Showing posts with label Graphs. Show all posts
Showing posts with label Graphs. Show all posts
2016-10-31
US Industrial Decline in Progress - Recession Possible
There has been a long term deterioration in US Industrial production, as shown in the INDPRO index.
While monthly decreases happen all the time, a long-term decline in yearly production averages has been in place since September 2015.
When the yearly averages are placed on a graph and compared with US recessions since 1960, there is a clear correlation between long term industrial decline and recessions.
A decline in the yearly average can occur before a recession, or during a recession, as the graph below shows.
Note that I define a recession different to the NBER, but there is an overlap.
Here is how it appears on my spreadsheet:
While monthly decreases happen all the time, a long-term decline in yearly production averages has been in place since September 2015.
When the yearly averages are placed on a graph and compared with US recessions since 1960, there is a clear correlation between long term industrial decline and recessions.
A decline in the yearly average can occur before a recession, or during a recession, as the graph below shows.
Note that I define a recession different to the NBER, but there is an overlap.
Here is how it appears on my spreadsheet:
2012-09-08
2012-07-28
US Labor Force as percentage of population: 1952-2012
This is a different metric to, say, the Labor force Participation Rate.
Although there has been a marked decrease in recent years, the most salient part of this graph has to be the 1962-1990 growth period, whereby large amounts of people entered the workforce. This reflects the growth of women choosing to work in the workplace rather than remaining at home. I'm sure that birthrates during this period would also reflect a downward trend.
And although productivity is certainly a important feature in GDP growth, this graph should also prove that GDP growth between the 1962-1990 period was also driven by an expansion of the available workforce. Similarly, any discussion about how GDP growth in recent decades has been lower than the previous ones should also take into account the plateau from 1990 onwards.
Note also that the 1981-1990 period grew at a slower pace than the 1964-1980 period. Reaganomics?
The 1952-1962 period is interesting in that the population grew faster in proportion to the workforce. In a word: Baby Boomers. By 1962, the eldest Baby Boomers were 17 and ready to go to work.
The post 1990 period corresponds with the tech boom, the housing boom and the GFC.
As the population ages and more people retire, there will be a fall in the above graph. I'd love to look at a graph for Japan, considering their population is aging and now in decline.
Sources: CLF16OV, POP.
2011-10-20
US Recession Indicators - October 2011
According to data from negative Real Interest Rates, another US recession is likely to begin between now and 2012 Q4, with 2012 Q1 the most likely... See below.
The growth of the Net Monetary base (M0 minus excess reserves) over inflation has been above the historical average since September 2010 and has remained high at 659 in September 2011.
These results continue to be high and any future recession will either be delayed or else the results will begin to drop drastically.
Already there has been two months of straight decline in both M0 and Excess Reserves (2011-08 and 2011-09 results). Nevertheless Net M0 remains positive because reserves had declined faster than M0.
Inflation in September was 3.9%, the highest it has been since October 2008. This is the third straight month of price increases since a deflationary monthly result in June. The rate of monthly inflation has decreased however, with 6% in July, 4.5% in August and 3.6% in September.
September ended with a reading of 190 after 10 year bond rates continued to decline. This is the lowest spread since May 2008. The recent decline is increasingly precipitous.
What I said in August needs to be remembered:
Real Ten Year Bond rates came in at -1.32% in September. As I have pointed out before, all experiences of negative 10 year bond rates since the 1950s have resulted in an eventual recession.
If we take previous instances of negative real bond rates into account, a recession will begin between now and 2012 Q4, with 2012 Q1 the most likely. These previous experiences also indicate that unemployment will also likely peak between 12.1% and 18.7%, with a result around 16.9% the most likely.
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Net Monetary Base vs Inflation (spread)
The growth of the Net Monetary base (M0 minus excess reserves) over inflation has been above the historical average since September 2010 and has remained high at 659 in September 2011.
These results continue to be high and any future recession will either be delayed or else the results will begin to drop drastically.
Already there has been two months of straight decline in both M0 and Excess Reserves (2011-08 and 2011-09 results). Nevertheless Net M0 remains positive because reserves had declined faster than M0.
Inflation in September was 3.9%, the highest it has been since October 2008. This is the third straight month of price increases since a deflationary monthly result in June. The rate of monthly inflation has decreased however, with 6% in July, 4.5% in August and 3.6% in September.
Note: A negative result implies that inflation is growing faster than the money supply, an event which indicates that a recession will occur within 1 to 36 months (with an average of 12 months)
Note: All recessions are preceded by a negative result.
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Federal Funds Rate vs 10 Year Bond Rate (spread)
September ended with a reading of 190 after 10 year bond rates continued to decline. This is the lowest spread since May 2008. The recent decline is increasingly precipitous.
What I said in August needs to be remembered:
If this indicator stays true to its historical data, then there will be one of two events leading up to the beginning of the recession.Will Ten Year Bond rates drop to zero? Or will there be an outbreak of inflation first?
The first is if the Federal Reserve will keep the Federal Funds rate effectively at zero, which it will do barring any major inflationary outbreak. If this occurs then 10 year bond rates will drop to zero as well, or at least converge to within a few basis points. This appears to be the situation currently.
The second event will occur if the Federal Reserve increases rates in response to an outbreak of inflation. If this occurs then the Federal Funds rate will exceed the 10 year bond rate, thus placing the indicator into negative and presaging a recession. Inflation has been increasing markedly in the last six months, so this event may yet be the result.
Note: A negative result implies a highly restrictive monetary environment, an event which indicates that a recession will occur within 4 to 39 months (with an average of 22 months).
Note: If both the first and second graphs are negative at the same time it indicates that a recession will occur within 1 to 21 months (with an average of 11 months).
Note: All recessions are preceded by a negative result.
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Real 10 Year Bond Rates Rates
Real Ten Year Bond rates came in at -1.32% in September. As I have pointed out before, all experiences of negative 10 year bond rates since the 1950s have resulted in an eventual recession.
If we take previous instances of negative real bond rates into account, a recession will begin between now and 2012 Q4, with 2012 Q1 the most likely. These previous experiences also indicate that unemployment will also likely peak between 12.1% and 18.7%, with a result around 16.9% the most likely.
Note: Real Interest Rates based upon 10 year Bonds can indicate how the value of money is determined in comparison with the market's safest investment. A negative result implies that inflation is eroding the savings of those who have invested in 10 Year Bonds. A negative result over a three month average indicates that a recession may occur between 4-18 months, with an average of 8½ months and a median of 6 months.
Note: Not all recessions are preceded by negative real 10 year bond rates. Nevertheless all instances of negative 10 year bond rates (since the 1950s) have been followed by a recession.
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Market Capitalisation adjusted by USDX
(The orange line is the recession line, the red line is the line of resistance)
Data Sources
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2011-10-19
Cost of US oil consumption as percentage of GDP
With oil prices now $20 cheaper than 2011-Q2, 2011-Q3 will likely see a drop.
Methodology:
The average oil price for the quarter is multiplied by oil consumption for the quarter, which is then measured as a percentage of nominal GDP.
Sources:
- West Texas Intermediate, price averaged out for quarterly figure. Link.
- US Oil Consumption, quarterly. Link.
- Nominal GDP, quarterly. Link.
- Orange lines represent recessions (annual decline of real GDP per capita)
- Yellow line represents historical average of 0.82% of GDP.
2011-09-23
US Recession Indicators - September 2011 - Market turmoil edition
According to data from negative Real Interest Rates, another US recession is likely to occur between 2011 Q4 and 2012 Q4, with 2012 Q1 the most likely... See below.
The growth of the Net Monetary base (M0 minus excess reserves) over inflation has been above the historical average since September 2010 and has remained high at 646 in August 2011.
The results for August were higher than expected but I think a peak is likely to have been reached. M0 declined between July and August from 2706.799 to 2679.481, while Excess Reserves declined during the same period from 1618.188 to 1583.525. The result was an increase in Net M0, since reserves declined faster than M0. Over the following months, this should lead to a converging of inflation with the growth of net M0.
Inflation in August was 3.8%, the highest it has been since October 2008.
Nevertheless since the introduction of QE2 in November 2010, the net monetary base has increased faster than inflation.
