Patrician Economic Report: October 2009

Well, well. October, the month when every single major stock market crash has occured, is here. While I'm not suggesting there will be one this October, this October marks a solemn anniversary -- that of the Crash of 2008.

One year ago today, on October 11, the reality was just sinking in of the crash and associated economic depression, and the fact that the Dow was then at 8400, after plummeting earlier in the morning to 7882.51, only to rise above 8900 in the afternoon, the first such 1000+ point trading range in Dow history.

But in reality points do not matter very much. They may make good headlines, but what is behind the numbers is what is real. What was behind them then was an ongoing financial crisis along with a depression.

Why use the term depression? For one thing, the American economy is depressed, but most importantly, the losses in GDP, after accounting for BLS's underestimates of inflation (see earlier articles for more info), the total decline from Q4 2007 to Q2 2009 is 12 percent, well above the 10 percent threshold many economists use to denote a depression. But it is by no means a great depression, at least not yet. A reasonable definition of that would be a decline of >20 percent, which has only occured twice -- the Depressions of 1837 and 1929, with the 1929 one being the more severe of the two.

However, as far as the stock traders are concerned, they may as well be saying "Damn reality -- full speed ahead". They have said this with the 60 percent rally which has occured since March. Here is a chart of the S&P 500 over the past year:



It just so happens that a 6 percent drop occured just after my rather pessimistic economic report, only to rebound later near the highs. Some traders are concerned that this will be a double-top, but most just dismiss it as a downward blip, having blind and full faith that the nebulous, mystical, ambiguous "money on the sidelines" will come in and feed the irrational exuberance that is this little bull market.

Sure, there is money that is not being put to use sitting around that was pulled out in the crash time (2008-09-15 to 2009-03-09). But what matters is not its existence, what matters is the owners of the money. Still cautious, they are still putting this money to use. But it is not predominately in the stock market -- they are putting it into 2 classes of investments -- bonds and gold.

In case you had not noticed, gold has recently hit a record-high dollar price, breaking 1040 per ounce. This breaks a major resistance level, and paves the way for further gains, at least in the short-term. Keep in mind that gold may correct as part of the normal process of continuing a long-term uptrend. Below is a 5-year chart:




The unemployment report was also released by the BLS earlier in the month, and U3 unemployment rate increased to 9.8%, and payroll losses were much worse than expected. However, the U3 rate is a flawed statistic, in that it excludes those unemployed who are discouraged and those employed part-time for economic reasons, which was included in the statistics prior to the 1990's.

Therefore it gives a distorted reading of today compared to the past, and today compared to today. The U6 rate, buried in the BLS tables, shows a slight decrease to 16.1 percent, a far cry from the golden years of the bull market.

Also, if you add in those who are "not in the labor force but want a job now", at least some of whom may be actual unemployed, the rate spikes up to 19.8 percent, unchanged from last month, and showing only a 0.3 percent improvement from July. While this statistic may be a bit distorted, due to some of those people not being actual unemployed, it is nevertheless an important part of this economic puzzle.

Finally, if the seasonally-adjusted measurements from BLS are used (and I'm not vouching for the validity of the adjustments), then the employment situation actually worsened by about 0.2% since last month, putting the U6 rate at 17.0 percent, and the U6 + not in labor force but want job now rate to 20.9 percent.

If you use the U6 measurements, which were used in the 1980's recessions (the ones this labor market is constantly being compared to), then this labor situation is far worse (a good 5-10 percent), and constituted the worst employment situation since the Great Depression. Back then unemployment stood at 25 percent, which is worse than it is now regardless of what statistic you use. Now it stands at around 16 percent.

This assessment is also backed up by another statistic, the amount of job openings avaliable, which have sunk by 2.7 million, or put another way, cut in half, since their 2007 peak, making it the worst decline since the Great Depression.

The scenario that I have outlined in the last report seems to be still playing out. Remember the six points I outlined in my scenario. Let's do a checklist:

- Stock market continuing a rabid runup with no supporting facts. Check.
- Doubling of the money supply. Check.
- Gold continuing to rise. Check (record high)
- Commodities in general shooting up. Check
- Weaker dollar. Check (on verge of new low)
- Higher inflation. Check (inflation is accelerating)

The points outlined above are the points indicative of an inflationary spiral, which will eventually (<5 years) produce a downturn on its own. With the runup in the money supply, inflation accelerating (in what would ordinarily be a deflationary environment), and the gold indicator showing a red flag, as well as a stock market rally, the "cure" in this depression will be worse than what it was trying to treat in the first place (the depression).

GDP was also revised upwards for Q2 2009 to -0.7 percent. Adjusting for actual inflation that figure is more like -3.4 percent. A modest "less-bad" case, but still there is no growth, and as Robert Reich has pointed out, there is nowhere the growth will come from. Due to the Americans putting themselves in a corner with 70 percent of the economy being consumer spending, unemployment will continue to push GDP down for a long time to come. Think -- if you have no job, you don't spend much, do you?

Also consider that Q3 2009 GDP will be coming out in a few weeks. If the so-called "second-half recovery" does not materialize, I expect that the market will be in for a major downturn. Expectations are now so high for growth that it would be easy to disappoint them.

Lastly, I would like to point out that the terms and attitudes being bandied about now are eerily reminiscent of 1930. Just do a google news search for "economic depression" for 1930, and see for yourself. This concerns me significantly, especially after reading the very cautious and tentative rhetoric being used in 1932, the bottom of the downturn.

The next report, barring a traditional October crash, will be in November.