We have been on the receiving end of endless analysis suggesting double-dip recession risks in the U.S. are either zero or completely trivial. The primary reasons given for this view are: the positively sloped yield curve, negative real short-term rates, no sign of inventory excess and no sign of a flattening in the trend in the leading indicators (aside from the Economic Cycle Research Institute's weekly leading index).
We were sent one particular Street report recently that began with a comment on how the analysis incorporated data from the last eight recessions in the United States. But why are these eight recessions in the post-Second World War era relevant? This past recession was not just a blip or correction in GDP due to a manufacturing inventory-led recession; it was a traumatic asset price deflation and credit contraction of historic proportions.
Cat:e528746c-3414-401a-b14b-50247e3bdf01Forum:2d13dc33-9921-4d4a-815f-e809277631e4
Take us at our word, if Ben Bernanke is worried, it is not about what drives a post-Second World War cycle. He has the 1937-38 brutal downturn in mind and this is actually a much more appropriate template, notwithstanding the changed structure of the economy.
Heading into both the 1937-38 recession there was no sign of inventory excess (prior to the 1937-38 recession, inventories contributed 20 per cent to the economic expansion; in 2009, it was more than 60 per cent). And, going into the 1937-38 meltdown in the economy and the stock market, the U.S. yield curve was positively sloped to the tune of 240 basis points. But why do so many cling to the "yield curve" in a credit cycle in any event?
Just as the flattening yield curve and tightening Fed (the funds rate did rise 450 basis points) were no match for the parabolic credit expansion from 2003 to 2007, it would seem foolhardy to revert to the yield curve's steepness today as some bellwether leading indicator when we are on the other (darker) side of the credit cycle. At best, it gives the banks another way to generate low-multiple trading profits, and that's about it.
Moreover, where were "real" short-term interest rates heading into the unexpected 1937-38 collapse? How about minus 200 basis points. What was at play in that recession were not inventories, the curve or real rates - it was the sudden withdrawal of fiscal support after years of massive New Deal stimulus.
Let's look at the situation from a top-down view. During this statistical recovery from the 2009 bottom, real U.S. GDP growth averaged 3.5 per cent at an annual rate. Of that, two percentage points came from inventories, and so, excluding inventories, otherwise known as "real final sales," it was 1.2 per cent - the weakest post-recession recovery on record. This despite a 10 per cent deficit-to-GDP ratio, a debt-to-GDP ratio rapidly heading to 100 per cent, a near zero Fed funds rate, record low mortgage rates, an unprecedented tripling in the size of the Fed balance sheet, shifting accounting rules to help rejuvenate profit growth in the financial sector, cheap and easy Federal Housing Administration financing to virtually anyone who wants to buy a home, relentless government pressure on banks to modify defaulted loans, and bailout stimulus galore. Yuk.
Well, what's past is past. Where are we going? It's pretty clear from the manufacturing components of the last payroll report and the latest ISM index that the inventory cycle is either reaching its peak or it already has.
We can see from the latest auto sales reports that absent cash-for-clunkers, sales are, at best, stuck in neutral.
As for housing, sales and mortgage purchase applications are hitting new lows despite mortgage rates at record low levels. This also attests to the degree of excessive demand from the prior bubble that is still being worked off. Moreover, commercial construction is beset by high and still-rising vacancy rates in the office and shopping centre space.
It would be nice to see an export boom but the overseas economies, to varying extents, are tightening either monetary or fiscal policy to rein in growth. And, although the consumer is not exactly rolling over, spending fatigue seems to be setting in, along with a natural rise in the personal savings rate, whenever a quick fix fiscal policy gimmick runs its course and expires.
Perhaps U.S. capital spending will be a lynch pin, but at only 7 per cent of GDP, it will contribute only a handful of basis points to headline growth. It certainly doesn't seem to be generating a whole lot of new jobs; however, corporate spending growth, along with a sharp eye on cost-cutting, may make you want to stay long in Intel a while longer. But, what it means for the economy, beyond tech capital expenditures, probably isn't very much.
Then we come to the almost 20 per cent chunk of the U.S. economy, the government sector. Two-thirds of that comes from the beleaguered state and local government sector, which is in a full-fledged retrenchment mode as it cuts services, raises taxes, and lays off 10,000 employees month in and month out to reverse the flow of red budgetary ink. This will likely persist well through 2011.
In addition, we have the federal government, with 70 per cent of the ballyhooed spending stimulus behind us. In a midterm election year, as always, the opinion polls hold sway for the incumbents - and the survey says, there is no more public appetite for more fiscal largesse. We'll see the extent to which this sentiment shifts as three million unemployed Americans roll off the jobless benefits data just in time for the holiday shopping season.
Fiscal policy in the industrialized world, after contributing about two percentage points annually to growth in OECD countries over the past two years, is set to subtract a percentage point in the coming year. In a world of small numbers, that's pretty big.
In the U.S., the fiscal withdrawal will be closer to 1.5 percentage points of GDP. So, if the peak inventory contribution is behind us, and all we have left is a baseline growth trend in real final sales of 1.2 per cent, then how does the economy not contract in the coming year?
David Rosenberg