Recessions almost always occur at the beginning of each decade, shortly followed by central bank easing. The world economy moves into a recovery phase with rising interest rates. There is always a mid-cycle, or as it usually happens, a mid-decade slowdown, which often stops central bank tightening. "It is after this mid-cycle slowdown that an asset bubble of some kind then begins to build," Mr. Zhao said. "Financial manias and bubbles begin to gather force toward the end of each decade, setting the stage for a climatic drop either at the end of each decade or the beginning of the new one." Mania candidates this time around? Equities, the energy sector, emerging markets and China, Mr. Zhao said.

About time for mania or bubble, BCA says

I won't mind being wrong, and I hope everyone has a great 2007!

That is why I love your blog. I don't mind being wrong either but I'd like to at least flesh out the details in the process... you always do that and more.

I believe that sometimes being wrong for the right reasons is a better exercise than being lucky & right but having had just 'guessed right'.

Having said all that I agree with all most all you write on this post - about oil being lower, housing continuing to decline, over all the economy slowing and about the Fed being slow to catch on to the 'risks'.

But I do NOT believe we will have a recession in 2007 - not officially - though I am pretty certain it will feel like one for my industry... mfg.

The only other blog I read as religiously as this one is Setser's and everything he says is more hot money flowing in from Asia & OPEC (and even lower oil at say $45-50/bbl is WAY above production cost in the Gulf & Russia resulting way more reserve growth their... China more reserve growth also... it all has to go somewhere).

I think the big story next year will be the stress in the global financial system as the point sources of this liquidity gradually realize how much their principal is at risk betting on the US consumer & try to work their way out... back themselves out of the ditch.

Eventually it will have a serious effect but it won't have a DIRECT effect on our economy until after 2007, maybe much after - until they have an option other than to continue keeping on (buying USD denominated assets to keep their currency weak to assure their export competitiveness).

I've been wrong so often betting AGAINST liquidity & saying the end is near... that it would be the ultimate irony that this time I would be wrong again (that a credit crunch recession would actually occur in 2007). But I just don't see it happening given the flood of hot money.

And obviously I don't mind being wrong either or I'd keep my fingers off the keyboard.

Have a great year CR & all - even you patrick.

"So perhaps LK was being sarcastic and was actually arguing that profits are not a good leading indicator."

Well said, CR. Sorry, I'm got a hair trigger today.

As I see it, the extraordinary degree of manic, speculative activity in SFR housing is best illustrated by the unprecedented level in turnover of existing homes that has been brought to our attention on several occasions by CR. Given the costly, complex and time consuming process that buying or selling a home entails, this explosion in turnover can only be explained as a manifestation of a widespread and deeply-entrenched belief in the inevitable profitability of home ownership. Unlike prior speculative bubbles in stocks or even tulips, this mania has been much more democratic in its scope – embracing a broad demographic of individuals many of who have no conscious speculative inclinations and believe they are simply doing what any industrious, financially responsible citizen should do to participate in the benefits of our “ownership society.” 2007 will bring the first phase of general disillusionment, and will mark the beginning of a severe recession that no one will have difficulty recognizing. Subsequent years will bring economic turmoil and political repercussions that are presently unthinkable. The bottom line is that Americans are sore losers -- and that the kind of division of wealth propagated by Reaganomics and its bipartisan aftermath is much easier to sustain in countries like Russia where the concept of serfdom is deeply ingrained in the national psyche. This century’s Huey Long is waiting in the wings, and the dish he will be serving up to the smug, sneering sociopaths on the corner of Broad and Wall will make crow look positively appetizing.

FredW, a lot of consumers won't be able to access MEW this year, particularly the ones with high LTVs. They won't be able to refinance. There's going to be a lot of consumer bankruptcies and jingle mail.

In the heretofore hot urban markets comps will fall, and that will also hurt the rest of the market.

There's a credit crunch coming, and the ironic thing is that, as Dryfly says, the world is sloshing in liquidity.

There's a credit crunch coming, and the ironic thing is that, as Dryfly says, the world is sloshing in liquidity.

That's it exactly.

A day of reckoning is coming as it comes to all mega-credit cycles... question is when and what it will look like. Focusing on the symptoms (dot.bomb, RE boom/bust, etc.) is to miss the disease. There could be a whole lotta money to be made before its over or it might end with tomorrow's market open - who really knows.

I can't even begin to read it because I can't fully understand the motives of some of the key market participants - the FCB officials. Who knows what marching orders they have. Political, social & economic motives all mixed together.

At least that's my take.

You certainly don't bite the hand that feeds you.

Not more than once anyway.

CR, Dryfly, I don't foresee the end of the world as we know it, but I do see liquidity problems in the consumer sector.

Then there is the quaint possiblity that economics and capitalism as we known it have ended.

It is supposed to be a fact that when your predictions based on your theories and models consistantly fail, then the basic assumptions are wrong.

I understand the liquidity issue, in that there is alot of cash looking for a home, hence the low rates, money flow into equities etc. The only thing I don't understand is how that money gets into the hands of the consumer to spend (which drives our economy).

There are only two ways I know of for the average joe to get his hands on more money.

1) through payraises at his current job and a job upgrade increasing income.

2) through borrowing.

1 either usually means inflation and thus higher rates short term rates.

2 means that long rates will have to drop from current levels to even have a hope of increased borrowing.

