Readers of this blog expect the recession to last redux
Back in June I asked you all “When will the U.S. economy recover?.” The response was basically either “there will be no recovery to speak of” or “recovery is a long way off.” The poll results are embedded below.
I asked a similar question as the new year began since arguably a ‘technical recovery’ is underway. This time I phrased the question How long will the recovery last?. The answers were again the same with the majority saying “We are not in a recovery.” Again, the poll results are embedded below.
Why you don’t believe in the recovery
When I put the question up two weeks ago, I phrased it ambiguously on purpose because I wanted you to explain why you would answer one way or another. Here is a sampling of some of the responses:
Very nice. A group who does not believe a recovery is defined by bouncing along the bottom with no investment nor prospect of investment nor anything good to say about credit growth, employment or the outlook for consumers. My compliments to your readership.
Here’s another good one:
It’s not a recovery, it’s a stimulus.
Once the stimulus is removed the only thing that will turn out to have grown will be the debt, which will be unsustainable and will eventually bring about default and collapse on a scale never seen before.
Another take on the same meme says:
We are not in a recovery because job growth is not happening. We are recycling the same dollars between ourselves and our communities. I saw a chart that listed the top job growth sectors, almost all of them service jobs. Where are the manufacturing jobs? We produce almost NOTHING! Those who took bailout funds are not lending yet they continue to increase interest rates on credit cards. Cable bills, cell phone bills continue to go up yet hourly rates do not. People around me are getting fired/laid off/let go left and right. Where is this recovery happening?
I think you get the point. This cartoon kind of sums it up. But, this comment gets not only to the general feeling that things are not headed in the right direction, but the anger:
One trusts words like "recovery" when something substantial, not something will-‘o-the-wispish or ethereal, grounds them. The reality seen to be "recovering" of itself must have experienced something approximating permanence to be perceived as such. Ours is a house of cards responding like some ventriloquist’s dummy to the manipulation of desperate charlatans intent on finding some vindication in their chicanery. In any case what permanence is there in a "recovery" seen by many as a near-term adjustment in a more fundamental, longer term nose-dive and, particularly, one directed by such snakes? Ask yourself if the vermin that created the crisis possess the skills to resolve it. Only a politician or a lobbyist might say yes to this question.
So this is a fake recovery then?
So what do I think? Pretty much what I have said before in two posts whose themes bear repeating here. Here’s the message from the first. Last April, I wrote about the fake recovery I suspected was due to come. I said:
This is a fake recovery because the underlying systemic issues in the financial sector are being papered over through various mechanisms designed to surreptitiously recapitalize banks while monetary and fiscal stimulus induces a rebound before many banks’ inherent insolvency becomes a problem. This means the banking system will remain weak even after recovery takes hold. The likely result of the weak system will be a relapse into a depression-like circumstances once the temporary salve of stimulus has worn off. Note that this does not preclude stocks from large rallies or a new bull market from forming because as unsustainable as the recovery may be, it will be a recovery nonetheless.
As I see it, this is what is now happening. Marshall’s post So what are banks for, anyway? points to the underlying insolvency which has been covered up through accounting and bailouts. And of course, this is why banks are not lending – one reason the Obama bank tax is a bad idea (see my post Asymmetric information and corporate governance in bank bailouts for a more personalized account). As I indicated in the April post, the ‘fakeness’ of a recovery doesn’t preclude a cyclical bull market aka bear market rally.
The data say recovery though
Now, as to the data which underpins the rally and the recovery, let’s look at five areas: GDP, retail sales, personal income, production, and employment.
- GDP is up. For Q3 2009, GDP was up 2.2% and for Q4 2009, Menzie Chinn recently pointed to forecasts of 4% when assessing the efficacy of recent stimulus measures. Clearly, output is up and has been increasing for half a year now. Many of you believe this is stimulus-related and therefore ‘fake’’ hence some of the comments above. Irrespective, we are likely to see another increase in GDP as inventory builds add to the cyclical agents supporting recovery.
- Retail sales are up. Despite the disappointing numbers for December, retail sales are up a lot year-on-year. Bottom line: the consumer is not dead. Retail sales have been increasing since the summer. I will soon revisit the secular deleveraging theme in later posts. For now, suffice it to say, the consumer is hardly deleveraging in the U.S. or elsewhere. Why would one when interest rates are low and GDP is increasing? People deleverage when they are forced to do so – and that’s not what is happening right now. Wait until the next downturn ; that’s when you will see deleveraging.
