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September 19, 2006
Watching the Fed, and the baht, and...
Subtitle: One nasty little shock away from recession (thank goodness)
First, look at Tim Duy's take at Economist's View. Solid analysis and a couple of great lines worth quoting.
Are Fed officials just clueless? Don't they see that the end is coming? I think not – I bet Fed officials are not working overtime to spin a negative story out of every number...
and
If you forced the Fed to choose between cutting rates and hiking rates, they would choose the latter. Luckily, they can choose to pause as well.
I agree. Talk of recession is everywhere. A data point that comes in with slower growth, but growth nonetheless (the ol' "increasing at a decreasing rate" as I like to tell my macro classes) leads some to put on sackcloth and ashes. One certainly has to look at the broader picture, as James Hamilton has done, for example.
Yes, the point is often made that the Fed's record at producing a soft landing is a bit weak, with the only real success being in the mid '90s. Some say that overtightening in the late '80s brought on the 1990-91 recession. I agree that it was certainly a contributing factor. But that makes them 1 for 3 in the last 20 years (2001 being the other negative result). But I'm not sure that I'd look at the scenarios of the 1970s or the early 1980s as being similar enough to that of the last 10 years to want to make the comparison. Could Chairman Volker have managed a soft landing instead of a recession with the lousy deck of cards that he was dealt? Bernanke isn't sitting on a royal flush, but by the same token this clearly isn't 1979.
Whether or not a recession occurs is probably going to be due less to Bernanke's skill or lack thereof than it will be due to whether or not some additional exogenous shock hits the U.S. or world economy. I don't think I'm alone in saying that despite my overall optimism, I am not at all squeamish about saying that we are one nasty little shock away from a recession.
And that brings us to the news of today. Here, CNN channels Reuters:
NEW YORK (Reuters) -- The Thai baht staged its largest one-day fall in three years Tuesday after Thai armed forces ousted the prime minister, sparking a broad decline in a number of Asian currencies.
...
Prime Minister Thaksin Shinawatra, who was in New York to speak at the United Nations, declared a "severe state of emergency" in a broadcast on Thai television.
Looking ahead, the market will watch to see whether the Thai crisis prompts investors to abandon other risky emerging market trades.
The dollar would be the main beneficiary in such a scenario, said Divyang Shah, strategist at IDEAGlobal in London, as it is "not only a high-yielder but is also an attractive safe haven."
But other market participants said solid economic fundamentals in Thailand and other emerging Asian markets make a mass rush for the door unlikely.
"There's been an immediate reaction and people will move to the sidelines to see how it all unfolds, but what we'll see will probably be a short-term disruption," said Upadhyaya.
...
Karl Jackson, president of the U.S.-Thailand Business Council, said the country has experienced a military coup 17 times since 1932.
"Basically before democracy came to the forefront, this was the their way of changing the government and it continues," said Jackson, who is also director of Southeast Asia studies at Johns Hopkins University.
"There might be a momentary glitch on the part of investors, but as in previous coups, investment and property rights won't be affected. If the coup is successful, I expect everything will be normal in the morning," he said.
Still, investors were watching the situation closely, since the Asian currency crisis in 1997 started with the devaluation of the Thai baht, then grew into an international economic slowdown.
Yes, it may be that everything will be normal in the morning--except perhaps for Mr. Shinawatra. In all likelihood this will not cause the sort of contagion that took place when the baht collapsed in 1997. But as I read the news coming out of the Asian markets tonight as their trading day comes to a close, I can't help but get the feeling that someone is looking over my shoulder and saying, "Made you look!"
Yes, indeed I looked. Because if there is trouble to be made for the U.S. economy, or the world economy for that matter, it will be made by that unexpected exogenous shock. The straw that broke the camel's back--a classic non-linearity. Maybe not today. Maybe not the baht, but it made me look.
For the last year, I've been cautiously optimistic that we could avoid a hard landing, and to this point it would seem that we have. However the tensions of the last year or two (rising interest rates, rising then falling housing markets, questions about the health of the labor market, etc.) are beginning to give even the optimistic among us a little cause to look over our shoulder once in a while.
