Thursday, August 19, 2010

U.S. Economic Double-Dip Is Coming

Signs that the U.S. economy is moving into a double dip recession continue to gather with initial jobless claims rising to 500,000, and the Philly Fed manufacturing index dropping into negative territory. Most other data this week confirms this picture, with the strong July industrial production data being the only real anomaly. But given how consistent other indicators have been, that is probably a misleading aberration.

The most important cause of this is the lagged effect of the stagnant (slightly contracting) money supply numbers during the latest year. For some time, this was masked by a decline in money demand (a decline in money demand has a similar effect as an increase in money supply), but now that pessimism is increasing the decline in money demand has halted and perhaps started to reverse.

The expectation of significant tax increases in January 2011 as the Bush tax cuts expire is another key factor behind the weakening economy.

The fact that Treasury yields continue to drop despite the horrible fiscal situation of the U.S. government is a sign that money demand is increasing as many investors perceive them to be as safe as money.

UPDATE: About the industrial production numbers see this follow-up post.