Is a Recession Forming in the US?
Stocks continue downward.. China is struggling… Commodity exporting countries are in trouble… industrial production is projected to be weak in September as it was in August… Could the US economy be forming a recession?
First, I have had the opinion that there are hidden weaknesses in the economy partly due to the strange monetary policy since the last recession. Some marginally-profitable firms were nurtured along by the banking system and policies. Also investment in productive activities has been weak. Productivity is stagnant. Labor income is not rising with strength.
I sense that hidden weaknesses are coming into the light, because of the struggles in China, Brazil and the oil industry… and now we can add the auto industry. (Let me note that the struggles in China should allow for more investment to come back to the US and for labor share to start rising again… a view I share with Noah Smith. So the stock market troubles could be short-term effects before the benefits appear in the US. Yet, a recession may have to come first.)
In my view, the economy hit the effective demand limit last year. As seen in the following graph where the plot reached zero.
Angry Bear’s own Steve Roth once rightly commented that after the economy hits the effective demand limit, it can jiggle and jog thereabouts for many quarters before a recession starts. (I do not have the direct link to where he said that, but I remember.) And we are seeing this jiggling and jogging again over the past year. The graph is showing us that the economy hit its natural effective demand limit and would be in this process of jiggling around trying to keep going.
I was thinking that the economy might bounce twice upon the limit like it did before the last two recessions. But maybe not so this time… Maybe the economy will head straight for a recession after hitting just once on the effective demand limit.
So is a recession currently forming in the US economy? I have my yellow flag up. I want to see numbers from the 3rd quarter and then I want to see some numbers for October, like capacity utilization. But hidden weaknesses of the economy seem to be coming into the light. And I know that Bill McBride from Calculated Risk has shades on because he sees a bright future ahead. The hidden weaknesses in the economy may need those shades as they come out into the light from the hidden shadows.
The St. Louis Fed Financial Stress Index over at FRED (link) jumped up in the last month showing an increase in financial stress.
or is economic boom coming with the next credit cycle phase? Utilization is pretty useless in todays economy. You need to look at different spots.
If we have another recession , I predict taxpayers will once again have to bail out the big banks. It will turn out that their off-balance-sheet entities also had off-balance-sheet entities , which were created specifically to pass the bank stress tests. This practice will come to be known as the “Volkswagen Diddle”.
Where do you see the next credit cycle putting money? Cars? Oil exploration? Emerging markets? Education? Houses? Manufacturing? … boosting productivity? … where?
Speaking of financial stress/risk:
“The market” has already begun to “tighten” in terms of the ChiFed’s ANFCI and the widening of the Baa-10-year spread without the Fed raising rates, and with the ECB, BOJ, PBoC, and many other central banks responding to the “tightening” by resuming or expanding QEternity.
If one is waiting for a yield curve inversion to signal a later bear market and recession, one will be waiting a long time during a debt-deflationary regime of the Long Wave.
We’re in a debt-deflationary regime’s liquidity trap of new normal of secular stagnation exacerbated by unprecedented debt to wages and GDP; Peak Oil (increasing energy cost of energy extraction per capita); population overshoot: resource depletion per capita; climate change; peak Boomer demographic drag effects; overvalued assets to wages and GDP hoarded by the top 0.001-1% to 10% at zero velocity; a record low for labor share causing productivity to decelerate; the Marxian falling rate of profits (and lack of capital formation/accumulation to GDP) crisis; and EXTREME wealth and income inequality.
There are no textbook economic prescriptions to the foregoing, once-in-history, self-reinforcing effects, apart from debt forgiveness, redistribution of income, and “normalization” of labor share to GDP.
Marko, the banks are flush with cash. That is why they want the Fed to raise rates so they can put pressure to expand debt. I have no clue where the flows go next. I suspect they don’t either. Follow the animal spirits and ‘trend”.
The “recession” talk is about the drop in oil/shale exploration budget. I just don’t see a crossover to finance.
Lamberts point is the drop in this exploration investment will drive a recession, it will be tough by itself.
The drop in exploration investment is only a part of the story. I focus on the limit of effective demand mostly as the trigger around which other factors respond.
Effective demand is not that great of usage in todays economy. It is heavily debt driven and that leads toward debt servicing driven. When banks drive financial booms, that had a tendency to drive consumption booms. The key question then becomes the ability to service. This is what really triggered the financial crisis in its bones.
Labor share allows debt to be serviced by the bulk of consumers. Like you say, “the ability to service”. Even debt dynamics are triggered by labor share.
Ultimately as I see it, labor share controls the aggregate utilization of labor and capital. From 2005 to 2008, the utilization of labor and capital rode along the effective demand limit in spite of the consumption booms. Look at the graph in the post. That is 3 years…. The housing boom couldn’t surpass the limit… for 3 years.
