Flexible markets get us out of a recession?

For a moment we were thinking that Jim Cramer might have been on to something with his call for a bottom in the market. He didn’t provide any reasons (at least none that we are aware of), and just a week before he had been terribly gloomy, arguing that there was nothing he would buy and we had to sell everything. However, there is an argument in favour of his bold change of hearts..

There is an (obvious) economic slowdown, but that slowdown has also taken the wind out of the sails of the commodity prices. These have corrected rather spectacularly. If that lasts, this takes the heat out of rising inflation.

If inflation doesn’t provide the same threat it did just a month ago, the Fed isn’t as boxed in between fighting inflation and fighting the recession (an uncomfortable situation because they need opposite policy reactions). It can concentrate on fighting one front, not two (contradictory) ones.

In short, that’s the thesis for calling a bottom in the markets, and this has been the reason for the little bounce from the lows just over a week ago. If you analyse it, it’s actually a case of bad news is good news, this is what’s often get newbies so vexed on the markets, because the logic can be a little hard to grasp.

Will it last? Well, there is a lot more bad news out there, but with a little fantasy, this can also be interpreted as good news:

  • Retailers posted disappointing July sales results on Thursday as shoppers ran out of extra tax rebate cash and tentatively began their back-to-school shopping.
  • Wal-Mart Stores Inc, the world’s largest retailer, said its July sales at U.S. stores open at least a year, or same-store sales, rose 3 percent, missing Wall Street expectations for a gain of 3.4 percent.
  • “With the end of the stimulus checks, we know consumers are spending more cautiously, and we continue to see a pronounced paycheck cycle at the end of the month,” said Eduardo Castro-Wright, head of Wal-Mart’s U.S. operations.
  • Also reporting disappointing results were clothing retailer Gap Inc , Pacific Sunwear, Hot Topic and Children’s Place.

One way to see this is hey, it’s bad, spending has been artificially boosted by the tax rebates, but now that has petered out, spending will worsen again. But on the other hand, lower spending means less demand for those commodities, which will lessen inflationary pressures, which will allow the Fed to concentrate on fighting the recession..

And inflation is still out there:

  • U.S. consumer prices jumped at the sharpest rate in more than a quarter century during June, and consumers coping with soaring costs received their smallest income gain in a year, the government said Monday.
  • The Commerce Department said personal incomes edged up 0.1 percent after rising 1.8 percent in May. June’s rise was the smallest since April 2007, when income was flat.
  • On a year-over-year basis, prices rose 4.1 percent in June, up from 3.5 percent in May, for the biggest annual gain since May 1991.
  • An inflation gauge tied to consumer spending jumped 0.8 percent in June, its steepest gain since a 1 percent rise more than 27 years ago, in February 1981.

What we see is one of the most important self-correcting mechanisms of market economies. An economic crisis lowers spending, and that lowers prices (or, in this case, makes them rise less rapidly than before), and the lower prices boost real earnings, which could get us out of the recession.

Or, another one: the economic crisis lowers demand for labour, which has a mitigating effect on wages, so labour becomes cheaper than it would have been if economic conditions would have been better, which stimulates the demand for labour.

This is classical economics. We’re afraid it doesn’t always work so neatly.

But if it doesn’t, a flexible Fed policy can supplement flexible markets, now that the inflation problem seems less severe, perhaps we could get another rate cut..

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