Summary: This month’s sharp drop in stock prices has raised fears about the US economy. Are they warranted? Is the expansion “old”? How can we predict the next recession? See the answers you won’t find in the news.
The US and global stock markets have fallen, with the usual hysterical headlines (it is up 6.1% before dividends over 12 months, up 0.6% YTD, down 7.3% from the October 3 peak). Are equity investors telling up something about the economy? The answer might shake America – businesses, households, and Washington DC.
This expansion has run for 112 months counting from the 2009 trough (the second longest), and 130 months from 2007 peak (the longest) – using the NBER’s data since 1854. It continues to run strong. When will the growth end? What happens then?
Do economic expansions grow old and die?
Glenn D. Rudebusch (Fed EVP) summarized economists’ answer in “Will the Economic Recovery Die of Old Age?” (San Francisco Fed’s Letters, 4 February 2016. He gives two graphs answer the question. First, a simple mortality table shows that people grow old and die.
See the same graph for economic expansions. They aged and died before the Great Depression and WWII. But that taught economists about the value of economic stabilizers (e.g., unemployment insurance), plus fiscal and monetary stimulus. Since then the odds of recession ending each month increase only slightly over time. That is progress!
Non-economists cosplaying economists in the news often say that this expansion is “living on borrowed time.” That is false. Also, it is not a recovery. Almost all measures of economic activity long-ago passed their previous peaks. This is an economic expansion.
What kills expansions?
People often confuse signs of a slowdown (e.g., consumer confidence falls, economic activity slows) with the factors that cause the slowdown. Such as economic or political shocks. A partial list includes trade wars, real wars, monetary policy (excessive rate increases by the Fed, restrictions on lending, breaking growth of the money supply), fiscal policy (large cuts in spending, large tax increases), and popping of big investment bubbles. As with most disasters, multiple errors are usually necessary (a dozen mistakes, plus an iceberg, sank the Titanic). There are many links that can break in our complex world.
Two causes are especially common in the post-WWII era. First, the Fed brakes too hard to prevent “overheating.” Sometimes overheating means a rapid rise of inflation. Sometimes it means full employment forcing businesses to share productivity growth with their workers. “Profit inflation” is good in bankers’ eyes. “Wage inflation” is bad!
Second, “imbalances” in the economy. These can be excessive growth in government, consumer, or business borrowing – which ends suddenly, creating a shock. Or sector imbalances – such as the tech boom and the regional real estate boom-bust cycles.
The slow growth in real GDP after the 2008-2009 bust – roughly 2.5% from 2010 – 2017 – created few imbalances. Optimists cheered as the dawn of a new age the Q2 growth of 4.2% (SAAR) and Q3’s 3.5%. Just as they did in 2014: Q2 of 5.2% and Q3 4.9%. But those micro-booms fizzled. As this one might: estimates for Q4 are about 2.7% – despite the GOP’s massive debt-fueled fiscal stimulus (quite mad to do late in an economic expansion, when we should be reducing the Federal deficit).
Recessions and depressions are normal!
Thou know’st it’s common; all that lives must die,
Passing through nature to eternity.
— Queen Gertrude to Hamlet (Act I, scene 2).
Something will eventually end an expansion. Expansions are part of the business cycle, along with recessions – and depressions. They do not represent God’s judgement on our moral faults, or failure to follow the One True Simple Ideology of Economics. They are similar to weather: to be prepared for in advance, to be mitigated when they strike, and learned from afterwards (to do better next time).
The US economy has been in a recession roughly 20% of the time since 1854. Depressions were frequent before the creation of the Fed and use of fiscal stabilizers.
A look at our future
First, the bad news. Economists have little ability to predict recessions. Surveys of economists’ consensus forecast have never successfully predicted a recession. For example, look at the predictions made in February 2008. The consensus forecast for real GDP in 2008 was +1.8%; actual was –0.1%. Their forecast for 2009 was +2.8%; actual was –2.4%. The recession had begun in December 2007.
Some economists expected a recession (but being pros, were vague about when). I have found nobody that predicted the collapse of the global banking system, which turned a US real estate downturn into the Great Recession (see my series about some claims of successful forecasts: here, here, and here).