We don’t even have a boom at the moment… and we don’t know where one can happen.
You should find this amusing :
“Potential Output and Recessions: Are We Fooling Ourselves ?”
Your previous post showing that we are already at potential could well be on the mark , though I’m not sure the term “potential output” has any plausible meaning these days.
That paper on potential output is interesting. They are seeing that potential is reduced after recessions, but they do not give an explanation of how.
I see how through effective demand. Here is a post that I did 2.5 years ago. I have a graph there that predicts real GDP will stay low upon the new lower trend line. I saw how others were predicting real GDP to return to its former trend. but I did not see it that way, and I turned out to be right.
That was a good call , Edward , especially since it was based on your own model.
I can remember all the push-back by the econ types whenever a blog comment suggested that potential gdp projections were bogus , that demand would be limited because of debt overhang , that we were likely to replicate the Japan experience , etc. The argument was always ” But we can still produce as much as ever – monetary policy will correct the demand shortfall. ” Well , we know how that turned out , but I’m pretty sure those people would make the same argument today.
The answer to the question in the title of that article is : Yes , they ARE fooling themselves.
I believe that we are overdue for a recession. If it follows the long term trend, then it will be worse than 2008.
I find things to disagree with in that Fed paper.
In the first line of their conclusion is this:
“We expand on earlier work in the literature that finds evidence that banking and financial
crises are associated with persistent negative deviations in the level of GDP from pre-crisis trend.”
Of course the underlying cause of the Great Recession was not banking and finance, it was consumers trying to maintain a standard of living while getting stagnant wages. Thus they were willing to borrow more and more money at cheaper and cheaper interest rates. The housing bubble facilitated the process, since with rising home prices the consumer could refinance to remove equity and spend those dollars. That allowed increased spending until consumers could not continue to borrow. (There is always a limit on any consumer’s total debt.) During all that borrowing, the banking and finance worlds would be presented with opportunities to commit major sins, like not doing legitimate underwriting or allowing shenanigans around the securities based on home mortgages.
Then we have this in the conclusion:
“In particular, this loss of output may imply that demand shocks have permanent effects or that recessions are driven by long lasting supply or productivity shocks.”
The implication is that supply side economics is fine, except when there are “demand shocks”. Of course this ignores the possibility that a slow grinding process of reducing consumers wherewithal to purchase goods is an extremely serious problem. (Wherewithal to include income and new borrowing.)
How do you solve a problem without really understanding it? Accidentally?
Obviously I agree with your ideas concerning labor share. With inadequate labor share maxed out credit, the consumer may have the will to purchase but that is as far as it goes. (And maxed out it will be, sooner or later.) Consumers can not spend what they do not have.
That Fed paper throws out some ideas without any model.
My model uses labor share as the anchor for potential GDP. But you know, even with the run-up in debt before the crisis, the effective demand limit still held. The increasing debt could not push the utilization of labor and capital over the labor share effective demand limit… for 3 years trying.
“But you know, even with the run-up in debt before the crisis, the effective demand limit still held.”
The way I see it, the run-up in debt just delayed the crisis. There is always a limit to allowable borrowing. And I expect that increasing debt would always be a associated with decreasing labor share.
Makes me wonder if some other factor is not currently delaying our next crisis (recession)?
Here’s one factor that may play a role :
“Borrowing from the Future: 401(k) Plan Loans and Loan Defaults”
( My suggestion : Borrow from the past )
I believe you are right on the mark.
There would be a tendency to save those long term retirement savings until there was nothing else left. (Except possibly a little equity in their homes.)
Then the accounts would be borrowed against, and as a last resort the funds would be withdrawn.
The draining of those accounts would probably occur slowly as first one small group and then another was laid off and exhausted their other savings.
Yep. Here’s how I expect the numbers to play out : Bottom 90% share of wealth will gradually shrink until there is essentially no extra demand that arises from spending down that pot of savings. Debt-based increases in demand won’t come from the bottom 90% either – after depleting their savings they’re even worse credit risks than before. Now the bottom 90% can at most consume their meager incomes , all while at the same time knowing that they need to try to replenish savings if at all possible.
So , we’ll have an economy that is entirely built on servicing the needs of the top 10% , and mainly the upper reaches of that 10%. Then , even if by some miracle we got a progressive Prez and Congress , they’d be forced to implement redistributive policies only very gradually , so as to allow the economy to adjust to the new patterns of demand.
Our overlords have a good game plan , I must admit. Even in a worst-case progressive revolution scenario , they’ll still be shitting in high cotton for decades.
Over the longer term you might be right. But I like to allow for the possibility for corrections, human beings are adaptable.
And as Edward Lambert has pointed out, the worst damage seems to occur in each recession. Right now I think we are just working up to the next recession.
We are witnessing the slow motion wreck of a very large economy.