Like last month, I have factored in recent market turmoil in this indicator. August ended with a reading of 220 after 10 year bond rates plummeted to 2.3% for that month. By the close of trading on 2011-09-22, rates have dropped further to a record low of 1.72%, which has led to a mid-monthly reading of 163. What I said last month still applies:
Real ten year bond rates came in at -0.83% in August. As I have pointed out before, all experiences of negative 10 year bond rates since the 1950s have resulted in an eventual recession.
If we take previous instances of negative real bond rates into account, a recession will start between 2011 Q4 and 2012 Q4, with 2012 Q1 the most likely. These previous experiences also indicate that unemployment will also likely peak between 12.1% and 18.7%, with a result around 16.9% the most likely.
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Net Monetary Base vs Inflation (spread)
The growth of the Net Monetary base (M0 minus excess reserves) over inflation has been above the historical average since September 2010 and has remained high at 646 in August 2011.
The results for August were higher than expected but I think a peak is likely to have been reached. M0 declined between July and August from 2706.799 to 2679.481, while Excess Reserves declined during the same period from 1618.188 to 1583.525. The result was an increase in Net M0, since reserves declined faster than M0. Over the following months, this should lead to a converging of inflation with the growth of net M0.
Inflation in August was 3.8%, the highest it has been since October 2008.
Nevertheless since the introduction of QE2 in November 2010, the net monetary base has increased faster than inflation.
Note: A negative result implies that inflation is growing faster than the money supply, an event which indicates that a recession will occur within 1 to 36 months (with an average of 12 months)
Note: All recessions are preceded by a negative result.
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Federal Funds Rate vs 10 Year Bond Rate (spread)
Like last month, I have factored in recent market turmoil in this indicator. August ended with a reading of 220 after 10 year bond rates plummeted to 2.3% for that month. By the close of trading on 2011-09-22, rates have dropped further to a record low of 1.72%, which has led to a mid-monthly reading of 163. What I said last month still applies:
If this indicator stays true to its historical data, then there will be one of two events leading up to the beginning of the recession.
The first is if the Federal Reserve will keep the Federal Funds rate effectively at zero, which it will do barring any major inflationary outbreak. If this occurs then 10 year bond rates will drop to zero as well, or at least converge to within a few basis points. This appears to be the situation currently.
The second event will occur if the Federal Reserve increases rates in response to an outbreak of inflation. If this occurs then the Federal Funds rate will exceed the 10 year bond rate, thus placing the indicator into negative and presaging a recession. Inflation has been increasing markedly in the last six months, so this event may yet be the result.
Note: A negative result implies a highly restrictive monetary environment, an event which indicates that a recession will occur within 4 to 39 months (with an average of 22 months).
Note: If both the first and second graphs are negative at the same time it indicates that a recession will occur within 1 to 21 months (with an average of 11 months).
Note: All recessions are preceded by a negative result.
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Real 10 Year Bond Rates Rates
Real ten year bond rates came in at -0.83% in August. As I have pointed out before, all experiences of negative 10 year bond rates since the 1950s have resulted in an eventual recession.
If we take previous instances of negative real bond rates into account, a recession will start between 2011 Q4 and 2012 Q4, with 2012 Q1 the most likely. These previous experiences also indicate that unemployment will also likely peak between 12.1% and 18.7%, with a result around 16.9% the most likely.
Note: Real Interest Rates based upon 10 year Bonds can indicate how the value of money is determined in comparison with the market's safest investment. A negative result implies that inflation is eroding the savings of those who have invested in 10 Year Bonds. A negative result over a three month average indicates that a recession may occur between 4-18 months, with an average of 8½ months and a median of 6 months.
Note: Not all recessions are preceded by negative real 10 year bond rates. Nevertheless all instances of negative 10 year bond rates (since the 1950s) have been followed by a recession.
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Market Capitalisation adjusted by USDX
(The orange line is the recession line, the red line is the line of resistance)
Data Sources
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2011-08-26
Some interesting presimetrics
I did some interesting "Presimetrics" yesterday - the study of the economy under various presidential administrations and the title of a book written by Mike Kimel. Since I prefer to use Real GDP per Capita as a measurement for economic success and failure (a decline in annual Real GDP per Capita being my definition of a recession) I decided to check up on how the post-war presidents have performed. I don't know if Mike Kimel did this in his book (which I have sitting in a box in my garage) so please excuse me if I have discovered something that Mike has already pointed out.
My study started with the desire to measure economic performance under Obama against GW Bush. Of course the problem with such comparisons is that Obama has not been in office for as long as Bush had been, so I had to measure according to how many quarters each president had served and divide economic performance by those quarters. The result was very interesting - Real GDP per capita under Obama has grown by 0.29% per quarter while under GW Bush it grew by a paltry 0.19%. Encouraged by this interesting result (Newsflash: Economy growing faster under Obama than Bush!) I decided to go back and compare everyone since Eisenhower. This is the result:
By way of methodology, I access the data on Real GDP, then divided that number by the population at the end of each quarter (with 2011 population data being mid-monthly) to get a Real GDP per capita figure. I then measured the change in Real GDP per Capita from the first quarter of the president's first term in office against the final quarter of his final term in office. For Johnson and Ford, I measured the first quarter in office as the quarter they became president, which means that Kennedy's and Nixon's last quarter in office was followed by the quarter in which they ceased to be president. Once I measured the change in Real GDP per Capita as a percentage, I then divided it by how many quarters the president spent in office. So what do we find?
Obama - 0.29%
Too early to tell but there has certainly been a growth in Real GDP per Capita faster than Bush II. I am predicting another recession, so I expect this number to drop over time. Moreover Obama's result has the statistical advantage of an economic trough being followed by a recovery.
Bush II - 0.19%
His presidency was bookmarked by recessions and there is no doubt that the 2008 credit crisis affected his result badly. A quick check of the spreadsheet tells me that up until 2007 Q4, Bush's performance was 0.38% per quarter.
Clinton - 0.71%
Do we miss the 90s yet? In hindsight economic growth during Clinton's time in office was based upon the unsustainable dot-com bubble. if we measure Clinton's performance to 1994 Q4 (the quarter before the bubble began to expand), growth was lower at 0.56% which is, however, a reasonably good result.
Bush I - 0.18%
GHW Bush's result suffers from a recession at the middle and end of his single term, but even if we factor that out his performance from 1989 Q1 to 1990 Q2 the result is 0.31%. I'm wondering if GHW's figures suffer from a bust from the Reagan years (though some conservatives would argue that his "read my lips, no new taxes" taxes killed it)
Reagan - 0.62%
From memory, studies into Real GDP show that Reagan's years weren't that good. Per Capita, though, the results are worth talking about. Yet while Clinton's higher growth came at the expense of a sharemarket bubble, Reagan's growth came at the expense of the public debt. In essence, Reagan borrowed against the future to boost the present. Now that the present is Reagan's future, I would argue that we are reaping now what Reagan and congress sowed back in the 1980s. Also, let's not forget Paul Volcker - killing inflation really did stabilise the economy in the 80s.
Carter - 0.47%
Malaise never had it so good. The further into the future we get the more we realise that Carter's presidency was better than what was believed. "History's greatest monster" he was not. 0.47% growth was certainly not as good as other periods in postwar history (and certainly not as good as Reagan) but is certainly better than both Bushes, Ford and Nixon.
Ford - 0.42%
Not a great sample size admittedly (10 quarters, or 2½ years) so we could probably add this onto Nixon. Certainly not a great number compared to previous years but better than recent times.
Nixon - 0.44%
What happened here? Nixon inherited some of the strongest growth on record and managed to halve it. Two recessions (1970 and 1974) damaged it severely. We also shouldn't forget the first oil crisis as well. Barring any further evidence of economic stupidity, I don't think Nixon is responsible for such low growth in this period.
Johnson - 1.00%
The postwar US economy grew fastest on a per capita basis under Johnson. This was aided by two wars - the war in Vietnam and the war on poverty. While military expenditure created a demand for labour, conscription created a shortage of it. At the same time wealth was redistributed via poverty reducing policies and the creation of Medicare. And this was done without a huge increase in public debt.
Kennedy - 0.97%
Obviously the Johnson growth had its basis in Kennedy's 11 terms in office, though Vietnam was not as prominent in calculations here. We also need to factor in the effects of substantially better transport infrastructure, thanks to Eisenhower.
