A Business Recession Looms

 

shutterstock_368927783The May jobs report was a shocker, with nonfarm payrolls up only 38,000 and private jobs up a mere 25,000. A lot of investors and economists are making the case that this was a weird, one-off, statistical glitch, and that stronger employment is on the way. They may well be wrong.

If you smooth out the numbers with a three-month moving average, job increases have been slowing for five months. The three-month pace last December was 281,000 jobs. In the May report, the pace nosedived to 107,000. The unemployment rate fell to 4.7 percent, but that’s largely because 458,000 people left the labor force.

This spells trouble for the economy. And if you step back and look at the whole business sector, a case can be made that the U.S. has been in a mild business recession for as much as a year, if not longer.

Take, for example, business fixed investment in equipment, software, plants, buildings, and so forth. This has been slowing for six straight quarters, and even went negative in the first quarter on a year-on-year basis.

Behind this business-investment slowdown, the broadest measure of profits from the GDP accounts, which very closely tracks IRS profits, has been negative for the past three quarters measured year-on-year. In fact, this slump began in the second half of 2014, almost two years ago.

Profits are the mother’s milk of stocks and the lifeblood of the economy. While so many people obsess about the Federal Reserve, the reality is that stocks have been flat over the past year as profits and business investment have been weakening.

Another point: Core capital goods, including orders, shipments, and backlogs, have turned negative over the past three months and across the past year. This is a proxy for business investment, and it’s not a good omen.

Finally, the closely watched ISM reports for manufacturing and services are barely above 50. In other words, they point to the front end of a recession. On the manufacturing side, key indicators like production and employment are below year-ago levels. New orders are flat. On the services side, the overall index is below year-ago levels, as is employment and new orders.

Many financial folks concentrate on consumption rather than business indicators, clinging to an outdated view that consumers are 70 percent of the economy. To be sure, consumer spending and housing are rising modestly. But new research by economist Mark Skousen of Chapman University shows that if you look under the hood of the GDP accounts, you will find that the intermediate stages of business production and services, including business-to-business activity, account for 50 percent of overall output. That’s higher than consumption, which runs about 40 percent.

As a result of Skousen’s work, the Bureau of Economic Analysis has created a new “gross output” measure, which is published with a lag. This GO measure tells us a lot more about the inside workings of the economy. And according to Skousen, 80 percent of all employment actually comes in the early and intermediate stages of business activity.

So let this be a warning. The overall economy is not yet in recession. But the business economy has been slipping for quite some time. And if falling profits and business investment continues, the jobs slowdown will follow suit — if it hasn’t already.

As for Fed watching, in this environment the Fed should stay put. No rate hikes. The time for raising target rates was back in 2011, when QE2 drove the consumer price index up to 3.8 percent. That’s when it should have increased the target rate by a percentage point or so. If it had, it would have gotten back to Stanford economist John Taylor’s rule. We would have all been better off for it.

But now is the time to turn away from monetary policy and focus instead on fiscal solutions to the ailing economy. Slashing business tax rates to 15 percent for large and small companies and overturning burdensome regulations is what the economy needs to get out of the doldrums.

That would bring business investment back. The U.S. would be the most hospitable investment destination in the world. America would win the global race for capital. Cash would be put to work in productivity-enhancing investments. And the economy would grow by 4 or 5 percent for years.

Real interest rates, reflecting higher economic returns, would rise as a sign of economic health. And then the Fed could normalize its policies by following market rates higher.

For a time, the dollar would jump, again reflecting market forces and not currency manipulation. Then the G-20, with strong U.S. leadership for a change, could coordinate currency values and stability.

That’s my vision. Alas, we’re going to have to wait until next year.

Published in Economics
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  1. Fake John/Jane Galt Coolidge
    Fake John/Jane Galt
    @FakeJohnJaneGalt

    Obama and the Democratic governments will delay it enough to get HRC and a Democratic congress elected so they can then blame it on the GOP.

    • #1
  2. I Walton Member
    I Walton
    @IWalton

    Larry and many other informed observers watch the inertia, the momentum of existing business that show up in our aggregate data, stock prices, investment, consumpiton, inventories, orders etc.  Such things are not without some meaning,  but the important stuff doesn’t show up  clearly even  looking  back we see growth, change, new products new business, and new technology but we, the aggregate, won’t really know what went on because it takes place well beyond our statisical vision with all the important nuances averaged away.  The consumers that matter are hopes, expectations in the heads of thousands of people who might just take a risk, make the plunge  hoping there will be consumers in specific places at specific times for specific products.  They have nothing to do with aggregate data and everything to do with perceptions of risk, enviornment, atmosphere optimism and the guts and vision of real people.   The Fed and Federal government  believe they can create demand or stimulate investment and hence spur  animal spirits, with spending or borrowing or debt, but it’s just the opposite.  They kill them by creating uncertainty, funding cronies, building poltical machines, destroying information contained in stable prices or currencies.

