Recession Red Light?
For all of history, humans have loved to build things. Some of our creations are extravagant, such as the great Taj Mahal of India, one of the most exquisite palaces ever built, and some represent pure engineering brute force, like the rapidly growing mammoth Three Gorges Dam in China. Some human building creations weather the harsh tests of time well, and others succumb to the inevitable victory of entropy. Of every incredible thing humanity has collectively constructed so far, the Seven Wonders of the Ancient World stand near the top of the list in raw engineering prowess, romance, and outright beauty and elegance.
Scattered around what we call the eastern Mediterranean and Middle East today, the Seven Wonders rightfully inspired vast awe and pride in the times of antiquity. These fabled Seven Wonders were the pyramids of Egypt, the Hanging Gardens of Babylon, the statue of Zeus at Olympus, the Mausoleum at Halicarnassus, the Temple of Artemis (Diana) at Ephesus, the Colossus of Rhodes, and the Pharos (lighthouse) of Alexandria.
Unfortunately, the only ancient Wonder surviving today is the mighty man-made mountains of the Great Pyramid and its pair of companions gracing Egypt's Giza plateau. As well as being the only surviving Wonder, they are also the oldest. The Pyramids are endlessly fascinating, and the more scientists study them the more amazing they seem. The mathematical precision that went into engineering and constructing these monoliths would be difficult to duplicate today even with modern state-of-the-art laser-guided construction techniques. The Pyramids still inspire awe and wonder after over four and a half millennia, and we can look at these magnificent buildings and gain a sense of the marvel that the ancients must have felt when viewing ALL seven of their Wonders.
The second Wonder, the Hanging Gardens of Babylon, was a mountainlike series of heavily planted terraces that dwarfed the Babylonian skyline. Babylon, today sixty miles south of Baghdad, Iraq, was one of the mightiest empires of antiquity. King Nebuchadnezzar, the same king that sacked the original Jewish Temple in Jerusalem around 600 BC, another amazing construction, commissioned the Hanging Gardens for his favorite wife, who was homesick for her lush green homeland while observing the barren desert surrounding Babylon. For travelers approaching the mighty city, the Hanging Gardens where said to look like a magical jungle mountain in the middle of a foreboding desert. Engineers today are still unsure of how the waters of the mighty Euphrates River, which bisected Babylon, were pumped up into the verdant green terraces.
The massive statue of Zeus, the chief God in Greek mythology, at Olympia was the third Wonder. Over 40 feet tall, the Greek sculptor Phidias's opus magnum awed pilgrims for almost 1000 years. It was so BIG that visitors often spent more time discussing the ornate throne Zeus sat on, which was much easier to inspect than the body and head of the statue high in the air. If the statue would have stood up, it would have ripped the roof off the Temple of Zeus. It was the central feature of the temple, and no doubt the most impressive work of Greek sculpture in history.
The fourth Wonder, the Mausoleum of Halicarnassus, is perhaps the most curious of all seven of the Wonders. It was named after a vain King, Mausolus, of the kingdom of Caria in what is today the southwest coast of Turkey. He was obsessed with death and he commissioned a vast army of the best sculptors and engineers available to build a monstrous rectangular tomb. The Mausoleum was huge, sporting an Ionic colonnade that supported a pyramid on the roof. Its total height was over 140 feet, equivalent to a 14 story building today. The outer surface of the tomb was literally covered with large exquisite statues. At the apex the largest statues were a four horse chariot team pulling King Mausolus and his lovely wife Artemisia. Today the generic word "mausoleum" applies to any magnificent tomb.
The fifth Wonder was the Temple of Artemis in the city of Ephesus (also in western Turkey today). It was a mammoth temple surrounded by hundreds of massive columns, 60 feet high and over six feet wide at their base. It took 120 years to complete. Although mostly rock and fine metals, it had extensive wooden fittings. On July 21, 356 BC, the very night the famous Greek conqueror Alexander the Great was born, a madman named Herostratus set the Temple afire, and in his trial he said he wanted his name remembered forever. Mission accomplished! Rebuilt after the arson attempt, the Temple of Artemis was ultimately destroyed by the Goths in 262 AD.
The sixth Wonder graced the harbor at the Greek island of Rhodes. The Colossus was a huge 105 foot tall bronze statue of the Greek sun god Helios, erected to guard the harbor of Rhodes. Legends say the statue straddled the entrance to the harbor, but modern engineers believe the statue would not have been structurally strong enough to stand with its legs spread apart. It may have stood off to the side of the entrance in reality. Nevertheless, the bronze giant guarding the harbor looked like a sun god when the bright sunlight reflected off the polished metal, and inspired great awe. Only six decades after it was built, an earthquake destroyed it in 224 BC. The huge pieces lying on the ground were still regarded with wonder for nearly a thousand years. In 656 AD a metal dealer bought the pieces for scrap metal, and melted them down, ending the tale of this Wonder.
The seventh Wonder, and perhaps the most magnificent of all, was the Pharos (lighthouse) of Alexandria. Located on an island in the harbor of Alexandria, Egypt, the Pharos stood a phenomenal 440 feet tall, comparable to a 44 story skyscraper today! The great lighthouse was made of exquisite white marble, and for more than 1000 years safely guided Mediterranean trading vessels to safe harbor in Alexandria. Built in 280 BC by Ptolemy II, the lighthouse was severely damaged by an earthquake in 955 AD, and had crumbled completely by 1500 AD. It must have been an incredible structure to survive for over a millennium in the strong winter storms that ravish that part of the Mediterranean Sea.
