It's the economy Stupid

The latest news on inflation and unemployment seem to be pointing to a gathering storm in the U.S. economy. A lot of readers are wondering: Just how bad is this downturn going to be?

The economists say we are in a recession? I don't think so. Would you say that we are more in a "'30s-type depression"? I have never seen the country in such bad shape. Rising gas and food prices. How do we live?
— Mary Ann R., Port Charlotte, Fla.

Well, Mary Ann, we’ve seen the economy in much worse shape. There’s little doubt left that we’re headed for — or in the beginnings of — an economic downturn. The housing recession that began in 2006 is one of the worst since the 1930s. It’s likely that things will get worse before they get better. But it’s impossible to say at this moment in time how bad they’ll get.

Economic forecasters and weather forecasters have a few things in common. Since no one can see into the future, both kinds of forecasters look at the forces that have created and shaped storms in the past — and then look at current data to help guide their predictions. When you see a sharp drop in the barometer, it’s a pretty good bet there’s a storm coming.

That’s where we are now — the economic barometer has just started dropping. Unfortunately, economists don’t have radar and satellite imaging to measure how big the storm is before it gets here.

There are lots of economic data out there to chew on, but the broadest measure of the economy’s strength is the gross domestic product — the total value of all the stuff we all make and services we sell each other. So a good yardstick of the damage done by a recession is the drop in GDP from start to finish.

By that measure, it’s too soon to say we're even in a recession: the last GDP data, for the last quarter of 2007, showed very weak growth of 0.6 percent — but growth nonetheless. Given the latest news on job losses in January and February, it’s likely we’ll see a negative number for the quarter that wraps up at the end of this month. (A preliminary figure will be reported in late April.) Depending on how long it takes for banks and other lenders to get through the ongoing turmoil in the credit markets, we may have more down quarters this year — and possibly even next.

That could make this the worst downturn in recent memory. The last recession — in 2001 — was pretty short and shallow by historical standards. But things would have to get a whole lot worse to put the current downturn on the list of all-time worst.

The 1980-82 recession (technically two quick, back-to-back downturns) sent the unemployment rate to 10.8 percent — more than double current levels. In the second quarter of 1980 alone, GDP fell 7.8 percent.

The worst recession since the Great Depression ran from November 1973 to March 1975 and wiped out more than 5 percent of GDP. For all of 1974, inflation averaged 12.3 percent, which meant that unless you got a fat raise that year, you had to figure out how to get by with a big drop in spending power. Inflation also destroyed savings and investment: From the start of 1973 to September 1974, the stock market, as measured by the S&P 500 index, fell by 46 percent.

But as bad as the 1970s were, that downturn didn’t come close to the economic contraction we now call the Great Depression. There’s good reason for using that superlative — and for avoiding it when describing current conditions. From August 1929 to March 1933, the economy (as measured by GDP) shrank by more than a quarter. The stock market, as measured by the Dow Jones industrial average, fell from 380.33 in August 1929 to 42.84 in June 1932. If that happened today, the stocks in your 401(k) retirement fund would be worth about 11 cents on the dollar. The Dow didn't fully recover from the '29 crash until November 1954.

It’s entirely possible we’re at the beginning of what may turn out to be a nasty recession, and we may see further drops in the stock market. There are plenty of ominous conditions, especially the recent rise in the inflation rate and the drop in the value of the dollar. Fed Chairman Ben Bernanke said recently he expects some banks will fail. On the other hand, the Fed’s aggressive interest rate cuts take time to work through the system. Many forecasters we respect maintain that the downturn will be relatively mild and over by the second half of this year.

So we’re not saying there won’t be a severe downturn; the point is that no one knows. It’s just too early to know how bad it will be. And it would have to get a whole lot worse to measure up to the biggest economic storms we’ve been through.





I know this is a ridiculous question, but I have to ask it because asking ridiculous questions is the only way I can really understand things that I just don't understand at all.

