[Texgreen] Hard times to come

[Roger Baker]

[Krugman is a smart widely read New York Times economist. -- Roger]

December 1, 2006

Op-Ed Columnist

Economic Storm Signals
By PAUL KRUGMAN


=93It=92s tough to make predictions,=94 Yogi Berra is supposed to have =20=

said, =93especially about the future.=94 Actually, his remark makes =20
perfect sense to economists, who sometimes have trouble making =20
predictions about the present. And this is one of those times.

We=92re now two-thirds of the way through the fourth quarter of 2006, =20=

so you might think we=92d already know how the quarter is going. Yet, =20=

economists=92 assessments of the current state of the U.S. economy, =20
never mind the future, are all over the place.

And here=92s the bad news: this kind of confusion about what=92s going =
on =20
is what typically happens when the economy is at a turning point, =20
when an economic expansion is about to turn into a recession (or vice =20=

versa). At turning points, the various indicators that usually tell =20
us which way the economic wind is blowing often point in different =20
directions, so that both optimists and pessimists can find data to =20
support their position.

The last time things were this confused was early in 2001, when most =20
economists failed to realize that the United States was sliding into =20
recession. If that sounds ominous, it should: the bond market, which =20
has a pretty good record of forecasting recessions, is pointing =20
toward a serious economic slowdown next year.

Before I explain what the bond market is telling us, let=92s talk about =20=

why the economy may be at a turning point.

Between mid-2003 and mid-2006, economic growth in the United States =20
was fueled mainly by a huge housing boom, which created jobs directly =20=

and made it easy for consumers to spend freely by borrowing against =20
their rising home equity.

That housing boom has now gone bust. But the optimists and pessimists =20=

disagree both about how bad the bust will get and about how much =20
damage the housing slump will do to the economy as a whole.

The optimists include Alan Greenspan, whom some accuse of letting the =20=

housing bubble get out of hand in the first place. On Tuesday, he =20
told investors at a conference that the worst of the housing slump is =20=

over, saying that =93it looks as though sales figures have stabilized.=94

But the very next day the government released grim data on new home =20
sales for October, and revised its estimates for earlier months =20
downward. Most, though not all, of the other economic numbers that =20
came out this week were also substantially weaker than expected.

Pessimists feel vindicated by the downbeat data. Nouriel Roubini of =20
Roubini Global Economics, who has been forecasting a housing-led =20
recession for some time, now believes that the economy has already =20
stalled: he predicts zero growth for the current quarter. Economists =20
at Deutsche Bank say the same thing.

But that=92s still a minority position; most forecasters are still =20
telling us not to worry. So whom should you listen to? And how can =20
you avoid believing what you want to believe?

Maybe the best answer is to look at what the financial markets say. =20
Not the stock market, which is a notoriously bad indicator of the =20
economy=92s direction, but the bond market. (Paul Samuelson, the Nobel =20=

Prize-winning M.I.T. economist, famously quipped that the stock =20
market had predicted nine of the last five recessions).

Since last summer, when the housing bust became unmistakable, =20
interest rates on long-term bonds have fallen sharply. They=92re now =20
yielding much less than short-term bonds. The fact that investors are =20=

willing to buy those long-term bonds anyway tells us that these =20
investors expect interest rates to fall. And that will happen only if =20=

the economy weakens, forcing the Federal Reserve to cut rates. So =20
bond buyers are, in effect, betting on a future economic slowdown.

How serious a slump is the bond market predicting? Pretty serious. =20
Right now, statistical models based on the historical correlation =20
between interest rates and recessions give roughly even odds that =20
we=92re about to experience a formal recession. And since even a =20
slowdown that doesn=92t formally qualify as a recession can lead to a =20=

sharp rise in unemployment, the odds are very good =97 maybe 2 to 1 =97 =20=

that 2007 will be a very tough year.

Luckily, we=92ve got good leadership for the coming economic storm: the =20=

White House is occupied by a man who=92s ideologically flexible, =20
listens to a wide variety of views, and understands that policy has =20
to be based on careful analysis, not gut instincts. Oh, wait.