Is the Pulse of the Post-War Business Cycle on the Verge of Stopping?

Warning: this is research not investment advice. You invest at your own risk.

My site is dedicated to the proposition that “animal spirits” or confidence levels are a prime—if not the prime—driver of the business cycle. My models have not sent a false signal of recession in over a decade in real time, and in over fifty years in back testing. So while the markets made a pretty big deal of the drop in the Michigan consumer sentiment series on Friday, the reported number is well within the range of random variation around a rising trend.

Click on graph for larger image in new window.

Why might the pulse of the postwar business cycle stop? The ongoing collapse of effective demand that so many of us have written about (see this and this). Briefly, if consumption returns to a long-term trend share of about 65 percent from over 70 percent of GDP, that’s a ~5 percentage point drop. Private investment demand has fallen ~20 percent year-over-year recently, and the residential portion of that is not going to return to previous levels any time soon. Capacity utilization is still quite low. The government’s stimulus falls far short of replacing this lost demand.

Anticipation of a deflationary collapse might invalidate the Big Mo in the stock market (which is “discounting a V-shaped robust recovery”). Short rates would rise as T-bill auctions are crowded with refugees from the long end, and the 1/10 yield curve would invert, the reliable recession signal I use in my recession forecasting model. Unemployment would shoot up even further, and “animal spirits” would collapse.

All this may happen, but turning the macro economy is like turning a supertanker, it takes time. Even if the yield curve inverted this fall, history suggests the collapse would not come until a year or so later in 2010. In the meanwhile we are likely to see a stabilization and perhaps weak growth of real output in absolute terms although the percentages might seem high. Industrial production ticked up for the first time in nine months, often a sign of recession’s end.

Of course, a natural catastrophe or a hot war might break the mould immediately, probably in the direction of hyperinflation.

So we will probably witness yet another act of our long-running national drama, “Fake Democracy,” or “Money Gets What Money Wants.” The President has already gutted the health care “reform” bill by giving away price negotiation with the drug companies and the possibility of a public option. Wall Street continues to defecate in the faces of the American people paying themselves outsized bonuses while accepting welfare from the Feds… yada yada yada.

Abject failure of the existing system would be consistent with our over-arching hypothesis of Strauss and Howe of a revolutionary change in the American social contract within the next two decades (see this and links for an introduction. However, as a previous post indicates, we could as easily go toward neo-feudalism as toward a reformed democracy.

Big recessions and depressions tend to happen at the beginning of decades: the Great Depression, the recessions of 1973-1974 and 1980-1982. We may see one last hurrah from a stock market bid up by computers playing chicken while the insiders sell all they can—or the stock market may begin to discount the deflationary collapse before the yield curve inverts. Why not have a sucker’s rally on free Fed money and a carry trade that Wall Street may find too good to pass up? If the dollar rallies as Bob Prechter forecasts, it might bring in international hot money.

Hang on, we’ve only just begun this rollercoaster ride.

Comments

[Dave Wrixon:]

The working assumption for the last fifty years has been that if growth slows and inflation is under control then you can pump demand by reducing interest rates and increasing the money supply, until inflation threatens to take off, until which time interest rates have to rise and the money supply has to be brought back under control. However, none of this had ever addressed the issue of Debt, either of the consumer or of the Government. Debt is now the over-riding issue and consequently all the previous stoking and quenching of the economy is now somewhat irrelevant to the problem except that Ben has decided to compound our current problems with the risk of hyperinflation by over supply the economy with money.

The scenario before the Federal Bank interfered was something along the line of the economic crash of the early 1930s. Now unfortunately the US faces something, albeit somewhat deferred, that is potentially much worse.

Aug 16 10:11 AM

[chap08:]

"Short rates would rise as T-bill auctions are crowded with refugees from the long end, and the 1/10 yield curve would invert"

You might want to re-think this.

Aug 16 10:25 AM

[LKofEnglish:]

"never addressed the issue of debt"?!!! his name was ronald reagan and the democrats have been apoplectic ever since. "how could you destroy my evil lovliness" has been their mantra ever since. THIS COUNTRY WAS RUNNING TRILLION DOLLAR SURPLUSES UNDER BILL CLINTON. There isn't even the pretense of cost control and only Republicans with a total meekness save for the shutdown in 93 have ever advocated it. Interesting article. The social contract however got torn up in 1973. that was the revolution because that was the end of the draft. there's no way to "soak up the liquidity" of a vast unpaid labor force. sure there's no "wage inflation." but goods inflation is absolutely soaring with the bic mac index absolutely soaring down here in Mississippi. think the fact that people can't afford a bic mac means the end of the world? think again.

