Wednesday, April 23, 2014

No Distant Thunder . . .

Despite the seemingly-never-ending debt crisis in Europe, despite an impotent Congress, and despite a slowdown in China as the world's economic engine, the American economy has been growing for 58 months now.  That's the good news!  The bad news is that it has been growing at the puny rate of only 1.8% annually.

Most people think that is proof we are doing something wrong, but the proof is also pretty clear that recoveries from a financial crisis are longer and weaker than recoveries from an ordinary recession, which could result from imbalances in inventories, for example, or shocks to economy, like the Arab oil embargo.

Still, 58 months is significant because that is also the average length of economic recoveries since World War II.  At this point, this recovery is longer than usual.  Should we expect a recession in the near future? No!   Ordinary recessions usually experience a boom before the trouble begins, but we've had no economic boom yet, suggesting we still have room to run before the next recession.  (Of course, Cold War II might produce something unpredictable.)

Famed American economist Hyman Minsky died in 1996.  He was famed for his theory that credit continues to expand until the balloon bursts, which is called "the Minsky moment" and is followed by a financial crisis.  We had our Minsky moment in June of 2007, when two funds of mortgage-backed securities by Bear Stearns suddenly blew-up.

I'm not worried about another recession.  Despite an increasing capacity utilization, there is still too much spare capacity in our economy, as well as a lack of "boom" for an ordinary recession.  If it comes, it will pass.  Don't lose sleep over it!

I do worry about another financial crisis.  There is no historical precedent for one financial crisis to be followed quickly by another, but that is small comfort.  With an impotent Federal government, the only recession-fighter in America is the Federal Reserve.  Unfortunately, their only tools could create the very Minsky moment we want to avoid.

If we hear the distant thunder of a derivatives blow-up (probably in Europe), it will be time to do more than worry.  It will be time to invest in cash.