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Are We Entering a Recession?

Mises Daily: Monday, March 13, 2000 by

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A number of signs indicate that our prosperity is ending. The stock market has fallen, crude oil prices are rising, and the Federal Reserve is tightening money. An esoteric signal of impending recession is the "yield curve."

Normally, yields on U.S. Treasury securities rise from short-term Bills to mid-term Notes to long-term Bonds. But, from time to time, the yield curve inverts. This happened prior to every past recession.

However, there been a few times when the yield curve inverted and we did not fall into recession. Is the present inverted yield curve one of its infrequent false positives, or are we about to fall into recession?

Nobody can say for sure. Obviously, the risk of recession is higher than it was a few months ago. But, economies usually give off mixed signals at times like this, and economists are not able to conclude that we are going into recession until we have already been in recession for three to six months.

Same thing with getting out of recession. In 1992, President George Bush was asked if the economy was in recession. He gave the scientifically correct but politically incorrect answer that economists weren*t sure. In fact, the National Bureau of Economic Research eventually marked the end of that recession as July 1991.

President Bill Clinton and Vice President Al Gore claim that our prosperity is due to his first budget, which was passed in 1992, and which took effect in 1993. Since our prosperity began in 1991, this claim is simply one of their many lies.

As to why our prosperity has lasted so long, there is plenty of room for argument. The Clinton administration could claim responsibility for the extraordinary length. The Republican Congress, which was elected in 1994, and which negotiated the Budget Agreement of 1995, could also claim responsibility.

While responsible fiscal and monetary policies underpin the economy, the real reasons for the sustained progress in our economy are to be found in the economy itself. In technological and managerial breakthroughs that increase the responsiveness of producers. Today*s corporations have adopted *just in time* policies. Thus, when supply and demand conditions change, they are better able to adjust on the fly, instead of accumulating excess inventories and then laying-off workers.

Indeed, the best index of the business cycle is the number of sectors in the economy that are out of balance, including both the sectors in which productive capacity exceeds demand and the sectors in which productive capacity falls short. Most recent recessions have been characterized by sudden increases in energy prices.

The economy is well able, in the long run, to adjust to almost any price of energy. With lower prices, we'll have bigger cars and larger homes, longer commutes, and more air travel. With higher prices, we'll have more fuel-efficient cars and smaller homes. We'll choose to live closer to work and accept the inconvenience of mass transit. But, the adjustment from low to high prices is disruptive.

During the early 1980s, President Ronald Reagan dramatically lowered energy prices by deregulating the oil and gas industry, and by undermining the OPEC cartel.

During the late 1980s, President Bush had to deal with the Persian Gulf War and the threat it posed to energy supplies. The allied coalition did its best to maintain supplies during the war and, as a consequence, the recession that began in 1989 was relatively mild.

But, now, OPEC has become emboldened to restrict production and jack up prices, and the Clinton administration has no response. The reason is that the Clinton administration does not want to do anything to upset the environmentalists within the Democratic Party who actually want the price of energy to be high.

The Clinton administration could, for example, have the Strategic Petroleum Reserve enter into long-term contracts with domestic suppliers who capped their stripper wells because of low prices; and, at the same time, release crude oil from the Reserve. It could re-open energy production from a variety of domestic sources, including offshore, the Alaskan North Slope, and low-sulfur western coal.

But, most importantly, the Clinton administration could suspend the monitoring of world energy supplies, designed to prevent Iraq from exporting more than the UN allows, and allow some of the greedier members of OPEC to "cheat" by exporting more crude. But, for obvious political reasons, the Clinton administration will not pursue any of these options.

Thus, the odds are that we will go into recession. But, that doesn't mean recession is a sure thing. It is possible for the economy to deal with high-energy prices until the next administration is in office, or else until we have adjusted ourselves permanently to them.

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CLIFORD F. THIES is a professor of economics and finance at Shenandoah University. Send him mail at cthies@su.edu.

See also The Austrian Theory of the Trade Cycle and Other Essays, Another Energy Crisis?, and How to Bring Oil Prices Down.