Looking Toward the Next Recession

I don't know when the next recession will hit. One of the things about studying economics is that it makes you less certain about making pronouncements about the world.

It is why Truman wanted a one-handed economist. That economist would not be able to talk about on one hand and then the other, being limited by only having one hand.

What I do know is this - we are running out of policy options to prevent it. 

I think this is why Trump is breaking norms to lean on the Fed. He wants rates lowered because either he or his advisors can see the rot that is underlying the system.

But he's trumpeting the good news. Jobs numbers are up. The unemployment level is flat. The stock market is up.

Photo by Vladislav Reshetnyak from Pexels

Like I said though, we're running out of standard policy options. On fiscal policy, what can you normally do? You spend money. Shovel money out the door to people.

Get money in the hands of people who want to spend it. Bush did this. Remember getting a random six hundred dollars from the treasury over a decade ago?

That was nice. It wasn’t sufficient to stop the slide, but it was nice. I paid down my credit cards.

The problem with this is that there are still sufficient people in congress who speak ill of deficit spending in any form. 

Many came to power complaining about profligate spending during the last recovery. I guess if Trump does it it will be fine though.

Another way to combat a falling economy is to cut taxes. Instead of distributing funds, have people and corporations keep it in the bank.

Problem here is that we already did that. The tax law cut the top marginal rates and sliced the corporate rate. 

We saw a pop in earnings, this is what helped juice the market. It does not change the rate of growth though. It just raises the level.

If you own stock, this is good, but the vast majority of the securities in this country are ultimately owned by the top 10% - over 80% of stocks, and what the bottom 90-% own are mostly tied up in retirement funds.

The other way to juice the economy is through monetary policy. You lower the rate the central bank charges. You stop paying interest on reserves. This makes banks lower their rates.

Companies, in turn, see this cheap money and decide to make an investment in building capacity. Consumers make those big purchases, like houses or cars (or Boats!).

Problem here is that the interest rates the Federal Reserve sets, the federal funds rate, was stuck at zero for a decade. The recovery, over two presidents, has been the longest on record, but it was a shallow recovery.

Average growth was under 3%. That's better than a recession, but it makes you look at past expansions with envy. 

The rate now is near historical lows if you don't look at the recent recovery. There are very few investments that make sense now but are waiting for a quarter point drop in the fed funds rate to make your internal hurdle rate lower.

That leaves unconventional policy - quantitative easing or helicopter money or direct debt monetization to move the needle. 

The bottom line is that there are signals flashing now.

Manufacturing is slowing. The yield curve has inverted, meaning that it is cheaper to borrow money for a long time than a short time. 

This has in the past been a signal of slumping market confidence and recession on the way.

And recessions come. The mechanism may vary, but once the broad market turns, then it becomes a self-reinforcing process.

One thing the market does like is certainty, and that's the policy variable that our president is the worst with.

Globalization has grown and supply chains are put in place, and then he makes a pronouncement that changes incentives, until he changes his mind.

In a lot of ways, he is his own worst enemy, as these trade wars of his choosing are not fun and easy to win. 

Manufacturing is hard to bring back onshore. If it comes back, it will be capital intensive because the job market is tight, and hiring is hard.

This has been true for a while now. Look at manufacturing output versus employment for the last 40 years. They are moving against each other. 

We need to look to the past and be ready for a future that is uncertain. There will be a downturn, and of course the president will look for scapegoats.

The policy team will be unprepared for only finding that scapegoat. "If only Powell didn't raise rates in December!" They'll say as people go hungry and lose their houses, and die of preventable diseases.

We know where he won’t point the finger though.