With that out of the way, let’s look at some indicators. There are many quantitative indicators. My favorite is the Econbrowser Recession Indicator Index created by James Hamilton (econ prof at UC San Diego). The probability that Q2 was a recession was 1.1%. That’s reassuring – if you worried about that.
Then there are the US leading indicators and the OECD’s Composite Leading Indicator (shown for the major nations and regions). They nicely show were we are; none are reliable guides to the future. All look OK today.
There are many methods for predicting recessions. None work well. Many of the best look at the shape of the yield curve. See this graph from “Predicting recessions in the United States with the yield curve” by Cyrille Lenoel (senior economist, NIESR) in the National Economic Review, May 2018. Data is as of March 2018. Backtesting shows this model’s predictions of a recession are correct 69% of the time (accuracy), but it predicts only 35% of recessions (sensitivity). The odds of recession in the next 12 months is rising fast.
For more about this indicator, and what it is telling us, see this dark but clear report: “Forecasting the Next Recession: The Yield Curve Doesn’t Lie” by Guggenheim Investments, 29 October 2018 — “Our Recession Probability Model and Recession Dashboard continue to suggest a recession is likely to begin in early 2020. Investors ignore the yield curve’s signal at their peril.”
Some forecasters rely on quantitative methods and personal skill. Such as the team at the Economic Cycle Research Institute. Their co-founder, Lakshman Achuthan, gave a warning in the New York Post, October 24.
“The economy has been boosted by massive fiscal stimulus – plus an energy boom for the ages – steering it clear of recession risk. But it’s remarkable that it is already in a slowdown that not many see – certainly not the Fed.”
Their reports look at some darker aspects of recent data. They noticed that real GDP has been wonderful, but growth of real GDI (gross domestic income) has been slowing since Q2 of last year. Housing construction is weak.
There are other signs of slowing. Sales of light vehicles has been flattish since June 2014. There is another indicator “flashing red”, described by Achuthan on October 26.
“Notably, the combined debt of the US, Eurozone, Japan, and China has increased more than ten times as much as their combined GDP [growth] over the past year. …the world’s largest economies are generating debt 10X faster than economic growth. Adding debt at that pace, if it continues, will boost the debt-to-GDP ratio at an alarming rate.
“Remarkably, then, the global economy – slowing in sync despite soaring debt – finds itself in a situation reminiscent of the Red Queen Effect we referenced 15 years ago, when tax cuts boosted the US budget deficit much more than GDP. As the Red Queen says to Alice in Lewis Carroll’s Through the Looking Glass
But stock prices predict recessions!
But they don’t. There is a low correlation between stock prices and GDP, or anything else (on an ex ante basis), or stock market traders would be richer than stock brokers (they’re not). Investors in stock and bonds have no special insights, either as individuals or crowds. My favorite example was their inability to see WWI as it began.
On the other hand, a stock market crash would have only a small effect on the economy. Watch the banks! If they crumble, the economy crumbles too (as it did after 1929+ and 2008-2009).
Why should we care?
We need a long warning because we are unprepared for a recession. Monetary policy is the fast and effective method to fight a recession. But with rates so low, that cannot help much. Fiscal policy is the second big tool. Trump’s tax cuts, part of the GOP’s long-term effort to make the rich richer — and bleed the Federal government — will make that more difficult to use. The April 9 CBO report gave this chilling warning.
“CBO estimates that the 2018 deficit will total $804 billion, $139 billion more than the $665 billion shortfall recorded in 2017. …In CBO’s projections, budget deficits continue increasing after 2018, rising from 4.2% of GDP this year to 5.1% in 2022 (adjusted to exclude the shifts in timing). That percentage has been exceeded in only five years since 1946; four of those years followed the deep 2007–2009 recession.”
Keynes recommended running deficits during recessions — countercyclical stimulus — with surpluses during expansions. The GOP keeps cutting taxes during expansions, sending the Federal deficit skyrocketing. Reagan did it. Bush Jr. did it. Now Trump has done it.
The Federal deficit was 1.1% of GDP in 2007. It zoomed during the recession as tax receipts crashed and expenditures rose (e.g., unemployment and welfare payments, and later the fiscal stimulus). We will begin the next recession with a deficit of 4 – 5%. That is insane. The politics of stimulus programs will be complex. If we have a Republican President and Congress, the US economy might have a bad time. That is guaranteed if Trump is President.