Eisenhower - 0.14%
This has to be one of the most interesting results of all. It is generally believed that the 50s saw an economic boom but what we see here is something different. Under Eisenhower, real GDP grew from $2.3484 to $2.8002 trillion, a total growth of 19.24%. But per capita figures divide this by population. Under Eisenhower, population grew from 159 million to 182 million, a total growth of 14.24%. So while the economy undoubtedly grew, the sheer number of baby boomers born in that period reduced GDP per capita something severe and thus skews the figures.
My study started with the desire to measure economic performance under Obama against GW Bush. Of course the problem with such comparisons is that Obama has not been in office for as long as Bush had been, so I had to measure according to how many quarters each president had served and divide economic performance by those quarters. The result was very interesting - Real GDP per capita under Obama has grown by 0.29% per quarter while under GW Bush it grew by a paltry 0.19%. Encouraged by this interesting result (Newsflash: Economy growing faster under Obama than Bush!) I decided to go back and compare everyone since Eisenhower. This is the result:
By way of methodology, I access the data on Real GDP, then divided that number by the population at the end of each quarter (with 2011 population data being mid-monthly) to get a Real GDP per capita figure. I then measured the change in Real GDP per Capita from the first quarter of the president's first term in office against the final quarter of his final term in office. For Johnson and Ford, I measured the first quarter in office as the quarter they became president, which means that Kennedy's and Nixon's last quarter in office was followed by the quarter in which they ceased to be president. Once I measured the change in Real GDP per Capita as a percentage, I then divided it by how many quarters the president spent in office. So what do we find?
Obama - 0.29%
Too early to tell but there has certainly been a growth in Real GDP per Capita faster than Bush II. I am predicting another recession, so I expect this number to drop over time. Moreover Obama's result has the statistical advantage of an economic trough being followed by a recovery.
Bush II - 0.19%
His presidency was bookmarked by recessions and there is no doubt that the 2008 credit crisis affected his result badly. A quick check of the spreadsheet tells me that up until 2007 Q4, Bush's performance was 0.38% per quarter.
Clinton - 0.71%
Do we miss the 90s yet? In hindsight economic growth during Clinton's time in office was based upon the unsustainable dot-com bubble. if we measure Clinton's performance to 1994 Q4 (the quarter before the bubble began to expand), growth was lower at 0.56% which is, however, a reasonably good result.
Bush I - 0.18%
GHW Bush's result suffers from a recession at the middle and end of his single term, but even if we factor that out his performance from 1989 Q1 to 1990 Q2 the result is 0.31%. I'm wondering if GHW's figures suffer from a bust from the Reagan years (though some conservatives would argue that his "read my lips, no new taxes" taxes killed it)
Reagan - 0.62%
From memory, studies into Real GDP show that Reagan's years weren't that good. Per Capita, though, the results are worth talking about. Yet while Clinton's higher growth came at the expense of a sharemarket bubble, Reagan's growth came at the expense of the public debt. In essence, Reagan borrowed against the future to boost the present. Now that the present is Reagan's future, I would argue that we are reaping now what Reagan and congress sowed back in the 1980s. Also, let's not forget Paul Volcker - killing inflation really did stabilise the economy in the 80s.
Carter - 0.47%
Malaise never had it so good. The further into the future we get the more we realise that Carter's presidency was better than what was believed. "History's greatest monster" he was not. 0.47% growth was certainly not as good as other periods in postwar history (and certainly not as good as Reagan) but is certainly better than both Bushes, Ford and Nixon.
Ford - 0.42%
Not a great sample size admittedly (10 quarters, or 2½ years) so we could probably add this onto Nixon. Certainly not a great number compared to previous years but better than recent times.
Nixon - 0.44%
What happened here? Nixon inherited some of the strongest growth on record and managed to halve it. Two recessions (1970 and 1974) damaged it severely. We also shouldn't forget the first oil crisis as well. Barring any further evidence of economic stupidity, I don't think Nixon is responsible for such low growth in this period.
Johnson - 1.00%
The postwar US economy grew fastest on a per capita basis under Johnson. This was aided by two wars - the war in Vietnam and the war on poverty. While military expenditure created a demand for labour, conscription created a shortage of it. At the same time wealth was redistributed via poverty reducing policies and the creation of Medicare. And this was done without a huge increase in public debt.
Kennedy - 0.97%
Obviously the Johnson growth had its basis in Kennedy's 11 terms in office, though Vietnam was not as prominent in calculations here. We also need to factor in the effects of substantially better transport infrastructure, thanks to Eisenhower.
Eisenhower - 0.14%
This has to be one of the most interesting results of all. It is generally believed that the 50s saw an economic boom but what we see here is something different. Under Eisenhower, real GDP grew from $2.3484 to $2.8002 trillion, a total growth of 19.24%. But per capita figures divide this by population. Under Eisenhower, population grew from 159 million to 182 million, a total growth of 14.24%. So while the economy undoubtedly grew, the sheer number of baby boomers born in that period reduced GDP per capita something severe and thus skews the figures.
2011-08-21
An analysis of the past 30 years
So I was playing around with my spreadsheet and some numbers recently and decided to work out just how much money has been invested in the sharemarket as a proportion of GDP. Of course we remember the time when the Dow hit 10,000 and unemployment was low - but it's currently over 10,000 and unemployment is high. This should indicate something strange going on, not to mention question the idea that the Dow represents the economy.
I couldn't use the Dow index, though. Instead I decided on the Wilshire 5000, which is an index that a) encompasses all shares in all publicly traded markets in the US, not just the top performing ones, and b) comes up with an index number that also closely approximates the dollar value of the entire sharemarket. For example, the W5000 index for 2011-08-18 (last Friday) closed at 11806.16, which approximates $11.8 Trillion. Historical numbers of this broad index can be found at St Louis, as always. So what happens when you look at this index and compare it to GDP? This:
By way of comparison, throughout the 1970s this index averaged around 56% of GDP, and swung between 38% and 83% of GDP. The 1980s and half the 1990s thus saw a W5000 performance not too different from previous experiences. Then from 1995 onwards we have the tech boom, which peaks in 2000 Q1 at over 140% of GDP. Yet there was no decline back to the sub 80s for the long term but a re-inflating of the bubble from 2003 Q1 onwards (which, by the way, occurs around the same time as the Federal Funds Rate drops from 1.75% to 1.25% and then 1.00% for the rest of 2003). A second, lower, peak is reached in 2007 Q2 (108%), which then plunges back down to 58% in 2009 Q1 as a natural result of the 2008 credit crisis. Since then it has re-inflated back up to 92% of GDP in 2011 Q2. Of course, there is a huge chance that this number is going to crash down again.
What appears to have happened is simple - there has been a sharemarket investment bubble that has inflated since 1995 and which has yet to be properly dealt with. My belief is that the higher the sharemarket value to GDP ratio is (as demonstrated by the graph above) the more chance there is of a bust and a damaging recession. Either the sharemarket needs to crash down or GDP has to increase to ensure a more sustainable level. Anything below 50% of GDP should be a policy goal. This can be achieved through a Tobin Tax or a Market Capitalisation Tax imposed upon the sharemarket - with taxation rates increasing the higher the ratio gets in order to prevent runaway over-investment.
This issue also reveals shortcomings in monetary policy. While monetary policy affects the entire market, it affects the financial market and its behaviour directly through its operations. If the market is in the process of over-investing, then all monetary policy ends up doing is re-inflating the bubble, rather than mitigating liquidity issues arising from a deflating bubble. Ideally monetary policy in this situation should create a "soft landing" for the deflating bubble - but in practice it has simply re-inflated the bubble and, as a result, postpones the bubble bursting to a later date.
This issue also reveals shortcomings in fiscal policy. Tax cuts for the rich have not resulted in a substantial increase in money velocity but rather a further investment into the share market.
Finally it also appears that our current economic state is the result of the tech boom's bust. We're paying now for decisions made by the financial market up to 16 years ago. While it is true that the 2008 credit crisis had a more damaging impact upon the economy and upon unemployment than the 2001 recession, we can trace back the credit crisis to the tech boom.
Now the second graph to look at concerns personal saving. I've based this upon the St Louis Fed PSAVE series which measure the dollar amount of personal saving. I've then compared it to GDP. What has happened since 1981? This:
By way of comparison, between 1951 and 1980, the ratio of personal savings to GDP averaged 6.04%, with the lowest being 3.86% in 1951 Q1 and the highest being 9.28% in 1975 Q2. The average between 1980 and today has been 4.27%.
