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Source link: http://archive.mises.org/6496/recession-2007/

Recession 2007

April 11, 2007 by

It seems increasingly clear that we will see a US recession this year. The main reason for this is that the housing bubble that fueled the recovery of the last few years has essentially burst. Yet there are increasing signs that the worst is yet to come. Much of the housing bubble was financed by so-called subprime mortgages, mortgages to people with a low credit rating. Subprime mortgages were encouraged greatly by the government, with the Federal Reserve providing a cheap source of credit and with Bush encouraging it as part of the “ownership society” that he envisioned. FULL ARTICLE


TLWP Sam April 11, 2007 at 9:19 am

I don’t know, maybe it’s a case of ‘behind every silver lining there’s a cloud’. But I thought, within reason, that recessions and crashes can be good inasmuchas they are also called ‘corrections’. It has been said many times here that booms are false wealth bubbles created by easy credit and the false good times have to come to end eventually. Hence an economic downturn really means the false wealthy get kicked off? Or hasn’t it been said that in an economic downturn we find out who are the true investors and who were merely speculators?

RogerM April 11, 2007 at 9:34 am

TLWP, I agree. Recessions clear out the mistakes made during the boom caused by artificial money pumping by the Fed. It’s also a time when great fortunes are started because some investors will buy the capital assets that were poorly invested for pennies on the dollar. Then, when the economy recovers, those assets will regain their value.

The Fed will lower rates sometime this year, but keep in mind the lag between Fed action and the effect on the economy. The slowdown we have today is the result of the Fed’s raising interest rates a year or so ago. Any rate decreases won’t take effect until sometime in 2008. I think Karlsson is right that the recession will happen in 2007, so investors should start selling and head for cash or gold so that when the economy hits bottom, they can buy assets on the cheap.

steve April 11, 2007 at 10:02 am

Famous last words,

On February 26, 2004, Allen Greenspan said, “American consumers might benefit if lenders provide greater mortgage product alternatives to the traditional fixed rate mortgage. To the degree that households are driven by fears of payment shocks but willing to manage their own interest – rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.”


What a racket! If you think the US dollar’s purchasing power has shriveled in the last 7 years, wait and see what it buys after the latest bust ends.

N. Joseph Potts April 11, 2007 at 10:14 am

Well, now on the Mises Daily Articles, we’ve got Robert Murphy’s earlier and very cogent pronouncement that there won’t be a recession in 2007, and we’ve got Karlsson saying with roughly equal confidence (“barring a positive shock…”) that there will be. This is a prognosticator’s horserace. I watch with great interest, and not just because I want to see who wins that race . . .

ed April 11, 2007 at 10:33 am

One thing that even the pragmatists seem to gloss over is the relationship between expected inflation, long term rates, and housing prices. So we have a bubble in housing and it is getting ready to burst is the premise. And high prices in commodities ties the Feds hands to lower rates. We can argue that foreign holdings of long term bonds also ties the Feds hands. If the Fed lowers rates and weakens the dollar, foreigners will sell the US bonds they hold –> raising long term rates and cratering the housing market further. OK thats fine so far. But if the Fed keeps rates near where they are now we can assume that foreigners continue to hold US bonds and gold and housing fall slightly. If the Fed moves in any directin consensus says that it will be lower but only slightly. Lets assume thats what he does this year and next. Assume also that the dollar doesn’t crash. The result will most likely be that gold and oil will remain relatively high or about $700/oz and $70/barrel with inflation “higher than Bernanke would like it”. Housing will be in a tug of war between fewer buyers and a hard asset that is valuable relative to the extrememly low 30 year rates. Ie an inflation hedge just like gold or oil.

The money thats sloshing around has to go somewhere. If the argument is that hard assets are going to remain high then housing should also remain high. I read so oftem from either gold bugs, inflation hawks, or outright bears that the housing bubble is going to burst but put all your money into gold and oil. I’m convinced that those three will follow each other with small variations here and there while tracking inversely to the money supply, ie true inflation.