What might happen in a recession?
I wrote several posts about that during the 2015-2016 slowing, when the theory about a “stall speed” of the US economy (below which it would fall into recession) made a recession appear likely. This proved that there is no stall speed. The most valid is that the big victim of the coming stock market crash will be the San Francisco Bay Area. It sells dreams for money, an industry that I expect to crash hard in the next recession. The accelerating exodus of middle-class families makes the region even more vulnerable.
Beyond that we can only guess. Much depends on the nature of the downturn and the government’s response. The private and public pension systems are already weak, despite the long expansion. A stock market crash and long recession will push many past the point of recovery, as the date at which their cash flows turn negative approaches (i.e., more payments than contributions) — see this about the coming bankruptcy of government pension plans. Also, boomers have saved too little for retirement, and too much of that is in real estate and stocks – both probably severe casualties of a long recession.
My best guess: it won’t be pretty. My advice: expect the unexpected.
For More Information
Ed Dolan (senior economist at the Niskanen Center) has some similar thoughts about the next recession, posted at Focus Economics.
Ideas! For shopping ideas, see my recommended books and films at Amazon.
If you liked this post, like us on Facebook and follow us on Twitter. For more information, see these posts …
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- Cacophony about Social Security shows our real political dysfunctionality.
- Fact & myth about the debt supercycle, a story of modern America.
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- Today’s mythbusting: the Fed is not suppressing interest rates.
- Exciting but fake news about our strong economy – The economy is not overheating.
Step back and see the big picture about America’s economy
The Rise and Fall of American Growth:
The U.S. Standard of Living since the Civil War
By Robert J. Gordon (Prof economics, Northwestern U).
From the publisher…
“In the century after the Civil War, an economic revolution improved the American standard of living in ways previously unimaginable. Electric lighting, indoor plumbing, motor vehicles, air travel, and television transformed households and workplaces. But has that era of unprecedented growth come to an end?
“Weaving together a vivid narrative, historical anecdotes, and economic analysis, The Rise and Fall of American Growth challenges the view that economic growth will continue unabated, and demonstrates that the life-altering scale of innovations between 1870 and 1970 cannot be repeated. Gordon contends that the nation’s productivity growth will be further held back by the headwinds of rising inequality, stagnating education, an aging population, and the rising debt of college students and the federal government, and that we must find new solutions.
“A critical voice in the most pressing debates of our time, The Rise and Fall of American Growth is at once a tribute to a century of radical change and a harbinger of tougher times to come.”
My impression is that part of the reason for running things so hot – other than an ideological, bordering on the theological fascination with the salvific and healing power of tax cuts – is that this way the next time there’s a big recession, they can fulfill the other great and holy dream of finally cutting or abolishing Social Security and/or Medicare.
I mean, I don’t get why they want to do that so bad, but that will be the Republican prescription.
SF,
Conservatives have been quite open about their desire to roll back the New Deal. I’ve run a dozen posts documenting this.
This goes to an essential fact of US politics: both Left and Right deploy armies of (to use Lenin’s apt phrase) useful idiots. That is, people who serve their leaders despite low agreement with their goals. On the Right, conservatives who like the New Deals core programs (eg, social security and medicare) — and even depend on them — serve leaders who seek to destroy those programs.
That’s why 4Chan’s meme about NPCs (non-player characters) hit so hard. Useful idiots are in essence NPCs.
This is, imo, a major factor preventing political reform of American. Perhaps it means we don’t deserve a better system, being sheep.
You really were an unhappy person yesterday, FM. I hope you’re having a better day today.
Regarding your points:
1) The people of the US for last two centuries had vastly less entertainment options waiting for them in their own homes. This forced them to focus on what was important to them. Our current situation no longer has that benefit. We are discovering whether our current political system can and will survive the pestilence of too much entertainment and apparent (but not real) wealth. As you’ve noted, there are lots of people who would be happy if it fails but that does not bode well for the country at large.
2) Are you SURE that the people of the Hispanic countries prefer their old customs of government? You point to the Southwestern border regions as an example of Latino influence. I suspect the vast quantities of drug money rolling through the area have at least as much to do with the problem as immigrants, probably more.
