The Next U.S. Recession

January 22, 2019

I can’t recall any U.S. President, Treasury Secretary, or Fed Chairman predicting a recession prior to its onset. For that matter, financial advisers tend to avoid the R-word until its partly in the rear-view mirror, and conventional wisdom all around usually doesn’t identify a recession until it’s underway. Because of this phobia against shouting that a recession is coming, the current lack of recession forecasts in 2019 doesn’t make that possibility zero or even near-zero.

In some respects, the current situation seems reminiscent of late 2000. Then, like now, there were no single overwhelming shocks or unsustainable imbalances making a downturn unavoidable. However, like now, there were a number of negative developments that taken together could and which in fact did lead to an economic downturn that started during the first quarter of 2001.

  • The price of West Texas Intermediate oil had tripled from $10.87 in December 1998 to $34.31 in November 2000.
  • The federal funds target was lifted by 175 basis points in 321 days between mid-1999 and mid-May 2000. A 7% trade-weighted dollar over that same period was like a further 70 basis points of restraint, and the dollar had continued climbing even after the Fed stopped lifting its interest rate target.
  • The U.S. business cycle had been expanding since April 1991, and while old age doesn’t cause recessions, economies that have been expanding for a long time tend to develop imbalances that make them less resistant to sudden shocks.
  • There was also fiscal drag. In the absence of explicitly expansionary fiscal measures, the mere growth of the economy within a progressive income tax structure exerted an increasing drag on aggregate demand.
  • The stock market in 2000 took a hit as many dot-com companies failed.
  • The global economy had softened, with projected GDP growth in 2001 for Japan and Germany below 2% coming into the year.
  • With a current account gap  above 4.0% of GDP when the 1990s ended, the U.S. was highly dependent on foreign capital inflows.
  • Although the U.S. federal budget had swung into surplus, a big private sector debt had emerged in its place.
  • The Republicans retook the White House in a controversial election decided by a Supreme Court ruling. Since William McKinley, the last person to be elected president in the 19th century, every Republican president has overseen at least one recession and three of them in the case of Eisenhower and two each in the case of Nixon and Bush43.

None of the above situations by itself would have sufficed to produce a recession, but together they did. The threat was not seen, however, as pundits instead focused on some growth-supportive factors. Nominal GDP had expanded by a healthy 5.5% between the final quarters of 1999 and 2000. Money market liquidity seemed abundant. Unemployment, inflation, and long-term interest rates were relatively low. Jobs had grown 1.4% between end-1999 and end-2000 and by 369K in the final two months of the year. Real GDP rose 4.1% in 2000 as a whole, the fourth straight calendar year to eclipse 4.0%.

At the start of 2019, global growth is looking softer and a whole lot softer if the U.S.-Sino trade dispute can’t be diffused. Share prices have been very volatile. Japan can’t escape adequately from the pull of deflation. China just had its weakest calendar year growth since 1990. Brexit poses a threat, not just to Great Britain but to the entire European Union. Italy could expose Europe to additional strain. Political nationalism is busting out all over the world. Central banks are poorly positioned to reduce interest rates should growth prove weaker than anticipated. The U.S. yield curve is worrisomely flat, with only 21 basis points separating the 3-month from the 2-year yield and just 8 basis points between the two-year and 7-year yield.

The month-long federal government shutdown will from here generate an exponential arcing drag on economic growth.  President Trump’s policies of deregulation and huge tax cuts goosed U.S. growth in 2018, but that support is now fading and leaves fiscal policy unprepared for the next downturn. Climate change has changed from a future threat to a present and ever-growing calamity weighing on potential growth. And there’s little means to really know what’s happening to the economy while data collectors and analysts stay furloughed.

Nobody expected the Spanish Inquisition. And very few ever see a recession coming before it comes ashore. But who really wants to bet that Donald Trump becomes the first Republican president since the 19th century not to oversee a U.S. recession on part of his watch?

Copyright 2019, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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