by Stephen Swanson, bio end of article
With a highly uncertain global economy and accumulating geopolitical risks, peering into 2012 is a challenging and inherently difficult exercise fraught with uncertainty. To minimize further uncertainty, it is believed an examination of hard data will offer more insight into the next year than “noisy” surveys, opinions or many leading and coincident economic indicators open to interpretation.
After announcing third quarter growth in GDP of 2.5%, which was met by many questions and doubts, the BEA notched down its second estimate to 2.0%. On December 22nd the BEA released its final estimate for real growth in GDP for the third quarter, further reducing its second estimate of 2.0% to 1.8%. As will be discussed, it’s important to note that second quarter growth was 1.3% and first quarter growth was 0.4%.
Combing through the most recent BEA data and tables reveals that modest growth in personal consumption expenditures accounted for 1.5 percentage point’s real GDP growth (68% of total growth) with an improvement in trade adding .4 percentage points, accounting for the balance of growth. A substantial increase in business investment in equipment and software was almost entirely offset by inventory reductions and the impact of government spending was negligible.
Can the Consumer Carry the Load Forever?
Put succinctly, the economy as presently constituted still remains highly reliant upon the consumer for both the bulk of economic activity and growth. The critical interrelated questions for 2012 are (1) is growth below 2%, which is widely viewed as stall speed, sustainable, (2) will consumer spending expand and (3) will business investment increase and support further employment gains.
With personal savings drawn down to 3.5% and access to credit limited, consumer spending can only be increased through wage increases or employment gains, both of which, thus far, have remained elusive. While there have been reductions in first time unemployment claims and November saw the creation of 120,000 non farm jobs, this does not constitute a trend and the fact remains employment levels are about where they were ten years ago. And the Commerce Department reports that real wage growth over the last ten years has been worse than any period for which we have data—including the Great Depression. Private sector wages grew just 4.2% over the last 10 years, compared to 5% from 1929 to 1939.
The unprecedented stagnation in wages probably has a lot to do with the continually high unemployment rate as well as globalization, which gives employers the leverage to pay workers less. At the same time, as manufacturing has become increasingly automated, higher wage jobs have disappeared, while most new jobs have been in the lower paying service sector. And while the underlying “core” inflation rate has remained low, rising food and fuel prices have pushed real wages even further down.
The Outlook for Consumption in 2012 is Bleak
Much of this can be seen in recent reports on disposable income and spending that point to a deceleration in both incomes and spending. In November personal disposable income recorded no growth and personal consumption expenditures (PCE) increased .1%, the same as it did in October.
Thus, in the current climate it’s highly unlikely we will see a sudden surge in consumer driven final demand that will result in sustained employment increases, suggesting that a secular increase in employment will only result from expanded business investment. But this is unlikely to unfold as reports on business spending show that orders for non-defense capital goods excluding aircraft, core capital spending, has declined three consecutive months, falling 1.2% in November after declining .9% in October. Slowing global growth, regulatory uncertainty, the financial crsis in Europe and other uncertainties are all constraining investment decisions.
In the event these conditions continue to dampen investment, which is likely to be the case, employment gains will be muted and unlikely to rise much above the level needed to absorb growth in the labor force, variously estimated to be 120,000 to 130,000 jobs per month. This is pretty consistent with a muddle through economy particularly vulnerable to shocks, whether a sharp increase in the price of oil, events spiralling out of control in Europe or a hard landing in China.
Beyond Consumption There is Not Much Positive Either
Mining recent public data releases for further clues and confirmation reveals a mixed picture but nothing so concrete as to suggest either robust growth or recession. The ISM PMI increased to 52.7% in November while industrial production decreased 0.2 percent in November after having advanced 0.7 percent in October and registering zero growth in September. The Conference Board Leading Economic Index for the U.S. increased 0.5 percent in November to 118.0, following a 0.9 percent increase in October, and a 0.1 percent increase in September. The Conference Board notes: “November’s increase in the LEI for the U.S. was widespread among the leading indicators and continues to suggest that the risk of an economic downturn in the near term has receded.
More ominously, the Philadelphia Fed ADS high frequency series points to an economy operating below average conditions; the San Francisco Fed sees a 50% of a recession early next year; and ECRI, almost alone and confident, is making a call for an outright recession. And Reuters/UM consumer confidence rose to 69.9, above its low of 55 in August but also well below the level of about 90 that is common in good economic times.
Historical Comparison is Discouraging
Easily the greatest insight into current conditions and likely direction of future economic activity is in research undertaken by Jeremy Nalewaik of the Federal Reserve. He finds that since 1947, when two-quarter annualized real GDP growth falls below 2%, recession follows within a year 48% of the time. This is more than twice as high as the unconditional probability that an economy in expansion enters a recession within a year (about 19%). When year-over-year real GDP growth falls below 2%, recession follows within a year 70% of the time.
The present reality is that the great recession reduced GDP by about 6% and while there have been improvements on many fronts as reflected in various statistical releases, we remain deeply mired below levels needed for a healthy economy and have been operating at or near stall speed for three consecutive quarters. And when at stall speed for three consecutive quarters muddling through is unlikely to prove to be a viable option; the economy must either grow or contract.
Can the Economy Balance on an Unstable Edge?
And given recent growth patterns, the weak global economic environment, the many uncertainties, the fragile nature of our economy, lack of economic drivers (PCE and business investment) and the prospect of continued deleveraging, this writer believes a recession to be more likely than a resumption of sustainable growth. Suggestions that the economy will muddle through at or around stall speed are at odds with the facts of history and imply a resiliency a vulnerable economy lacks. A stall implies lack of sufficient air speed, and we all what comes after that.
About the Author
Stephen Swanson has a degree in economics and an MBA. His corporate experience includes several executive positions including a divisional VP assignment. More recently he has left the corporate world and has been investing in financial instruments and real estate, with interests expanding into S&P futures and commodities. Stephen is known on the internet under the pseudo nom CautiousInvestor and is a frequent commentator at Seeking Alpha where he also posts blogs.