Nice metrics to track are the three ratios. Gold/oil Gold/housing and oil/housing.

Yancey Ward April 11, 2007 at 10:34 am

Nah, there will be no housing led recession! We can stop the meltdown in the housing sector with brilliant plans like this.

ed April 11, 2007 at 11:03 am

Here are the ratios to give a rough estimate of comparibles. The way I interpret them is that the pure commodities like gold and oil have risen much faster than the median house prices. There are definite regional issues in housing but for the purpose of the article, an overall US median price works best. I also checked average prices instead of median and the same trend showed up. Keep in mind that most people don’t live in NYC, San Francisc, DC, or Miami just most reporters looking for the biggest rise and dropoff.

I hope these numbers show up formated OK. Housing numbers came from Realtor.com and Oil and Gold were estmiated as an average for the year using typical charts off Bloomberg.

House (med) Gold Oil
2004 $195,400 420 40
2005 219,600 470 55
2006 221,900 580 65
Feb 07 212,800 670 62


Gold/Oil House/Gold House/Oil
2004 10.5 465 4,885
2005 8.5 467 3,993
2006 8.9 383 3,414
Feb 07 10.8 318 3,432

David White April 11, 2007 at 11:18 am

I predict that the Fed will loosen amid the mounting carnage in housing, as the powers that be know that the dollar is toast anyway and that China is eventually going to pull out of the US bond market, as the vendor-financing of its US exports becomes a losing proposition.

Thus will the dollar’s collapse be papered over with the amero; thus will the loss of China’s cheap goods require the effective naturalization of the Mexican workforce via the North American Union; and thus will Iran be attacked, the better to create a state of emergency that will provide the necessary legal cover for these desperate but “necessary” acts.

But what else can one expect from the unwinding of the greatest fraud in the history of the world.

ed April 11, 2007 at 11:40 am

So what comes first, housing prices drop or the Fed loosens? If the Fed loosens first (which I predict but who knows) then the doomsday scenario may occur. If thats the case, I would rather own a (overpriced) house leveraged with the most (fixed rate) debt I can find which I can then pay off with inflated dollars.

But the doomsday scenario is either the dollar takes a dive and housing is reasonably secure


housing takes a dive and the dollar is reasonably secure.

But you really can’t have a (US wide) housing bust and a dollar collapse. Stagflation could happen of a sort where housing is simply overpriced and inflation hits everything else but the ratios I showed above counter that argument. The other major doomsday would be a collapse in property rights combined with a collapse in the dollar resulting in a crash in housing prices and hyperinflation. I won’t rule that out but its very unlikely at this stage.

kel April 11, 2007 at 11:54 am

Let’s not forget, that it’s not the interest rate per-se that matters, but the rate relative to the natural rate. Even though rates are higher than before, they are still below the natural rate. In other words, the Fed is still pumping money just to keep the rates at the level they are now – it’s just not pumping quite as hard as it would be to have the rates lower than current rates. So the Fed is still increasing the money supply even as we speak (though M1 seems to be stabilizing).

David White April 11, 2007 at 12:10 pm


Factor in Peak Oil — http://video.google.com/videoplay?docid=-596805984521272213 — and/or an attack on Iran — http://news.bbc.co.uk/2/6376639.stm — and you’re looking at stagflation on steroids, otherwise known as a hyper-inflationary depression.

And let me add the words of Michael Kosares, who posted the following this morning on his website’s discussion forum:

I believe that the seeds are being sown this spring for a crisis of enormous proportion in both the near and medium term futures, and none of the pundits in the mainstream media have given this problem proper attention. When faced with a long list of negative scenarios, the problem of financing the American government to many observers takes on the importance of all the rest. But let me say again, this is not your run of the mill crisis. None of us are immune to the results of this crisis quietly building behind the scenes.

I note in this morning’s paper that China will not take part in the upcoming G-7 conferences on the international economy, trade, etc. Is this a boycott? Or is it another political stratagem on the part of the Chinese to avoid a commitment to free currency exchange rates and pressure to support the U.S. Treasuries market? If nothing else, it sends a message of digging in its heels. Positions are being honed to a sharp edge, and that, at some point, will be viewed with alarm in the world’s capitals.

