Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
How to Trade Binance Vanilla Options for the First Time on Bitcoin Crypto's - 2nd Aug 21
From vaccine inequality to economic apartheid - 2nd Aug 21
Stock Market Intermediate Top Reached - 2nd Aug 21
Gold at a Crossroads of Hawkish Fed and High Inflation - 2nd Aug 21
Bitcoin, Crypto Market Black Swans from Google to Obsolescence - 1st Aug 21
Gold Stocks Autumn Rally - 1st Aug 21
Earn Upto 6% Interest Rate on USD Cash Deposits with Binance Crypto Exchange USDC amd BUSD - 1st Aug 21
Vuze XR VR 3D Camera Takes Near 2 Minutes to Turn On, Buggy Firmware - 1st Aug 21
Sun EXPLODES! Goes SuperNova! Will Any planets Survive? Jupiter? Pluto? - 1st Aug 21
USDT is 9-11 for Central Banks the Bitcoin Black Swan - Tether Un-Stable Coin Ponzi Schemes! - 30th Jul 21
Behavior of Inflation and US Treasury Bond Yields Seems… Contradictory - 30th Jul 21
Gold and Silver Precious Metals Technical Analysis - 30th Jul 21
The Inadvertent Debt/Inflation Trap – Is It Time for the Stock Market To Face The Music? - 30th Jul 21
Fed Stocks Nothingburger, Dollar Lower, Focus on GDP, PCE - 30th Jul 21
Reverse REPO Market Brewing Financial Crisis Black Swan Danger - 29th Jul 21
Next Time You See "4 Times as Many Stock Market Bulls as There Are Bears," Remember This - 29th Jul 21
USDX: More Sideways Trading Ahead? - 29th Jul 21
Waiting On Silver - 29th Jul 21
Showdown: Paper vs. Physical Markets - 29th Jul 21
New set of Priorities needed for Unstoppable Global Warming - 29th Jul 21
The US Dollar is the Driver of the Gold & Silver Sectors - 28th Jul 21
Fed: Murderer of Markets and the Middle Class - 28th Jul 21
Gold And Silver – Which Will Have An Explosive Price Rally And Which Will Have A Sustained One? - 28th Jul 21
I Guess The Stock Market Does Not Fear Covid - So Should You? - 28th Jul 21
Eight Do’s and Don’ts For Options Traders - 28th Jul 21
Chasing Value in Unloved by Markets Small Cap Biotech Stocks for the Long-run - 27th Jul 21
Inflation Pressures Persist Despite Biden Propaganda - 27th Jul 21
Gold Investors Wavering - 27th Jul 21
Bogdance - How Binance Scams Futures Traders With Fake Bitcoin Prices to Run Limits and Margin Calls - 27th Jul 21
SPX Going for the Major Stock Market Top? - 27th Jul 21
What Is HND and How It Will Help Your Career Growth? - 27th Jul 21
5 Mobile Apps Day Traders Should Know About - 27th Jul 21
Global Stock Market Investing: Here's the Message of Consumer "Overconfidence" - 25th Jul 21
Gold’s Behavior in Various Parallel Inflation Universes - 25th Jul 21
Indian Delta Variant INFECTED! How infectious, Deadly, Do Vaccines Work? Avoid the PCR Test? - 25th Jul 21
Bitcoin Stock to Flow Model to Infinity and Beyond Price Forecasts - 25th Jul 21
Bitcoin Black Swan - GOOGLE! - 24th Jul 21
Stock Market Stalling Signs? Taking a Look Under the Hood of US Equities - 24th Jul 21
Biden’s Dangerous Inflation Denials - 24th Jul 21
How does CFD trading work - 24th Jul 21
Junior Gold Miners: New Yearly Lows! Will We See a Further Drop? - 23rd Jul 21
Best Forex Strategy for Consistent Profits - 23rd Jul 21
Popular Forex Brokers That You Might Want to Check Out - 22nd Jul 21
Bitcoin Black Swan - Will Crypto Currencies Get Banned? - 22nd Jul 21
Bitcoin Price Enters Stage #4 Excess Phase Peak Breakdown – Where To Next? - 22nd Jul 21
Powell Gave Congress Dovish Signs. Will It Help Gold Price? - 22nd Jul 21
What’s Next For Gold Is Always About The US Dollar - 22nd Jul 21
URGENT! ALL Windows 10 Users Must Do this NOW! Windows Image Backup Before it is Too Late! - 22nd Jul 21
Bitcoin Price CRASH, How to SELL BTC at $40k! Real Analysis vs Shill Coin Pumper's and Clueless Newbs - 21st Jul 21
Emotional Stock Traders React To Recent Market Rotation – Are You Ready For What’s Next? - 21st Jul 21
Killing Driveway Weeds FAST with a Pressure Washer - 8 months Later - Did it work?- Block Paving Weeds - 21st Jul 21
Post-Covid Stimulus Payouts & The US Fed Push Global Investors Deeper Into US Value Bubble - 21st Jul 21
What is Social Trading - 21st Jul 21
Would Transparency Help Crypto? - 21st Jul 21
AI Predicts US Tech Stocks Price Valuations Three Years Ahead (ASVF) - 20th Jul 21
Gold Asks: Has Inflation Already Peaked? - 20th Jul 21
FREE PASS to Analysis and Trend forecasts of 50+ Global Markets by Elliott Wave International - 20th Jul 21
Nissan to Create 1000s of jobs with electric vehicle investment in UK - 20th Jul 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The US Economy: Is Manufacturing and the Yield Curve Signalling Recession?