So since 1980 personal savings as a percent of GDP has dropped. In fact it dropped below the 4% level on a more or less continual basis since... 1995 Q2. Now where have we heard of that quarter before? Oh yes... that was when the sharemarket tech bubble started. In recent years the savings ratio has tried desperately to rise above 5% but has gotten no further than 4.84%
My belief is that too much personal savings is bad, but that too little is bad as well. If we assume that the 1951-1980 period was a better period for personal saving then obviously it should increase in these times. But it hasn't. Why?
The first is that we need to look at personal saving at the same time as we look at sharemarket investing. As sharemarket investing has grown so has personal saving dropped. This indicates that people are investing more in the share market than they are in cash.
The second reason is that GDP has grown substantially in response to sharemarket investment. While it has created a "virtuous cycle" for part of that time, it means that ordinary people have had less money in proportion to GDP for them to save.
But here's another graph: Public debt.
One rule of thumb that people over the years have believed in is that when the government goes into debt, the private sector begins to save. Yet this doesn't appear to be true when it comes to personal saving. Since 1980 personal saving as proportion of GDP has decreased, while US government debt has increased. If the rule of thumb worked, then why wasn't there an increase in personal savings?
Well in one sense there was an increase in personal savings - investing in the share market. Share market investing, because it became so attractive, took money away from cash investment.
And the fourth graph is interesting too: The balance on the current account.
By way of comparison, the period between 1960 Q4 and 1979 Q4 saw an average current account surplus of 0.26% of GDP, with a high of 1.06% of GDP in 1975 Q4 and a low of -0.87% in 1978 Q3. Since 1980 the current account has averaged around -2.58% per year, with a high of 0.05% in 1991 Q4 and a low of -6.11% in 2006 Q3.
The first thing to note is that the first drop in the current account between 1984 and 1988 occurred during a time when the US Dollar increased in value. The Plaza accord was signed in 1985 Q3 to reduce the value of the US Dollar. This eventually saw the current account reach a trough in 1987 Q2 and begin to rise again.
The 1997 Asian financial crisis then saw a rush of investment into the US Dollar, which began rising again. By 1998 Q3 the current account had dropped past -2% of GDP. Since then the current account has been deeply negative.
We need to remember that the world cashed in on America's sharemarket boom as well. The current account deficit hid inflation and prevented any meaningful tightening of monetary policy to rein in the asset-price bubble that had formed.
In light of this, what would OSO do?
I couldn't use the Dow index, though. Instead I decided on the Wilshire 5000, which is an index that a) encompasses all shares in all publicly traded markets in the US, not just the top performing ones, and b) comes up with an index number that also closely approximates the dollar value of the entire sharemarket. For example, the W5000 index for 2011-08-18 (last Friday) closed at 11806.16, which approximates $11.8 Trillion. Historical numbers of this broad index can be found at St Louis, as always. So what happens when you look at this index and compare it to GDP? This:
By way of comparison, throughout the 1970s this index averaged around 56% of GDP, and swung between 38% and 83% of GDP. The 1980s and half the 1990s thus saw a W5000 performance not too different from previous experiences. Then from 1995 onwards we have the tech boom, which peaks in 2000 Q1 at over 140% of GDP. Yet there was no decline back to the sub 80s for the long term but a re-inflating of the bubble from 2003 Q1 onwards (which, by the way, occurs around the same time as the Federal Funds Rate drops from 1.75% to 1.25% and then 1.00% for the rest of 2003). A second, lower, peak is reached in 2007 Q2 (108%), which then plunges back down to 58% in 2009 Q1 as a natural result of the 2008 credit crisis. Since then it has re-inflated back up to 92% of GDP in 2011 Q2. Of course, there is a huge chance that this number is going to crash down again.
What appears to have happened is simple - there has been a sharemarket investment bubble that has inflated since 1995 and which has yet to be properly dealt with. My belief is that the higher the sharemarket value to GDP ratio is (as demonstrated by the graph above) the more chance there is of a bust and a damaging recession. Either the sharemarket needs to crash down or GDP has to increase to ensure a more sustainable level. Anything below 50% of GDP should be a policy goal. This can be achieved through a Tobin Tax or a Market Capitalisation Tax imposed upon the sharemarket - with taxation rates increasing the higher the ratio gets in order to prevent runaway over-investment.
This issue also reveals shortcomings in monetary policy. While monetary policy affects the entire market, it affects the financial market and its behaviour directly through its operations. If the market is in the process of over-investing, then all monetary policy ends up doing is re-inflating the bubble, rather than mitigating liquidity issues arising from a deflating bubble. Ideally monetary policy in this situation should create a "soft landing" for the deflating bubble - but in practice it has simply re-inflated the bubble and, as a result, postpones the bubble bursting to a later date.
This issue also reveals shortcomings in fiscal policy. Tax cuts for the rich have not resulted in a substantial increase in money velocity but rather a further investment into the share market.
Finally it also appears that our current economic state is the result of the tech boom's bust. We're paying now for decisions made by the financial market up to 16 years ago. While it is true that the 2008 credit crisis had a more damaging impact upon the economy and upon unemployment than the 2001 recession, we can trace back the credit crisis to the tech boom.
Now the second graph to look at concerns personal saving. I've based this upon the St Louis Fed PSAVE series which measure the dollar amount of personal saving. I've then compared it to GDP. What has happened since 1981? This:
By way of comparison, between 1951 and 1980, the ratio of personal savings to GDP averaged 6.04%, with the lowest being 3.86% in 1951 Q1 and the highest being 9.28% in 1975 Q2. The average between 1980 and today has been 4.27%.
So since 1980 personal savings as a percent of GDP has dropped. In fact it dropped below the 4% level on a more or less continual basis since... 1995 Q2. Now where have we heard of that quarter before? Oh yes... that was when the sharemarket tech bubble started. In recent years the savings ratio has tried desperately to rise above 5% but has gotten no further than 4.84%
My belief is that too much personal savings is bad, but that too little is bad as well. If we assume that the 1951-1980 period was a better period for personal saving then obviously it should increase in these times. But it hasn't. Why?
The first is that we need to look at personal saving at the same time as we look at sharemarket investing. As sharemarket investing has grown so has personal saving dropped. This indicates that people are investing more in the share market than they are in cash.
The second reason is that GDP has grown substantially in response to sharemarket investment. While it has created a "virtuous cycle" for part of that time, it means that ordinary people have had less money in proportion to GDP for them to save.
But here's another graph: Public debt.
One rule of thumb that people over the years have believed in is that when the government goes into debt, the private sector begins to save. Yet this doesn't appear to be true when it comes to personal saving. Since 1980 personal saving as proportion of GDP has decreased, while US government debt has increased. If the rule of thumb worked, then why wasn't there an increase in personal savings?
Well in one sense there was an increase in personal savings - investing in the share market. Share market investing, because it became so attractive, took money away from cash investment.
And the fourth graph is interesting too: The balance on the current account.
By way of comparison, the period between 1960 Q4 and 1979 Q4 saw an average current account surplus of 0.26% of GDP, with a high of 1.06% of GDP in 1975 Q4 and a low of -0.87% in 1978 Q3. Since 1980 the current account has averaged around -2.58% per year, with a high of 0.05% in 1991 Q4 and a low of -6.11% in 2006 Q3.
The first thing to note is that the first drop in the current account between 1984 and 1988 occurred during a time when the US Dollar increased in value. The Plaza accord was signed in 1985 Q3 to reduce the value of the US Dollar. This eventually saw the current account reach a trough in 1987 Q2 and begin to rise again.
The 1997 Asian financial crisis then saw a rush of investment into the US Dollar, which began rising again. By 1998 Q3 the current account had dropped past -2% of GDP. Since then the current account has been deeply negative.
We need to remember that the world cashed in on America's sharemarket boom as well. The current account deficit hid inflation and prevented any meaningful tightening of monetary policy to rein in the asset-price bubble that had formed.
In light of this, what would OSO do?
- Institute a Tobin Tax or Market Capitalisation Tax to dissuade over-investment in the sharemarket. Rates would be increased the more the market over-invests. This money would, at the moment, be useful in paying off government debt.
