It's Back: Welcome to the Downturn for Real
Well time to pick up the discussion on the state of the economy; and if you've been playing along with us here last Friday's GDP numbers are no particular surprise. You may recall our mentioning (graphically) the slowmotion slowdown devolving into a tipping point turnover ?? We won't review those posts but will dive right into these and try and sketch things out for you. But first a little light relief - instead of Apocalypse Now we bring you Collapse Now with Col. Ben taking the role of Col. Duval. The dual problem with that sort of black humor is we've been warning about the situation for so long our innate reaction is "so what" but judging from the casual strangers we find weeping in airports 98% of the population is beyond surprised.
Which leads us right to the charts and numbers. First off the bad news - in our judgment this recession which we're really starting to enter will be longer and deeper than anticipated by almost everybody. Worse, some joking aside, most folks - especially business decision-makers - are getting caught more flat-footed than they should be. Think of it as Darwinian filtration in action except it'll take a lot of innocents with the idioten.
Q3 GDP Results
Starting with the basics this charts shows YoY changes in GDP, Consumption (PCE) and Employment back to 1980 and there's a lot of nuanced information buried in it. Have a drink and let's talk. Normally we don't run back this far as it's hard to see that Consumption went in the tank at this scale. But that immediately sets up our next point about the length and duration of the on-coming recession. Notice that the slowmotion slowdown tipped over in Q407 for Consumption but GDP had been holding up and has now followed over the cliff. Further notice that, as long advertised, Employment took a long time to build, peaked quick and low compared to prior recoveries and has been deteriorating for quite a while. And we're still early days yet - in our judgment this will be drawn out and deeper than anticipated.
Business Decelerations
If you look at harbingers of future growth, i.e. business spending it's just beginning to tip over; which is what you'd normally expect give the lags between different parts of the business cycle. The 800lb. canary here is Industrial Production which has tipped over rather quickly and abruptly - based on the most recent data. Now aggregate investment has been dropping for a while because of problems with Real Estate and Housing; what this tells us is that capital spending (& hiring) are about to slow; perhaps sharply in the months ahead.
Future Demand
You may recall our mentioning occasionally that the best indicator of future demand was the sum of the changes in real wages and employment. On this chart you can see how closely PCE is correlated with W+E and how consumption drives the economy. Now take a look at how the W+E curve is doing - looks like an Acapulco cliff diver to me. Now put the pieces together - if future consumer demand is about to take one in the neck AND employment has yet to really turn over what does that tell us about the future path of the economy ?
The answer is left as a take-home exercise of the student (HINT: can you spell longer and deeper ?). As usual if you care to continue reading you'll find an eclectic set of excerpts on the state of the economy that highlight some of these points. And perhaps might serve to crib your answers from if we haven't been clear enough.
The good news, btw and it is indeed good, is that while this will be worse than anything we've seen since 1980 we don't expect it to significantly worse than that or 1975. In other words we've been here before. And this most certainly is not the beginnings of another Great Depression. Someday we'll post those charts for compare and contrast but trust us - when aggregate GDP drops by over 25% in three years and when it takes almost a decade for aggregate growth to get back to breakeven a few measley % points of downturn are nothing.
Economy
Off the Charts - More Evidence That the Recession Has Already Arrived The Federal Reserve Bank of Chicago maintains an index, called the National Activity Index, which in the past has nearly always signaled the beginning of a recession when it fell to a certain level, shown as negative 0.7 in the accompanying chart. It hit that level last December, and has stayed there since. This week, the Fed released the reading for September, which was the worst for a single month since 1982 and a sign that the recession is deepening. The actual reading for September was a negative 2.6, although the three-month average was negative 1.8. The lowest three-month reading in 2001 was negative 1.4, indicating that this downturn is worse than that one. “It’s the first aggregate index to clearly break through the mild recession of 2001, and it looks like the reading will break through the recession before that when the October data comes in,” said Robert Barbera, the chief economist of ITG. And yet it was not until last month that many economists began to think a recession was likely, and many believe it began in the third quarter of this year, rather than many months earlier. The index measures the change in the economy each month as shown by 85 indicators of economic activity. A value of zero indicates the economy is growing in line with long-term trends, while values above that indicate above-trend growth. The Fed says that a level of negative 0.7 indicates a recession may well have begun. For those who care what the numbers actually signify, a number of plus or minus one indicates the month’s results were one standard deviation above normal economic growth. The Fed said the biggest cause of the sharp falloff in September was a decline in income and production, particularly industrial production. The Fed has index figures going back to 1967, and in one way the current downturn is the longest ever. The three-month average has been negative — meaning that the economy is not growing as fast as normal — for 29 consecutive months beginning in May 2006. The longest previous streak was 25 months, ending in February 1983.