One of the great puzzles of antiquity is how the light in the lighthouse was kept shining. Some historical accounts claim a huge fire was kept burning at the top, 24x7x365. No one is certain what the fire burned or how the logistics of feeding the voracious beast were accomplished. Alexandria is certainly not in the middle of a forest, so if wood was the fuel where did it come from? If some petroleum product was used, how did the ancient Egyptians transport and store it, and feed it into the fire without blowing up the top of the Pharos like a Roman candle? How did the Egyptians protect the rock superstructure from the intense heat of a perpetual fire?
Some reports allege that the Egyptians developed a brilliant system of glass lenses and bronze mirrors to focus the light thrown off by the great fire out to sea. Some scholars also report that these mirrors where used to reflect sunlight during the day instead of stoking the fire, which would solve part of the heat dissipation problem.
At night, however, the fire always burned intensely. The fire was typically orange, and lent an orange cast to the light beamed out of the Pharos. When sandstorms bludgeoned the Egyptian coast and blew sand far north into the Mediterranean, lookouts manning the extensive merchant fleets would see a blood red light from the Pharos, the pervasive sand filtering out the other visible light wavelengths. The bright red light reminded the ancient mariners of the dangerous waters ahead and assured they were on maximum alert to safely guide their vessels into the harbor of Alexandria, carefully avoiding the unforgiving shoreline hazards.
And what on earth does this have to do with a recession, you wonder? Fast forward one thousand years…
Today, even Alan Greenspan can sit before Congress and claim he has no idea how to know if we are in a recession until after the fact, and investors should be on maximum alert. Deciding we are in a recession in a post-mortem autopsy will do nothing to protect capital lost on the rocky shores of the turbulent markets. Like the great Pharos of Alexandria, many financial lighthouses of the modern world are beginning to glow with blood red warning lights.
Michael Bolser has recently completed some excellent research that may have ferreted out yet another indicator of an impending recession. In this essay Mr. Bolser granted us the privilege of presenting his results of this intriguing new look at the M3 money growth rate, the federal funds interest rate, and the ECRI Coincident Index. We will embark on our journey by briefly introducing the data series analyzed…
M3, of course, is simply the broad measure of the money supply in the United States. We discussed it last week in our essay "Exploding Inflation". Lately, M3 has been expanding like a terminal supernova. This phenomenal growth has led many analysts to conclude the Fed is in panic mode, sensing far more ominous rocky shoals ahead than it has publicly predicted so far. M3 is also among the best proxies for true inflation in an economy from an Austrian school of economics perspective.
The federal funds interest rate is the interest rate banks charge other banks for the use of federal funds, which are monies deposited at Federal Reserve banks by member commercial banks. Lately, from watching bubblevision, one rapidly gets the impression that the only thing that matters for the stock market anymore are short-term interest rates. After all, who needs the antiquated and overrated concepts of earnings, cashflow, and dividends? (dripping with sarcasm) For a look at how effective interest rate cuts were in halting the implosion of past bubbles, please check out our earlier essay "Bubbling Interest Rates".
The ECRI Coincident Index is constructed by the Economic Cycle Research Institute. Per the ECRI (www.businesscycle.com), the ECRI US Coincident Index (USCI) is designed to track the current state of the US economy. It is a comprehensive summary measure of the US economic conditions made up of indicators of the US economy including measures of production, employment, income, sales, and mortgage lending activity. Cyclical turning points in the USCI generally match the peaks and troughs in the US business cycle.
Mr. Bolser chose to use the ECRI index instead of Gross Domestic Product to represent US economic conditions for a couple important reasons. First, the GDP contains controversial accounting adjustments and arcane hedonics wizardry like the now virtually worthless Consumer Price Index. Also, there is a huge political incentive for the US government to exaggerate the final GDP growth value. Since the officially reported GDP numbers have unfortunately grown more suspect in recent years, Mr. Bolser wanted to use an independent measure of US economic activity.
Like the legendary blood red light of the Pharos of Alexandria, he believes that these three variables may interact to create a red warning light for US investors about impending recessions. Being vigilant for recessions is just as important for investors as being vigilant for rocky shoals was for the ancient mariners. The strategies to build and preserve capital through negative economic growth, recessions, can be VERY different from tactical capital deployments in normal growth periods.
Before we leap into the fray, an important caveat is in order. The complexity of the US economy makes the space shuttle look like a paper airplane, so there are large risks involved in drawing macro-economic conclusions from simple data sets. These charts and this hypothesis should be viewed with caution and in light of other economic information becoming available, not in a vacuum.
The first graph shows over 40 years of M3, fed funds rate, and ECRI Coincident Index (henceforth just "ECRI") data. The red line represents the M3 growth rate, the sky blue line the fed funds interest rate, and the dark blue line the ECRI. In this first graph, focus on the dashed zero line and the ECRI dark blue line. In the last 40 years, there have been five major recessions, each marked by negative economic growth. The first one around 1960 is not labeled, because this dataset does not extend far enough back to make a leading prediction on this early recession. The remainders, on which we want to focus, are tagged with letters A-D. Recession C in the early 1980s is considered as a single recession, because the brief "recovery" in the middle was nothing more than a head fake to lure optimistic cheerleader economists to their doom…
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