Historians are constantly reexamining the past in the hope of shedding new light on events that took place decades or centuries ago. In some cases, the revisionism may be an attempt to make the past conform to today's politically correct standards.
It's no different with economic history. There isn't a whole lot of difference, arithmetically or experientially, between an increase in real gross domestic product of 0.6 percent (old history) and a decrease of 0.2 percent (revisionist history) in the fourth quarter of last year. Eight months ago, the housing market was still imploding, loan defaults were still rising, and food and energy prices were still taking a bigger bite out of the family budget.
What the fourth-quarter minus sign does is make it easier -- more politically correct, if you will -- for the official arbiter of the U.S. business cycle, the National Bureau of Economic Research's Business Cycle Dating Committee, to declare a recession, assuming the coincident indicators they track continue to deteriorate.
In its annual benchmark revisions for 2005 through 2007, the Bureau of Economic Analysis revised real GDP down by 0.2 percentage point a year (on a fourth-quarter over fourth-quarter basis). That adjustment belies huge quarter-to-quarter swings.
For example, strong growth of 4.8 percent in both the second and third quarters of 2007 was bracketed by weak bookends: GDP rose 0.1 percent in the first quarter and declined 0.2 percent in the fourth.
Not So Hot
The BEA's first guess at second-quarter GDP growth was 1.9 percent. The drawdown in inventories subtracted almost 2 percentage points from growth while the shrinking trade deficit added 2.4 percentage points, the most in almost three decades.
Half the trade improvement was the result of a 6.6 percent annualized decline in real imports, according to Goldman Sachs Group Inc. economists. ``Imports don't fall that sharply in a strong economy, at least not in the United States,'' they wrote in a note to clients.
Residential investment fell 15.6 percent, the smallest decline in a year. Consumer spending rose 1.5 percent, shy of estimates, even with the presumed boost from one-time tax rebate checks. By the end of the second quarter, Treasury had distributed $78.3 billion in rebates as part of an economic stimulus program.
Mind the Spread
There's a more important reason economists and statisticians are interested in economic history. They are constantly constructing (and deconstructing) econometric models, creating indexes and searching for indicators that will give them a forecasting edge.
For whatever reason, most of them fail to heed the message of the yield curve, one of the more reliable harbingers of recession.
The slope of the yield curve -- the difference between a short-term rate under the direct control or influence of the central bank and a market-determined long-term rate -- has been one of the best predictors of recession over the last half century. Its stellar reputation prompted the Conference Board to add the spread to its Index of Leading Economic Indicators in the 1996 overhaul.
When the curve is inverted -- when the monetary authority is holding the overnight rate above the long rate -- it augurs bad times ahead.
In the current cycle, the fed funds/10-year spread was inverted on a monthly basis from July 2006 through December 2007. Fed officials ignored the message until the financial system blew up in their faces.
Policy makers argued that a ``global savings glut'' was keeping long rates low. (The reason is irrelevant.) Almost everyone else pooh-poohed the spread, saying the economy doesn't turn down when long-term interest rates are low, inversion or no inversion.
Maybe, just maybe, the inverted yield curve contributed to banks' distress. Late last year, after the banks started to own up to the extent of their losses, New York Times columnist Floyd Norris put everything in perspective.
``We should have known something was strange,'' Norris wrote in a Nov. 16 column. ``The banks were doing a lot better than they should have been doing.''
Banks borrow short and lend long. They profit handsomely from the existence of an upward sloping yield curve. They can borrow at the fed funds rate and invest in risk-free U.S. Treasuries and rack up nice profits.
Reaching for Yield
At the time, the curve was flat or inverted, and credit spreads were historically low, Norris pointed out. ``Yet the bank stocks were buoyant, and so were reported profits.''
I remember kicking myself for not putting it all together. Banks, we now know, were dabbling in AAA rated garbage in the proverbial reach for yield.
They stretched too far and are paying the price.
What's the yield curve telling us now? The 200-basis-point spread between the funds rate and 10-year Treasury yield is indicative of an expansionary monetary policy in ordinary times.
The times are hardly ordinary. Previous periods of banking- system stress -- the early 1990s, for example -- have required an extended period of a near-vertical yield curve (400 basis points in 1992) to allow the banks to heal.
It takes a wider spread to achieve the same result when banks are choosing to restrict credit availability or, worse, shrinking their balance sheets to improve capital ratios.
That's the single most-important reason the Fed isn't likely to raise its benchmark rate, currently at 2 percent, anytime soon.
The second reason is, it's politically incorrect, not to mention risky, to raise rates in recession.