Post by Steve Gardner on Dec 2, 2007 11:30:40 GMT
... a Big Red Flag: The Role of Animal Spirits in the Coming Severe US Recession
Source: Nouriel Roubini's Global EconoMonitor
There are plenty of forward looking indicators of economic recessions, including various asset prices (yield curve, risk spreads, equity markets, etc.), macroeconomic variables, the consensus of experts and analysts as well as more quirky indicators (such as sales of St. Joseph statues to indicate housing recessions, or sales of lipstick, a proxy for cheap make-up in tough tight-belting times). Certainly many of these indicators are now pointing in the direction of a very high probability of a US recession in the very near term. US growth in Q4 may be closer to 0% than 1% and will, in my modest view, turn negative (recession) in H1 of 2008.
Last year, when I started to talk about the risks of a US recession in 2007, one unconventional indirect indicator of the risks of a recession that I mentioned and started reporting was the number of times the term recession was used in the news media (as measured by the numbers of mentions of the term “recession” in Google News). This Google New Recession Barometer is of course not a scientific measure of the probability of a recession; but, as far as forward looking indicators are concerned, it is a pretty interesting one for a variety of reasons: 1. it suggests how much media and analysts are concerned about an economic recession; so it is a proxy for the “wisdom of crowds”; 2. recessions can be, in part, self-fulfilling and due to what Keynes called “animal spirits” in the sense that, while weakening economic fundamentals are the crucial trigger of a recession the degree of confidence about the future of consumers, firms, investors is an important determinant of their economic decisions (how much to consume and invest in real capital) and their portfolio decisions (how much to shun risky assets because of increased subjective risk aversion). If consumers and firms become less confident about the future and worry about a coming recession they will behave in ways – cutting consumption and capital spending – that will reinforce such recessionary trends and increase the likelihood that such a recession will take place.
To assess this element of “animal spirits” and confidence consider the 1990-91 recession that started in August 1990. It was indeed triggered by economic fundamentals: the boom and bust of commercial and residential real estate and the credit crunch caused by the collapse of the S&Ls; the sharp increase in oil prices following the Iraqi invasion of Kuwait in August 1990. Indeed, the recession was mostly driven by the boom and bust of the S&L as it started two months before such invasion; the oil price shock that followed that invasion only worsened and exacerbated a recession triggered by other factors. But one important element of the 1990-91recession was the effect of animal spirits and confidence. That recession is sometimes called the “CNN recession” as nervous consumers spent the summer and fall of 1990 watching on TV the unfolding Kuwait drama and the US preparations for war rather than going out to restaurants, movie theaters and to shopping centers. This was a combination of fundamental-justified fear and Keynes animal spirits pushing a weakened economy into a deeper recession.
And the role of animal spirits in ending a recession was also evident in this episode; the trough – or end - of the recession was in February 1991 when the US successfully freed Kuwait from the Iraqi invasion and the war was over.
Of course there are dozen of measures of consumers, firms and investors’ confidence and all of them in the last months are heading sharply south and raising red flags on the perception by such agents that a recession is coming; also recent polls have consistently signaled that 60% of Americans now believe that we will have a recession in the next 12 months. So, the perverse effects of animal spirits and confidence are in full swing now on top of an onslaught of lousy and worsening macro and credit news.
So let us consider now what the Google News Barometer is telling us about the media and the country mood regarding the risks of a recession. In July 2006 when this author started to talk about the risk of US recession in 2007 this Barometer showed 4,850 citations of the term “recession”. That Barometer rose to 5,500 mentions in late August 2006 after the housing bust started to get into full swing and after the Fed stopped raising the Fed Funds rates as the first sign of a significant growth slowdown appeared. Today, the Recession Barometer is up to 22,047 mentions of the term recession.