- Personal income is up. It has been increasing every month since the summer. That’s why retail sales are up. So, despite 10% unemployment, those people who have jobs are actually making more money. End of story.
- Production is up. Look no further than the ISM manufacturing survey to see this. The ISM manufacturing index is at the highest level in nearly 4 years. It has been increasing since late summer. End of story. As for the services sector, this too is increasing…if just barely.
- Employment is the weakest link. This is where the problem lies. 10% unemployment, 17% underemployment, the loss of 85,000 jobs last month, the loss of 450,000 weekly, 40% unemployed for more than 6 months, structural issues. The employment picture is a mess. Yes, it is not nearly as dire as it was early in 2009. But, it is still a mess. I think we are in a secular trend. And that means problems down the line.
Let’s call this a technical recovery then
Overall, it sounds like a recovery to me. I anticipate that by late 2010 the NBER will make a recovery call and the date for its begin will be summer 2009 – just after I asked the recovery question the first time (sounds like the recency effect in action to me).. Of course, this is merely a technical recovery right now. The data on employment points to why. But, just to make clear what I mean when I say ‘technical recovery,’ I will quote from my July post which defined the term as I use it:
The period just following recession until the previous level of output before recession is re-attained is what I will term a ‘technical recovery.’ This is a time during which economic activity is increasing, but the economy is still operating below levels of the recent past. Unemployment will still be rising and many businesses will still be going bankrupt. Because this period will still be very painful for many, it seems perverse to call it a recovery. So, let’s use the term ‘technical recovery’ to describe this phenomenon. That way, we all understand the reality behind the numbers.
The question of course is when are we going to reach that magical previous level of output. As I indicated in my post on jobless claims this week, employment at a minimum is likely to remain below previous highs for some time to come. David Rosenberg says we will need an additional 20 million jobs to get to get back to the previous employment population ratio peak of 63.7% in November 2007. That’s a lot of jobs. I guarantee you we won’t create that many jobs for a decade at least. So this is clearly an economic depression we are experiencing. Right now, it is not a ‘Great’ Depression, but it is a depression nonetheless.
How do I see things progressing going forward? Here’s the message from the second post from October on how I see things (the full post is here).
So, what does this mean for the American and global economy?
- The private sector (particularly the household sector) is overly indebted. The level of debt households now carry cannot be supported by income at the present levels of consumption. The natural tendency, therefore, is toward more saving and less spending in the private sector (although asset price appreciation can attenuate this through the Wealth Effect). That necessarily means the public sector must run a deficit or the import-export sector must run a surplus.
- Most countries are in a state of economic weakness. That means consumption demand is constrained globally. There is no chance that the U.S. can export its way out of recession without a collapse in the value of the U.S. dollar. That leaves the government as the sole way to pick up the slack.
- Since state and local governments are constrained by falling tax revenue (see WSJ article) and the inability to print money, only the Federal Government can run large deficits.
- Deficit spending on this scale is politically unacceptable and will come to an end as soon as the economy shows any signs of life (say 2 to 3% growth for one year). Therefore, at the first sign of economic strength, the Federal Government will raise taxes and/or cut spending. The result will be a deep recession with higher unemployment and lower stock prices.
- Meanwhile, all countries which issue the vast majority of debt in their own currency (U.S, Eurozone, U.K., Switzerland, Japan) will inflate. They will print as much money as they can reasonably get away with. While the economy is in an upswing, this will create a false boom, predicated on asset price increases. This will be a huge bonus for hard assets like gold, platinum or silver. However, when the prop of government spending is taken away, the global economy will relapse into recession.
- As a result there will be a Scylla and Charybdis of inflationary and deflationary forces, which will force the hands of central bankers in adding and withdrawing liquidity. Add in the likely volatility in government spending and taxation and you have the makings of a depression shaped like a series of W’s consisting of short and uneven business cycles. The secular force is the D-process and the deleveraging, so I expect deflation to be the resulting secular trend more than inflation.
- Needless to say, this kind of volatility will induce a wave of populist sentiment, leading to an unpredictable and violent geopolitical climate and the likelihood of more muscular forms of government.
- From an investing standpoint, consider this a secular bear market for stocks then. Play the rallies, but be cognizant that the secular trend for the time being is down. The Japanese example which we are now tracking is a best case scenario.
Things are certainly shaping up exactly as I indicated. And if stimulus starts being withdrawn this year – as I believe it will be – expect a recession sooner than later. When this possibility comes into focus, the present cyclical bull market will come under pressure. And when asset prices start to fall, this whole asset-based recoverywill start to look troubled indeed.
Comments are appreciated.