behind the curve and has much more easing to do.  He didn't honey coat his doom and gloom. 

All the other speakers were less pessimistic than Gary, most particularly, Brian Westbury, another friend, who focused on inflation rather than the subprime crisis. He said, very emphatically, that the Fed shouldn't have eased at all to deal with the subprime fallout and certainly shouldn't ease more.  He had some rather colorful unkind things to say about our beloved central bankers; I don't think he expects them to go to central banker heaven.  Having sat around the FOMC table with Alan Greenspan for 14 years, including 3 with Ben Bernanke, my knee twitched a bit, but didn't go into full jerk mode.  Since I'm long gone from the Fed — well, just over 3 years now — I'm not sure why I still feel unfair criticism — or partially unfair criticism — in my gut. On the other hand, maybe I was just suffering from the motion of the ocean.  (See my posting: "The Blame Game.")

My funk resulted partly from the fact that either Gary or Brian could be right, but I didn't know which one.  Like an old-line Texas politician, "I can argue it round; or I can argue it square."  That's about where I am these days, hearing all black and white and coming out grey.  I've always avoided the two-handed economist approach, which drives listeners mad and harms my self esteem.  Splitting the difference and taking a middle-of-the-road approach isn't satisfying either, especially in Texas where they say the only things found in the middle of the road are yellow streaks and dead armadillos.  Remember the old cowboy movies where the bad guy in the black hat always called the good guy in the white hat "yellow"?  A yellow streak is not good.

Actually and unfortunately, I'm forced to go with grey, bland shades of grey.  Nobody wants to hear it, but I expect the economy to do better than the pessimists expect, but not as good as the optimists expect.  Not in the middle of the road, but the middle of the optimistic half of the road.  I'll admit that's based more on a hunch and hope than on rigorous analysis.  But my hunches are educated hunches, if I have to say so myself.

I'm not alone in my uncertainty.  The dirty little secret is that economists just aren't good at forecasting.  They know it and most will admit it, but the public, employers of economists, and talking-head interviewers all expect forecasting; so, in good Keynesian fashion, demand creates its own supply.  Smart economists have figured out, however, that, if you must forecast, it's best to do it late and often. The FOMC recently caught on and promised release of quarterly rather than semi-annual forecasts, cutting their average embarrassment time in half.  They also foolishly expanded their forecast horizon to 3 years out, revealing in their 2010 forecast a very pessimistic view of productivity expectations and the growth potential of the economy.  (See my previous blog posting: "The FOMC's Enhanced Transparency Reveals Old Paradigm Pessimism.")

I recall the last time the Fed and Fed watchers were on recession watch.  It was late 2000 and all of 2001.  Each quarter would produce a barely positive real GDP number — not good enough for anything else, but good enough to avoid the dreaded two consecutive negative quarters that would constitute a recession.  We kept dodging the bullet until 9/11 tipped the third quarter into negative territory, the first one.  Everyone expected, a more-negative 4th quarter, but surprise, surprise, thanks largely to zero interest auto loans, the quarter was positive. The 4th quarter of 2001 was the beginning of the current expansion, which is now six years old and counting.  The 3rd quarter of 2001 was the only negative quarter!  No recession!  No recession that is until the National Bureau of Economic Research later decided retroactively that a recession began as early as March 2001 and bottomed out in November.  The recession was ending about the time we thought it was beginning.  Makes you think, doesn't it?

I don't think that will happen this time, since 3.8 percent and 4.9 percent real GDP growth in the 2nd and 3rd quarters of 2007 would be hard to revise to zero or below.  But many talking heads started talking about a 1 percent 4th quarter number as early as October, months before the Bureau of Economic Analysis releases their first forecast of the 4th quarter. 

This morning's newspapers (December 26) "confirmed" the expectations for a weak Christmas season.  Not so if my mall is any indication.  Besides, we will join millions of smart people in the coming days buying on sale what was full price through yesterday and using all those new gift cards, which apparently don't count in official retail sales numbers until they are spent on merchandise.

The early and unexpected bounce back in economic activity in the 4th quarter of 2001 was only one of several convincing pieces of evidence of the remarkable resilience of the U.S. economy in recent years.  We seem to have a Timex economy: it takes a licking, but keeps on ticking.  The proven resilience of the U.S. economy, my friends, is the main reason I don't expect extreme pessimism to win out.  Not very scientific, is it?  Sorry Gary.

But neither can I be as optimistic on the economy, and as worried about inflation, as Brian Westbury.  Maybe too many seeds of inflation have fallen on fertile ground and will have to be dealt with eventually.  But given the balance of risks that most people see, including me, I can't imagine that the FOMC will risk looking back on 2007-2008 and admitting that it let the sub-prime crisis get out of control while it fretted about inflation.  They won't be fiddling while the economy implodes, and if the economy turns out to be weaker than they expect, it will dampen inflation on its own.  Of course, either way, the Fed will be criticized for the downside of the choice it makes as well as the downside of the choice not made.  Time will tell and reveal the final verdict on Ben Bernanke's performance.  I'm betting on him.

Happy Holidays.