Submitted by Edward Harrison of Credit Writedowns.
Below is a post I penned earlier this week about double dip recessions. The Volcker Whip-inflation-now induced double dip in 1980-1982 is the best precedent for today. What could tip us into a secondary relapse? A lot of things: commodity prices, oil, higher interest rates, commercial real estate, or swine flu.
The basic problem is that much of the underlying disequilibria remain in the system, both in the US and globally. That makes us vulnerable to a second dip – one that would likely be worse than the first.
So, here are my thoughts on the subject. Enjoy. (ps. see my thoughts on the ISM data for more reason why I think this recession is close to over.)
On Friday, in reporting on second quarter GDP statistics, I wrote with some skepticism about the underlying consumer demand which would underpin a sustainable recovery. I do feel that the stage is set for recovery; Alan Greenspan thinks the economy has already recovered. However, I am worried that a double dip could result as much of the likely output gains will come from changes in inventory destocking and not from consumer demand.
Then again, why do I think there will be any recovery at all? An astute reader asked me “how could that be possible when, as you document well, this is a technical recovery, and there’s no sign of consumer recovery? It seems more likely that this will continue to last for the foreseeable future.” That is a very good question which I hope to answer here with some words about what recession is, about the ‘new normal’, and about GDP being a first derivative statistic. Then I will finish up with a look back at the 1980-82 double dip to show you how the 1980-82 double dip looked statistically and why it could presage what we are about to experience.
What is recession?
In a nutshell, a recession is a period of diminishing economic activity. That’s it, plain and simple. Now, the NBER, which decides the official dates of recession in the U.S., looks at five areas to decide when a recession begins and ends: output (real GDP), production, sales (wholesale and retail), employment and real income. When those areas show a general decline, the economy is in recession. When those statistics start increasing, the recession has ended. In a post last month “Technical recovery won’t feel like a recovery to most,” I said:
The NBER is looking to date the period when economic activity is diminishing, not when it is diminished. That means that economic activity MUST be LOWER when an economy ends recession and starts a recovery than when it entered the recession. Recovery starts from a position of diminished economic activity. I attempted to get this point across in detail in my post “Economic recovery and the perverse math of GDP reporting.”
Read those two referenced posts. They make fairly clear that we are talking about falling output, falling sales, falling employment during a recession. When the fall ends, the recession is over.
The New Normal
A lot of pundits have been looking to that period when the recession is, indeed, over. They are talking about the New Normal which is likely to result after this downturn. Some like Bill Gross believe recovery growth rates will be much lower going forward. We’re talking 1-2% here, not 3%+ like we are used to. Others are talking about a new normal of savings and lower consumption. My take on the new normal is that it represents a new baseline from which to start.
The US economy was pumped up artificially due to excessive leverage and artificial consumption. The GDP statistics of the last decade reflect this. The level of output in late 2007 is not likely to achieved again for a very long time. After a 2-year period of falling output, the worst plunge in at least half a century, we will reach a new lower baseline level, the new normal. We will then start again from that new diminished economic plateau.
GDP is reported as a first derivative number
When will we reach that lower plateau? In my view, that period is almost upon us. Manufacturing statistics show a level just below 50, the demarcation between expansion and recession. Real GDP is likely to rise in Q3. Retail sales are now rising. Personal income is flat to rising. And jobless claims have come down substantially. All of this says that we are fast approaching a flatline where the economy stops falling.
Moreover, pro-cyclical effects like the inventory cycle are likely to give an extra shot in the arm to the economy, reinforcing this dynamic. Add in fiscal stimulus which is due to come online now and a recovery is likely by late this year or early next year.
Remember, GDP as reported is a measure in the change in output. So, once we reach a level of output that is sustainable only over the medium-term (say 6-18 months), recovery is likely to take hold. For example, even if the underlying consumption growth is slightly negative, government spending and inventory adjustments can and will offset this long enough for employment gains to begin, boosting income and spending enough for recovery to take hold. Recovery can come even if consumer demand remains weak.
But what about a double dip?
So what happens if demand remains weak over the longer term as consumers repair their balance sheets? Isn’t the new normal in part about increased savings and lower consumption? In that case, the excess capacity in the system remains – and right now it is at all time lows below 70%. And when there is excess capacity, people lose their jobs, unemployment spikes, income falls and recession takes hold again. Given that there is record excess capacity in the U.S. and elsewhere (especially China), unless demand resurfaces, a double dip seems a likely outcome.