Aug 16 10:50 AM

[wheelbarrel...:]

What's a bic mac?


On Aug 16 10:50 AM LKofEnglish wrote:

> "never addressed the issue of debt"?!!! his name was ronald reagan
> and the democrats have been apoplectic ever since. "how could you
> destroy my evil lovliness" has been their mantra ever since. THIS
> COUNTRY WAS RUNNING TRILLION DOLLAR SURPLUSES UNDER BILL CLINTON.
> There isn't even the pretense of cost control and only Republicans
> with a total meekness save for the shutdown in 93 have ever advocated
> it. Interesting article. The social contract however got torn up
> in 1973. that was the revolution because that was the end of the
> draft. there's no way to "soak up the liquidity" of a vast unpaid
> labor force. sure there's no "wage inflation." but goods inflation
> is absolutely soaring with the bic mac index absolutely soaring down
> here in Mississippi. think the fact that people can't afford a bic
> mac means the end of the world? think again.

Aug 16 11:43 AM

[socrateazz:]

If Democrats acted democratic. Really believed everybodies veiws are important. Attacked the problem and not the other people. Acted non-racist while calling others racist. Really believed in fairness as equal chance to succeed instead of take from others so others can have more. And actually the biggest real bias is protecting their wealth while sucking more out of those who already contribute greatly. Yes unless major leadship change is coming, then fuedalism is the future. Kings of old became powerful by protecting their serfs. The serfs rewarded the kings for that protection. The problem developed as the kings started to believe they deserved more. Government overwhelmed the producers, and they became poor. I see that happening today! What do you think?

Aug 16 01:46 PM

[untrusting ...:]

Interesting link on "the income inequality" statistics at the bottom of your article. Worth considering and giving some thought to, even though nothing is likely to change in that arena in the near future. It certainly appears that capital maintains significant advantages over labor at this time, so the logical conclusion is to increase captial and become a lot smarter at increasing and leveraging capital including managing risk, if the individual wants to "get ahead". Only problem is that is much easier said than done and obviously most individuals are pretty inept at it.

Aug 16 02:36 PM

[derryl:]

Debt is used to spend forward your future earnings. As you bring more and more of your future consumption into the present the debt load becomes intolerable and you either give up and default or you spend your present earnings paying off past consumption. The end of post-war effective demand just means people have taken on all the debt they can stomach and are now defaulting and paying back rather than buying more stuff with future earnings.

This means, as the author notes, that consumption as a share of the economy will decline. Unless exports can replace domestic consumption this also means overall economic output (GDP) must decline to meet falling demand. Obama's fiscal equations depend on growing GDP but there is nothing in the economic outlook that would support belief in a rising US GDP. Indicators point to a new normal of a declining GDP settling into a lower new normal until the debt situation plays out over a period of years.

On top of this is the demographics of baby boomers entering the end of their high consumption years. The reversal of debt-fueled consumerism plus the demographic downturn both contribute to a large hole in short to medium term GDP growth. So yes, the post-war business cycle may be on the verge of stopping for a multi year breather.

And unless governments at all levels accept the pain and get their fiscal houses in order by massive spending cuts, quantitative easing will be necessary to finance deficits because market interest rates would have to skyrocket in order to sell all that debt into the capital markets. In a deflationary economic environment tax revenues will decline so higher interest rates would become impossible to fund through earnings (i.e. taxes) so quantitative easing would end up producing hyperinflation.

Aug 16 02:40 PM

[danf:]

Can't really have feudalism without a monopoly on tools and capacity for violence. At least where I live, everyone is armed to the teeth.

What we are seeing is the rise of national socialism - the mutual embrace of large state and large corporate interests to seve the interests of the party, corporate elite.

Longer term this will fail because it depends on the virtue of others to keep producing while at the same time prosecuting an all out war on that virtue which lies at the heart of productivity.

The first step in the creation of a national socialist police state is the explosive growth of law and regulation. Of course you want everyone to be a law breaker so as to empower the police powers of the state. Therefore you need laws that will be broken.