Yet, this is something we may have to get used to every decade or so. We have not eliminated the business cycle, but we have tamed it a little. That is going to mean sailing close to the rocks now and then. As long as we keep inflation low and stable, there will be less need for major course corrections. A soft landing, while not assured, is then possible if you are fortunate. It's nerve-racking, but it's better than the boom-and-bust alternative that comes from chasing the Phillips curve too hard.
Thus it is all the more important for the Fed to stick it its inflation fighting guns. As Tim Duy said, given a choice between raising and lowering rates, they would probably raise. That would be my choice as well. But given the increased uncertainty about the effect of the housing slowdown and the lagged effect of past rate increases yet to be felt, keeping rates where they are at this point in time (with a bias toward tightening) is an even better idea. Keeping inflation low and stable is the best thing the Fed can do to ensure that we are one nasty little shock away from a recession more often than we are rushing headlong into one.
Posted by William Polley at September 19, 2006 10:03 PM
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Comments
I look at it a little differently. We have had two soft landings-- one in the late 1960s and the other in the mid-1990s. But in both cases what caused it to be a soft rather then a hard landing was a sort of exogenous growth shock.
In the 1960s it was spending on the Vietnam war.
In the 1990s it was the sharp drop in technology prices that induced a massive capital spending boom.
So what growth shock will emerge this time?
Posted by: spencer at September 20, 2006 02:42 PM
Spencer,
Good point. Most of what has been written on the "soft landing" topic has been suggesting that there has been only one. The late '60s would fit my idea of a "growth recession". (A rose by any other name...) Certainly the spending boost for the war was a factor in that outcome.
It seems appropriate to ask whether we need a growth shock to keep us out of a recession or whether the absence of a negative shock is enough for the economy to right itself. That sounds a bit like a Keynesian litmus test. And I admit that I find myself leaning towards the opinion that an absence of bad news would be indeed very good news. But your point is well taken.
If I knew the answer to your question (what shock will emerge--or if one will emerge), I would be a rich man. But positive shocks, like the negative ones, can come from unexpected places. It's what you don't see coming that matters. What you can see coming you build into expectations (e.g. oil prices over the past couple years).
Thanks, as always.
Posted by: William Polley at September 20, 2006 05:01 PM
I thought of the late 60s too, but (at least with several decades of econometric hindsight) I don’t think I would consider that a “landing” at all. It was more like just a temporary reduction of altitude. The inflationary pressures that had been building did not stop. The late 60s are exactly what the Fed is trying to avoid. (And I’m guessing Martin himself came to think of it as a failure pretty soon after it happened.)
But if we can exclude the 70s and 80s from the Fed’s batting average, I don’t think we should exclude the 60s. If you include both incidents in the late 60s and count either “swung too high” or “swung too low” as a miss, we’re down to 1 out of 5, which is not quite so attractive. Of course, you might exclude 69-70 on the same grounds that you exclude Volker (inflation already a problem), but it still seems to show that it’s easy to tip the economy into recession. (Anyhow, for that matter, why exclude the 50s?)
Posted by: knzn at September 21, 2006 09:22 AM
"Anyhow, for that matter, why exclude the 50s?"
Because I really honestly think that many of the forces affecting the effects of (and the effectiveness of) monetary policy are quite different today than in the '50s.
I'm inclined to agree with you on the late '60s not being a "landing" in the sense that they never really got inflation under control, which in turn led to '69-'70. In early 1970, CPI inflation was running at over 6%. Hard to achieve a soft landing from that point... a lot harder than I think it would be today.
Thanks to you as well, knzn, for your comments.
Posted by: William Polley at September 21, 2006 09:37 AM
Hi Bill, I am a expat.11years ago I retired in Thailand. The Baht was at 25. I never knew how to use this currency. As time went by, the Baht seemed to decrease .In 1997 the Baht was floating. Since then the Baht has decreased. In a matter of days it has dropped drasticly. From 41Baht to the present35.85,what happened? I am much interested in it's progress. Right now I am sitting tight on my spending. What should ,not only me,but many expats do to help get the Baht to it's formal place in Thailand? Should it be pegged at a certain amount again? Believe me; I love the King, and enjoy living in the Kingdom, but I am confused. I guess I am not the only one.
Posted by: Joseph R Trezza at December 1, 2006 04:02 AM