Two weeks ago,Ben Bernanke and the Fed issued a statement that the Fed would hold interest rates stable (near zero) until the middle of 2013. There seemed to be some relief in the markets until they realized that that was two years from now... and that it meant that the economy was expected to be slow beyond that. The Fed certainly wouldn't raise rates suddenly to 5% once they got to mid-2013, would they? They're where they are for the long haul, and that haul will be very long.

The growing concerns about the world economy, especially Europe's problems with the debts of Greece and Italy (and Spain and Portugal and Ireland) threw markets into a tizzy this past week. There was concern that there would be another banking crisis, just like the U.S. had in 2008, and that the Eurozone would break up as Germany and France tire of supporting their unhealthy economic brethren. Did I say 2008? Our economy is supposedly not in danger of that kind of collapse because the banks, it is claimed, are much healthier now. So Europe is going through our pain of three years ago, and the U.S. is going through its own unique pain, I guess.

The comments by the Fed did not help. Its forecast implied a very slow economy, yet there were Fed members out on the stump making somevery optimistic economic forecasts. Wall Street and other economists are all cutting their forecasts. This is from the same Fed that kept saying inflation was “tame.” Data from the newsletter Shadowstats showed that the core inflation rate (which excludes food and energy) has gone from +0.6% when the Fed started quantitative easing,QE2, in October 2010 to its current level of +1.77%.

Our look at the economic situation is summarized by our monthly chart of macroeconomic data. Remember, we look at three time frames: the comparison with this time last year, the annualized change over the last six months, and the annualized change over the last three months.

GDP is has slowed considerably, and there is growing evidence that the most recent report of second quarter GDP will be revised down. Those data are released this Friday, August 26. There is increasing concern that the economy is on the edge of recession, and indeed, there is a good possibility that a recession has already started. Remember, the date of the beginning of the last recession was December, 2007, and it was not until eleven months later that theacademic committee that determines these dates officially announced it. Does it really matter? Recession or not, the economy is not growing at a rate that is even close to the +3.4% post-WW2 average.

The primary reason for our heightening economic concern that another recession has started is what is happening with employment. I discussed this in some detail in aprior blogpost. At issue is the continuing emphasis on business efficiency and not expansion. This is clearly seen in the increase in productivity since the recovery began in June 2009. When productivity is greater than GDP, there is no need for the economy to employ more workers. It is not until GDP grows faster than productivity that business is growing so quickly that the only way to keep up is to add more staff.

Real earnings, the value of earnings after adjusting for inflation, have been flat but might be ready to improve slightly. Throughout most of the recent years, workers have not been seeing the fruits of their increased productivity. Benefits costs were rising, and the significant price increases for the materials used in production were paid for by productivity.

The price inflation of materials and other factors of production have been rising faster than prices on the store shelves. On a year-to-year basis, the Producer Price Index was +7.2% compared to +3.6% for the Consumer Price Index. Earlier in the year, we noted that the PPI vs. CPI disparity did not play out well last time it happened in 2008, and that seems to be the case now. Commodity prices are dropping, except for gold, because of fear of an economic slowdown. On a 3-month basis, PPI and CPI are much closer than they have been. Inflation may be considered tame at these levels, but it is a convenient case of amnesia to forget the inflationary damage caused in recent months, especially with food and energy. Even though the oil price has backed off a bit recently, it's still 13% higher than last year at this time.

That can be seen in one set of data that I track, but not included in the table below, real disposable personal income. This is inflation-adjusted income after taxes. On a per capita annual basis, it is $37,074, down -0.5% since the start of the 2007 recession.

Since those income data were published, the stock markets have taken a beating. Savings and investments had not fully recovered since the start of the recession, and as households attempted to build them up, they were saving at a higher rate than in recent years as well as paying down their debts. Now, many have had a severe downdraft in savings again. It is likely consumers will hunker down yet again. It is possible that the gyrating stock markets have lost the confidence of a generation of investors in terms of their financial planning. The financial talking heads on cable keep saying that stock dividends are paying higher than Treasury securities, with many stocks paying 3% and 4%. It always seems the next day that the market drops by 5%, wiping out the value of the dividend and eroding their savings. This does not inspire future investments by new savers.

On an inflation-adjusted basis using the close of the NASDAQ at the end of December 2007 compared to the close on this last Friday, stocks are down -18%. Stock prices were being propped up by the Federal Reserve's QE2 (quantitative easing round 2). When that ended in June, the Fed announced that it would replace all of the matured securities it had purchased with new ones, but would not be expanding its balance sheet. If you look at how much the Fed has increased its holdings, the latestchart of the monetary base is rather scary.

The reason the Fed wanted to take this action was to increase the value of the stock market and to stop housing prices from falling. The Fed has failed in both actions. The stock market's rise has not been sustainable. The rise during QE2 was illusory and not built on the natural money supply increase that comes with economic activity of increasing quantities of goods and services. Housing prices are still a problem, and the Fed is terrified (but they put up a good front) that there would be yet more homes that are worth less than their mortgages.

The economic incentives are all backwards. The Fed is attempting to stop the fall in prices of goods that were already made years ago (housing) rather than dealing with the production of new goods. The incentives for business expansion are lacking. Marginal tax rate levels, even if they are not at historical highs, discourage new investment, and combined with the certainty—not the uncertainty, the certainty—of higher business operation tax rates, fees, and regulations, have companies focused on their present operations and not on any expansion.

Even if we do not fall into an officially declared recession, there will be growing calls for more Fed easing (QE3, but probably named something else so no one notices) and for more stimulus spending that would break the inadequate window-dressing debt ceiling deal of just a few weeks ago.

The Fed seems to be taking a cue from the old Jay Leno Doritos commercials about not worrying about eating more Doritos because they'll just make more. They'll print more money. Now that it looks like the Eurozone may decide to do the same, The Fed may consider it to be a wise decision. There's nothing like the game of competitive devaluation.

And that brings us to gold. The yellow stuff is still more than $600 below its inflation-adjusted high from 1980. It still retains interest, despite gold's inability to supply any kind of return. The fact that Treasury securities and gold are being considered safe havens show how disorienting the economy has become. The Treasury instruments are guaranteed to lose purchasing power because their interest rates are below inflation. Gold, by definition, cannot pay a dividend or create new goods. When the flight to safety includes investments that have no returns, that is a warning sign in and of itself.

About Dr. Joe Webb

Consultant, entrepreneur, and economics commentator Dr. Joe Webb started his career in the industrial imaging industry more than 30 years ago. He found his way into business research, planning, marketing and forecasting executive positions along the way, as well as consulting for firms ranging from large multinationals to small businesses. Dr. Webb started an Internet-based research business in 1995, selling it to a multinational publisher in 2000. Since that time, his consulting, speaking, and research projects have focused on the interaction of B2B economics and technology trends. He is a doctoral graduate in industrial and corporate education from New York University, holds an MBA in Management Information Systems from Iona College, with baccalaureate work in managerial sciences and marketing at Manhattan College. He has taught in graduate and undergraduate business programs in a number of Northeast US colleges, and currently resides in Rhode Island.