How did the last double dip look?
Let’s look at the double dip from 1980-1982 for a historical reference using the five economic areas the NBER tracks. In the monthly charts, the dark regions represent expansion. The white regions represent recession.
GDP
Below is the table for Real GDP statistics.
This gives you a flavor for how uneven both the recession and the recovery were. Supposedly, recession began in Feb 1980 and ended that summer, only to reappear again in the Summer of 1981 and last until November 1982.
Personal Income
The real story starts with personal income and inflation. This chart shows you how high inflation crushed income growth so that incomes started shrinking again during the expansion of 1981. In nominal terms, personal income was increasing, but not in inflation-adjusted terms.
Retail Sales
As a result, this led directly to a renewed lapse in consumer demand as evidenced by retail sales falling from March 1981.
Output
Then, looking at the ISM numbers, you can see production started to ramp up in late 1980 due to the economic improvement, but the numbers started down again in 1981 when demand buckled and went much lower in the second dip.
Employment and Capacity Utilization
My take on this dynamic is this: capacity was very slack. As the numbers were unable to turn around and Volcker also cranked interest rates higher and higher, layoffs began in earnest again. Here are the charts on Capacity Utilization and Non-Farm Payrolls.
Inventories
I would also add that inventories acted with a two-quarter lag, detracting from output while the economy was expanding in late 1980, and then erroneously adding to output in late 1981 even though the economy had already slipped into recession. Businesses were still purging inventories well into 1983, even though the economy had turned up in November 1983.
What to look for in 2010 for signs of a double dip
In my view this episode says a lot about what to look for in 2010 regarding sustainable growth. First and foremost, we should be looking to disposable personal income i.e after tax money consumers have to spend. Given the high debt levels in America and the need to re-build savings in a non asset-based economy, people aren’t going to spend unless they make more. Right now Personal income is pretty much flat-lining. This is a weak link for sure.
The next link to watch is retail sales. I said that the negative number for spending on basic non-durable goods in the second quarter was a bad sign. This can be overcome by inventory adjustments and government stimulus for 6 months, maybe a year. But, eventually, demand must turn up or recovery will fade.
So, in my view, the real new normal baseline output level in the U.S. economy is probably lower than where we are today. However, government spending will fill the gap temporarily. My hope is that we can reach that new lower level before any stimulus loses its punch. However, if this stimulus runs out before we get to that baseline new normal, the economy will head down again. But, because of all the built up macro disequilibria in the U.S. economy, you can bet we would head down even lower next time than this time – lower in GDP, lower in inflation, and lower in government bond yields and shares.
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This time around we're not starting with 20% interest rates – we're at zero and the only path is up. There are other impediments to demand: the certainty of higher taxes, a much higher level of indebtedness and a global depression. We had none of these in '81. And this time we're not likely to benefit much more from consumer price disinflation. That was a multi-year process in the 80's with tangible effects on gas and food prices. Currently the government is doing everything it can to avoid this!
At this point personal income is not flatlining, it is still falling decisively. So though the eventual shape of the demand curve may be similar, we're still early in the game and much lower on the graph. It's going to feel more like an "L" than a "W".
Recently, while talking to myself in the mirror, I had a discussion as to why I should narrow historical statistical information to about 2000. As the debate went, The Bush Coup pretty much re-invented America from day one of that coup — to suit the needs of those that wanted to abuse power ASAP. Thus as The Bush Ownership Society and Iraq and all that shit hit the fan, there was a great amount of economic bias and distortion, which was not within the realm of a normal economic range. To use any data before that period and then NOT add in The Bush Reign, as if there was NOT distortion is udderly stupid (no cow photo embedded there) and beyond reason!!!!!! How can one compare that period to anything other than itself????
Essentially, America was flooded with a Biblical Tsunami (BT) of credit, so that everyone that was breathing would have an easy opportunity to chain themselves to the unregulated banking industry, which was also swept along in the flood, running amuck and afoul and ahh, aaahhh, did I use the word afensive.
Of course everyone now understands the majority of the sad and reckless story and further understands that Obama is currently shifting policy away from the failed Home Ownership Society, to a newly designed Automobile Ownership Society as an innovative approach to helping Americans dig out of the previous government ponzi scheme (gps) — and help them all drive away in brand new F'ing cars that will all have cheap and easy financing and help restore The American Dream and help us all wake up from that slimeball crap that Bush was selling!! Thank God for derivatives, underwriting and a smarter, better managed banking system that takes the sting out of reality!
