Tuesday, September 4, 2007

Timing The Coming US Recession.....

For quite a while now, I've been arguing that the US economy is on the brink of recession (see, for example, here, here and here). I have seen little to change my mind on this one, although I am surprised that the recession is taking so long to arrive! There are two possible responses to this:

1) I am wrong; the US is not on a path to recession
2) I am right; but the recession is still coming

I'll stick with 2) for now, but there is a very important lesson here about the ability of economics to predict the future. Even if I'm right, it is very difficult to predict the timing of economic corrections.

In the case of the current business cycle, there remains clear evidence that the market is on a path to correction. The essential story is the same as I have mentioned before. The US has enjoyed several years of economic growth as a result of increasing asset prices- especially in the real estate sector. Households have used some of this increased perceived wealth to increase their consumption, by withdrawing equity from their homes. With consumption making up 70% of GDP in the US, this feeds through into increased economic growth.

But there are some risks to this process: now real estate prices, which have been pushed up artificially by easy access to credit (see here), have started falling. The whole process that pushed up economic growth in the past goes into reverse, and before we know it, the US is in recession.

But how long does it take for this process to work its way through the economy? Well, that all depends on how quickly individuals respond to decreased real estate wealth by reducing their consumption. And that is very difficult to predict, although there is some evidence of this effect now- see, for example, this story on CNN.

If it were easy to predict the timing of economic events, then we'd know exactly when to take leveraged positions in US Government bonds (since the Federal Reserve Board will cut interest rates if the US enters a recession, increasing the value of existing bonds), and Macroeconomics would be a recipe for making money. But alas, Macroeconomists are poor at predicting timing. Or, as an Economist for a major international bank recently remarked to me, "there's a big difference between being right and being able to make money." From the point of view of making money, timing is everything.

1 comment:

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