Don't Fear a Recession

I tried to express my thoughts in a simple diagram.

The last few years have been artifically stimulated demand (the bubble demand I indicate above). Call it the housing economy: part house sales and part home loan boosted consumer spending. Home sales contributed 5.5% to the GDP in 2006. That dropped to 5.1% in Q2 of 2007.

In other words - the GDP was artificially inflated by the simple fact of more home sales at higher prices. With fewer home sales, GDP will naturally drop. So negative growth is inevitable and in and of itself not a problem. The underlying economy continues to roar away, in normal cases.

Where it becomes a problem is the second bubble I chart above. Bumping up housing today is really borrowing from tomorrow's demand. That's a bit of a systemic problem for the longer haul for the construction, financial and real estate sectors.

But a bigger problem is that the housing economy included borrowing against that asset (and other excesses). Again, that is what boosted the GDP and made it appear robust. Remove that spending and GDP drops. The only other option is for folks to buy more cars, iPods and so forth. Dump that 3 year old furniture and buy a new set.

But that isn't goingto happen. So GDP will drop.

We shouldn't worry about a slowing GDP caused by slowing housing sales - that's just math. We should worry about the drop in consumer spending. That's when recessions lead to broader economic slowdown.

I believe that massive rate cuts will spur some spending. For example, I bought a car last year and used a credit card offer by Citibank to transfer a balance and pay 0% interest for 12 months. I just got another offer, good for 15 months. I'm going to use that one next. A low interest rate enables these offers. And it frees up my cash for other things to buy.

This reduces the severity of the broader recession.

As more information comes out, focus on consumer spending habits and not on the GDP number.