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There’s More Here than Just the Bailout Package

A Commentary by Lawrence Kudlow

Friday, October 03, 2008

On the morning after Senate passage of the Treasury rescue bill stocks are down 200 points. So there is no silver bullet to our economic woes.

Now, the dollar is up strong, and gold is off $35. Those are positive signs that the Treasury bailout will improve the quality of U.S. credit. More and more over the past year, I have come to believe that gold and the greenback are more closely correlated with our credit problems than with inflation fears.

Turning back to the rescue package, tomorrow’s House vote is likely to be close, but there are a lot of positive signs that enough Republicans and Democrats will move from the nay column to a yea vote. I think the odds favor passage in the House. And the Treasury will probably start its auctions to purchase toxic bank assets in a couple of weeks. This will add much needed liquidity to the financial system.

But there is another problem: We are almost surely in a recession. Some of the recent numbers suggest the economy may have fallen off a cliff in September.

The ISM manufacturing report took a nosedive. Car sales were particularly dismal -- worst in twenty years -- both for Detroit and foreign auto makers. Jobless claims look recessionary and tomorrow’s nonfarm payrolls report could be down 100,000, according to the Wall Street consensus. Consumer spending for the first two months of the third quarter was 2.7 percent below the second quarter at an annual rate. The August report for business capex went negative. Non-financial corporate profits after tax are down close to 30 percent since their peak in late 2006. Profits are the mother’s milk of stocks and business. So it’s no surprise that the current bear market in shares is off nearly 30 percent since the cycle peak last October.

There are two broad reasons for the economic slump. One is, of course, the credit crunch, which seems to be biting hard. A recent survey by the National Small Business Association reported that 67 percent of small businesses said in August that they had been badly affected by the crunch. The number of small business using bank loans was at a fifteen-year low, and 32 percent said their loan terms were getting worse. The same with credit-card rates, according to 63 percent.

Let me add another cause of the recession: the oil shock, which began late last fall, and has deepened the credit crunch by draining cash from family and business budgets. Oil is trading around $94, which is a lot better than $150. But average gas prices at the pump nationwide are still around $3.65. And I don’t think that story gets any better until prices drop toward $3.

I have felt that we’ve been in a mild jobs recession this year. But surging exports, strong farm and energy sectors, and an almost unbelievable 3 percent productivity trend may have been keeping us out of a full recession. And now it looks like the cycle is truly descending. And I think the recession fear is driving down stocks today, just as I think it helped stoke Monday’s plunge. In other words, there’s more here than just the bailout package.

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