# Behavior of capital income is a precursor to a recession

A precursor is something that signals the arrival of something else. There are precursors to a recession. The trick is finding them. I want to show a precursor to the 2007 recession looking at the spending behavior of capital income.

Let’s look at a flow chart for the 1st quarter of 2007.

Graph of 2007 flow chart

Now we look at the flow chart for 1st quarter 2008. The recession actually started in 4th quarter 2007 (December). Between the first graph and the second graph here, the recession formed and then started. Somewhere between these two graphs is a precursor to the recession.

Graph of 2008 flow chart

I want to attract your attention to some numbers.

1. Investment as a percentage of GDP dropped from 17.9% to 16.9%.  However, investment stayed at 18% through the 3rd quarter of 2007, so we cannot call it a precursor.
2. Now look at capital consumption as a percentage of income. It dropped from 14.3% to 0.1%. Was it a dramatic drop in the 4th quarter? First realize that this capital consumption rate was running between 11% and 16% from 2004 to 2007. It reached its peak in 2006. Here is how capital consumption fell during 2007. (1st quarter=14.3%…. 2nd quarter=12.3%… 3rd quarter=9.0%… 4th quarter=3.6%… 1st quarter 2008=0%) By 1st quarter 2009 one year later, capital consumption had inched back up to 2.1% of its income.
3. There is another number that is not seen directly in the flow charts and has to be calculated. The percentage that labor saves to the total gross saving. In the chart, it is… “(Saving/Imports)/Gross \$\$ Saving. (Saving is not divided by imports. Just use the value in the box labeled “Saving/Imports” in the labor income section.) This number was running at 55% during 2006 until the 1st quarter of 2007. Here is how it fell during 2007. (1st quarter=55%… 2nd quarter=53%… 3rd quarter=51%… 4th quarter=50%) The number eventually kept falling to its current level of around 48%, which has held since 2009.

The idea is that we could use the capital consumption rate and labor’s percentage of gross saving as precursors to a recession, because they start dropping months in advance of the actual recession.

When capital starts consuming less a couple of quarters before a recession, they see the writing on the wall that there is trouble. They tighten their spending or are forced to tighten their spending. Capital sees this trouble before the general public and changes their behavior. Capital starts saving money instead of using it for consumption. Once the recession began, capital income stopped being used for consumption.

2001 recession (started 1st quarter 2001)

Capital consumption rate (1stQ 1999=12.3%…  4thQ 1999=5.8%…  1stQ 2000=0%…  2ndQ 2000=3.9%…  3rdQ 2000=2.0%…  4thQ 2000=1.1%…  1stQ 2001=0.5%…  1stQ 2002=3.1%…  1stQ 2003=7.2%) We see the same behavior. Capital consumption was falling at least a year before the recession. It finally reached a capital consumption rate near zero for the quarter when the recession started. Then two years after, it had climbed back up to 7.2% on its way to 16.4% in 2006.

(Note: Do you find it interesting that the capital consumption rate fell from 5.8%% to 0% from 4th quarter 1999 to 1st quarter 2000? It seems capital had its hopes up to make money off of Y2K. When the problems didn’t appear, capital didn’t consume. Capital income consumed again in 2nd quarter 2000, but then decreased its consumption until the recession.)

The key to these numbers is to see them as guidelines showing the behavior of capital consumption. In the case of 4th quarter 2000, a 1.1% would have signaled major problems brewing a month or two before the actual start of the recession in March of 2001. Even so, we would have been aware of problems 8 months ahead of the recession by seeing a low capital consumption rate of 3.9% in 2nd quarter 2000.

Currently the capital consumption rate is running around 21%. The rate had reached 16% by the 1st quarter of 2012. Even before the 2007 recession, capital had never used more than 17% of its income for consumption. The most I have seen so far in the flow charts I have done is 24% in 1980. So, capital is consuming a lot at the moment. Capital’s consumption may be close to peaking, and in such a case would make a good “sensitivity” precursor for economic trouble ahead… the “canary in the coal mine” for a recession as it were.

From these flow charts, we can see what the rich are thinking. They cannot hide their consumption or lack thereof. Within a couple of months, we see their behavior through these charts. We know what they are doing with their money. I might think that if capital’s consumption rate fell to 17%, for example, a yellow flag might go up for economic trouble ahead. If it fell to 14%, maybe a red flag. If it fell below 10%, recession imminent.

We will just keep an eye on how capital spends their income. So far they seem to be enjoying the income they have.