Once, when I was at a large German investment bank, I noticed the bond market's response to a bearish number was curiously bullish. I don't recall what the release was, but I remember thinking the market response was exactly opposite of what it should be. So I went to the firm's trading-floor economist (who has since become their chief economist) and I asked "What do you think of the data?" He proceeded to give a very tortured explanation of how the data in fact were bullish, but it was clearly reaching for straws. I said "I don't see how that could be right. This looks clearly bearish to me." His response spoke volumes for the way he approached his job. He said "Mike, the market disagrees with you. The market is going up. So it must be bullish."

I don't think economists should be allowed to look at the ticker. Economists who tell us what the market thinks the data mean are useless. I want to know what the data does mean, and then decide if the market reaction is appropriate.

But many, if not most, Wall Street economists do this. If the stock market has been rallying, they interpret data bullishly; if the market has been down, they interpret data bearishly. And that really hurts the profession of economics.

Currently, every economist - even ones who have been right about the recession from the beginning - is falling victim to this bias. With stocks continuing an epic rally, economists from Bernanke ("the recession is probably over") to those at Citigroup ("Housing activity is transitioning from a major drag to a leading source of recovery") and Deutsche Bank ("Don't Fret Declining Consumer Credit") are trumpeting the end of the downturn already.

And this weekend, they picked up a trophy when Jim Grant (who has been bearish on the bond market for the last 20 years or so) wrote a piece in the weekend Wall Street Journal. While I love to read Grant, he doesn't even reach "broken clock" status since to do so he'd have to be right twice. But this weekend he made a classic mistake that is worth mentioning.

Grant observed (while claiming that all economists right now are very pessimistic, which is a sure sign he wants to be continue to be considered a contrarian while he joins the crowd) that the robustness of post-recession recovery has historically tended to be proportional to the depth of the recession. This is a well-known correlation, but the classic error is that it implies no causality. There is an unstated explanation for that correlation; it is that explanation that needs to be examined to see if it applies here or is lacking.

Most recessions end because the economy retrenches to a new, sustainable level of consumption and production, from which level normal growth can resume. Have we done that in this case?

The chart below (Source: Bureau of Economic Analysis) shows the drawdown from peak consumption over the last 60 years (the data doesn't go back, in a quarterly form, any further but this covers the entire postwar experience). Note that in terms of the "amount of retrenchment" in personal consumption, this is one of the mildest recessions on record. That is, it isn't at all clear that we have reached any sort of stable 'base level' from which we might feasibly expect to grow robustly.

Now, perhaps the "recession" question may just be an academic discussion among Grant and some of these other economists about the technical meaning of the word recovery. Grant argues that the first full year of economic recovery from the Great Depression, in 1934...but, while it is true that the economy grew between 1934 and 1937 (before another savage downturn in 1938), most normal people don't consider the Great Depression to have lasted from 1929 to 1933, but from 1929 to 1941 or so.

Perhaps that is what could transpire here. Bernanke could be right that the recession is technically over, if we look at GDP accounts that are currently being juiced by massive government spending. But the "solution" has caused such enormous imbalances - in some cases, even worse than those which caused the last collapse - that the chance of a healthy, robust, multi-year recovery is effectively zero. Could we string together a few quarters of growth? Sure, although if credit continues to contract that can only happen through government spending borrowed from the future. But if this happens, it means the next downturn is only a few quarters or at most a couple of years away, and it will be as savage as what 1938 brought.

I don't believe that is what will transpire, because I think the political will to respond to the slowdown that will accompany the ebbing of government stimulus (and contracting credit, about which I fret) is seriously lacking. We've already thrown the kitchen sink. We are running out of things to throw.

We are surely past the worst of the panic, but that doesn't mean that the ongoing bust in commercial mortgages and consumer credit will be painless. Now, is there a chance that equities go up anyway, even if the economy struggles or starts to contract again? Sure, and there's a chance you can make money buying equities at the exceptionally high multiples we're seeing right now. The Fed's massive money-printing scheme can (and has in the past) led to asset inflation. But that's not necessarily a great way to bet, especially if the reflation scheme is petering out. Money and credit are contracting. Betting on a bubble now is perhaps not the best idea even though there is still massive stimulus working its way through the pipeline.

Our proprietary inflation indicators, interestingly, are not declining very much despite this contraction, because the dollar's recent weakness is providing a counterbalancing effect. We still see core inflation bottoming in 2010, and we will write later this week on the outlook for core-ex-housing inflation.

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