As a matter of comparison mentions of recession in the onset of the last recession – that started in March 2001 - were:
June 2000 - 1,620
January 2001 - 6,400
February 2001 - 5,540
March 2001 - 7,290
April 2001 - 6,350
May - 4,950
June - 4,250
July - 5,060
There are of course many shortcomings of this unscientific Recession Barometer: it may provide false alarms; it may mention concerns about recession in other countries; comparing its coverage in 2000-2001 and in 2006-2007 is unfair as many less online sources existed and were used by Google News in 2000-2001. On the last issue, of course a comparison between 2001 and 2007 may be unfair as in 2001 the number of online new publications existing and covered by Google News was much smaller then. To control for this bias compare the change in the mentions of the term recession between June 2000 (when the economy was still growing at a 5% rate) and June 2001(when the economy was clearly in a recession): this is the difference between 1,620 mentions and 4,950 mentions or a 205% increase. Instead the change in mentions of the term recession between July 2006 and today is 355% or the change from 4,850 to 22,047 mentions.
It is also interesting to note that, as late as August 2001, when it was clear based on most economic indicators that the US was in a recession a lot of market commentary was still discussing whether the US was in a recession and whether a Fed easing would prevent such a recession. Indeed, while ex-post the NBER dated the start of the recession to March of 2001, that dating decision was made over a year after the recession had started. So, in the last US recession even five months after its onset – in August 2001 - many analysts on Wall Street were still arguing that we were not in a recession and that the Fed actions would prevent a recession from taking place. Since the NBER Business Cycle dating committee – the official arbiter of the US business cycle (that is headed by Bob Hall of Stanford – has barely started this time its process of deliberations and will take its own time – more than a year – to decide if and when a recession has started in the past expect this time around the same saga of markets’ and analysts’ denial of a recession even after such a recession will be in a full swing in early 2008.
Like in 2001 expect most analysts to argue that Fed easing will prevent a recession (95% of economists polled by the Economist magazine in March 2001 – the month the recession started – argued that the US would avoid a recession in 2001 because the Fed easing will prevent it), expect the Fed to be in denial about the risks of a recession and expect the stock market to have its last legs of a sucker’ rally before the hammer of ever worsening macro and credit news will beat on the head of the most obtuse and in-denial observers the reality of an existing recession.
So consumers, firms, and investors’ confidence and animal spirits are always important determinants – complementary to economic and financial fundamentals – of economic recessions. And such animal spirits are now signaling a significant risk of a US recession in the near term.
Source: Nouriel Roubini's Global EconoMonitor
There are plenty of forward looking indicators of economic recessions, including various asset prices (yield curve, risk spreads, equity markets, etc.), macroeconomic variables, the consensus of experts and analysts as well as more quirky indicators (such as sales of St. Joseph statues to indicate housing recessions, or sales of lipstick, a proxy for cheap make-up in tough tight-belting times). Certainly many of these indicators are now pointing in the direction of a very high probability of a US recession in the very near term. US growth in Q4 may be closer to 0% than 1% and will, in my modest view, turn negative (recession) in H1 of 2008.
Last year, when I started to talk about the risks of a US recession in 2007, one unconventional indirect indicator of the risks of a recession that I mentioned and started reporting was the number of times the term recession was used in the news media (as measured by the numbers of mentions of the term “recession” in Google News). This Google New Recession Barometer is of course not a scientific measure of the probability of a recession; but, as far as forward looking indicators are concerned, it is a pretty interesting one for a variety of reasons: 1. it suggests how much media and analysts are concerned about an economic recession; so it is a proxy for the “wisdom of crowds”; 2. recessions can be, in part, self-fulfilling and due to what Keynes called “animal spirits” in the sense that, while weakening economic fundamentals are the crucial trigger of a recession the degree of confidence about the future of consumers, firms, investors is an important determinant of their economic decisions (how much to consume and invest in real capital) and their portfolio decisions (how much to shun risky assets because of increased subjective risk aversion). If consumers and firms become less confident about the future and worry about a coming recession they will behave in ways – cutting consumption and capital spending – that will reinforce such recessionary trends and increase the likelihood that such a recession will take place.