Chicago Fed National Activity Index
Spending Stalls and Businesses Slash U.S. Jobs As the financial crisis crimps demand for American goods and services, the workers who produce them are losing their jobs by the tens of thousands. Layoffs have arrived in force, like a wrenching second act in the unfolding crisis. In just the last two weeks, the list of companies announcing their intention to cut workers has read like a Who’s Who of corporate America: Merck, Yahoo, General Electric, Xerox, Pratt & Whitney, Goldman Sachs, Whirlpool, Bank of America, Alcoa, Coca-Cola, the Detroit automakers and nearly all the airlines. When October’s job losses are announced on Nov. 7, three days after the presidential election, many economists expect the number to exceed 200,000. The current unemployment rate of 6.1 percent is likely to rise, perhaps significantly. “My view is that it will be near 8 or 8.5 percent by the end of next year,” said Nigel Gault, chief domestic economist at Global Insight, offering a forecast others share. That would be the highest unemployment rate since the deep recession of the early 1980s. The broadening layoffs are most pronounced on Wall Street, in the auto industry, in construction, in the airlines and in retailing. The steel mills, big suppliers to many sectors of the economy, are shutting 17 of the nation’s 29 blast furnaces — a startling indicator of how quickly output is declining as corporate America struggles to adjust to the spreading crisis. In September alone, 2,269 employers each laid off 50 people or more, the Bureau of Labor Statistics reported, up sharply from the spring and summer months, and the highest number since September 2001, when the aftermath of the 9/11 attacks coincided with a recession to spook employers. A spike in 2005 was related to Hurricane Katrina. The financial services industry has been cutting jobs since last summer, when the credit crisis took hold. By some estimates, 300,000 jobs will disappear from banks, mutual fund groups, hedge funds and other financial services companies before the crisis subsides — 35,000 of them in New York. Goldman Sachs alone, among the best performers on Wall Street, has announced plans to cut 10 percent of its work force, which stood at 32,594 at the end of last month. The current unemployment rate, 6.1 percent — up more than a percentage point since April — is still relatively mild by post-World War II standards. The highest level since the Great Depression, 10.8 percent, came in November and December of 1982 as the economy was shaking off a severe recession. The unemployment rate hit 9 percent during the mid-1970s recession, and 7.8 percent in the 1990-1991 downturn. The next peak, 6.3 percent, occurred in June 2003, during a long jobless recovery in the aftermath of the 2001 recession.
Job Losses Buffet U.S. Early, Compounding the Downturn A rash of new job data show the labor market is now the worst it's been since the two prior recessions in 2001 and the early 1990s. One of the starkest indicators is that the number of people who have been unemployed for 27 weeks or more reached two million in September. That's 21% of the total unemployed, and approaching the prior peaks of about 23% in 2003 and 1992. The prospects of these job seekers grow dimmer as layoffs spread beyond the financial, home-building and auto industries. Also in September, companies saw 2,269 mass layoffs -- in which at least 50 people are let go at once -- more than at any time since September 2001. And while the unemployment rate is at a five-year high at 6.1%, a broader measure of weakness that includes people who have stopped looking for work or whose hours have been cut to part-time is 11% -- the highest in 15 years. What worries many economists is that labor markets usually reach their weakest point after a recession has ended. During the so-called "jobless recovery" following the 2001 recession, jobs continued to be shed after it was officially declared over. But the current weakness comes as the country heads into a recession that is now forecast to be deeper and longer than previously thought. "No one thinks we are anywhere near the bottom of this, and we're already rivaling these other recessions," says Heidi Shierholz, an economist at the Economic Policy Institute, a left-leaning think tank in Washington. As chances of getting a new job right away grow more faint, so too does the ability to pay mortgages and credit-card bills. That could lead to more foreclosures, chill consumer spending and delay recovery.