Economics / Inverted Yield Curve Apr 10, 2007 - 12:57 AM GMT

By: Gerard_Jackson


The US yield curve is giving a lot of economic commentators the jitters. The rule is that whenever the yield curve goes negative, i.e., short-term interest rates exceed long-term interest rates, a recession emerges some 12 to 18 months later. There was a great deal of hand-wringing in late 2005 when the yield turned negative. Recently the curve has started to flatten, with some commentators now predicting that it will once again go positive and give the US economy another spurt of growth.

The odd thing here is that the economic commentariat do not seem to realize that in a truly free market the yield curve would always tend to be flat. If a difference between long-term and short-term rates emerged then arbitrage would eliminate the difference. Say, for instance, short-term rates began to rise, then investors would desert long-term rates in favour of short-term rates. This would see short-term rates fall and long-term rates rise until the curve was flat.

What the vast majority of commentators overlook is that it is the central bank that manipulates short-term rats. When the economic consequences of this manipulation forces the bank to slap on the monetary brakes interest rates rise and the economy goes into recession. Note: it is the monetary tightening that brings the boom to an end. The rise in short-term rates is just a symptom.

Some have it that the current movement in the yield curve is the result of investors speculating that the Fed is about to loosen the monetary spigot to rescue the housing market. This means that investors are selling long-term bonds and buying short term notes that would benefit from a rate cut. Be that as it may, this action, if it is occurring only serves to confirm our view that in a free market arbitrage would ensure that the curve remained flat.

At the end of March the federal funds rates was 5.26, which is only about 2.5 per cent in real terms. On 9 April 3 month notes were 5.03 per cent while 30-year bonds stood at 4.92 per cent, a difference of 0.13 per cent. So what does all of this tell us about recession? Not much really. Economic figures have to be interpreted. Now many people would see these rates as stimulating output and hence GDP. But there are other factors at work.

The effect of artificially lowering short-term rates is to mislead business into thinking there are more savings available then actually exist. This leads to a pattern of investment in the higher stages of production that cannot be sustained by the real rate of savings. Eventually the process reverses itself and the demand for consumer goods starts accelerating as real wages rise. It is at this point that manufacturing output tends to slowdown and eventually go negative. In the meantime manufacturing employment drops while aggregate employment rises.

This is the classic pattern of boom and bust and the one that marked Clinton's last term of office. When this pattern emerges commentators are likely to lament the weakening of capital spending, thereby successfully confusing cause and effect. But what they should be looking at is spending of fixed capital but spending on 'circulating' capital, otherwise known as intermediate goods. Therese are the goods that pass from stage to stage. Now, having said that, do the facts fit the theory?

During the last 9 months of 2006 inflation-adjusted expenditure on capital goods, factories as well as machinery, grew by 3.9 per cent per quarter. The previous three quarters witnessed an average of 8.2 per cent. Moreover, statistics for January and February indicate a severe drop in orders for capital goods. In addition, manufacturing has been shedding labour. Nevertheless, it is reported that in March the economy generated an extra 180,000 jobs driving the unemployment rate down to 4.4 per cent.

So where are all the jobs coming from? Austrian economic theory predicts that the additional jobs will appear at the lower stages of production, those closest to the point of consumption. As expected, we find that educational services, leisure and hospitality companies, retailers and health care providers, etc., were among those occupations where the demand for labour rose significantly. Clearly increased consumer spending is making itself felt. (It should be pointed out that increased spending on consumption goods does nothing to raise the marginal productivity of labour. Something that the classical economists fully understood). All of this brings us to the money supply. From October 2005 to the end of last March money supply (currency, demand deposits and other checkable deposits) rose by 4 per cent.

Now to top it all off, it has been reported that businesses plan to increase capital spending by 7 per cent during the next 12 months as against 4.9 per cent in December. So what gives here? Off hand I'm inclined to think that the Fed may be loosening money policy. Furthermore, large profits and low capital gains taxes may very well have extended the boom.

For those of you who think I might be hedging my bets -- I don't blame you for being suspicious. But let me draw your attention to three economic events that illustrate why one should always exercise prudence in these matters. In 1923 the US economy began to experience a mild downturn. Left alone the market would have easily liquidated the malinvestments. However, the Fed quickly reversed the situation by rapidly expanding credit. Therefore those observers who were led by the data to believe that a recession was imminent had to wait until 1928 to have their warnings about the state of the American economy confirmed.

In the 1920s the Fed used open-market operations to mop up 'excess' liquidity. Yet credit kept on expanding. The reason was two-fold: firstly, open-market operations were more than offset by a low rediscount rate that allowed banks to replenish their reserves and so expand credit further. Secondly, new banking rules not only allowed interest to be paid on time deposits it also reduced their reserve from 7 per cent to 3 per cent. The result was that banks were able to expand credit further by converting demand deposits into time deposits.

My third example comes from Australia. I had been predicting that the country was heading for a recession. In early 1999 business investment dropped and the current account deficit blew out to 5.2 per cent of GDP. Things were looking grim. Then the March quarter for 2001 showed that manufacturing output had fallen by 2.2 per cent, a figure that exceeded industry predictions and which followed successive falls in the December and September quarters. Furthermore, output had been falling during the previous 12 months. Firms were cutting back on investment, shedding labour, introducing short-time working, and profits were declining.

Naturally I declared that the jury was in that Australia was in recession. The Reserve Bank of Australia then did what I should have expected it to do and let the money supply rip. It cut rates from 6.25 per cent to 4.25 per cent, a full two per centage. M1 rocketed by 22 per cent and credit exploded by 25 per cent.

So before readers start making predictions at this stage about the US economy, I strongly suggest that they recall their economic history and continue to bear in mind the monetary power of central banks.

Note: The Austrian definition of the US money supply is currency outside Treasury, Federal Reserve Banks and the vaults of depository institutions.

Demand deposits at commercial banks and foreign-related institutions other than those due to depository institutions, the U.S. government and foreign banks and official institutions, less cash items in the process of collection and Federal Reserve float.

NOW (negotiable order of withdrawal) and ATS (automatic transfer service) balances at commercial banks, U.S. branches and agencies of foreign banks, and Edge Act corporations. NOW balances at thrifts, credit union share draft balances, and demand deposits at thrifts.

AMS definition therefore equals cash plus demand deposits with commercial banks and thrift institutions plus saving deposits plus government deposits with banks and the central bank.

By Gerard Jackson


Gerard Jackson is Brookes economics editor.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in