To assess this element of “animal spirits” and confidence consider the 1990-91 recession that started in August 1990. It was indeed triggered by economic fundamentals: the boom and bust of commercial and residential real estate and the credit crunch caused by the collapse of the S&Ls; the sharp increase in oil prices following the Iraqi invasion of Kuwait in August 1990. Indeed, the recession was mostly driven by the boom and bust of the S&L as it started two months before such invasion; the oil price shock that followed that invasion only worsened and exacerbated a recession triggered by other factors. But one important element of the 1990-91recession was the effect of animal spirits and confidence. That recession is sometimes called the “CNN recession” as nervous consumers spent the summer and fall of 1990 watching on TV the unfolding Kuwait drama and the US preparations for war rather than going out to restaurants, movie theaters and to shopping centers. This was a combination of fundamental-justified fear and Keynes animal spirits pushing a weakened economy into a deeper recession.
And the role of animal spirits in ending a recession was also evident in this episode; the trough – or end - of the recession was in February 1991 when the US successfully freed Kuwait from the Iraqi invasion and the war was over.
Of course there are dozen of measures of consumers, firms and investors’ confidence and all of them in the last months are heading sharply south and raising red flags on the perception by such agents that a recession is coming; also recent polls have consistently signaled that 60% of Americans now believe that we will have a recession in the next 12 months. So, the perverse effects of animal spirits and confidence are in full swing now on top of an onslaught of lousy and worsening macro and credit news.
So let us consider now what the Google News Barometer is telling us about the media and the country mood regarding the risks of a recession. In July 2006 when this author started to talk about the risk of US recession in 2007 this Barometer showed 4,850 citations of the term “recession”. That Barometer rose to 5,500 mentions in late August 2006 after the housing bust started to get into full swing and after the Fed stopped raising the Fed Funds rates as the first sign of a significant growth slowdown appeared. Today, the Recession Barometer is up to 22,047 mentions of the term recession.
As a matter of comparison mentions of recession in the onset of the last recession – that started in March 2001 - were:
June 2000 - 1,620
January 2001 - 6,400
February 2001 - 5,540
March 2001 - 7,290
April 2001 - 6,350
May - 4,950
June - 4,250
July - 5,060
There are of course many shortcomings of this unscientific Recession Barometer: it may provide false alarms; it may mention concerns about recession in other countries; comparing its coverage in 2000-2001 and in 2006-2007 is unfair as many less online sources existed and were used by Google News in 2000-2001. On the last issue, of course a comparison between 2001 and 2007 may be unfair as in 2001 the number of online new publications existing and covered by Google News was much smaller then. To control for this bias compare the change in the mentions of the term recession between June 2000 (when the economy was still growing at a 5% rate) and June 2001(when the economy was clearly in a recession): this is the difference between 1,620 mentions and 4,950 mentions or a 205% increase. Instead the change in mentions of the term recession between July 2006 and today is 355% or the change from 4,850 to 22,047 mentions.
It is also interesting to note that, as late as August 2001, when it was clear based on most economic indicators that the US was in a recession a lot of market commentary was still discussing whether the US was in a recession and whether a Fed easing would prevent such a recession. Indeed, while ex-post the NBER dated the start of the recession to March of 2001, that dating decision was made over a year after the recession had started. So, in the last US recession even five months after its onset – in August 2001 - many analysts on Wall Street were still arguing that we were not in a recession and that the Fed actions would prevent a recession from taking place. Since the NBER Business Cycle dating committee – the official arbiter of the US business cycle (that is headed by Bob Hall of Stanford – has barely started this time its process of deliberations and will take its own time – more than a year – to decide if and when a recession has started in the past expect this time around the same saga of markets’ and analysts’ denial of a recession even after such a recession will be in a full swing in early 2008.
Like in 2001 expect most analysts to argue that Fed easing will prevent a recession (95% of economists polled by the Economist magazine in March 2001 – the month the recession started – argued that the US would avoid a recession in 2001 because the Fed easing will prevent it), expect the Fed to be in denial about the risks of a recession and expect the stock market to have its last legs of a sucker’ rally before the hammer of ever worsening macro and credit news will beat on the head of the most obtuse and in-denial observers the reality of an existing recession.
So consumers, firms, and investors’ confidence and animal spirits are always important determinants – complementary to economic and financial fundamentals – of economic recessions. And such animal spirits are now signaling a significant risk of a US recession in the near term.