- Create a currency board to control US currency. This would not be an abandonment of a floating currency and nor would it be a return to Bretton Woods. Instead a currency board would act to ensure a balanced current account by entering the Forex market and either buying or selling US dollars in response to current account fluctuations. The US would also take the lead in creating a new world trade agreement to ensure that all major industrialised nations would institute currency boards to do the same thing for their own currency zones: ensure balanced current accounts (rather than current account deficits or surpluses). I go into more detail on this idea here.
- Create more broad-based monetary policy to ensure a wider scope for its effect: Quantitative easing needs to do more than just buy back government bonds - it could also be used to directly fund treasury, to create banks or even be used in Keynesian stimulus programs.
- Regulate the financial industry to dissuade the ponzi-like nature of modern financial investment. More details here.
- Expand government services with a commensurate increase in taxation to create another "New Deal". A minor "Total War" economy needs to be examined again, though with money being spent on growth (and obviously the environment and global warming) rather than on military equipment and wars. More details here.
2011-08-19
US Recession Indicators - August 2011 - Market turmoil edition
According to data from negative Real Interest Rates, another US recession is likely to occur between 2011 Q4 and 2012 Q4, with 2012 Q1 the most likely... See below.
The growth of the Net Monetary base (M0 minus excess reserves) over inflation has been above the historical average since September 2010 and has remained high at 572 in July 2011.
As a result of recent market turmoil the numbers for August will be very interesting indeed. Since a recession will not occur until this spread turns negative, and since one indicator shows that a recession will occur within 18 months, we can assume that this indicator will begin to drop down over the next few months. Inflation has already picked up again and, at 3.6%, is the highest it has been since October 2008.
Nevertheless since the introduction of QE2 in November 2010, the net monetary base has increased faster than inflation.
I have factored in recent market turmoil in this indicator. While July 2011 ended well with a reading of 293, the turmoil in recent weeks has seen 10 year bond rates drop nearly 100 basis points from 3.00% to 2.08% by the close of trading on 2011-08-18, which has led to a mid-monthly reading of 195. If this indicator stays true to its historical data, then there will be one of two events leading up to the beginning of the recession. The first is if the Federal Reserve will keep the Federal Funds rate effectively at zero, which it will do barring any major inflationary outbreak. If this occurs then 10 year bond rates will drop to zero as well, or at least converge to within a few basis points. This appears to be the situation currently. The second event will occur if the Federal Reserve increases rates in response to an outbreak of inflation. If this occurs then the Federal Funds rate will exceed the 10 year bond rate, thus placing the indicator into negative and presaging a recession. Inflation has been increasing markedly in the last six months, so this event may yet be the result. As far as I know, 6% inflation seems to be the new Fed goal so any change in the Federal Funds rate will have to see inflation increase beyond this amount.
Real ten year bond rates came in at -0.43% in July. As I have pointed out before, all experiences of negative 10 year bond rates since the 1950s have resulted in an eventual recession.
If we take previous instances of negative real bond rates into account, a recession will start between 2011 Q4 and 2012 Q4, with 2012 Q1 the most likely. These previous experiences also indicate that unemployment will also likely peak between 12.1% and 18.7%, with a result around 16.9% the most likely.
This is a new index based on some playing around with a spreadsheet. The idea is to adjust the Russell 2000 - the indice that measure market capitalisation (amount of shares multiplied by share price) for the whole market - by the US Dollar Index. This would, in turn, measure the value of US market capitalisation throughout the world, rather than just the US.
As you can see there appears to be a "line of resistance" that has formed since 2000. The high of 532.12 was reached in August 2000. The second high of 417.43 was reached in May 2007 while the third high of 351.4 was reached in February 2011. The 2000 and 2007 highs were followed by a recession and it looks as though the 2011 high might be followed by a recession too.
I'm still trying to work out if this is just a coincidence so take this indicator under advisement. Before 2000 such "lines of resistance" didn't seem to apply when looking at recession indicators. Note also that the most recent index number (286.01) is a mid August figure based upon figures from close of trading 2011-08-18.
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Net Monetary Base vs Inflation (spread)
The growth of the Net Monetary base (M0 minus excess reserves) over inflation has been above the historical average since September 2010 and has remained high at 572 in July 2011.
As a result of recent market turmoil the numbers for August will be very interesting indeed. Since a recession will not occur until this spread turns negative, and since one indicator shows that a recession will occur within 18 months, we can assume that this indicator will begin to drop down over the next few months. Inflation has already picked up again and, at 3.6%, is the highest it has been since October 2008.
Nevertheless since the introduction of QE2 in November 2010, the net monetary base has increased faster than inflation.
Note: A negative result implies that inflation is growing faster than the money supply, an event which indicates that a recession will occur within 1 to 36 months (with an average of 12 months)
Note: All recessions are preceded by a negative result.
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Federal Funds Rate vs 10 Year Bond Rate (spread)
I have factored in recent market turmoil in this indicator. While July 2011 ended well with a reading of 293, the turmoil in recent weeks has seen 10 year bond rates drop nearly 100 basis points from 3.00% to 2.08% by the close of trading on 2011-08-18, which has led to a mid-monthly reading of 195. If this indicator stays true to its historical data, then there will be one of two events leading up to the beginning of the recession. The first is if the Federal Reserve will keep the Federal Funds rate effectively at zero, which it will do barring any major inflationary outbreak. If this occurs then 10 year bond rates will drop to zero as well, or at least converge to within a few basis points. This appears to be the situation currently. The second event will occur if the Federal Reserve increases rates in response to an outbreak of inflation. If this occurs then the Federal Funds rate will exceed the 10 year bond rate, thus placing the indicator into negative and presaging a recession. Inflation has been increasing markedly in the last six months, so this event may yet be the result. As far as I know, 6% inflation seems to be the new Fed goal so any change in the Federal Funds rate will have to see inflation increase beyond this amount.
Note: A negative result implies a highly restrictive monetary environment, an event which indicates that a recession will occur within 4 to 39 months (with an average of 22 months).
Note: If both the first and second graphs are negative at the same time it indicates that a recession will occur within 1 to 21 months (with an average of 11 months).
Note: All recessions are preceded by a negative result.
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Real 10 Year Bond Rates Rates
Real ten year bond rates came in at -0.43% in July. As I have pointed out before, all experiences of negative 10 year bond rates since the 1950s have resulted in an eventual recession.
If we take previous instances of negative real bond rates into account, a recession will start between 2011 Q4 and 2012 Q4, with 2012 Q1 the most likely. These previous experiences also indicate that unemployment will also likely peak between 12.1% and 18.7%, with a result around 16.9% the most likely.
Note: Real Interest Rates based upon 10 year Bonds can indicate how the value of money is determined in comparison with the market's safest investment. A negative result implies that inflation is eroding the savings of those who have invested in 10 Year Bonds. A negative result over a three month average indicates that a recession may occur between 4-18 months, with an average of 8½ months and a median of 6 months.
Note: Not all recessions are preceded by negative real 10 year bond rates. Nevertheless all instances of negative 10 year bond rates (since the 1950s) have been followed by a recession.
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Market Capitalisation adjusted by USDX
This is a new index based on some playing around with a spreadsheet. The idea is to adjust the Russell 2000 - the indice that measure market capitalisation (amount of shares multiplied by share price) for the whole market - by the US Dollar Index. This would, in turn, measure the value of US market capitalisation throughout the world, rather than just the US.
As you can see there appears to be a "line of resistance" that has formed since 2000. The high of 532.12 was reached in August 2000. The second high of 417.43 was reached in May 2007 while the third high of 351.4 was reached in February 2011. The 2000 and 2007 highs were followed by a recession and it looks as though the 2011 high might be followed by a recession too.
I'm still trying to work out if this is just a coincidence so take this indicator under advisement. Before 2000 such "lines of resistance" didn't seem to apply when looking at recession indicators. Note also that the most recent index number (286.01) is a mid August figure based upon figures from close of trading 2011-08-18.
(The orange line is the recession line, the red line is the line of resistance)
Data Sources
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2011-07-21
A response to New Deal Democrat
"New Deal Democrat" at the Boondad blog took the time to examine my latest recession indicator and question some of the methodologies and outcomes. NDD actually contacted me a while ago and expressed some of his opinions over these issues so the fact that he has blogged about it is not only welcome but also allows me a chance to respond.