This is all simply a matter of mise-en-scene, where fact and fiction are swirled around like so much brown stuff in a flushing potty — but after all, no one wants to look at details or understand, why Willy Brandt suggested that one really doesn't want to see how sausage is made….. or was that Pelosi or her twin sister Hilary?
I guess that about covers up my feeling on statistics, politics and collusion, corruption and the state of the Union.
FD: The author s sorry for any confusion and probably should go back to edit and and all that other stuff, but I gotta go.
I wish my posts could be as entertaining as Doc's. Some days, I barely have enough non-dismal thoughts to muster the energy to even post here. As for the Bush Coup, I predicted after the re-election in '04 that it would take at least twenty years to undo the damage that would be wrought from '05 to '09. I now think that was optimistic. When you embolden and empower a narrow elite with a huge portion of the nation's (and the world's) wealth, you are not getting back that power or that wealth without a huge amount of violence. There are too many businessmen, too many bankers, who all *need* to have $10 million in liquid assets. They not only have the wealth now, but with that wealth they have bought the media and the politicians. This will not stop until something incredibly dramatic happens. I know not when, where or how that violence will occur, but it will not be fun for me or my descendants. I find it mostly irrelevant to keep talking about the recession's shape, whether it's a W or an L. We're headed off the cliff, and while that is certainly not all that matters, it's enough to keep everyone from getting all too worked up about what happens in the meantime.
I need a vacation. FWIW, it starts tomorrow.
before we discuss inflation, let us first address deflation. everyone is worried about the onset of inflation? if that was the case, then why are you waiting for housing prices to fall more? cash for clunkers is an inherent attempt to create a mindset of urgency when none exists. no recovery exists. the government is the only activity in the room, acting until it has marched time for long enough that the recovery occurs, and then it can say…look what we made happen, when time is all that happened.
live in the present, not the past, not the future. black swans break systems that are weak, and a nanny state is only holding innovation back.
the future is the knowledge worker supported by the service worker. shovels are not the answer. community organization…is a start, yet freedom must remain intact.
today it was reported that consumers are spending 95% of their income down from 99%. the US economy suffers when the american consumer improves their own balance sheet because an economy cannot function without its citizens spending 100% or more of what they earn. now that the citizens are improving their balance sheets, the corporate balance sheets suffer.
debt is a form of slavery, and we are marching toward freedom.
in the past, the commercials, said buy in a quiet voice, now the govt takes over and screams…consumer buy. here is money…go buy something..soon it will be forced upon us to buy in the form of higher taxes.
this tax is going to be hard to digest. it will start with the rich and work its way down as the citizens bring it upon themselves by first taxing the rich. it is the only way polity can get the votes to pass the trojan horse.
I truly mean no offense, but economists operating today do so in what seems to me to be a fantastic reality. As such, economists appear to fulfill the same bogus function as German composer and conductor, Richard Strauss, who chose to remain in The Third Reich in order to act as a guardian of (his) art.
Of course the idea that any art worthy of the name had a place inside a nation possessing such a grotesque sociopolitical system was nothing but delusional nonsense. No art could be preserved, or spawned, because the entire milieu of Nazi Germany was antithetical to art.
Likewise, I wonder how economists can meaningfully operate in the U.S. when official data and statistics are largely the province of a government captured by interests that are not interested in allowing anything to see the light of day that might run contrary to a whole set of massive and convenient fictions.
Which makes me wonder how your work squares with, for example, economist John Williams of Shadowstats?
Let me make sure I understood this correctly. Mr. Harrison is saying that the sinking—and perhaps stabilizing—U.S. economy and standard-of-living have reached or will reach a “plateau,” a lower base level from which economic growth might resume, perhaps at a slower, more reasonable pace than in the recent past when bubbles and borrowing took things to an unsustainable level. From this plateau, he suggests, the decline might eventually start up again (a double dip) and go to a lower plateau. Or it might not.
He also seems to say that all recessions lead to upturns, so I guess there is no chance that the recent decline could resume tomorrow or next month and keep right on going into a permanent abyss, which is good. He also doesn't mention the possibility that the current real or imaginary upturn could keep on climbing until we get money for all again and lots of nice things to buy, so I guess that isn't on the table unless you are a banker.