In short the dollar-based quid pro quo which has fueled the world economy over the past half century appears to be breaking down and all of us had better do something to cushion the upcoming shocks.


TGGP April 11, 2007 at 12:54 pm

Gold-bugs/libertarians have been predicting “the big one” for years and been wrong. Instead we simply continue to become richer, but at a slower rate than we would if it were not for all the stupid government policies leaching off the expanding economy.

Regardless of whether or not there is a recession, I am confident that “peak oil” is nonsense (it was originally theorized to be imminent in 1875) and there not be a war with Iran. Sorry to dissappoint the tin-foil-hat wearers.

David White April 11, 2007 at 1:20 pm


You might reconsider if you watch the presentation and note the connection between oil and credit — i.e., the former would have been depleted far less rapidly were it not for decades of easy, fiat-based credit.

And bear in mind that Marion King Hubbert of “Hubbert’s Peak” fame — http://en.wikipedia.org/wiki/Peak_oil — predicted in 1956 that US oil production would peak by 1970. It did. Thus are others are now saying — http://en.wikipedia.org/wiki/Peak_oil#Peak_oil_production.E2.80.94has_it_happened_already.3F — that world oi production may have actually peaked in 2005.

This is hard data, not the computer modeling that drives the absurd War on CO2, that would be all the harder if the governments of oil producing nations weren’t trying so hard to keep it out of public view — http://www.grist.org/news/maindish/2005/11/03/simmons/index.html

I wonder why.

ed April 11, 2007 at 3:34 pm

“and you’re looking at stagflation on steroids, otherwise known as a hyper-inflationary depression.”

This just can’t happen if what you mean by depression you mean depressed prices. With Hyperinflaion or even just high inflation; housing, even current “overpriced” housing, becomes a great hedge. Certainly better than stocks and siginficantly better than bonds. Probably also comparible to oil and gold.

Lets say we enter 12% inflation and 12% unemplowment a classic stagflation environment. Competeing forces on Housing are inflation and lack of buyers. Take the scenario comparing a home fully paid for or a home levered 80% at a 30 year fixed loan at 6% when inflation is at 10%? The value of the loan itself would allow for the price of the home to decline 40% in value before you finaincially lose out, ie rebuy the house at a lower price but with at a new loan rate.

You probably mean a large downturn in the economy which is a definit possibility but the point of the article and other articles is that housing will cause the fall. Housing will reflect what the government/fed does going forward.

The Mises take on it is that the excess money has poured into housing causing excess inflation in housing relative to other goods. Like the tech bubble, this specific sector will come crashing down. OK maybe but most likely in the areas where growth has occured exponentially. No all stocks crashed in 2000-2001 and this probably will wash out the same way in housing. The very hottest sectors will crash but overall prices may fall a bit but not unhinge the economy.

T.G.G.P April 11, 2007 at 5:37 pm

There’s a pretty good post at Overcoming Bias (of course, just about every post there is great) that deals with the likelihood some of the events discussed here will transpire. It is about using markets to predict the future, something I bet many here will find intriguing.

Chris L. April 11, 2007 at 5:38 pm

TLWP’s and RogerM’s comments remind me of the adage (I doubt he originated it, but he popularised it in Australia) of the Australian/Rhodesian entrepreneur, Robert Hamilton Holmes à Court: “in a bear market, the money returns to its rightful owners.”

PW April 11, 2007 at 6:57 pm

I just finished reading “economics of inflation”. Its about the German experience in the ’20s.

Its a fascinating study of what happens when government obligations meet a loss of confidence in the currency.

Most interesting point in the whole book: when the inflation really got going house prices became extremely cheap on a relative basis. Not hard to figure out why. Rents are linked to real wages. Real wages fall. Therefore yields on houses are and remain low.

If you are going to use houses as a hedge you better have fixed rate debt and be prepared to hold them all the way through to after the stabilization crisis.