    • #2
  3. Kozak Member
    Kozak
    @Kozak

    Gonna make it tough for the Beast to sell a “third Obama term”.

    • #3
  4. BD Member
    BD
    @

    LarryKudlow – You were right on the economy, the Reform Conservatives were wrong.

    • #4
  5. Richard Fulmer Inactive
    Richard Fulmer
    @RichardFulmer

    Other than the most anti-business president since FDR, an explosion in regulation over the last quarter century, increasingly aggressive and litigious federal agencies, failing government-run schools, some of the highest corporate taxes in the world, endless monetary manipulation by the Federal Reserve, and ever-rising employer mandates, I can’t think of a thing that might be causing business investment to decline.

    • #5
  6. Muleskinner Member
    Muleskinner
    @Muleskinner

    We are past due for the next recession, given the postwar average duration of an expansion. The graph below is built from the Philadelphia Fed’s State Coincident Index, an Index calculated for each state designed to estimate the growth of state GDP in something close to real time (six weeks after the reference month of the data). The Philadelphia Fed’s diffusion index, based on the coincident index runs from 100 (50 states with growing economies) to -100 (50 states with a contracting economy).

    I’ve included recession bars in red. It appears that most of the time that when the index falls below 40 (35 states growing, 15 shrinking) a recession is underway, or a few months away. Or when the index is above 60, breaking below 60 (40 growing, 10 shrinking) appears to be related to a recession a little more than half the time. The diffusion index for April is 64.

    Diffusion Index

    • #6
  7. Joseph Eagar Member
    Joseph Eagar
    @JosephEagar

    Real interest rates, reflecting higher economic returns, would rise as a sign of economic health. And then the Fed could normalize its policies by following market rates higher.

    For a time, the dollar would jump, again reflecting market forces and not currency manipulation. Then the G-20, with strong U.S. leadership…

    Haven’t we moved past the tired old idea of “Keynesian fiscal stimulus to boost growth now, supply-side structural reform to boost it later” of the Reagan years?

    The U.S. cannot afford to be the consumer of last resort.  I’m all for structural reform, but if the past thirty years have taught us anything it’s that if one front loads structural reform with demand stimulus, the demand stimulus will undo the positive effects of the reform (e.g. through malinvestment).

    What the U.S. needs, more than anything else right now, is for the Germans to consume more.  That’s the immediate priority.  After that, we need to do something about labor productivity, preferably something that doesn’t blow up the current account deficit again.

    Other priorities include encouraging China to liberalize its currency (which will mean a small devaluation in the near term), force the Germans to choose between breaking up the euro and writing down Greece’s debts, deal with troubled Latin American economies, etc.  Let’s be honest, the U.S. doesn’t have a domestic demand problem; the rest of the world does, and our policies should reflect that.

    • #7
  8. Front Seat Cat Member
    Front Seat Cat
    @FrontSeatCat

    Not a financial guru, but isn’t this what Trump is advocating? Make the US more hospitable to businesses, and start producing again instead of focusing so much on consumption? We used to make things – and fair trade enabled our goods and services to compete – that is no longer. Just the secrecy surrounding the trade deal made one wonder what was going on.  Add in all the new regulations, Obamacare, minimum wage and overtime rules – it’s not surprising.

    PS. Joseph, how can Germany or the EU overall consume more when they are facing massive immigration issues, unemployment, threats from Russia, etc. of their own?

    • #8
  9. Joseph Eagar Member
    Joseph Eagar
    @JosephEagar

    Front Seat Cat, the solution (we probably agree on this) is guns and walls.  Big, tall walls to keep the refugees out (and, btw, deter them from crossing, and thus drowning in, large bodies of water), and big, nasty guns (lots of spending on big, nasty guns) to keep the Russians out.

    • #9
  10. Front Seat Cat Member
    Front Seat Cat
    @FrontSeatCat

    Joseph Eagar:Front Seat Cat, the solution (we probably agree on this) is guns and walls. Big, tall walls to keep the refugees out (and, btw, deter them from crossing, and thus drowning in, large bodies of water), and big, nasty guns (lots of spending on big, nasty guns) to keep the Russians out.

    I’m not quite sure I agree with guns and walls – insulating ourselves with either.  Controlling the refugee situation with better methods, and strong leadership to stand up to Putin I agree.

    • #10
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