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John Hussman: Implications of a Likely Economic Downturn



July 06, 2010 – Comments (2)

John Hussman of puts out a Weekly Market Comment (which I highly encourage you to read every week). Per usual, this is another good article. This one goes along with the last WMC - John Hussman: Recession Warning (Unthinkability is Not Evidence) - The entire thing is a very good read, but I have highlighted a few particularly good gems.


Implications of a Likely Economic Downturn
John P. Hussman, Ph.D.
July 6, 2010


A week ago, we accumulated enough evidence to conclude that the U.S. economy is most probably headed into a second leg of recession. It is unclear whether this will be identified as a second recession or a continuation of an existing downturn. In either case, I've repeatedly noted that the apparent strength in the U.S. economy over the past year has been driven almost exclusively by an almost inconceivably large burst of fiscal and monetary "stimulus" last year, whereas intrinsic economic activity has stagnated. Personal income remains at its lows once government transfer payments are excluded, which is in stark contrast to typical post-war recoveries. Weekly jobless claims are pushing again toward 500,000, whereas prior post-war recoveries have seen jobless claims quickly retreat below the 400,000 figure that roughly delineates job growth from continued job losses. The most straightforward explanation of the economic data is that we've observed a stimulus-led recovery that has not translated into private economic activity, and that the effects of the stimulus are now diminishing.

Our recession warning composite, on which part of my present concern is based, reflects essentially the same combination of factors that produced the warning I reported in the November 12, 2007 weekly comment Expecting A Recession , as well as the recession warning I reported in October 2000 . Based on the high correlation and roughly 13-week lead that the ECRI Weekly Leading Index provides, compared with the ISM Purchasing Managers Index, I noted last week that the use of the ECRI Index provides somewhat more timely signals. I want to emphasize, however, that our use of the ECRI Index is as one component of a broader set of indicators that we look to observe in concert to produce a recession warning.

..... (the next section contains an excellent discussion of Keynesian algebra, which you should read, and why they propose the same solutions) .....

One might also wonder why we don't consider the dynamics of output over time, which would also force us to ask how productive different sorts of spending might be. Surely, the allocation of resources is crucial, because every form of spending has a different effect on the cumulative amount of future output created. The true debate in economics is not between Keynesians and Monetarists, but between economists who care about the productivity of resource allocation and those who only pay lip service.


Meanwhile, I continue to believe that both Bernanke and Geithner's hands should be tied quickly. If we have learned anything over the past 18 months, it is clear that these bureaucrats can misallocate an enormous quantity of public resources with mind-numbing speed. The diversion of public resources to the bondholders of failing financials - to precisely the worst stewards of capital in society - is not stimulative, but ruthless. A second economic downturn should encourage the repudiation of the policies that Bernanke and Geithner pursued during the first.

By all appearances, Ben Bernanke has a four-second tape in his head that says "We let the banks fail during the Depression, and look what happened." Then the tape repeats. There is no subtlety that says, "yes, but we let the banks fail in the most disruptive and disorganized way possible, forcing them into piecemeal liquidation as Lehman had to do. Today, the FDIC is fully capable of preserving and transferring the operating entity while properly cutting away the failing bondholder and stockholder liabilities so that depositors and customers are not affected." This understanding would prove useful in the event we observe further credit strains.

Basic ethical principle dictates that policy makers should not burden ordinary Americans to pay the losses that well-informed bondholders voluntarily took when they lent money to failing institutions. From my perspective, it is urgent to recognize that Fannie Mae and Freddie Mac obligations are not legally obligations of the U.S. government, that its backing was always at best implicit, and that even the Treasury's distressingly generous 3-year promise to bail out Fannie and Freddie only takes those obligations through 2012.

2 Comments – Post Your Own

#1) On July 06, 2010 at 11:56 AM, outoffocus (24.06) wrote:

Good stuff. I may not agree 100%, probably closer to 98%.  But still good stuff nonetheless.  But I'm beginning to feel like we're gonna experience more deflation in the coming months, especially in the equity markets.  It makes me want to hold on to my cash for a while as opposed to "buying the dlps".

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#2) On July 06, 2010 at 12:02 PM, binve (< 20) wrote:

outoffocus ,

>>Good stuff. I may not agree 100%, probably closer to 98%.

Exactly, same here. I like reading Hussman's work a lot, but I am also in maybe mid-nineties agreement :)

>>I'm beginning to feel like we're gonna experience more deflation in the coming months, especially in the equity markets.

Very much agreed. This is a very deflationary time. The Fed and the government with monetize with impunity in the future but there will definitely be a large deflation bout first. I think 900 is calling the SPX like a magnet...

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