Are We Headed for Great Recession 2.0?

by Guest Authors Caroline Corbett and Lance Roberts of Streettalk Live

Is a second recession in so short of a time in the offing? It certainly seems that way. The hope for a continued recovery has grown dim lately as many of the economic indexes are moving towards contractionary territory.

As we posted recently in “EOC Index Shows Economic Weakness” there are several concerns pressing the US economy and, in the words of David Rosenberg, chief economist at Gluskin Sheff, “one small shock” could send us into a second recession. With the recent release of the Chicago Fed National Activity Index, our proprietary economic index is just one small step away from crossing the 35 mark which has always been a precursor to recession.

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We have discussed many times recently that the unemployment rate remains high, housing prices are slipping into a secondary decline, consumer and business spending is slowing, while gas and food prices remain high, eating up more than 20% of consumers wages and salaries. Add on top of these factors the likelihood of a Greek debt default, a slowdown in the Eurozone, a weaker dollar and Washington locked in debate over the debt ceiling — well, the list of risks far outweigh the positives. It doesn’t take an economist to figure out that any one of these factors could send us tumbling into a second recession.However, that doesn’t seem to deter Wall Street economists and main stream media, who all seem to be wearing rose colored glasses these days.

Most of the mainstream media and economists claim this is simply a soft patch of the recovery. David Rosenberg refuted this claim in an interview with Bloomberg Television saying, “[it’s] not normal to have two soft patches this close together nearly two years after the recession ends. It doesn’t happen. This will be two separate recessions.” He also stated in the interview that he believes that there is a 99% chance of another U.S. recession and the only reason he didn’t put it at 100% was that he needed a “margin of error”. He noted in his most recent issue of “Breakfast with Dave” that real disposable income, household employment, real business sales, and manufacturing production all peaked in March. This type of behavior was not characteristic of the soft patch last year, and this is the first sign of a looming recession. More importantly, remember that the recovery to date in the economy has not been an organic one. With more than $5 Trillion injected into the system through various Federal interventions and stimulus, it is disappointing that we only increased GDP by a little more than $900 Billion in the last two years. That is expensive growth any way you price it and is unsustainable without further injections.

However, not to be daunted by facts and figures, a recent CNNMoney survey of 18 leading experts shows that they believe there is about a 15% chance of a new recession. Of course, this is pretty much the same group of individuals who told everyone that the economic slow down in early 2008 was just a “soft patch” as well.

The risks, however, are real. According to Bernard Baumohl of the Economic Outlook Group, “the fragile US recovery means the economy is much more vulnerable to geopolitical shocks and a rise in fuel prices. Since the instability in the Middle East is far from over, there are real risks for the U. S. and international economy.” Dr. Gary Shilling, author of The Age Of Deleveraging, also notes the threat to the economy of another drop in housing prices. There is currently an excess inventory of 2 to 2.5 million homes with only 500,000 homes being absorbed out of that inventory per year. This means that it will take at least 4 to 5 years to clear that inventory if rates stay the same. If home prices drop another 20% in order to clear the market, it will force price declines on existing homes that will move the number of underwater mortgages from the current level of one in five to more than one in three. Shilling argues that the ripple effect will drive the economy into a second recession.

Robert Samuelson, in an article for the Washington Post, compares the current state of the economy to the climate of the economy during the “depression within a depression” from 1937-1938. During this recession, the unemployment rate rose to 20%, the economy’s output fell 18%, and industrial production dropped 32%. The climate leading to this recession is very similar to the economy today. Then, as now, commodity prices were rising rapidly and inflation fears were growing. Federal budget was criticized as too large and the president was perceived as anti-business. Similar complaints exist today. However, there are some significant differences between then and now. Policy reversal in 1937-1938 was much more drastic than anything being considered today. The federal deficit fell from 5.5% to .1% of GDP between 1936 and 1938. Today’s budget deficits are much larger as a share of GDP and prospective reductions are much smaller. Still, the parallels are unsettling.

Finally, statistically speaking, the data suggest the definite possibility of a second recession. Mark Thoma recently analyzed a graph of real GDP growth in an article for The graph shows a downward growth heading to below 2% GDP growth. This 2% line has been indicative of a recession in the past. Almost every drop below this line has led to a recession measuring back to 1947. The Fed, however, is hoping for a turnaround in the third quarter that could prevent us from hitting this line. Thoma believes the government needs to start taking action in order for this to happen. “Policymakers need to realize that unemployment, not the deficit, is the immediate crisis to be addressed and take action. Unfortunately for the unemployed, that’s unlikely to happen,” he stated in the article.

We agree with Thoma that unless some initiatives are taken we will hit that 2% mark very soon and head into our second recession.

Of course, all of this is barring another round of Quantitative Easing by the Fed. However, even that may not be enough to offset the real problems facing the U.S. economy.

Editor’s note: (c) Streettalk Live        This article also appeared at Advisor Perspectives

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