David White April 11, 2007 at 8:16 pm


I’m with Twain on problems that turn out to, well, not be (e.g., global cooling, global warming, etc.). But the fact remains that we are 36 years into globalized fiat currencies, and to think that the imbalances that are already apparent are sustainable — i.e., can grow ad infinitum — is utterly absurd.

To quote Nobel Laureate Robert Mundell’s 2000 acceptance speech yet again:

“The main thing we miss today is universal money, a standard of value, the link between the past and the future and the cement linking remote parts of the human race to one another. … The absence of gold as an intrinsic part of our monetary system today makes our century, the one that has just passed, unique in several thousand years.”

Repeat after me: u n i q u e i n s e v e r a l t h o u s a n d y e a r s.

Björn Lundahl April 13, 2007 at 5:55 pm

Under a 100% gold reserve money standard, the business cycle would be wiped out of the economic system. But that does not mean that under current system we are heading towards a catastrophe.

I do not either believe that oil soon runs out. Markets solve our so called energy problem handsomely.

Björn Lundahl

Jeff April 13, 2007 at 6:46 pm

Many people are making predictions about how the next recession will unfold, but it seems to me that very few people have a good understanding of what is going on. With many people making all kinds of different predictions, sometimes for different reasons, the fact is a few people will be right, and most people will be wrong. I don’t think anyone can predict with any certainty how things will unfold. I do think that their are obvious fundamental problems that will lead one way or another to a lower standard of living in North America and Europe. Besides the terrible fundamentals we all know about, another big problem is that government will keep on getting bigger, with more regulations, more corruption, and more war. They will continue to make politically expedient decisions that will make things worse. So even though the economic fundamentals say were in for a nasty recession, the reaction of government will be predictably bad and will make things much worse.

gene berman April 14, 2007 at 9:09 am

Where are the Austrians?

The Fed doesn’t “set” interest rates, it tries to guess what interest rates actually are (as determined by peoples’ discount of future goods) and to influence them (fool the people) by their activities. When they announce a change in rate, it’s to correct what they perceive as past mistake. Their default prejudice, of course, is for lower rates and cheaper money: both encourage activities of which they approve.

I haven’t seen anyone mention the potential in the housing market dependent on current furor over the large number of illegal aliens (currently restrained from execising their true
preferences by the tenuousness of their legal circumstances). If large-scale regularization occurs (as seems likely), it would be a significant “shot-in-the-arm” for the housing industry only partially discounted in the speculative plans of investors.

gene berman April 14, 2007 at 9:31 am

Bjorn Lundahl:

I am normally in nearly 100% agreement with your positions. But now I am not quite sure.

I agree with what you’ve said. But I would disagree with the implication that a 100% gold reserve money standard would be other than a temporary improvement. (For the very same reasons that it has not provided any more than temporary benefit in the past.)

As I’ve remarked (on this site) before, a return to the failed methods of the past cannot be seen as an advance unless we’re resigned to perpetual alternation between a good but doomed-to-be-discarded system and a variety of bad systems. This is the single instance–throughout all of Mises’ works (especially in reference to monetary reconstruction) where I believe he was mistaken–by failing to take into account counter-evidence staring him in the face (the plain fact of prior departures from the standard and impossibility of preventing recurrence under any conceivable arrangement in the future.)

David White April 14, 2007 at 9:37 am


Two hyperlinks for your consideration: one on the inevitable demise of the dollar and the other on Peak Oil. An excerpt form the first appears below, while with regard to the second, I urge you to reflect on the connection the presenter makes between oil and credit — i.e., how the decades-long issuance on non-asset-based credit has resulted in a massively market-distorted depletion of the world’s oil.