My question is about the Federal Reserve lowering interest rates: I have heard that when the Federal Reserve lowers interest rates what they are really doing is creating dollars that didn't exist before in the attempt to create the interest rate they are targeting. So here comes my ridiculous question: If that is what they are doing, then why can't interest rates go below zero? Why is it impossible that they can create so much money that we have an interest rate of -1%?
— Robert Bloomer, Durham, N.C.

One of the reasons we started writing this column was the belief that there are no ridiculous questions — only ridiculous answers. (Since then, we’ve occasionally been proven wrong.)

Yours, however, is not at all ridiculous. The question of “negative” rates comes up all the time. Your analysis of how the Fed targets rates is close: The “creation” of money comes from the Fed’s actions in the bond market. The Fed’s New York trading desk is the mechanism by which policy decisions are carried out through sales and repurchases of Treasury debt.

If the Fed buys Treasuries, it takes cash from its own account and pays the holder of the bonds (usually big “money center” banks), who then send that cash circulating throughout the economy. To raise rates, the Fed sells Treasuries, mopping up excess cash and tightening credit. There are other tools in the Fed’s arsenal, but these market actions are the most powerful and immediate. (And “money” is created by other means: Every time you use your credit card, in theory, you’re “creating” cash that wasn’t there before. That cash gets mopped up when you pay off the card, but if we all just charge more and more every month, we’re “creating” money.)

Interest rates don’t have to go to zero to produce the effect you describe: Borrowers look at the “real” cost of money when they decide whether or not to borrow. The “real” rate is the stated rate minus inflation. That’s because inflation is burning a hole in the purchasing power of money while you’re paying it back. Since you repay with inflated dollars, you’re getting a break on the “real” cost of repayment. So If you borrow at 5 percent, and inflation is running 2 percent, you’re really only paying 3 percent in real (inflation-adjusted) dollars. So you can see that if inflation is running at nearly 4 percent, and overnight interest rates are at 3 percent, we’re actually in negative territory right now.

If the headline rate actually went to 0 percent, and inflation rose, you can see how money would get cheaper much faster. The problem is that as inflation rises, money also loses its purchasing power much faster, which destroys savings and investment. (That’s what we had in the 1970s.)

That’s the risk the Fed faces now: If it keeps rates too low, it risks losing control of inflation. Once that happens it’s extremely difficult — and painful — to get inflation back under control, as former presidents Nixon, Ford and Carter learned.

The real problem right now, however, is not the cost of money. Money is cheap enough; lenders are just too scared to lend. So they’re charging a lot more than they otherwise would. The reason they’re scared is that no one knows just how bad or widespread the damage has been from the housing/mortgage meltdown.

If you’re Bank of America and Citibank calls up and asks for a loan, you may be wondering in the back of your mind if Citibank has come clean with all the bad news about its loan losses. Accounting rules give you some leeway in rolling over bad debts. And the Fed seems happy to oblige. If these bad debts eventually blow up, you don’t want to be one of the parties on the list that is owed money.

Working at RKA

I have developed some great friends at RKA. We share lunch together in the back of Mike F's office almost every day.

Views from Somers New York

Hey everybody the snow is melting and it looks like spring is just around the corner. Anne is in the midst of all of the 8th grade tests and I am pushing my kids for the next 12 weeks before the Regents.

