Last week’s economic data shows that “risk aversion hysteria” has a major impact on economic activity in the United States.

The total number of people receiving unemployment benefits (a.k.a. continuing claims) increased to almost 3.9 million in late October.  As a share of the workforce, continuing claims are now back to the peak hit in the aftermath of the 2001 recession.  Meanwhile, retail sales plummeted in October and are down 4.1% versus a year ago, the worst one-year comparison on record.

September’s international trade data showed a smaller trade deficit, but the underlying figures reported record declines for both imports and exports.

All of these figures are consistent with our view that the US has been experiencing a once-in-a-multiple-generation negative shock to monetary velocity, the speed with which money its way through the economy, as both business and consumers pull back from economic activity.

As a result, we are forecasting that real GDP shrinks at a 4% annual rate in the current quarter, the largest decline since 1982.  However, we believe the economy will stabilize in the first quarter of 2009, grow at a 2% annual rate in Q2 and then expand at a 3% rate in the second half of next year.

An economic recovery does not require monetary velocity to reaccelerate.  As long as velocity simply stops falling, a recovery can take hold. 

Loan data for October suggest this may already be starting to happen.  In October alone, banks increased commercial and industrial lending by 4.2%, real estate loans by 3.4%, and consumer loans by 2%.  While securitized non-bank lending remains locked-up, other lending continues.

In addition, the Federal Reserve has rapidly expanded its balance sheet to offset the drop in velocity.  Inventory ratios remain very low.  In other words, this is not the kind of environment that creates an endless downward spiral.

~ From First Trust

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