Speaking only from personal experience (and from a very small amount of reading on the subject), the reason they want immigrate is to live in a better system. I have yet to meet a recent immigrant that said, “All I want is a check from the US government”, because they don’t understand how the US system works. They just know that it works a LOT better than their own country and they are willing to totally uproot their families, lose absolutely everything they know and understand, travel thousands of miles through increasingly hostile foreign lands, and pray that they can find an opportunity to live a better life, especially for their children. Then they push their children extremely hard to do well in school and to learn to speak English without an accent, to keep their heads down and live as good a life as possible.
The third generation (of whom I’ve met only a few) seem to be fluent only in English and do their best to enjoy life as average Americans (whom already I know you despise, regardless of skin color). They are well aware that their skin color makes life a lot harder for them (the police and election officials rarely lose an opportunity to point this out to them) which makes them less likely to be fully politically active in the way you would prefer but their confidence in themselves and their citizenship is slowly growing. Whether it will grow fast enough is another matter and I think you are right to me concerned.
FM: (2) “Lack of money and time. When you’re working 18 hours a day 6 days a week to keep your business afloat, you rarely volunteer an additional 20 hours a weekend for political campaigns.
I love rebuttal by wild exaggeration.”
I can give you the names of the people I’m thinking of. They are also trying to raise multiple children per family and cannot find workers for their shops because of the low unemployment rate. They tell me they DO vote but don’t do much else.
FM: “I admire your certainty that when they act, it won’t create a political system like those in Latin America. But I consider it unfounded, if not delusional — assuming high rates of immigration from the South continues.”
Why? Most (90%+) immigrants to the US actively hate the governing system they grew up with. They are unsure of their actual voting rights because they are well aware of the difference between what is written in the law books and the traditions of their old country but are not as sure about what will happen in the new country.
The key point in all of our discussions, I believe, is what I said that the beginning. Can the US system of government survive the deluge of entertainment options and distractions its citizens are encountering. I’m fairly hopeful IF the innovation slows down and not at all hopeful if it continues or intensifies.
There are days, like yesterday, when I decide to just stop, enjoy what I’ve got, make sure it keeps coming for me, and to hope for the best for the rest of you and the future. But when I look at things more objectively, I would not be surprised if you are right and we are already past the point of no return.
As you personally already know, I live in the frozen part of fly-over land and am very likely to have a very stable situation for the remainder of my years (ice tends to keep out the riff-raff).
By the way, why the focus on Hispanic immigrants? We’re currently enjoying(?) a massive flood of immigrants from Asia as well and their historic forms of government have not been that parallel to the US either.
Pluto,
You appear to be ignoring what I’m saying. I’ll give a few examples, then give up.
(1) “Are you SURE that the people of the Hispanic countries prefer their old customs of government”
I said nothing remotely like that. People’s behaviors are rooted deeply in their values and thought patterns. What they “prefer” is almost irrelevant. Otherwise everybody’s New Year’s Resolutions would make a better nation every year, and weight loss and stopping smoking would be a snap.
(2) “I can give you the names of the people I’m thinking of”
You totally ignored my response, which was not about the number of hours they work. I’ll repeat it for you.
You said “When you’re working 18 hours a day 6 days a week to keep your business afloat, you rarely volunteer an additional 20 hours a weekend for political campaigns.”
My reply:
(3) About entertainment
You might be right. I’ve seen no research about it, and am uninterested in such speculation. More relevantly, that is irrelevant to this post.
(4) “You really were an unhappy person yesterday,”
Don’t personalize comments. That leads to excessive emotionalism – very quickly. I reply to the words you type, as best I can. Nothing more, nothing less.
FM: “The Federal deficit was 1.1% of GDP in 2017. It zoomed in the recession as tax receipts crashed and expenditures rose”
Do you mean 2007 instead of 2017?
I’ve been dealing with far too many medical issues but I’ve been following your comments. Most of them are spot-on as far as you are going with them. A few are in danger of being wrong if we look far enough in the future. For example, you are (correctly) very concerned with the high level of ennui in this country and the general lack of willingness to do something about it. Have you ever worked with the adult children of Hispanic immigrants? Those young people are almost uniformly among the hardest-working and most resourceful people I’ve ever worked with and I, for one, was extremely happy to have them when I needed them.
