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

I’ve been a follower of economics since I had the opportunity to try to understand America.  I immigrated from Italy as a 10 year old, and everything was “new” to me.  In school I strived to understand cause and effect.  Having studied economics for almost 50 years, this article best describes how I feel about it all.  Enjoy!

We are currently in the grip of a temporary deflationary panic but based on the evidence I see from the Federal Reserve and its growth of the money supply, the long term trend is still inflationary and owners of tangible (non dollar-denominated) assets will be the winners at the end of this shakeout.  It’s disconcerting to see our portfolio values drop but being a diversified owner is still the best place to be if real world safety is your goal.

Bottom line:  I’m a buyer and not a seller.  And now is the time to be making financial decisions with your head, not your heart.

Update:  A transcript is linked below.

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Here’s a nice article in Investor’s Business Daily on what the pulse of America was like prior to Jimmy Carter’s election to office and the blunders that followed. 

Be sure to tune in to our radio show each week for more discussion. 

Have thoughts or questions?  Leave them in the comment field below.

Related Articles:

• Stock Market Volatility & Investor Expectations
• Gut Check Time and the Transfer of Wealth
• Lessons from an Innovator in Global Investing, Sir John Templeton
• The Story On Derivatives

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Aron Huddleston talks with WOWT in Omaha about what investors should be focusing on in today’s market environment:

 Video used with permission of WOWT

Update:  The transcript to Roland’s video can be viewed by clicking the link below.

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Lots of silly arguments on the economy are being made from both sides of the political aisle.  Here are some (slightly altered) paragraphs from an article I wrote last January to clarify the conventional thinking:

The infusion of what is called “loose money” is always a stimulating consequence for the economy in the short term.  The analogy I often use is pumping oxygenated blood into your body.

The downside to the Federal Reserve’s ability to create money out of nothing does cause malinvestment of capital as we’ve witnessed with the housing and banking fallouts.

Long term, creating money without limit always leads to increased prices and less buying power, which is a problem for people with the bulk of their financial assets in bonds, bank CDs, and other dollar-denominated investments.

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The “We are in the worst economic climate since the Great Depression” wackadoos sure put up a good fight.  But now more folks are finally seeing through their flawed logic. 

From a recent Newsweek article: 

The specter of depression stalks America.  You hear the word repeatedly.  Are we in a depression?  If not, are we headed for one?  The answer to the first question is no; the answer to the second is “almost certainly not.”  The use of “depression” to describe the economy is a case of rhetorical overkill that speaks volumes about today’s widespread pessimism and anxiety.  A short history lesson shows why.

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“There is no mystery behind the rise in oil prices.  They rose too high too fast because of booming demand for oil for petrochemical products, electric power and shipping from many emerging economies (particularly China, India and the Middle East).  Meanwhile, the supply of oil slipped in the US, Mexico, Venezuela, Nigeria, and Russia.

But now JPMorgan analysts estimate that oil will drop to $85 a barrel from 2009 to 2011.  Even Goldman Sachs analyst Arjun Murti, who recently guessed oil might reach $200, later told Barron’s that oil will likely drop to $75 or less in the long run.

The urge to blame speculators is as big a waste of time as blaming oil companies.  Americans want more oil and gas - not more hot air from politicians.”

From Scapegoating the Speculators by the CATO Institute’s Alan Reynolds.

Karl Rove had some interesting remarks in last Thursday’s WSJ about McCain and Obama’s economics.  Here are a few selected comments: 

• In Raleigh, N.C. last week, Sen. Obama promised, “I’ll make oil companies like Exxon pay a tax on their windfall profits, and we’ll use the money to help families pay for their skyrocketing energy costs and other bills.”
• Set aside for a minute that Jimmy Carter passed a “windfall profits tax” to devastating effect, putting American oil companies at a competitive disadvantage to foreign competitors, virtually ending domestic energy exploration, and making the U.S. more dependent on foreign sources of oil and gas.
• Sen. McCain doesn’t support the windfall profits tax, but he can be as hostile to profits as Mr. Obama.  “[W]e should look at any incentives that we are giving,” Mr. McCain said in May, even as he talked up a gas tax “holiday” that would give drivers incentives to burn more gasoline.
• This past Thursday, Mr. McCain came close to advocating a form of industrial policy, saying, “I’m very angry, frankly, at the oil companies not only because of the obscene profits they’ve made, but their failure to invest in alternate energy.”

Our Thoughts:  Free markets rule!  Washington needs to stay away from business.  Profit motive drives creativity and solutions for our future.  In 1986, Ronald Reagan said, “Government’s view of the economy could be summed up in a few short phrases:  If it moves, tax it.  It it keeps moving, regulate it.  And if it stops moving, subsidize it.”

Thanks to Aron Huddleston for this article.

Update:  Not sure where you stand on the political spectrum?  Then you might like The World’s Smallest Political Quiz. 

The Democratic National Committee recently ran an ad blasting John McCain for saying the country is “better off” than in 2000.  Yet, arguably, except as regards the Iraq war, Mr. McCain’s statement is true.  In turn, Mr. McCain is blasting Barack Obama for suggesting that international tensions are not as bad as they’ve been made to seem.  Yet, arguably, Mr. Obama is right.

Democratic attacks on Mr. McCain and Republican attacks on Mr. Obama both seek to punish impermissibly positive thoughts.  At a time when there exists a sense of crises over the economy, fuel prices and many other issues, this reinforces the odd, two realities of life in the United States today: The way we are, and the way we think we are.  The way we are could use some work, but overall, is pretty good.  The way we think we are is terrible, horrible, awful.  Possibly worse.

The case that things are basically pretty good?  Unemployment is 5.5%, low by historical standards; income is rising slightly ahead of inflation; housing prices are down, but the typical house is still worth a third more than in 2000; 94% of Americans do not have threatened mortgages, and of those who do, most will keep their homes. 

Inflation was up in 2007, but this stands out because the 16 previous years were close to inflation-free; living standards are the highest they have ever been, including living standards for the middle class and for the poor. 

All forms of pollution other than greenhouse gases are in decline; cancer, heart disease and stroke incidence are declining; crime is in a long-term cycle of significant decline; education levels are at all-time highs.

Sure, gas prices are up, the dollar is weak and credit is tight - but these are complaints at the margin of a mainly healthy society.

From Gregg Easterbrook’s Friday editorial in the Wall Street Journal.