NDD specifically has an issue with using real 10 year bond rates as a recessionary indicator. The reason is that the relationship between negative real 10 year bond rates and an eventual recession appears to break down in before 1953. Now the reason why I did not use any pre-1953 data in my study is because the 10 year bond rate series (GS10) available at the St Louis Fed only starts in 1953, while seasonally adjusted inflation (CPIAUCSL) starts in 1947. NDD, however, has pointed out that a discontinued government bond data series called LTGOVTBD has data going back to 1925, and that because both GS10 and LTGOVTBD follow each other closely from 1953 to 2006 (when the series was discontinued) it is therefore a good proxy. Add to the fact that non-seasonally adjusted inflation figures (CPIAUCNS) begin in 1913 and you have the beginnings of a pre 1953 data series that could confirm or deny my assertion that negative real 10 year bond rates will always lead to recession.
And the conclusion that NDD has come up with is that they don't always lead to a recession. And here is the salient graph:
When looking at this graph, understand that whenever the red line is higher than the blue one, then that is an example of negative real 10 year bond rates (or, more specifically, negative real long term bond rates). As you can see, there are seven instances since 1925.
Now of course what I have done is to average out the results over three months. This is what we get in the first instance:
1925 and 1926 see some low rates but the only negative result occurs in January 1926. So what happens after? A recession in October 1926. Hmmm.
The second and third instances occur during the New Deal era:
Actually what is notable from this graph is the sheer height that real long term bond rates hit during the depression - peaking at 14.27% in March 1932. If anything this is pretty solid evidence that real 10 year bond rates can operate as a "window" for the economy to grow: too low and the economy crashes, too high and the economy crashes.
As you can see, real bond rates return to more reasonable levels around 1934. The key date here is March 1933 when the Emergency Banking Act was passed. Another important date was June 1933 when Glass-Steagall was passed. Both of these acts resulted in an increase in the money supply and a subsequent move out of deflation. By December 1933, prices began inflating again. This is important to realise in the data in the graph above since the presence of inflation again reduced real long term bond rates from the stratosphere of 14% to around 3% by December 1933.
Of course the graph then shows that in 1934, inflation had reached a point where real long term bond rates had turned negative. They turn negative again for a short time in 1935, and then negative again 1937... which, um, then turns into another recession.
I suppose I could argue that the instances of negative real long term bond rates in 1934, 1935 and 1937 were the cause of the 1937 recession. I think that is not an unreasonable assumption to make, especially the 1937 instance. We need to remember though that the massive hangover of debt and deflation that typified the great depression's stratospheric real long term bond rates needed a little bit more than a few months of negative long term rates to balance against. Nevertheless, if my "window" theory is true, then it could possibly be said that the US economy might've avoided the 1937 recession had real ten year bond rates always remained positive from 1934 onwards. In short, too much inflation was created.
After all, you could put out a house fire with a fire hose, but if you immerse the burning house in the sea, you still end up damaging it badly.
Okay, so let's move on to the war and post-war years:
So as you can see, the war brought about a huge drop in real 10 year bond rates. A recession occurs in February 1945, and then another huge drop in real ten year bond rates occurs during 1946-1949. In fact that period has the deepest recorded period of negative real long term bond rates (which peaks at -16.96% in April 1947). Then another recession hits in November 1948. Then another period of negative rates hits between 1950-1952, followed by a recession in 1953. Beyond this point my data series kicks in.
The first thing to look at here is the effect of the war, specifically the effect of a Total war economy upon the United States. This graph shows what I'm talking about:
Between Japan's attack on Pearl Harbor and the demobilisation of forces in 1946, the US government effectively quadrupled in size. This was due to massive spending to create a war machine capable of defeating Japan and Germany. The growth in the size of government was not "added onto" the economy, but effectively "crowded out" the private sector. The US government increased taxation and went on a massive borrowing spree to fund the war.
Now this is very important for us to understand. In my analysis of real long term bond rates, we're not just looking at causal relationships but also the effect of such causal relationships to the wider economy. Long term bond rates are an indication of how the market is acting at a certain time. If the government is 10% of the economy then the private sector is 90% of the economy, which means that any negative long term bond rates are being experienced by that 90%. But in the war years we see an increase in the size of government and a decrease in the size of the private sector. This means that the negative real long term bond rates during this period are only experienced by around 55% to 60% of the economy. Thus the effect would be less - hence the lack of recession until 1945.
As for the period of negative real long term bond rates between 1946 and 1949, these end up presaging the 1948-49 recession.
In short while the pre-1953 data is essential to examine, I do not think that it rules out the correlation and causation effect at all. Two huge events - The Great Depression and World War 2 - are enough to affect the quality of the data under examination.
There is another issue: Is LTGOVTBD a good proxy for GS10? Just because they correlate when they are measured concurrently doesn't mean that the same correlation existed pre-GS10. Long term government bond rates hardly move much at all between 1925 to 1956, despite the huge swings in inflation and deflation in this period. They do not exhibit the same ups and downs which typify GS10 rates. this makes me think that LTGOVTBD rates, at least in the early days, were pegged by government order. GS10, especially from the 60s onward, seem to move according to the actions of the market.
And finally an answer to a commenter at Boondad who points out:
I think this commentator has got it wrong because the interest rate, while certainly applicable over a ten year period, is determined by what the market wants at the time. So while it has a long term function it also has a short term indicative effect. Bond rates go up when investors see bonds less as less attractive to other investments (such as shares) and go down when the market is running away from something. This can be seen during late 2008 when bond rates plunged to 2.42% during the credit crunch after being 4.1% 5 months before. The idea is that the interest rates of government bonds is a way of measuring market sentiment and activity. 10 year bonds are thus a good measurement of what is going on at the time that they are invested in.
And my argument is that when investors put money into ten year bonds they are essentially investing in something "safe". But when inflation exceeds that "safe" investment, things go wrong and a recession follows. This will be because a calculation of your return on interest will be less than the increase in consumer prices. In other words, the amount of money you gain from such an investment will be less than your increase in spending. Thus a recession. And if my "window" theory is correct, a recession will also occur when the amount of money you gain from an investment will be more than offset by a decrease in income from other sources.
NDD specifically has an issue with using real 10 year bond rates as a recessionary indicator. The reason is that the relationship between negative real 10 year bond rates and an eventual recession appears to break down in before 1953. Now the reason why I did not use any pre-1953 data in my study is because the 10 year bond rate series (GS10) available at the St Louis Fed only starts in 1953, while seasonally adjusted inflation (CPIAUCSL) starts in 1947. NDD, however, has pointed out that a discontinued government bond data series called LTGOVTBD has data going back to 1925, and that because both GS10 and LTGOVTBD follow each other closely from 1953 to 2006 (when the series was discontinued) it is therefore a good proxy. Add to the fact that non-seasonally adjusted inflation figures (CPIAUCNS) begin in 1913 and you have the beginnings of a pre 1953 data series that could confirm or deny my assertion that negative real 10 year bond rates will always lead to recession.
And the conclusion that NDD has come up with is that they don't always lead to a recession. And here is the salient graph:
When looking at this graph, understand that whenever the red line is higher than the blue one, then that is an example of negative real 10 year bond rates (or, more specifically, negative real long term bond rates). As you can see, there are seven instances since 1925.
Now of course what I have done is to average out the results over three months. This is what we get in the first instance:
1925 and 1926 see some low rates but the only negative result occurs in January 1926. So what happens after? A recession in October 1926. Hmmm.
The second and third instances occur during the New Deal era:
Actually what is notable from this graph is the sheer height that real long term bond rates hit during the depression - peaking at 14.27% in March 1932. If anything this is pretty solid evidence that real 10 year bond rates can operate as a "window" for the economy to grow: too low and the economy crashes, too high and the economy crashes.
As you can see, real bond rates return to more reasonable levels around 1934. The key date here is March 1933 when the Emergency Banking Act was passed. Another important date was June 1933 when Glass-Steagall was passed. Both of these acts resulted in an increase in the money supply and a subsequent move out of deflation. By December 1933, prices began inflating again. This is important to realise in the data in the graph above since the presence of inflation again reduced real long term bond rates from the stratosphere of 14% to around 3% by December 1933.
