"A Double-Dip Recession?"

Sydney M. Williams

Thought of the Day

“A Double-Dip Recession?”

October 11, 2011

In 1982, the U.S. economy fell into a double-dip recession. The first quarter of 1980 experienced a decline in GDP of 7.8%, the worst decline in quarterly GDP since the Great Depression. However, the recession proved short-lived, lasting for six months. A second recession – the double-dip - lasted sixteen months, from July 1981 through November 1982. That recession saw unemployment rise to 10.8%, another post-War record.

Both recessions had their origins in a rising inflation that had begun in 1966, a result of the “guns and butter” policy of President Lyndon Johnson – the Great Society and the Vietnam War. President Nixon then severed the Dollar from its ties to gold and instituted wage and price controls in 1972. The consequences of Mr. Nixon’s actions saw prices go higher, demand stifled and wages that were too high, so forced employers to lay off workers. The first oil embargo, in the fall of 1973, then helped tilt a weakened economy into recession. The third and fourth quarters of 1974 and the first quarter of 1975 saw GDP declines of 3.8%, 1.6% and 4.8% respectively. With its double, and at times contradictory, mandates of controlling inflation and maintaining full employment, the Federal Reserve under Chairman Arthur Burns opted to focus on employment. The Fed’s expansionary policies had the unintended consequence of businesses simply raising prices – in anticipation of rising inflation – instead of hiring additional workers . That resulted in inflation rising from 3.2% in 1972 to 9.1% in 1975, while unemployment also rose, over the same years, from 5.6% to 8.5%.

The short, sharp recession of 1980, which was generally blamed on increases in inflation driven by the second oil embargo and global food harvest failures, was in fact “man made”, as Paul Volcker who replaced Mr. Burns at the start of 1979 drove Fed Funds sharply higher. Mr. Volker had been appointed by President Carter to be Chairman of the Federal Reserve to address the growing inflationary concerns that were destroying confidence. Between June and December of 1980, the Fed raised Fed Funds from 8.5% to 20%. In early 1981 with recovery under way, Mr. Volcker lowered rates to 16%; but inflation remained stubbornly high. So the Fed Chairman acted again. By mid October, he had again raised rates to 20%. The cost was the double-dip recession mentioned above, but this time it worked. Inflation declined from 13.5% in 1980 to 3.2% in 1983. Unemployment, which had peaked in the fourth quarter of 1982 also declined to 7.5% in 1984. The market, anticipating the economic growth that would follow, began rising in August 1982 leading to what would become the longest and strongest bull market in New York Stock Exchange history – eighteen years during which the Dow Jones Industrial Averages compounded at 16.2%.

Today, the question is, are we headed into another double dip recession? The Economic Cycle Research Institute (ECRI), which has had the most accurate record of predicting recessions of any major research group, seems to think so. The Economist recently reported that ECRI has “never issued” a false alarm. Of course, there is always a first time for everything and perhaps this will be ECRI’s time in the penalty box. Regardless, one should not take their warnings lightly. In late September, co-founder of ECRI, Lakshman Achuthan stated: “The vicious cycle is starting where lower sales, lower production, lower employment and lower income leads back to lower sales.” A study released yesterday by the Sentier Research and reported in Monday’s New York Times indicated that household income has declined 6.7% since the end of the recession in June 2009, more than double the decline in household income during the recession! On the other hand, anecdotal evidence from among companies we follow does not indicate an economy tipping into recession. Similarly, Ken Prewitt of Bloomberg on Monday noted that economists from Goldman Sachs and Macroeconomic Advisors recently revised their third quarter GDP numbers from 2.2% to 2.5%. “We may have,” he said, “dodged a double-dip.”

Not being an economist, so not one who spends his weekends pouring over data from the Federal Reserve or from the Bureau of Labor Statistics, I have no idea as to whether or not we will experience a double-dip recession. But I also know that two experts looking at the same data can come to two different conclusions. President Truman once said “give me a one-handed economist,” so they wouldn’t be able to say “on the one hand…on the other hand.” John Kenneth Galbraith said: “Economics is extremely useful as a form of employment for economists.” Peter Lynch, in response to George Bernard Shaw’s famous observation on the inability of economists to form a consensus, was more helpful: “If all the economists in the world were laid end to end it wouldn’t be a bad thing.”

What I do know is that there is no confidence in politicians around the world, or in the economies for which they are stewards. And there is no confidence in markets. Capitalism has too often been trashed by the Administration and others in Washington. Confidence is an illusive sense and difficult to define, but we know it when it’s missing. It brings to mind Supreme Court Justice Potter Stewart’s famous riposte in 1964 when asked to describe pornography: “I know it when I see it.” Today’s lack of confidence can be laid at the feet of the President and Congress. Neither has done much to address its absence. Each side has blamed the other, with neither being honest about the fact it was a cultural issue, abetted by Washington, that had come to permeate our society, and which allowed all of us to assume debt irresponsibly – to ignore the future for the pleasure of living well today. But government is not solely responsible for the current environment. A lack of confidence is also the fault of those who labor on Wall Street, as they never treated the money that was used to bail them out three years ago with the respect it deserved. As Ayn Rand said, in a quote sent me yesterday by my friend Alan Rivoir, “We can evade reality, but we cannot evade the consequences of evading reality.”

In 1982, it took an effort by the Federal Reserve to slay the beast that was inflation. In doing so, they catapulted the economy into recession – the medicine necessary to right the ship. Today’s problems stem from too much leverage. Reducing leverage will not necessarily send the economy back into recession. What it does imply, though, is a far more sluggish recovery, which is exactly what we have been experiencing. In the U.S., it has been necessary for banks to write down mortgages that are no longer “in the money”, or those loans on which the mortgagor is no longer current. Banks which use their capital to write down existing loans definitionally have less money to lend. And economic growth relies on the availability of credit. If I had to wager a guess, it would be that sluggish growth will persist and that we will skirt recession, but that advice plus $2.50 will get you uptown on the subway.

As a guide to where we might be, a Swiss friend of mine offered some advice. You know that things are bad when:

          * Exxon-Mobil lays off twenty-five Congressmen.
          * A truckload of Americans gets caught sneaking into Mexico.
          * Angelina Jolie adopts a child from America.

We have not reached that point, and perhaps we will not. However, the fact that the ECRI has declared that we are in (or entering) a recession is a warning not to be taken lightly. I worry about the lack of confidence and suspect it will take a change in administrations to correct that situation, which may not happen until 2016. So be forewarned; the world is a surprising place; what seems obvious today may not seem so tomorrow.