Those same young people, by the way, STRONGLY agree with your assessment of the country and are doing everything they can to prevent a collapse. A lot of them are small business owners or are in the US military (bleeding in our unnecessary wars, ugh!).
My best and brightest hope for this country is that they will be able to energize new sections of the voting electorate and do what is needed. My worst, darkest fear is that they will succeed in energizing those voters and the old white folks start a shooting civil war to stay on top. Time will tell and the longer those young people wait, the less chance of the civil war.
Pluto,
(1) Thank you very much for catching that mistake about the date. Fixed.
(2) “For example, you are (correctly) very concerned with the high level of ennui in this country and the general lack of willingness to do something about it. Have you ever worked with the adult children of Hispanic immigrants? ”
That conflates two very different things. People can be hard working but politically apathetic. That’s the essential characterization of peasants throughout history.
(3) “Those young people are almost uniformly among the hardest-working and most resourceful people I’ve ever worked with …”
That is a category error, and a common one – conflating people’s behavior as individuals with their aggregate political and social effects. In economics, people extrapolate from microeconomics (eg, more savings is good) to macroeconomics (increased savings depresses the economy). Despite Americans belief that money is everything, hard-working is not the only element of good citizenship. Acting for the good of the community, not just the family or clan. Being active as citizens to run the community and nation. Etc.
No matter how hard-working, assimilation requires that people from other cultures adopt large elements of US culture. The mechanisms that do that have limits, and can be over-whelmed. The people of Latin America are hard working. If we bring too many in too quickly, America will become more like Latin America.
Regarding FM’s 2nd point:
The people I dealt with were NOT politically apathetic but they had a very serious concern about the potential for their political messages and intents being twisted by political noise machines on the Left and the Right to serve the needs of those organizations. They preferred to gather information and power as time went on and wait for the right moment to strike. It is possible that time has come but I am definitely not predicting it.
Regarding FM’s 3rd point:
Again, the people I dealt with would have profoundly agreed with you if you had put your points to them. But they had two huge issues:
1. They were also afraid of the potential backlash against them if they started organizing. You’ve already seen it with voter suppression efforts and Trump’s suggestion that he can make them non-citizens with the stroke of his executive pen and have them deported. While you and I know that it is unlikely that Trump can do such a thing, their parents stories of the old country and their experiences make them less certain. There is a very small chance that they are right this year.
You’ve had the enormous advantage of living in this country as part of the educated, connected political elite for your entire life. The stories I’ve heard from the other side make you very aware that life in this country looks quite different if your skin color is not quite the right shade, or you have a funny accent, or you live in fear of harassment for speaking your mind. People have already died for that sort of thing this year.
2. Lack of money and time. When you’re working 18 hours a day 6 days a week to keep your business afloat, you rarely volunteer an additional 20 hours a weekend for political campaigns. Particularly because you know that the candidate is likely to ask you to contribute money you need for other things every time (like inventory) you step into his political office to do something for him.
You will be right if they do not act in 10 years but I am pretty sure that will not happen. I’m not sure what happens after that though.
Pluto,
“The people I dealt with were NOT politically apathetic but …They preferred to gather information and power as time went on and wait for the right moment to strike”
(1) This is missing the point in two ways,
(a) This isn’t 1970. We don’t need to base forecasts on “talking to the people I know.” That methodology broke Literary Digest. They predicted Truman would lose because they surveyed people in their networks. This is 2018, and we have areas with large numbers of 3rd -plus generation migrants from Latin America. Europe has millions of 3rd-plus gen migrants from North Africa and other areas (eg, Pakistan in Britain).
It’s not a pretty picture. Look at the southwest border regions of the US. The rural areas, most affected, increasingly have similar social and political structures as in Mexico. Chiefly, client-patron politics. See the giant ring cities around Paris. At some point, a society’s assimilation mechanisms become overwhelmed. This is observational fact, not based on talking to my neighbors.
(b) Being politically apathetic does not mean having no options. It does not mean failing to express them. It does not preclude occassional riots. Complaining, rioting, and failure to do conventional political work are defining characteristics of subjects. As is “Waiting For The Great Day When We Arise And Smite Our Oppressors.
(2) “Lack of money and time. When you’re working 18 hours a day 6 days a week to keep your business afloat, you rarely volunteer an additional 20 hours a weekend for political campaigns.”