Of course the graph then shows that in 1934, inflation had reached a point where real long term bond rates had turned negative. They turn negative again for a short time in 1935, and then negative again 1937... which, um, then turns into another recession.
I suppose I could argue that the instances of negative real long term bond rates in 1934, 1935 and 1937 were the cause of the 1937 recession. I think that is not an unreasonable assumption to make, especially the 1937 instance. We need to remember though that the massive hangover of debt and deflation that typified the great depression's stratospheric real long term bond rates needed a little bit more than a few months of negative long term rates to balance against. Nevertheless, if my "window" theory is true, then it could possibly be said that the US economy might've avoided the 1937 recession had real ten year bond rates always remained positive from 1934 onwards. In short, too much inflation was created.
After all, you could put out a house fire with a fire hose, but if you immerse the burning house in the sea, you still end up damaging it badly.
Okay, so let's move on to the war and post-war years:
So as you can see, the war brought about a huge drop in real 10 year bond rates. A recession occurs in February 1945, and then another huge drop in real ten year bond rates occurs during 1946-1949. In fact that period has the deepest recorded period of negative real long term bond rates (which peaks at -16.96% in April 1947). Then another recession hits in November 1948. Then another period of negative rates hits between 1950-1952, followed by a recession in 1953. Beyond this point my data series kicks in.
The first thing to look at here is the effect of the war, specifically the effect of a Total war economy upon the United States. This graph shows what I'm talking about:
Between Japan's attack on Pearl Harbor and the demobilisation of forces in 1946, the US government effectively quadrupled in size. This was due to massive spending to create a war machine capable of defeating Japan and Germany. The growth in the size of government was not "added onto" the economy, but effectively "crowded out" the private sector. The US government increased taxation and went on a massive borrowing spree to fund the war.
Now this is very important for us to understand. In my analysis of real long term bond rates, we're not just looking at causal relationships but also the effect of such causal relationships to the wider economy. Long term bond rates are an indication of how the market is acting at a certain time. If the government is 10% of the economy then the private sector is 90% of the economy, which means that any negative long term bond rates are being experienced by that 90%. But in the war years we see an increase in the size of government and a decrease in the size of the private sector. This means that the negative real long term bond rates during this period are only experienced by around 55% to 60% of the economy. Thus the effect would be less - hence the lack of recession until 1945.
As for the period of negative real long term bond rates between 1946 and 1949, these end up presaging the 1948-49 recession.
In short while the pre-1953 data is essential to examine, I do not think that it rules out the correlation and causation effect at all. Two huge events - The Great Depression and World War 2 - are enough to affect the quality of the data under examination.
There is another issue: Is LTGOVTBD a good proxy for GS10? Just because they correlate when they are measured concurrently doesn't mean that the same correlation existed pre-GS10. Long term government bond rates hardly move much at all between 1925 to 1956, despite the huge swings in inflation and deflation in this period. They do not exhibit the same ups and downs which typify GS10 rates. this makes me think that LTGOVTBD rates, at least in the early days, were pegged by government order. GS10, especially from the 60s onward, seem to move according to the actions of the market.
And finally an answer to a commenter at Boondad who points out:
You cannot calculate CURRENT "real long term interest rates." It's a fallacy.
To calculate a CURRENT "real long term interest rate," you would need to know what "inflation" (CPI, whatever) WILL BE over the next TEN YEARS while you collect your 10-Year Treasury Coupons. You don't know that.
I think this commentator has got it wrong because the interest rate, while certainly applicable over a ten year period, is determined by what the market wants at the time. So while it has a long term function it also has a short term indicative effect. Bond rates go up when investors see bonds less as less attractive to other investments (such as shares) and go down when the market is running away from something. This can be seen during late 2008 when bond rates plunged to 2.42% during the credit crunch after being 4.1% 5 months before. The idea is that the interest rates of government bonds is a way of measuring market sentiment and activity. 10 year bonds are thus a good measurement of what is going on at the time that they are invested in.
And my argument is that when investors put money into ten year bonds they are essentially investing in something "safe". But when inflation exceeds that "safe" investment, things go wrong and a recession follows. This will be because a calculation of your return on interest will be less than the increase in consumer prices. In other words, the amount of money you gain from such an investment will be less than your increase in spending. Thus a recession. And if my "window" theory is correct, a recession will also occur when the amount of money you gain from an investment will be more than offset by a decrease in income from other sources.
2011-07-20
US Recession Indicators - July 2011
According to data from negative Real Interest Rates, another US recession is likely to occur between 2011 Q4 and 2012 Q4, with 2012 Q1 the most likely... See below.
The growth of the Net Monetary base (M0 minus excess reserves) over inflation has been above the historical average since September 2010 and has increased even further with a June reading of 598. This is an increase from last month's reading of 540.
Since the introduction of QE2 in November 2010, the net monetary base has increased faster than inflation.
The 10 Year Bond Rate has decreased markedly from 3.46% in April to 3.17% in May and 3.00% in June. The Federal Funds rate remains at near zero. As a result the June spread comes in at 291 basis points, well above the historical average but a decrease from the previous readings.
Again a tweak to my reporting in this area after discovering that a three monthly average was better than a monthly result. I have also decided to call this indicator "Real 10 Year Bond Rates" rather than "Real Interest Rates" since the latter term can be used to refer to the Federal Funds Rate.
Real ten year bond rates came in at -0.12% in June. As I have pointed out before, all experiences of negative 10 year bond rates since the 1950s have resulted in an eventual recession.
If we take previous instances of negative real bond rates into account, a recession will start between 2011 Q4 and 2012 Q4, with 2012 Q1 the most likely. These previous experiences also indicate that unemployment will also likely peak between 12.1% and 18.7%, with a result around 16.9% the most likely.
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Net Monetary Base vs Inflation (spread)
The growth of the Net Monetary base (M0 minus excess reserves) over inflation has been above the historical average since September 2010 and has increased even further with a June reading of 598. This is an increase from last month's reading of 540.
Since the introduction of QE2 in November 2010, the net monetary base has increased faster than inflation.
Note: A negative result implies that inflation is growing faster than the money supply, an event which indicates that a recession will occur within 1 to 36 months (with an average of 12 months)
Note: All recessions are preceded by a negative result.
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Federal Funds Rate vs 10 Year Bond Rate (spread)
The 10 Year Bond Rate has decreased markedly from 3.46% in April to 3.17% in May and 3.00% in June. The Federal Funds rate remains at near zero. As a result the June spread comes in at 291 basis points, well above the historical average but a decrease from the previous readings.
Note: A negative result implies a highly restrictive monetary environment, an event which indicates that a recession will occur within 4 to 39 months (with an average of 22 months).
Note: If both the first and second graphs are negative at the same time it indicates that a recession will occur within 1 to 21 months (with an average of 11 months).
Note: All recessions are preceded by a negative result.
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Real 10 Year Bond Rates Rates
Again a tweak to my reporting in this area after discovering that a three monthly average was better than a monthly result. I have also decided to call this indicator "Real 10 Year Bond Rates" rather than "Real Interest Rates" since the latter term can be used to refer to the Federal Funds Rate.
Real ten year bond rates came in at -0.12% in June. As I have pointed out before, all experiences of negative 10 year bond rates since the 1950s have resulted in an eventual recession.
If we take previous instances of negative real bond rates into account, a recession will start between 2011 Q4 and 2012 Q4, with 2012 Q1 the most likely. These previous experiences also indicate that unemployment will also likely peak between 12.1% and 18.7%, with a result around 16.9% the most likely.
Note: Real Interest Rates based upon 10 year Bonds can indicate how the value of money is determined in comparison with the market's safest investment. A negative result implies that inflation is eroding the savings of those who have invested in 10 Year Bonds. A negative result over a three month average indicates that a recession may occur between 4-18 months, with an average of 8½ months and a median of 6 months.
Note: Not all recessions are preceded by negative real 10 year bond rates. Nevertheless all instances of negative 10 year bond rates (since the 1950s) have been followed by a recession.
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2011-06-30
The events leading up to the coming downturn
Further to my thinking from last post, I began to consider the two other recession indicators I have discovered - obviously they will both turn negative in time for the next downturn. This means there is a possibility that we can predict what may occur.In short we have two potential outcomes leading up to the downturn: an inflationary one or a deflationary one.
