Preliminary sign of a coming contraction

Enjoy this Christmas because next year Christmas may not be as Merry…

As real GDP nears the effective demand limit, we should see some signs of the economy turning the corner toward a contraction. So, do we see any signs? … Well, yes.

This graph plots the aggregate profit rate against the savings rate of capital income.

prof rate 7

Aggregate profit rate uses the left axis. Capital income’s saving rate uses the right axis. (vertical red lines are starts of recessions.) I have adjusted the axes so that the lines come together and then split apart through time. The economy reaches its limit of expansion when the lines are “far” apart. A recession occurs as the lines come back together.

The most recent data implies that the economy is reaching the limit of its expansion. Capital income’s savings rate tends to decline to a level around 59% since the 80′s. Then it rises before a recession. It jumped briskly up in the 3rd quarter 2013. You really only see increases like that before and during recessions.

In the 3rd quarter 2013, capital income is saving more because government borrowing and private investment both rose. That may not seem like a cause for a recession, but there is another side to this. Capital income consumption of final goods and services drops, which also happened in the 3rd quarter 2013.

Also, some capital over-extends itself at this moment of optimism to their future sorrow. Some capital income protects its assets too. This dynamic of some getting into trouble while others are getting out of trouble is a common dynamic at the end of the business cycle.

As for the aggregate profit rate, it has been flat, but high, for 2 years. A flat aggregate profit rate is a sign of real GDP reaching the effective demand limit. The aggregate profit rate is showing signs of reaching its expansion limit.

The trend would now be to see these lines move together over the next year increasing the likelihood of a contraction. We will have to wait until March 2014 to get a good reading for 4th quarter 2013.

I realize many economists celebrate the strong real GDP growth of over 4% in the 3rd quarter 2013, and they forecast more strong growth for years to come… Many people get enthusiastic too. It is easy to celebrate the height of an expansion. However, everything needs to be put into the context of a larger picture. The dynamics of profit and savings for capital income are signaling the limit of the economic expansion.

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