Wednesday, September 1, 2010

Is the Great Recession Just a Precursor to an Even Worse Downturn?

Rick Davis at Consumer Metrics is out with his latest numbers on the economy. They show no end in sight to the current leg of the downturn. This view is compatible with those monitoring the slow to no growth M2 money supply.

It should be noted that when Rick mentions "consumer demand" in his report he is really referring to demand for durable goods (This is what his numbers measure). And "durable goods" in my book should be classified as capital goods. A decline in this area of the economy is thus consistent with Austrian Business Cycle Theory.

It should also be noted that Rick in this report breaks down the Great Recession into its various phases and classifies the subprime crisis as just an early indication of the crisis that then changed its form.

This coincides with my thinking about the Great Recession.  As I wrote to my private clients earlier this year:

It is extremely instructive to review in detail how the financial crisis unfolded to get a sense for where things stand now.

The start of the financial crisis can now be pegged to the February 27, 2007 announcement that The Federal Home Loan Mortgage Corporation (Freddie Mac) would no longer buy the most risky subprime mortgages and mortgage-related securities. Prior to that announcement the real estate market was in a roaring full-fledged bull market.

One key to a roaring bull market is that more and more money needs to be added to the ballooning structure to keep it climbing. If the flow of money simply slows down, then the most leveraged who are betting on a quick return will find difficulty making that quick return. In the stock market, those seeking quick returns are exemplified by day traders, in the real estate market it is the equivalent "flippers".

The Freddie Mac announcement slowed the flow of the most risky, most aggressive money that was blowing up the real estate bubble. It was enough to prick the bubble.

But if that Freddie Mac announcement was not followed by a tightening of the money supply by the Federal Reserve, especially in the Summer of 2008. The Freddie Mac move would have been just a bump in the road.
I then go on to say that the crisis would have eventually developed anyway, but Bernanke's lack of money printing in the Summer of '08 spurred everything along.

Rick's commentary on his data supports this view. However, I caution, Rick's data is the best around, but he does tend to view things from a somewhat Keynesian perspective of aggregate demand being the key factor that drives the economy. He does throw in the occasional analytical commentary that the "consumer thought this", "the consumer did that" etc.

In other words, he collects the best data, and we can use it for our purposes in trying to detect from an Austrian Business Cycle perspective where exactly we are in the cycle, but ignore his commentary when it gets too Keynesian and where he thinks the consumer drives the economy.

Here's Rick's latest:

The "Great Recession" that began in 2008 has had many nuances, some of which can only be seen in data with higher resolution than that provided by the BEA or NBER. Our day-by-day profile of consumer demand helps us understand triggering events while also making it clear that many recent changes in consumer behavior have begun to linger -- much as the recession itself now appears to have done.

We have previously reported that consumer demand for discretionary durable goods is now at recessionary levels after starting to contract on a year-over-year basis on January 15, 2010. On the surface this would indicate a "double-dip" recession following the 2008 economic event. We may have inadvertently promoted the "double-dip" aspect of 2010's contraction by often graphing the two events superimposed upon each other in our "Contraction Watch" chart -- as though they were independent episodes.

But to even a casual observer there is something unsettling in the above chart, especially if we've been told that the "Great Recession" was a once-in-a-lifetime event that required once-in-a-lifetime amounts of new national debt to fix. Clearly, the 2010 contraction already appears well on the way to equaling or exceeding the "Great Recession" in severity despite those "fixes."

By the end of August, the 2010 contraction had out-lasted the "Great Recession" in duration, and was contracting at a rate that we might expect to see only once in every 15 years. But it is highly unlikely that two fully independent contractions this severe would happen only two years apart -- just as the 1937 recession is not generally thought to be just another closely spaced severe recession, but is rather seen in the proper context.

Perhaps we need to take a look at our longer term charts, including our 48 months of Weighted Composite Index data (a nominal base 100 index where 100 = zero net year-over-year change):

From this perspective, we might reasonably ask whether the upward bump that reached a daily peak on August 12, 2009 is a "Great Recovery" or merely a stimulus fueled anomaly within a longer term economic slowdown. If the latter is true, then the shape of the 2010 contraction in our "Contraction Watch" chart makes more sense; we might be seeing now how the 2008 event would have progressed without generous doses of short term consumer stimuli during 2009 (e.g., "Cash for Clunkers" and the Federal Housing Tax Credit).