Under what possible scenario could more money get into joe's hands to continue to drive consumption growth?

A couple of points on profits. I dont know of any recession where corporate profits went up double digits. The point CR made was that profits can do very well right up to the point the recession starts, then reverse. Unfortunately good earnings expectations data only exists back to the early 1980's so can't test it against a long series of past recessions. However, I would expect that analysts will be cutting their estimates fast and hard b4 we slip into a recession. Currently the total earnings on the S&P 500 are expected to climb by 9.8% and the median firm in the 500 is expected to see a 12.8% growth rate in 2007. So far little evidence of widespread estimate cuts, and earnings have cosnisitently come in ahead of forecasts in recent quarters (usually about 3.5 positive surprises for every disapointment). For S&P 500 stocks a weak $ will help earnings since most have significant overseas revenues and would thus see translation gains. That being said, where I would disagree with CR is on the world economy slowing. I think the rest of the world grows better than the U.S. this year. Europe is starting to pick up, Japan is back on its feet. China is not going to slow significantly b4 the 2008 Olympics and India just posted its best quarterly growth since it decided to join the real economic world. The govt there is intent on having at least a 9% CAGR over the next five years and the talk is about boosting it to double digits. I think world growth keeps the price of oil at least stable if not a slight upward bias. Most likely case is a trading range scenario on oil. Lower relative growth plus the trade deficit plus the likelyhood of interest rate cuts here and increases in Europe/UK/Japan means the dollar is headed south. Big question is how fast. Nobody really wants to see a plunge, but there is a big advantage to being the first through the door. As for the U.S. economic growth I think Goldielocks is going to need a sweater. Not a full recession, but decidedly slower than the consensus forecast of 2.5-3.0% growth. Fed more likely to cut than increase, but not until 2Q at earliest. Housing decline is about half over. Just look at the housing starts chart, the bottom of every housing cycle since Ike has been below 1M. We will get there this time also. I think the decline in the $ will result in long term rates headed upwards, but not to dramatically. The net result though is that we end 07 with a more normally shaped yield curve. Inflation should not be to bad, unless the decline in the dollar is faster and sharper than I think it will be. Stocks should do ok in 07, particularly the first half. The market tends to do well through May historically. We are in the 3rd year of the prez cycle and the market has been up in each 3rd year since the Kennedy/Johnson cycle (maybe even further back than that, just didnt check) and by double digits in every time but one. Futhermore stocks are cheap relative to other major assets (bo

The only thing I don't understand is how that money gets into the hands of the consumer to spend (which drives our economy).

It happens mostly via your route #2 - increased borrowing.

While route #1 (income 'trickle down') certainly occurs, the biggest impact to the economy is via credit expansion.

You understand how the FCBs buy the debt & drive down rates so we can all borrow 'cheaply'. This is how credit cards finance their offerings to us.

What also happens is that low rates make it possible for mfgrs facing sluggish demand to increase sales via promotion. They roll the borrowing up into the terms of a specific purchase.

This is important to them because if they just rely on the credit card industry to provide liquidity - that still doesn't mean THEIR stuff gets sold - so they try to couple the credit necessary to close the deal directly to their offerings.

For example - during the holidaze I saw promos for plasmas... zero down, zero interest rate & zero payments until 2009. Neither the mfgr nor the retailer have the kind of cash sitting around to float the cost of this over three years all by themselves... but thanks to low rates & flooded capital markets their bank does.

Their bank (or even a separate finance arm of the retailer or mfgr) can 'package' a bunch of this debt as 'collateralized debt obligation' bonds & sell them on the secondary market just like the credit card companies do... paying a surprisingly low yield to the investor buying the bonds because there is so much demand out there trying to buy debt...

Ultimately they pay the investor from a combination of margin allocation from the initial sale & the eventual revenue stream from the consumer payments - assuming the consumer does eventually pay off the debt... a big 'if'.

A transaction like this in effect becomes a no doc liar loan taken out at the check out counter by the consumer, tied to a secondary debt market offering somewhere far, far away. The mfgr, retailer & their bank/fin dept. are in effect the 'originators'.

I mean this is exactly how auto mfgrs were able to 'offer' seven year zero down, zero interest loan promotions on $40K SUVs - the capital markets are so flush with cash... making rates so cheap... it was almost too easy. Resulted in them stealing demand from the future big time - which is biting them in the ass now.

But it sure worked great for a while.

GM made more money doing this kind of thing via GMAC than they did making cars... and it was & is all possible due to excess liquidity. It sure wasn't that painless back in the early 80s when rates were 12-15%.

Any way, the end result is no different from a macro economic 'consumption' perspective than if the money was deposited directly in your account like a regular loan.

It can't go on forever but it doesn't have to end immediately either.

It looks like a great paper mp - the pdf is on the HD drive now waiting to be chewed on.

As Detroit Dan said, then you've got a vicious cycle. CR has written about it extensively, and it's worth re-reading. A key element of the vicious cycle is a higher interest rate. That's one possible path.

Perhaps we'll have 2 vicious cycles -- one after the other. The first vicious cycle will be driven by the decline in disposable income caused by chronic bleeding of jobs to other countries. Only when this is fairly well developed will the dollar start to fall and interest rates rise, compounding the problems of an already weak economy.

I think we're making "good progress" on this scenario, as housing has collapsed and the MEW borrowing, which has masked the weakening disposable income situation, has fallen dramatically...