A shadow falls across the land, as the expansion that wasn't becomes the downturn that mustn't. It is no wonder that some, never enamored with the bushconomy, commentators, such as Barry Ritholtz and Nouriel Roubini have begun to sharpen the claws. The sounds of growling are heard, as they say "Come, Bear with me." Today a crucial milestone was passed, as the Treasury Yield Curve entered "top to bottom inversion", where the shortest t-bill had a higher interest rate than the longest t-bond.

The shadow is more than the increasingly bad numbers from the bond market, GDP and inflation – it is the unraveling of the structure of the Bush economic program. We may see a 1986 stealth recession, where GDP for the whole year drops, and under monetary pressure inflation subsides. The coda to that story is that the same monetary pressure led to a world wide market crash, the collapse of the S&L system requiring a trillion dollar bail out, and the beginning of the Japanese "Bright Depression" from which they are just emerging.

Just as we see the first hint of what a season of storms could do in the Atlantic, the first whisper of wind of a possible recession has become a stiff breeze that rustle the leaves of the economy. The problem is oil, and the money made from it.

What the cash bond market thinks is that we are going to see a year of stagnation with higher inflation. However this is misleading, because the constant maturity view of the same market – taking out the oddities of how much of what is auctioned when – shows that we are hovering on the next stage of an inverted bond market, where short money is more expensive than long money. This is a powerful indicator that the coming down turn is going to hit hard. As of today, there is "top to bottom inversion", that is the 1 month treasury bill has a higher interest rate yield than the 30 year long bond. This isn't news to people who have been following this, and it means that we are now within spitting distance of the most reliable indicator of recession in the US economy.

The reality is that the present economy is dependent on federal stimulus, it has never evolved a self-sustaining reason to be. Even though technologies such as HDTV and wireless have only nibbled around the edges of the economy. The problem is that we are now on the backside of the large economic cycle, as risk has bottomed and begins climbing. Either investment must take larger risks for more reward, or it must flee risk, and thus lower long term economic growth. Even Bernanke admits we have had our time of "above trendline" growth, and must expect "below trendline" growth going forward. That's econospeak for recession, down turn or slog – slowing of growth.

This might seem to be contradicted by the ending of the long mired German and Japanese economies. However it is that we are now in such a money spring tide, that it has even reached the sluggish sectors of the industrial world. Instead, Germany faces a generation of retrenchment.

The reason for this argument is rather simple: the present expansion has not been good, in general, to people who work for a living. Paris Hilton has gotten tax breaks, but the rest of us have not. Even some of the rest of us who have been doing fairly well. A the same time that wages have been stagnant, even for professionals. So what does the doom and gloom caucus have to say?

The key factors in predictions of outright recession, from George Soros among others, come from the dependence of this economic cycle on housing for both jobs and domestic spending, and from the very low interest from both the US Federal Reserve, and from the Bank of Japan. This flood of money has shown up as rising energy and housing prices, since rising energy and housing prices were not deemed to be a concern until they became rising general prices. When these became rising commodity prices, concern set in, because commodity prices might well be passed on as general price increases. This meant that inflation was allowed to fester, even as falling wages without falling consumption has created an American consumer who is technically insolvent. The "doom and gloom" caucus argued that there had to come a point where tighter credit would mean falling home prices, which would kick off a double spiral of doom. First it would remove the assets that consumers used to borrow and… er… spend shall we say. Second, it would further depress wages, since housing had been the mainstay of jobs and wages.

So why has the consensus been Bullish? Because by the measures that we use, the economy has been chugging along well, with capacity utilization up, low headline unemployment, and while inflation has been higher than the Federal Reserve's "comfort zone", it has not been, according to official numbers, all that bad. But an economy is something that needs to be believed in, to be seen. All economic numbers answer a very specific question, not "how well is the economy doing?" but "how well is the economy doing what we think it should be doing?" Different decisions about what is important lead to different measures of inflation, unemployment and, therefore, interest rate decisions and measured growth.

One simple example of this is the use of "hedonic adjustments." This is a fancy way of saying that if products get better, that isn't really inflation. And who defines better? Why economists of course. What do they mean by "better," because, after all, there is no objective way to measure happiness directly? They mean. Well, the mean that people are willing to each chicken if beef gets too expensive, and they mean that if a processor has twice the CPU speed, it is twice as good. Seems to me that there are good jobs waiting for these people at KFC and Intel. Hedonic adjustments have been put in, and taken out, of our numbers.