Sadly Darfur in the news again

They came to this dusty town in the Darfur region of Sudan on horses and camels on market day. Almost everybody was in the bustling square. At the first clatter of automatic gunfire, everyone ran.
The militiamen laid waste to the town — burning huts, pillaging shops, carrying off any loot they could find and shooting anyone who stood in their way, residents said. Asha Abdullah Abakar, wizened and twice widowed, described how she hid in a hut, praying it would not be set on fire.
“I have never been so afraid,” she said.
The attacks by the janjaweed, the fearsome Arab militias that came three weeks ago, accompanied by government bombers and followed by the Sudanese Army, were a return to the tactics that terrorized Darfur in the early, bloodiest stages of the conflict.
Such brutal, three-pronged attacks of this scale — involving close coordination of air power, army troops and Arab militias in areas where rebel troops have been — have rarely been seen in the past few years, when the violence became more episodic and fractured. But they resemble the kinds of campaigns that first captured the world’s attention and prompted the Bush administration to call the violence in Darfur genocide.
Aid workers, diplomats and analysts say the return of such attacks is an ominous sign that the fighting in Darfur, which has grown more complex and confusing as it has stretched on for five years, is entering a new and deadly phase — one in which the government is planning a scorched-earth campaign against the rebel groups fighting here as efforts to find a negotiated peace founder.
The government has carried out a series of coordinated attacks in recent weeks, using air power, ground forces and, according to witnesses and peacekeepers stationed in the area, the janjaweed, as their allied militias are known here. The offensives are aimed at retaking ground gained by a rebel group, the Justice and Equality Movement, which has been gathering strength and has close ties to the government of neighboring Chad.
Government officials say that their strikes have been carefully devised to hit the rebels, not civilians, and that Arab militias were not involved. They said they had been motivated to evict the rebels in part because the rebels were hijacking aid vehicles and preventing peacekeepers from patrolling the area, events that some aid workers and peacekeepers confirmed.
“We are simply trying to secure the area from the bandits that are troubling civilians in the area,” said Ali al-Sadig, a government spokesman. “There is nothing abnormal about a government doing this.”
But residents of the towns said the rebels had been long gone by the time the government attacks began, leaving defenseless civilians to flee bombs and guns. In interviews, survivors of the attacks described a series of assaults that had left dozens dead, turned large sections of towns into hut-shaped circles of ash and scattered tens of thousands of fearful residents, including hundreds of children, who fled classrooms in the middle of a school day and have not been reunited with their families.
“My son Ahmed, he ran, but I have not seen him since,” said a woman named Aisha as she waited for a sack of sorghum from United Nations workers in Sirba, one of the towns that was attacked. “I just pray he is still hiding in the bush somewhere and will come back to me.”
A Terrorized Population
The United Nations estimates that the recent fighting has forced about 45,000 people to flee their homes in Darfur, which is roughly the size of Texas and has a population of about six million people. Some fled to Chad, where they have not been able to reach the safety of refugee camps because of continued bombing along the border. Others fled to Jebel Moun, a rebel stronghold to the east, and aid workers fear for the safety of about 20,000 people who are in the path of future attacks if the government presses ahead with its offensive and the rebels vow to resist.
Military officials from the peacekeeping force in Darfur said in recent days that the Sudanese military had added nearly a brigade of troops to West Darfur, along with two dozen tanks and armored vehicles and many heavy weapons.
“You see a buildup from both sides,” said Ameerah Haq, the senior United Nations aid official in Sudan. “Both sides must desist. We have a population that is just being attacked and hit from both sides.”
Pressure is mounting on Sudan over Darfur. In January, a long-sought hybrid United Nations and African Union peacekeeping force began working in Darfur, but the Sudanese government’s quibbling over which countries the troops will come from and bureaucratic delays have stalled the force’s deployment.
Sudan’s biggest trading partner and ally, China, has also come under pressure from advocates who have linked the Olympic Games in Beijing this summer to the fighting in Darfur. China has been more publicly critical of the Sudanese government in recent weeks. Sudan has also been trying to improve its relationship with the United States, and last week, President Bush’s new special envoy to Sudan, Richard S. Williamson, visited Darfur and the Sudanese capital, Khartoum, meeting with President Omar al-Bashir. Any improvement in relations, he said, would be contingent on tangible improvements in the humanitarian situation.