I love rebuttal by wild exaggeration. Political participation does not necessarily mean making it a part-time job. There is a wide spectrum between voting and doing a few hours per week during the elections every few years.
By the way, the people who founded this nation worked really hard. Brutal hard manual work, year around, without heating and airco, with poor diets and no medical care. Yet they found the time to risk everything they had to create America — and build its political systems over the next century or so. The farmers who attended the Lincoln Douglas debates – six hours long – were politically active, yet lives harder than almost anyone has in America today.
(3) “You will be right if they do not act in 10 years but I am pretty sure that will not happen.”
I admire your certainty that when they act, it won’t create a political system like those in Latin America. But I consider it unfounded, if not delusional — assuming high rates of immigration from the South continues.
My guess is that such confidence in America’s ability to assimilate – even though we’ve dismantled most of the machinery from the early 20th century’s migration wave — comes from the delusional belief in American Exceptionalism (many of America’s pernicious behaviors come from this, imo). God sprinkled magic pixie dust, so good things happening are our right. We don’t have to work for them. Hard choices and tough actions are for lesser nations. Our Constitution is a “machine that works by itself” – no need to risk “lives, fortunes, and sacred honor” to defend it.
People have been destroyed by smaller errors.
I’m not an expert but the low Fed reserve means that when a recession comes there aren’t tools to fight it, yes?
Sven,
Yes, As I said in this post:
That leaves only unconventional tools. Quantitative easing – which helped a little after the Great Recession. There are more extreme tools. For example, in Europe they pushed nominal rates below zero. I predicted they would try that. It was fun to see commenters squeal that it couldn’t happen!
Imagine if the Fed had started raising interest rates during the Obama years instead of waiting for Trump. That would have rocked the investment community.
Gunnar,
Remember, the Fed does not “set” interest rates. They set the base rate – the riskless overnight rate. By using their balance sheet, they can buy and sell — pushing the market rate for short maturities up or down, which in turn influences longer riskless rates (eg, Treasuries) and (to a lesser degree) rates on lower rated securities.
The Fed kept rates low because that’s what the market wanted. As shown in the treasury yield curve. Changing that, and maintaining that rate against the market for a long time, would have been difficult. They waited until rates were rising, then — working in the direction the market was moving – they pushed up, slowly.
Despite the often hysterical criticism by conservatives — hyperinflation coming! the US dollar will crash, becoming wastepaper — it is clear that the Fed’s management of the crash and recovery was masterful. It puts Bernanke, and to a lesser extent Yellen, among the most successful central bankers – ever.
In general, I strongly agree with FM that the US Federal Reserve has done the best in the world at handling the crash and the recovery. I’d stop just short of “masterful” for the crash and the recovery was a bit less well-handled overall.
I have 2 complaints about the Federal Reserve’s handling of the last 10 years and I really don’t see a way they could have avoided the issues in the first 5 years.
1. Reinforcing the bank holdings is a very good choice but I strongly believe they needed to stop earlier. The primary problem here is that the wealthy figured out how to leverage that money a LOT sooner than the rest of the population and were vastly more successful doing so than the rest of us. In large part this is due to the fact that banks REALLY like wealthy in general and have a long history of doing business with them.
2. Janet Yellen needed to start raising interest rates by the 5-6th year of the Obama administration to prevent the stock market from reaching its current ridiculous extreme.
But essentially these are both nit-picks compared to the dire consequences of handling the recover incorrectly.
My only other comment is to wonder how long that strategy for handling recessions will last. All strategies eventually get stale and economic strategies tend to have a shorter shelf life than other areas.
Pluto,
(1) Every pro sports team has people in the stands yelling advice to the players, and criticizing them afterwards. Things look so simple from the stands, especially in hindsight. I think you know how the pros regard their comments.
(2) “Janet Yellen needed to start raising interest rates by the 5-6th year of the Obama administration to prevent the stock market from reaching its current ridiculous extreme.”
The Fed does not change interest rates in response to stock prices. That would be nuts. Despite journalists obsession with stock prices – easy headline generators – they have a microscopic effect on the economy, and their movements are byproducts of deep economic changes.
FM, you’re right on both points. My only consideration is looking forward to the future and seeing if the Fed will do slightly better next time and how it will do better (regardless of whether it followed my advice or not).