The real question that economic policy has been asked to answer over the last 30 years has been "will bond holders hold US bonds? Will holders of dollars hold US dollars?" Because if they don't then they will dump those dollars, which will devalue the purchasing power of the dollar. In short, the question asked was "assuming inflation is a tax, is it falling on people who can do something about it?" If not, then all was well.

This question has lead to a corollary, namely that while we didn't see "the inflation tax", we did see the "stagnation tax." The stagnation tax is the cost in terms of growth of real wages and standards of living that people experience. The stagnation tax is what is making people like Secretary of the Treasury Paulson warn that benefits will have to be cut in the US, while similar warnings about France, Germany and Japan are being issued. This shouldn't be surprising, after all, the inverse of too much money, is too little. The inverse risk of inflation, is stagnation. To the extent that the cost of slow growth falls on other people, stagnation is a tax.

In the late 1970's and early 1980's the big holders of dollars rebelled against using inflation as a way of fixing federal budget problems and in speeding up the rest of the economy. If you look at job creation and production under Jimmy Carter, you realize that the economy grew smartly. The problem is, buying power eroded, and even as more and more people could go to work, even more people needed to work, because families needed the second income. That pattern hasn't changed, even though inflation went away. The permanence of the 80 hour a week household is one example of how American families pay the stagnation tax. Another is seen in how the US economy now crawls its way out of recession, rather than bursts back to full health. In short, the stagnation tax is like the old royal habit of debasing the currency, it eats away at buying power and opportunity bit by bit.

The obvious reason for this is that in 1960, the government and the wealthy needed the support of a large body of able workers and producers – people who could fight wars, build the sinews of an advanced economy, and girdle the globe with roads, rails, wires and cities. In 2000, the people who need to be happy are the holders of bonds and money. Clinton was told this bluntly by Bob Rubin: that bondholders determine the limits of policy.

There is an increasing revolt against this state of affairs. One can see it in Senator Byron Dorgan's book Take This Job and Ship It, and in what Secretary of the Treasury Paulson calls "a rising tide of protectionism". But that isn't really true. It isn't protestors who collapsed the Doha round of trade talks. It isn't anti-globalizers who are saying that the disinflationary effect from globalization is ebbing away. It isn't anti-free traders who are jacking up the price of energy and resources. The reality is that protectionism has been thee overt policy of this economic cycle, and we are seeing the results of protectionism now. All that people like Senator Dorgan are saying is that if there is going to be protectionism, then they want in too. This is why the poster child for this growing populist revolt is Wal*Mart. I once argued that "Wal*Merica" was a place where a reverse wage price spiral had taken hold, people had ever lower wages, so they bought ever cheaper and lower quality goods, which allowed every cheaper and lower quality work forces to make them.

In short the real problem is not the monetary policy problem, which has been clear for over a year now, and was indicated well before that, it is that we have been dumping money on the economy, and have very little to show for it other than a dry hole in Iraq, McMansions, and an over-supply of plastic surgeons.

The reason, ultimately, that the "doom and gloom" caucus is predicting recession, is that the economy is tearing through the net of housing and federal stimulus that has held growth up, and there is very little but the cold, cold ground to break the fall. With inflation here, people are pulling out of short bonds, expecting more rate increases, this is forcing up short term rates. With profits still churning through the economy, large central banks are still buying long bonds, and with a general optimism about the long term, large projects that collateralize using long bonds are still going forward. Thus the long bond is still in demand, and therefore its interest rate is low. If demand for interest now is falling, while demand for loanable funds is rising, something has got to give.

And that is why a hard landing looks likely, and a recession is a few bad bounces of the oil market away from happening. Because lets face it, if we get another Katrina, there is no surplus of gasoline to tap into, which means that Bernanke will have to slow the US economy, and that will ripple around the world, to economies like China, Germany and Japan that sell to us.

And that, given how deeply in debt the US government is, and the US consumer is, would be a down turn that could be with us for a very, very, very long time. What will add to the pain is that while the profit taking classes have been bailed out from the 2000-2002 stock market crash, those who earn wages have never really felt this recovery take hold, not in their pay envelopes, and not in their chances for advancement. Younger people and older workers alike have been stranded, and this is in a time when jobs are going to be easier to find than later on. In fact, this expansion has featured the worst job growth and worst pay picture of any long expansion since the second world war.

Ultimately the solution to these problems will be found in changing, not merely the margins of economic policy, but in the basic thrust of who the key stake holders are. To make this change will require a compelling necessity that forces even those who do not want to accept it, that the world is no longer run for the benefit of those who have money to loan.

And while a recession can make the case that the present policy direction does not work, only a fundamental change in outlook can supply a policy direction which does.