The question is if that can succeed in an armed society.



On Aug 16 01:46 PM socrateazz wrote:

> If Democrats acted democratic. Really believed everybodies veiws
> are important. Attacked the problem and not the other people. Acted
> non-racist while calling others racist. Really believed in fairness
> as equal chance to succeed instead of take from others so others
> can have more. And actually the biggest real bias is protecting
> their wealth while sucking more out of those who already contribute
> greatly. Yes unless major leadship change is coming, then fuedalism
> is the future. Kings of old became powerful by protecting their
> serfs. The serfs rewarded the kings for that protection. The problem
> developed as the kings started to believe they deserved more. Government
> overwhelmed the producers, and they became poor. I see that happening
> today! What do you think?

Aug 16 05:50 PM

[Dave Wrixon:]

You may well have a rise of the Neo-Nazis, but Obama for all his faults is no Nazi. But I fear that he may well ease their path to power.


On Aug 16 05:50 PM danf wrote:

> Can't really have feudalism without a monopoly on tools and capacity
> for violence. At least where I live, everyone is armed to the teeth.
>
>
> What we are seeing is the rise of national socialism - the mutual
> embrace of large state and large corporate interests to seve the
> interests of the party, corporate elite.
>
> Longer term this will fail because it depends on the virtue of others
> to keep producing while at the same time prosecuting an all out war
> on that virtue which lies at the heart of productivity.
>
> The first step in the creation of a national socialist police state
> is the explosive growth of law and regulation. Of course you want
> everyone to be a law breaker so as to empower the police powers of
> the state. Therefore you need laws that will be broken.
>
> The question is if that can succeed in an armed society.
>

Aug 16 07:43 PM

[whidbey:]

This is the Nth story of ":how it could end". I love them all, but....

I feel things are changing because the structures that held up American life are gone or damaged beyond repair, ergo something must happen if we are to go on.

I think it leads to a greatly scaled down life style, and lots of inter-generational strife between the wrecker generations and the wrecked generations. We old people may be asked to kiss-off early and the youth to live in mud huts with 52" screens and free health care.

Hell who knows, because the forces that reshape a society are just now mobilizing for the most difficult period in American history and I am not overlooking the Civil War or Woodstock. Just get ready and pray Obama gives up most of his cockamamie initiatives.

Aug 16 09:40 PM

[Lexy:]

Yeah, when I see your obese and morally bankrupt generation driving around in free $6K scooters that you scammed from Medicare and a discount prescription program, the cost of which was sloughed onto us, and then my generation, who will not have Social Security and will be forced to make ethical decisions as to who receives life-saving medication and who will die, half of me says "kiss off early."


On Aug 16 09:40 PM whidbey wrote:

> This is the Nth story of ":how it could end". I love them all, but....
>
>
> I feel things are changing because the structures that held up American
> life are gone or damaged beyond repair, ergo something must happen
> if we are to go on.
>
> I think it leads to a greatly scaled down life style, and lots of
> inter-generational strife between the wrecker generations and the
> wrecked generations. We old people may be asked to kiss-off early
> and the youth to live in mud huts with 52" screens and free health
> care.
>
> Hell who knows, because the forces that reshape a society are just
> now mobilizing for the most difficult period in American history
> and I am not overlooking the Civil War or Woodstock. Just get ready
> and pray Obama gives up most of his cockamamie initiatives.

Aug 16 11:29 PM

[Boot:]

A sharp quill usually stirs up a- lot of commentary. Well done sir.

Aug 17 08:33 AM

[Benign Brod...:]

Thanks for the many comments. The best clarification I can give to the many issues raised is to say that the "social contract" in American appears to be broken--the ability to share in rewards and sacrifice in a way that most people perceive as fair is gone.

So either we come together democratically, with good old solidarity and a share-and-share-alike attitude, or we fall into an authoritarian "state socialism" and probable police state, a dark age that preserves the current distribution and perceived unfairness. Barring these, if we fall apart we become a collapsed state like Mexico apparently is, where day to day life is ruled by street criminals, and there is no law.

I am hoping we can come together democratically. But as long as Big Money owns our government, that will be difficult. Barack beat the system by raising his money on the Internet. Now it's time to take Congress away from the Big Money interests.

Aug 17 09:56 AM