“If it is not handled properly, the housing collapse could result in another Great Depression. America no longer has the (manufacturing) capacity to work its way out of a deep recession. While the Fed was sluicing $11 trillion into the real estate market via low interest loans; America’s manufacturing sector was being carted off to China and India in the name of globalization. Without capital investment and increased factory production, economic recovery will be difficult if not impossible. The so-called “rebound” from the 2001 recession was due to artificially low interest rates and easy credit which inflated the housing market. It had nothing to do with increases in productivity, exports, or paying off old debts. In other words, the “recovery” was not real wealth creation but simply credit expansion. There’s a vast chasm between “productivity” and “consumption” although Greenspan never seemed to grasp the difference. … Greenspan’s attitude was aptly summarized by The Daily Reckoning’s Addison Wiggin who said, “GDP measures debt-fueled consumption; it really only measures the rate at which America is going broke’.”



TGGP April 14, 2007 at 2:36 pm

The “death of American manufacturing” has been wildly overstated. I find it unfortunate that Ron Paul also seems to have fallen for it. People only look at the number of manufacturing JOBS, when a real economist would focus on manufacturing OUTPUT, which has consistently increased. We can make more manufactured goods with less labor input, so we do so.

David White April 14, 2007 at 3:47 pm


With the agricultural revolution, enormous productivity gains meant equally large job losses, which the ensuing growth in manufacturing easily absorbed. Now that manufacturing is experiencing its own productivity revolution, however, the question is what industry is going to absorb the millions of workers (outsourcing aside) who are no longer needed.

Services? I don’t think so, at least not on a wage scale comensurate with manufacturing, especially with US workers having to contend with rampant illegal immigration, to say nothing of the collapsing dollar (see above-referenced Atlantic Free Press article).

Björn Lundahl April 14, 2007 at 4:41 pm

Even if the peak oil theory was correct in regard to knowing if and when oil production will peak (which no one knows) and even if world oil production already has peaked, this does not prove that anything currently is “wrong”.

Markets can gradually choose to intensify the exploitation of other alternative energy sources and to increase energy conservation.

If markets do not “sufficiently” chose to do that in regard to some arbitrarily chosen theory and energy prices are kept high, are of no concern, as this would mean that this market outcome would be the most efficient one and therefore, also, the most “sufficient” one.

Markets and the interaction of billions of people and the total flexibility of price mechanisms are also adjusted today in regard to expectations of the future and can not be substituted by people believing they are omnipotent and having godlike characters knowing about the future.

If market decisions that are done today would tomorrow prove to be erroneous, is not either of any concern. Man is not omnipotent and the interaction of billions of people through market prices will only do what is best with regard to the information available. Markets adjust accordingly and all the time when new data is discovered. I would guess that everything we do today in all human fields would be erroneous compared to how we handle things at some unreasonable chosen time in the future.

Björn Lundahl

Björn Lundahl April 14, 2007 at 6:16 pm

From the book, “Dollars and Deficits, Inflation, Monetary Policy and the Balance of Payments”, by Dr. Milton Friedman published in 1968, chapter nine “Free Exchange Rates”, pages 230-231:

“What objections have been raised against floating rates?
One is the allegation that we cannot move to floating rates on our own, that just as two governments are now involved in pegging each rate, so it will take two to unpeg. This is in one sense correct, yet it is irrelevant. The United States can announce that it will no longer try to keep the dollar from depreciating- i.e., in the case of the pound, no longer try to prevent the price of the pound from rising above $2.82. If Britain wants to take on the task of keeping the price of the pound from rising, fine. It can do so only by either being willing to accumulate dollars indefinitely-which is to say, by extending us an unlimited line of credit-or by adapting its internal policy to ours, so that the free market rate stays below $2.82. In either case, we can only gain, not lose.”

Naturally the same principle is at work in regard to that the Chinese central bank (People’s Bank of China) keeps pegging the Chinese Yuan from appreciating against the dollar.

Björn Lundahl
Göteborg, Sweden

quincunx April 14, 2007 at 6:18 pm

How much of ‘peak oil’ is due to real factors and how much is due to policy?

Was the US domestic 1970s ‘peak’ a result of scarcity or of continual accelerating prohibition on energy exploitation? It is difficult to measure the opportunity cost associated with the explosion of ‘environmental’ irrationalism pervading our other legal idiocies. I think the domestic peak is mostly a self-fulfilling prophecy, while genuine scarcity being a moderate component.