Economists Search for End of Woes Economists struggling to gauge the depth of the U.S. downturn are turning to more forward-looking clues, such as home-vacancy rates and foreign stock markets. The standard measures of gross domestic product and monthly payroll figures give snapshots of what has happened, but say less about what will happen next. The current downturn is shaping up to be worse than the recessions of 1990-91 and 2001 and the prolonged downturn that ended in 1982. Banks are cutting back on lending, consumers are spending less, companies are shedding jobs amid sinking profits, and the housing bust that triggered the slide persists. Here are five areas economists are watching, and the indicators they are tracking. New Indicator Graphic
Get Ready For 'Stag-Deflation' Back in January, I argued that four major forces would lead to a risk of deflation-- or "stag-deflation," where a recession would be associated with deflationary forces--rather than the inflation that mainstream analysts have worried about. They were: (1) a slack in goods markets, (2) a re-coupling of the rest of the world with the U.S. recession, (3) a slack in labor markets, and (4) a sharp fall in commodity prices following such U.S. and global contraction, which would reduce inflationary forces and lead to deflationary forces in the global economy. How has such argument fared over time? And will the U.S. and global economies soon face sharp deflationary pressures? The answer: Deflation and stag-deflation will, in six months, become the main concern of policy authorities. Why? First, the U.S. has entered a severe recession that is already leading to deflationary forces in sectors where supply vastly exceeds demand (housing, consumer durables, motor vehicles, etc.). Aggregate demand is falling sharply below aggregate supply. The unemployment rate is up sharply, while employment has been falling for 10 months in a row. And commodity prices are sharply down--about 30% from their July peak--in the last three months, and are likely to fall much more in the next few months as the advanced economies' recession goes global. So both in the U.S. and in other advanced economies we are clearly headed toward a collapse of headline and core inflation. Is there any doubt about this ongoing inflation capitulation and the beginning of sharp deflationary forces?
When Consumers Capitulate The long-feared capitulation of American consumers has arrived. According to Thursday’s G.D.P. report, real consumer spending fell at an annual rate of 3.1 percent in the third quarter; real spending on durable goods (stuff like cars and TVs) fell at an annual rate of 14 percent. To appreciate the significance of these numbers, you need to know that American consumers almost never cut spending. Consumer demand kept rising right through the 2001 recession; the last time it fell even for a single quarter was in 1991, and there hasn’t been a decline this steep since 1980, when the economy was suffering from a severe recession combined with double-digit inflation. Also, these numbers are from the third quarter — the months of July, August, and September. So these data are basically telling us what happened before confidence collapsed after the fall of Lehman Brothers in mid-September, not to mention before the Dow plunged below 10,000. Nor do the data show the full effects of the sharp cutback in the availability of consumer credit, which is still under way. So this looks like the beginning of a very big change in consumer behavior. And it couldn’t have come at a worse time. For the fact is that we are in a liquidity trap right now: Fed policy has lost most of its traction. It’s true that Ben Bernanke hasn’t yet reduced interest rates all the way to zero, as the Japanese did in the 1990s. But it’s hard to believe that cutting the federal funds rate from 1 percent to nothing would have much positive effect on the economy. In particular, the financial crisis has made Fed policy largely irrelevant for much of the private sector: The Fed has been steadily cutting away, yet mortgage rates and the interest rates many businesses pay are higher than they were early this year. The capitulation of the American consumer, then, is coming at a particularly bad time. But it’s no use whining. What we need is a policy response. The ongoing efforts to bail out the financial system, even if they work, won’t do more than slightly mitigate the problem. Maybe some consumers will be able to keep their credit cards, but as we’ve seen, Americans were overextended even before banks started cutting them off. No, what the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend.