Recessions, Unemployment and Peak Oil

Again, the following chart was produced by FRED at the St Louis Fed:

This is a chart showing unemployment rates and GDP growth in the US since 1969. They grey lines are official recessions.

As you can see, GDP growth during recessions shows a "correction" before it continues upwards. Sometimes this correction is a small plateau, other times (say 1980-1982) there is a slight dip.

The important thing to note is how unemployment responds to recessions - namely a mighty jump upwards followed by a more gradual downward trend as the economy recovers. In some cases, namely the last two recessions (2000 and 1991), unemployment doesn't peak until a few years after the recession ends, which led to the phrase "jobless recovery" becoming popular.

Assuming America is in a recession now, one very obvious indicator would be a rapid rise in unemployment. In the following months, I am reasonably certain that we will see this occur.

The problem is, however, determining how severe the current recession is likely to be. Naturally, if the recession is severe, the result will obviously be a decline in GDP (instead of the plateaus seen in the graph above), along with skyrocketing unemployment.

The last two recessions - 2000 and 1991 - were mild compared to past recessions, which is why unemployment levels never rose too high. Nevertheless, there is always a level of hyperbole that accompanies recessions. Take this for example:
Housing is in its "deepest, most rapid downswing since the Great Depression," the chief economist for the National Association of Home Builders said Tuesday, and the downward momentum on housing prices appears to be accelerating.

The NAHB's latest forecast calls for new-home sales to drop 22% this year, bringing sales 55% under the peak reached in late 2005. Housing starts are predicted to tumble 31% in 2008, putting starts 60% off their high of three years ago.

"More and more of the country is now involved in the contraction, where six months ago it was not as widespread," said David Seiders, the NAHB's chief economist, on a conference call with reporters. "Housing is in a major contraction mode and will be another major, heavy weight on the economy in the first quarter."

A home-sales measure tracked by the association that includes data on cancellations from 30 large U.S. builders that account for one-quarter of all sales shows sales down 65% from their peak in 2005, Seiders said. Government measures of home sales do not include numbers from contracts that were signed but buyers later backed out.

Vacant homes for sale in the U.S. now number about 2 million, Seiders said, an increase of 800,000 from 2005. That inventory overhang is bedeviling builders, who have been forced to cut prices and write down the value of their holdings.
The problem with this report is whether or not the people quoted are merely engaging in hyperbole, or whether their statements are factual. Unfortunately, I have to side with the NAHB on this one and say that the current recession will probably be the worst since the Depression of the early 1930s. Since that depression is the worst ever recorded in history, it is difficult to predict the chances of anything exceeding it.

I am on record (somewhere on this website) in arguing that Peak Oil will cause an economic downturn at least as bad as the Depression. Since I believe that the peak has been reached, I have to therefore wonder whether my prediction will come true. If it does, there will be a severe contraction in American (and world) GDP accompanied by exceptionally high jobless levels. Moreover, I would also argue that economic recovery would be slow, resulting in a correspondingly slow fall in unemployment.

Doom gloom doom gloom. But it won't be the end of the world, just the end of an era.

Craig has some questions for me:
Let's get some hard figures around it Neil. 30% unemployment? By what year? 2010?
Like weather, economics is notoriously hard to predict, especially when you start putting in figures and dates.

I will make this firm prediction - US unemployment will rise above 7% this year (2008).

After that, who knows? The monetary conditions that plagued the Great Depression - notably world-wide deflation - will not be in evidence.

Look at the following graph, again courtesy of the St Louis Fed:

The blue line represents US GDP during the Great depression, from 1929 until 1940. As you can see, GDP declined by nearly one third from 1929 until 1933, before staging a recovery and then hitting another wall in 1937. After that, GDP increases and the war intervenes.

The red line is my own piece of graffiti on the graph, and represents what could happen in the next few years. Rather than a deep drop in GDP followed by a recovery, we have a situation in which GDP pretty much increases only incrementally over a ten year period. Now the line I have drawn is simply arbitrary, but it shows that it is possible to have the same GDP outcome but have a very different way of getting there.

My graffiti is not, of course, accurate - I expect there to be a recession in 2008 which means that GDP should contract. What I am trying to point out, however, is that the potential route over the next five to ten years is very unlikely to result in a one-third drop in GDP and 30% unemployment. What is probably likely is that unemployment may never get below, say, 8% while GDP may never expand by more than 1% per year (annualised). (note: these figures are for America)

The reason for this argument is twofold:

1) Monetary policy will prevent a 1930s style deflationary spiral. It was massive deflation which caused the massive contraction of GDP and the 30% unemployment.
2) Peak Oil's effects are a gradual drop-off in oil production. The current plateau has been reached and it is more than likely that a drop-off in production will occur. Demand destruction caused by expensive oil will cause oil prices to drop as the recession bites and people begin to be more economical in their use of cars. However, once an economic recovery begins to start up, oil prices will not be low enough to stimulate growth, and resulting oil price increases will "nip (the recovery) in the bud".

Add these two together and you get a reasonably flat and stagnant period of economic performance.


Dave Lankshear said...

Let's get some hard figures around it Neil. 30% unemployment? By what year? 2010?

This is so typical of Craig S. He's more interested in bagging someone's prediction than he is in dealing with the actual data. I'll predict something... say you DID predict 30% unemployment and a massive Great Depression by 2010 and unemployment only hit 20%. He'd bag you for the 10% rather than admit we were in a Great Depression and 20% is really quite bad. There's a prediction for you.

Dave Lankshear said...

Dude, my list of "predictions" is a bit "cruder". (Ha ha ha!)

Remember this poster I did from about early 2005?


Just imagine the following...
• Oil prices skyrocket.
• Inflation = high interest rates = mortgage foreclosures.
• Commercial airlines — bankrupt!
• International tourism — bankrupt!
• Stock market collapses!
• The Greater Depression begins.
• Crop yields halve without oil-based fertilizers and pesticides.
• USA ‘Carter Doctrine’ risks HUGE oil wars!
Are you prepared for the end of cheap oil?