I am of the opinion that a large part of the 2000 abyss was exacerbated by loss of sovereign debt accumulation by foreigners and domestic privates.
I think the Asian contagion of 97-98 spilled over into the US, and therefore was not contained. The FED did some interesting things around Y2K that blatantly appears on every monetary chart. Between 1998-2001 foreign and domestic private purchases of government debt declined, while government agency debt (think soc. sec., housing, highway, etc.) continued to pile on. This is important because if an Asian sneeze help cast a light on imbalances in the US economy that was revealed to us in 2000-02, then what will occur because of a totally home grown problem originating in the US? (housing pun intended)

The government has grossly understated CPI, by incorporating quality adjustments into the index. This allows them great leeway into conjuring up more credit. With new substitutions built into the CPI, even if the public was forced to eat bird seed as their main course – CPI would still be low. Since CPI does not measure inflation – but a symptom of inflation, by incorporating a substitution of goods/services into the CPI calculation, the government incorporates another symptom of inflation: quality depreciation (of what people would normally buy) into the index.

So rather than having more abundance of quality goods, we are getting less abundance of quality-deprived goods.

Some have tried to calculate the CPI using a non-changing methodology. http://www.shadowstats.com figures the CPI to be really about 10%, instead of 2-3%. So what we have are government bonds going for about 5%, while CPI is increasing by 10%. That would make ‘real’ earnings on gov debt to be -5%, as opposed to 2-3%. How long will this deception last?

I agree with gene bergman’s comments regarding what the fed doesn’t do. The FED hardly sets anything. It simply accommodates all commercial traffic. If one looks at other short term interest rates, they always seem to be a leading indicator to what the fed is going to do. Of course some of that be due to ‘rational expectations’ resulting from FED propaganda.

These days the fed keeps a close watch on commercial paper rates. Commercial paper rates have been a good leading indicator (of about 5-20 days) as to what the FED does.

Keep in mind that all the FED does functionally is buy government debt (non-yet-matured quasi IOU time deposits) and issues its own debt: federal reserve notes and electronic deposits, which are considered to be ‘debt paid’ but is actually debt to hard money theorists. The FED is nothing but a debt-swapping machine! The real engine of monetary growth is the treasury. The treasury creates debt certificates that act just like real exchangeable goods between big financials, non-financials, and gov agencies. The FED is simply charged with the power to issue high powered money so that banks can pyramid low powered treasury obligations with their new matured debt (fed notes/reserves). That’s why I have such a problem with folks who think the FED is evil because it is ‘private’, and that if we had an independent treasury all would be well. Of course those nations that have such a system have proven just as bad, if not worse, since there is no ‘private’ agency the government can blame for its own doing.

What really is the difference between a government certificate that says we will pay out 5% in 1 month, and a certificate that says: ‘congratulations, we payed you out 5% in 1 month’?

To the common man, one buys goods and services readily, whereas the other doesn’t.

But to firms they are essentially the same. The US debt market is much bigger than the stock market.

There will be a recession started in 2007, that is for certain, it will be mild, and likely forestalled a bit. The real pain will come in when the balance of payment reverses (possibly in by mid 2008). In many ways I think we are going to repeat the 70s (2007 being like 1973). There is a great chart to illustrate this:


David White April 16, 2007 at 7:09 am


To note the connection here — http://video.google.com/videoplay?docid=-596805984521272213 — between rapid oil depletion and easy (i.e., non-asset-based) credit is to understand that a sound-money economy would acted entirely differently — i.e., more restricted credit would have both slowed depletion and funneled investment into other alternatives.

Instead, we now have governments doing the same thing with their oil reserves that ours does with inflation — namely, under-report them — in an attempt to keep a lid on the oil price, the only question being how long they will be able to get away with doing so.

I say not much longer.

David White April 16, 2007 at 7:28 am

Oops, make that OVER-report, as in, Governments (especially OPEC) over-report their oil reserves for the same reason ours under-reports inflation: to dampen expectations that prices will rise.

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