Is The Recession Over?

From The Daily Capitalist

This morning the National Bureau of Economic Research (NBER) came out with the conclusion that it is too early to tell if the recession is over.

The NBER defines a recession as:

A recession is a period between a peak and a trough, and an expansion is a period between a trough and a peak. During a recession, a significant decline in economic activity spreads across the economy and can last from a few months [minimum of two months] to more than a year. Similarly, during an expansion, economic activity rises substantially, spreads across the economy, and usually lasts for several years.

 

In both recessions and expansions, brief reversals in economic activity may occur—a recession may include a short period of expansion followed by further decline; an expansion may include a short period of contraction followed by further growth. The Committee applies its judgment based on the above definitions of recessions and expansions and has no fixed rule to determine whether a contraction is only a short interruption of an expansion, or an expansion is only a short interruption of a contraction.

The NBER:

examines and compares the behavior of various measures of broad activity: real GDP measured on the product and income sides, economy-wide employment, and real income. The Committee also may consider indicators that do not cover the entire economy, such as real sales and the Federal Reserve’s index of industrial production (IP).

One can argue about the proper data to measure but the point of their conclusion is not to forecast but to identify broad trends in the economy. So, to say that they should look at money supply, credit, or U-6 rather than U-3 is not significant in the sense that we all understand that these markers are guesses and approximations, dicta, if you will, rather than "truths."

Let's look at this recession in comparison to past cycles (courtesy of the Wall Street Journal).

Our recession is the red line and you will see it is at the bottom of all the others which says something about the breadth of it. The NBER pegs December, 2007 as the commencement date of the current recession. While it shows a bottoming out of GDP after 6 months, industrial output and employment has contracted far more than in the other measured cycles.

While there are many data to look at, and I do comment on this regularly, I think this is a pretty good snapshot of the economy.

In light of the data how does one assess it?

I look at things in light of the following economic assumptions:

  1. Fiscal stimulus never works as a generator of sustainable economic activity.
  2. Consumers will not return to their former high spending patterns.
  3. Credit and money supply continues to decline.
  4. Past history can be wrong when applied to today.
  5. We still have the most dynamic economy in the world.

1. Fiscal stimulus never works as a generator of sustainable economic activity.

If some kind Keynesian out there would care to inform me when they think fiscal stimulus ever worked to revive an economy, I would like to know. Don't try to explain Keynes and the liquidity trap, just show me when you think it worked. Until that happens, I shall stand on my premise.

When the government takes money from people through taxation it has a temporary positive effect on those businesses to whom the money is transferred. When the money runs out, the effect runs out because this transfer of money creates no organic economic growth. If the government gives me money to repair a road, I hire workers, repair the road, and then fire them because there's no more money. Since the money has to come from somewhere (unless the government just prints it), the person from whom it is taken must put his/her economic plans on hold, thus the economy loses somewhere else.

We are "repairing a lot of roads" right now through the American Recovery and Reinvestment Act, and that is having a temporary impact on the economy which to some extent is reflected in some of the positive GDP numbers. When that wears off, the economy will regress unless there has been real organic growth.

2. Consumers will not return to their former high spending patterns.

As I've explained in "Economic Megatrends That Will Drive Our Future," the consumption machine is broken. Our residences are no longer an ATM machine. And, Boomers are facing retirement and they haven't saved enough. This means that consumers will increase savings and reduce spending. The fact that we have 16.9% unemployment right now, and declining wages, says that consumer spending won't turn around soon. While spending has recently been growing, a substantial portion of that is from the mortgage default boom. David Rosenberg of Gluskin Sheff has estimated the effect to be $190 billion. This won't last long. Pair that with the fact the Robert Shiller, co-creator of the Case-Shiller housing index, says residential values still have another 10% downswing potential, and you may conclude that PCE is systemically weak.

3. Credit and money supply continues to decline.

Credit continues to decline, as does money supply. The M1 Mult index has collapsed in the past 9 months. M2 and MZM continue to decline. Worse is credit. Consumer credit continues to crash. Business lending is just as bad and it continues to decline. The Fed has tried to flood the banks with cash (Money Base) but bank reserves have stayed historically high. Businesses aren't borrowing and banks aren't lending.

 

It is difficult to have a recovery without credit improving, substantially. Right now, large corporations are flush with cash from streamlining their businesses in light of the recession (layoffs, production efficiencies, reduction of debt) and they are internally financing capital expenditures. They also have access to the credit markets. It is different for smaller businesses (50% of the business world) struggling to stay alive.

The Q4 GDP expansion (now revised down to 5.6%) was impressive but I see this as a one-time phenomenon as a result of cyclical business factors. When consumer spending collapses, retailers and wholesalers are stuck with unsold inventory. The reduction of inventory by wholesalers and retailers ended by mid-2009.

But, it is not as if the entire economy is on hold. People still buy things, just not at level they did before. At some point retailers have to restock and they did, but cautiously. This is what drove the Q4 numbers (about two-thirds of the GDP number). As inventory and sales achieve equilibrium, as it seems to have done, the impetus from restocking will fade in H2.

4. Past history can't be applied to today

It is not especially useful to predict future events based on prior cycles. Each cycle is different as to asset class, as to the government's response to the recession, and as to the worldwide impact. Economists always predict tomorrow based on what happened yesterday. While comparison of past cycles is useful to put this cycle into perspective, it doesn't help us analyze where this one is going.

The key is to follow what the government's response is to this cycle.

The government seem to be doing everything they can to prevent the economy from recovering. Bailing out banks, buying up bad MBS, Cash for Clunkers, extend and pretend, suspension of mark-to-market, subsidizing housing with FHA, Freddie and Fannie subsidies, the Recovery Act spending and resulting debt, deficits, higher taxation, the specter of tariff and trade wars, all delay a recovery. Add to this corporate debt refinancing, CRE debt refinancing, the high level of homeowners behind on payments, public and private pension deficits, state and municipal bankruptcies, and the need for 12 million jobs.  All this leads to results that are quite different from past cycles, as the above charts show.

5. We still have the most dynamic economy in the world.

This is the part I have the most trouble with. I believe that as the most entrepreneurial economy in the world, we still have the ability to generate growth that will drive us out of our recession. By that I mean there is sufficient economic incentive to drive business and growth. At some point, perhaps when debt is equal to GDP (as Reinhart and Rogoff say) or when the government's share of the economy exceeds 40%, then growth stagnates. Since we are close to both of these scenarios now, it is hard to analyze the impact on private enterprise.

Here are some things I think about in trying to evaluate this.

  1. Will all the debt financing needs of federal and state governments "crowd out" (i.e., make money more expensive) business borrowing?
  2. Will increased government spending, including the new Obamacare programs, and future programs (such as cap and tax) put a significant drag on the economy through higher taxation?
  3. Will increased regulation hamper the creation of new capital?
  4. Will inflation distort future economic growth leading to a new boom-bust cycle?
  5. Is sufficient real capital being generated to support new growth?

I would have to answer yes to items 1 through 4.

What I don't know is item 5. This is hard to measure. Real savings are earnings saved and not consumed. If such "earnings" are generated in an inflationary environment, it isn't real savings, it is just an accumulation of inflated currency created by the Fed. If current growth in manufacturing is being supported by real savings, then we could have the basis for sustainable, organic new growth. In light of all of the government's distortions of the economy, I would have to doubt that.

I think we will see a softening of economic activity in H2.