Bill Gross, head of the enormous bond fund Pimco, recently stated that the chance of another recession is 50/50. These are good odds to call, since it means no matter what happens he can say, “see—told ya!”
In any case, the chance of another recession is 100% – the question is when, not if. After all the United States has had 11 recessions since World War II, accounting for roughly 15% of the 65-year period. Since World War I the total is 18 recessions, representing 20% of the time period (the share goes up sharply because of the Great Depression). This may seem like a surprisingly high share of the time—but it is because the incidences of recession have become less frequent over time, with the time span between the 1991 and 2001 recessions being the longest period of continuous growth ever seen in the United States.
Of course what Bill Gross and the other odds makers are saying is that there is a high probability that the nation is going to enter into another downturn this year, not at some random point in the future. But before we get spooked by the chance of a Double Dip, yank all our money out of the markets and start stashing it in gold bars buried in the backyard, I would suggest there are a couple more ‘D’s’ we need to look at—namely Drivers and Data.
Where Are the Drivers?
Economies don’t randomly fall into recessions. Rather they are pushed there by some negative shock – a shock that has three characteristics: large, rapid, and sustained. This is why natural disasters and the retirement of the baby boomers will not cause recessions. Disasters are large and rapid—but not sustained. As for the boomers—they are large and sustained, but the shift to retirement is not rapid. So for all the bears out there calling for another downturn I ask—what is the driver?
* Some might say oil prices. But the United States is more resilient to oil prices than ever before, in part because energy spending is a smaller share of consumption that it ever has been, and because Americans can ultimately hang up the pickup truck and start driving a Prius (admittedly it doesn’t have the same degree of machismo, but we all have to make sacrifices somewhere). Furthermore, with the market turbulence, prices are down $30 per barrel from the peak hit earlier in the year. Now that Libya is falling under rebel control this could bring prices down even more.
* How about the weak labor markets? Well—labor markets are a lagging, not a leading indicator. They sag after the economy does, not the other way around. They don’t cause recessions—they are caused by them.
* And the stock markets? It is true that financial turbulence doesn’t help the economy—but there has never been a stock market crash that caused a recession by itself. Rather, stock market crashes occur along with the driver of a recession—such as the mass of bank failures during the Great Depression, the large pull back in business spending at the end of the tech bubble, or the drop in consumer spending and credit crisis in 2008. There are other cases, such as in 1988 when the market dropped precipitously without a secondary driver – and no recession occurred.
* Then, there is Europe. With numerous European countries struggling with excessive public debt and slow growth economies, there are financial jitters aplenty. But the shock—a default—has yet to occur. It would seem logical to wait for that to happen before we call for a European credit-crisis-led-double-dip on this side of the pond. And in any case, it seems highly improbable that Europe would allow any major bank in the EU zone to fail. Europe is typically more liable to intervene in their economies at any time, and particularly while the lesson of Lehman Brothers is still fresh on the minds of regulators. In any case, it seems a small probability that any of the major European economies will be in trouble at any time in the next year or more. Only lowly Greece is truly on the brink.
* Housing? The double dip here was more hype than reality. Home prices fell a whopping 4% from the mini-peak in 2010 according to the Case Shiller numbers. And those declines have stabilized since the spring. Now all the major price indexes, including Case Shiller, Core Logic, and the data from Fannie and Freddie all show home prices starting to rise slowly. And while sales of homes are softening a bit, the number of seriously delinquent mortgages is falling. The worst is clearly behind us.
The most likely source of a new recession would have come from the Federal government. Had the debt ceiling not been raised, while the nation would not have defaulted on its debt, it would have been forced into a severe austerity spending plan. This rapid cut in spending would surely have caused a downturn by the end of the year. But the ceiling was raised and the crisis averted. Nothing to see here folks, move along.
And the Data Says…
Then, there is the Data. The biggest source of weakness in the first half of 2011 was consumer spending—particularly in the second quarter. But this is largely due to the brief spurt in inflation that was driven by food and energy costs, combined with a lack of cars on dealer lots. In the former case, the pressure is now off for the aforementioned reasons. As for the latter—we know it was a supply issue because the price of cars has risen sharply in recent months—the exact opposite reaction we would expect if the decline in auto sales had been demand driven. The supply chain is starting to move again, pushing U.S. industrial production up along with sales in July. Oh, and retail sales grew as well. You may not have seen these numbers under the litany of negative press—but they are out there.
Moreover, the data surrounding leading indicators of consumer demand—namely delinquency rates on consumer loans and growth in consumer credit—point to better times ahead, not worse. The labor market also picked up a bit of speed in July, and income growth remains decent. Another leading indicator of a downturn is falling home starts. They aren’t falling—they have just been sitting on the bottom for a number of years. And non-residential construction is picking up some speed. There is also good news on interest rates. They have come down so much in recent years that the financial obligations ratio—an estimate of the share of income households use to support their debt servicing and rent—is down to levels not seen since 1993. Americans are not credit constrained.
As for business spending—it never really came back much after the long downturn. Indeed, net business investment remains low from a long-run perspective. It seems unlikely that it could drop far enough to cause a big hit to the economy. And after all—corporate America is sitting on tons of cash. It would seem that they would be able to weather most storms at the moment. And yet again—good data—according to bank data from the Federal Reserve) the outstanding quantity C&I (Commercial and Industrial loans grew sharply in the first half of August. Firms are borrowing for some reason.
So add it up and I have my own probability. The chance of a Double Dip recession is pretty close to 0% for the second half of 2011 short of some major development not highlighted above. Now—that is number worth throwing out there.
This isn’t to say things are fine. The recovery in the United States is still too slow to get us back to the growth trend we were on pre-recession. The result is a labor market that is producing far too few jobs to bring the unemployment rate down in a meaningful way. The Federal Deficit is frightening, and there could be preliminary signs of inflation creeping into the economy.
But with all the truly worrisome stuff we need to deal with, why create menacing, pointless stories about a phantom Double Dip?