I studied the tables in his post. It appears there was a double dip recession back in 1980 to 1983. Not sure why he shows us these charts today or how he knows what he says he knows about the future, but I guess I don't understand economics. I look forward to seeing some more tables real soon that show what will happen in 2010.
Thanks,
Wally
Alan Greenspan says the economy has recovered. Alan Greenspan cannot tell a bubble from a hole in the ground, so at the very least his vision is suspect.
When you subtract increased government spending (more debt that will drag future growth down) in the second quarter, growth was -5%, not -1% as the "headline" figure states. In fact, the year over year % change in constant dollars is worse for the second quarter than the first quarter. See Market Ticker blog, July 31 for a detailed look behind the headline number.
I really do not see any relation between this recession and the early 1980s. At that time, total debt/GDP was less than 200%, and now approaches 400%. As was previously mentioned, interest rates were about to decline and taxes were about to be cut in the early 80s. Today the reverse is true. I'm not sure about foreclosures and bankruptcies at that time, but I believe that today is also much worse.
This happy talk may fool people who prefer to believe the government and the MSM instead of their own lying eyes. But the new normal is not even 1% growth until we start dealing with the reality of lack of business growth that is not tied to deficit spending.
It is much simpler than all this: As the economy picks up, the trade deficit will start to grow again. Since the blanket of credit won't be as opaque as last time, the impacts of the growing trade deficit, which were hidden the last time around thanks to an illusory level of wealth backed by excessive credit, will be much more apparent and much earlier on.
This will have a direct impact on commodity prices, investment, etc.
"Fool me once. Shame on you. Fool me twice… Can't get fooled again!"
BTW, remember that the true cause of the economic crisis is the trade deficit.
As an example; as long as the US and China trade excessively with one another, their economies will be in a balancing act. This is a law of nature, it can't be escape. The trade deficit will shrink over time as trade between the two countries becomes less and less excessive, until they balance out one another.
That has some serious implications for Americans' paychecks, and actual purchasing power.
@Doc Holiday: luvya! Yooz funny and infotaining.
I know it's impossible to consider everything in an article of this size, but to make predictions for coming quarters based on what happened in the early 80s without looking at the differences between then and now seems remiss to me.
I'm looking into technological unemployment right now, an old chestnut I know, but I think increasingly a problem unaddressed and hidden from view. Perhaps I am overly concerned with this, but it seems to me that tech is getting better at replacing humans in the work place. Stats like only 2% of global workforce working in factories by 2020 are pretty frightening. The banking sector needs less and less people too, there are fully automated MacDonald's coming an line, a waiterless restaurant in Germany etc. I don't see this trend slowing. The idea of new tech creating new jobs is all well and good, but only for a while. The tech keeps on improving you see, until you get lovely little slogans like "stop bothering me or I'll replace you with a small shell script" which are actually more than just funny. They're funny coz they're true. I know. I write them (shell scripts).
Tech unemployment, and the ecosystem, which isn't able to cope with a rapacious and burgeoning human species. For me, these two are increasingly large elephants in the room we ought to start seriously considering.
There's too much of economists looking only at economics, tech guys looking only at tech, and eco-warriors looking only at Gaia. Let's get together and have a pow-wow, OK? It's important.
Consumers have been burned and naturally now must work to pay off debt and increase savings. Consumers have seen their assets (home values, 401k values, etc.) take nose-dives. This occured when many had taken on too much debt. The debts will take some time to pay off. Many have also seen a decrease in wages. Consumers, however, have not seen a matching decrease in other prices, ie: food, service prices, etc. Gasoline has fallen, but the fall is not at the same rate as the falling disposable incomes of consumers. Taxes and the prices of many items and services are actually increasing.
In addition to experiencing lower wages, some higher prices, higher taxes, and an increased need to pay off debts, consumers have suffered a psychological change, a loss of trust and a change of mindset.
I wouldn’t hold my breath for the consumers to spur an economic recovery. Nothing has been done to really help the consumers. Some have remained approximately the same as they were, but many are now forever changed, financially and psychologically. It may take 5 or more years for some consumers to see the end to their dark financial tunnel, and even then, some may never put the same importance on consumption for the sake of consuming. Remember the psychological mindset of many who lived during the great depression? They were forever changed, and their spending habits were also forever changed.
I think any growth or stabilization seen is false as it is driven by government dollars.