Our data also indicates that the "Great Recession" unfolded for consumers differently than National Bureau of Economic Research ("NBER") might have us believe. The NBER is considered to be the official scorekeeper for recessions, and they have dated the beginning of the "Great Recession" to December 2007. While it is true that consumer demand (as measured by our Daily Growth Index) peaked prior to that month (on July 28, 2007 to be exact), we find that during December 2007 consumer demand was still growing year-over-year by more than 1% -- slow growth perhaps, but hardly a recession. In fact, on December 13, 2007 some sectors of consumer demand were almost giddy in their growth: housing was still growing at a 12.8% year-over-year rate while our retail department chain index was up double digits. Consumers were clearly not yet in any major funk.

By May 26, 2008 -- nearly two quarters after the NBER claims we were already in a recession -- consumer demand for discretionary durable goods had finally slipped into year-over-year net contraction. By that time the consumer climate had changed: crude oil was topping $130 per barrel and the collapse of Bear Stearns was in the nightly news. Additionally, in the U.S. the presidential primaries were in full swing, bringing with them unprecedented political uncertainty. When the timing of consumer behavior changes is better understood, the triggering events can be more readily identified. By May 2008 consumers had good reasons to be cautious about big-ticket discretionary expenditures -- reasons that simply had not existed six months earlier.

Similarly, the lowest levels of consumer demand we have ever recorded occurred on November 5, 2008 while the entire nation reflected on the results from the preceding day's elections. That was followed by an organic rebound in demand that brought the entire consumer economy into net growth by early January 2009, long before any major fiscal stimulus had reached the streets. The consumer climate had once again changed: oil was $33 per barrel and the election was behind us. Again, higher resolution data can help sort out cause and effect, making policy responses better timed and targeted.

Economic cycles are complex and economic cause-effect relationships can often be ambiguous. In May, 2008 unemployment was still only 5.4%, and the downturn that we monitored in consumer demand preceded and plausibly caused at least a portion of the subsequent rise in joblessness. Now, over two years later, the cause-effect relationship has at least been muddled and arguably flipped: on the one hand we have observed high unemployment levels persisting throughout the artificially stimulated "green shoots"; while on the other hand we see in our daily data that rising unemployment concerns inversely correlate with dropping overall consumer demand for discretionary durable goods. Unfortunately this means that unemployment has remained sticky in the face of positive stimuli while discretionary consumer demand remains free to float down on bad news or increased uncertainties.

Contrary to the timeline suggested by the NBER, our data strongly suggests that the consumer portion of this recession did not start out to be about housing or damaged consumer balance sheets. But it is now. It has clearly evolved, and the average consumer's version of a recession diary might look something like this:

► December, 2007: Spending slightly more than last year, sub-prime mess is somebody else's problem
► May, 2008: Gas prices way up, banking crisis in the news -- maybe we need to be little cautious
► August, 2008: Democratic National Convention says things really are getting different this time, maybe more caution is warranted
► November, 2008: Good, the election's over, and gas prices are down -- things are getting normal again
► March, 2009: The 401K may be hurting, but at least we have the house to retire on
► June, 2009: Unemployment numbers don't look good, but those usually start back down
► August, 2009: A lot of vacant houses in the neighborhood, let's rethink retirement funding
► January, 2010: Unemployment is getting worse, let's pay down our credit cards
► May, 2010: There may be a recovery going on somewhere else, but it certainly ain't here
► August, 2010: Politics are getting ugly again, things aren't about to improve anytime soon

There probably hasn't been two separate recessions in three years, simply one that has evolved in significant ways. But if this really is a "double dip" recession, then our data indicates that the "Great Recession" of 2008 was merely the precursor, and not the main event. It is this current dip that we should be really concerned about; the current contraction in consumer demand is about structural changes in consumer behavior, whereas the "first dip" was about short term loss of consumer confidence.

Read the rest here.

1 comment:

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