“Since the first of the year another 75,000 people in Darfur have been displaced,” Mr. Williamson said in a telephone interview. “That is more than a thousand a day. There are not going to be any changes until that reverses.”
Origins of a Conflict
Despite the pressure, the government seems determined to fight on, and the most powerful rebel groups — the biggest factions of the Justice and Equality Movement and the Sudanese Liberation Army — have refused to sit down for talks. So the violence continues, tracing a familiar arc as it wears on.
It was five years ago last week that an attack by rebels from non-Arab tribes like the Fur, Masalit and Zaghawa, seeking greater wealth and autonomy for the neglected and impoverished region of Darfur, prompted the Arab-dominated government to marshal Arab militias in the region that ultimately evicted millions from their homes, burning, looting and raping along the way. The campaign effectively pushed many non-Arab people off their land and into vast, squalid camps across Darfur and Chad.
In the first two years of the conflict, 2003 and 2004, joint attacks by the Sudanese Army, janjaweed militiamen and the government’s old Russian-made Antonov bombers terrorized Darfur, waging a brutal counterinsurgency against non-Arab rebel groups by attacking their fellow tribesmen in their villages. At least 200,000 are believed to have died as a result of the violence or sickness and hunger caused by the crisis, according to international estimates, with the majority of violent deaths in that period.
But in the past two years, the conflict has grown more complex and chaotic, and while some coordinated attacks by janjaweed militias and aerial bombardment have occurred, they were not of the same scale or intensity. But Darfur has remained a deadly place.
In 2006, before a peace agreement and then in the aftermath of its failure, rebel groups fractured and began fighting among themselves. Hundreds of thousands of people were displaced and hundreds died as a result of their battles. Today, according to some estimates, two dozen rebel groups are jockeying for territory and influence in Darfur. Some analysts and human rights workers say the government has sown chaos by splintering the rebel groups to weaken them.
In 2007, Arab tribes, some of which had allied with the government and some of which had taken up arms to fight the rebels, also began to fight one another. Many of the violent deaths of 2007 were caused by these bloody battles between Arab groups and their militias, according to aid workers and diplomats in the region.
But as the conflict enters its sixth year, an older, deadly pattern is returning, and with it fears are rising among villagers, aid workers, diplomats and analysts that Darfur is headed for a new cycle of bloodletting and displacement on a vast scale.
In recent weeks, bombs dropped from government planes hit Abu Surouj, Sirba, Suleia and other towns in West Darfur, then came janjaweed militiamen, who killed, raped and burned, helping themselves to livestock and grain, furniture and clothing. In one town, the raiders pried the corrugated metal roof off a school, aid workers said. In another, water pumps were destroyed.
“This is the kind of destruction that makes it hard for people to return,” said Ted Chaiban, the Unicef representative in Sudan, who has toured the area of the attacks. “People need security. They are totally vulnerable.”
Violence in Chad
The recent violence in Chad, where rebel groups with bases in Sudan tried to topple the government in early February, has worsened matters. Rebels in Darfur, who diplomats and analysts say have received arms and cash from the family of Chad’s president, Idriss Déby, rushed into Chad to help defend him, creating a vacuum in the territory they had occupied. Sudan’s government seized the opportunity to retake the ground and now appears to be pushing farther into areas long held by the rebels, according to peacekeepers stationed here.
Few people in the region were unhappy to see the Justice and Equality Movement evicted. Banditry was rife in the territory it controlled, and for months aid groups had dodged carjackings and other attacks. African Union peacekeepers had been barred from the area, according to Brig. Gen. Balla Keita, the new regional commander of the hybrid United Nations-African Union force in West Darfur.
"They were causing a lot of insecurity," General Keita said of the rebels, but he added that this did not justify attacks on heavily populated areas.
In Suleia, only a few hundred residents remained of the 15,000 who had lived here. Those left behind were too weak to run and have sought safety near the army camp at the edge of town, sleeping in the open, huddled together for warmth against the frigid night winds.
The Sudanese soldiers here have promised to protect them from militiamen who still roam the edges of town. They prevented militiamen from stealing sacks of grain delivered by aid groups, residents said.
Adam Adoum Abdullah, a former rebel fighter who joined the Sudanese Army as part of a peace deal with one rebel group in 2006, commandeered an army truck to help collect what little food, blankets and bits of shelter remained in the town for those sleeping out in the cold next to the army camp.
“I am ashamed that the janjaweed come with the soldiers,” Mr. Abdullah said. “What kind of army are we to fight like this? These people, they are suffering. We must help them.”