Net Monetary Base vs Inflation (spread)
This measures the growth of the net monetary base (M0 minus excess reserves) over inflation. My original study is here. If we assume that a recession is due, what will happen to this indicator as it approaches? For the spread to turn negative, inflation must exceed the growth of the net monetary base. This can happen one of three ways: An increase in inflation; a decrease in the Net Monetary Base; a combination of the two.
An inflationary outcome would result in inflation outstripping the new monetary base. This would mean that, in the time leading up to the recession, inflation would increase. If the Fed does not instigate any Quantitative Easing, the chances are that this increase in inflation won't necessarily be big. Although a Latin America style inflation increase is possible, it's probably likely for inflation to get close to 10% and not much more before the recession hits. The only reason I use for this is that, historically, the US hasn't experienced a hyper-inflationary hit.
We need to also understand that the Fed has probably pushed the inflation limit to around 6%. I remember Krugman talking about this and the Fed's reluctance to increase the Federal Funds rate (currently 0.09%) in the face of growing inflation (now 3.4% - the last time inflation increased to around this level in October 2007, the Federal Funds rate was 4.76%) speaks for itself. So we're probably looking at inflation increasing to beyond 6% and up to around 8% before the Fed begins to push rates up again. By that stage inflation would have increased beyond the growth of the Net Monetary Base.
An increase in the price or oil and/or a decrease in the value of the US Dollar (the USDX) is likely to accompany this inflationary growth.
For a deflationary outcome, this would mean that the Net Monetary Base would be shrinking faster than the inflation rate - which would remain benign or turn into deflation. Only once in postwar history has the Net Monetary Base declined: in December 2000 and January 2001, a decline which presaged a recession later in the year.
The deflationary outcome, like the inflationary one, won't have to be sudden or substantial to presage the recession. If inflation sits at 1% and the Net Monetary Base grows as 0.5% - both near zero but slightly inflationary - the result will still be a negative spread and an upcoming recession.
A decrease in the price of oil and an increase in the value of the US Dollar (the USDX) is likely to accompany this deflationary outcome.
The May 2011 result for this indicator was 540, still in positive territory. As the recession approaches this number will drop quite substantially. Moreover, considering the time it will take for this result to drop, a 2011 Q3 recession start date (next quarter) is highly unlikely.
Federal Funds Rate vs 10 Year Bond Rate (spread)
This measure the difference between the 10 year bond rate (GS10) and the Federal Funds Rate (FEDFUNDS). When the 10 Year bond rate drops below the Federal Funds Rate, the data indicates that a recession will follow.
The 10 Year Bond rate is, according to my stock ticker, 3.11%. The Federal Funds Rate is currently 0.09%. In order for this spread to turn negative, the Federal Funds Rate must increase, or the 10 Year Bond Rate must decrease, or a combination of the two must occur.
The only way the Federal Funds Rate will be increased is when the Fed decides that the problem of inflation is greater than the problem of high unemployment and low economic growth. As I stated above this thinking seems to hover around the 6% inflation level, so chances are that the Fed will begin to raise the Federal Funds rate once inflation begins to increase beyond 6%. As these rates go up in response to more inflation, it will inevitably exceed the 10 Year Bond Rate, thus presaging the downturn. This is the inflationary outcome.
The deflationary outcome would mean that the Federal Funds Rate remain low while the 10 Year Bond Rate crashes down to similar levels. This, in turn, would mean that the Bond Rate would be 0.09% or below. This, of course, would indicate massive financial distress that would be accompanied by a sharemarket crash of epic proportions and a credit crunch that would make 2008 look like a picnic. A soaring US Dollar is likely to accompany such a crunch (as it did in 2008).
So what will happen?
The most likely scenario in my mind is one in which inflation increases beyond 6%, forcing the Fed to increase the Federal Funds Rate. This growth in inflation will exceed any increase in the Net Monetary Base. The increase in the Federal Funds Rate will also allow the spread between it and the 10 Year Bond Rate to narrow and eventually turn negative.
The reason why this is the most likely scenario is that inflation is already increasing, and the Fed has chosen a deliberately inflationary policy (Quantitative Easing). Peak Oil ensures that oil supplies will be harder to maintain, thus forcing an increase in oil prices and thus inflation.
So when will this happen?
As I have pointed out in my last prognosis, the next downturn will begin any time between 2011 Q4 and 2012 Q4. In the 6-18 months prior to this, we will see inflation increasing beyond 6%.
It's important to keep an eye on the recession indicators over the coming months. Watch as the Net Monetary Base / Inflation spread begins to drop towards zero. As inflation increases keep an eye on Fed announcements on monetary tightening, with the knowledge that an increase in the Federal Funds Rate will inevitably lead to a negative spread between the funds rate and the 10 Year Bond Rate.
Can the downturn be avoided?
No. I'm fairly certain that it will happen within the timeframe that I predict. The only thing that would save us is a return to positive real interest rates in June, a result that would imply an increase in bond rates and/or deflation.
What would OSO do if he were Ben Bernanke, armed with this knowledge?
Raise interest rates / tighten monetary policy. Get the recession over and done with. Set a tighter inflation target (preferably "zeroflation"), rather than a looser one.
What will we learn from this experience?
The 2008 crisis caused a rethink in inflation expectations - specifically whether current inflation targets weren't working. I agreed with this rethink but suggested that future policy be aimed at what Krugman calls "Hard Money". My argument was and still is that prices need to remain constant, neither inflating nor deflating over the long run, and that the best way to measure success at this level is to have the GDP deflator at zero over the long term. Unfortunately current thinking is that inflation targets need to be looser rather than stricter (eg Krugman, Stiglitz). I believe that these loose policies have created the conditions for negative real interest rates which will now doom the US economy to another downturn. Had "Hard Money" policy been enacted (by which inflation was controlled), there is no doubt that the current recovery would be slower but at least it would be sustainable. As it is, the loose money policy will simply create another bust and make things even worse.
I've also believed that national debt needs to be paid off rather than inflated away or defaulted. Using the policies we already have at hand I have suggested that the best way to turn around government finances is to raise taxes on the rich rather than cut spending. Taxing an overinvested share market through a Tobin Tax or a market capitalisation tax would serve to both punish financial bubble formation and create revenue to pay back debt. As for new policy, I would suggest someone seriously implement part of my zero tax economic system and simply pay off debt through money printing (what is now known as Quantitative Easing) while increasing the reserve ratio to prevent any resulting inflation. And as for reducing unemployment... set up a universal employment subsidy that makes it cheaper for firms to employ people while simultaneously raising wages - all at the expense of higher taxes (or more QE).
2011-06-24
US Recession Indicators - June 2011
According to data from negative Real Interest Rates, another US recession is likely to occur between 2012-Q1 to 2014-Q1, with 2012-Q4 being the most likely. See below.
The growth of the Net Monetary base (M0 minus excess reserves) over inflation has been above the historical average since September 2010 and has increased even further with an April reading of 540. This is an increase from last month's reading of 536.
Inflation readings in May continue to grow. The index reading of 224.804 implies annual inflation of 3.4%. Prices since December (220.186) have increased by 2.1%, which implies an annualised inflation rate of 5.0%, still uncomfortably high. As 2011 continues the momentum of these high monthly figures will translate into higher annual inflation.
Since the introduction of QE2 in November 2010, the net monetary base has increased faster than inflation.
The 10 Year Bond Rate has increased over the past few months while the Federal Funds rate remains at near zero. The April spread comes in at 308 basis points, well above the historical average.
As a result of recent discoveries in this area of Real Interest Rates, I have chosen instead to report the monthly results of 10 Year Bonds Rates minus inflation, rather than the previous method of the Federal Funds Rate minus inflation.
As this recent discovery noted, real interest rates in the US dropped to -0.27% in May 2011, which means that a recession indicator has been triggered. Since recessions have occurred between 5-32 months after negative readings, we can expect another recession to begin between 2012-Q1 to 2014-Q1, with 2012-Q4 being the most likely.
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Net Monetary Base vs Inflation (spread)
The growth of the Net Monetary base (M0 minus excess reserves) over inflation has been above the historical average since September 2010 and has increased even further with an April reading of 540. This is an increase from last month's reading of 536.
Inflation readings in May continue to grow. The index reading of 224.804 implies annual inflation of 3.4%. Prices since December (220.186) have increased by 2.1%, which implies an annualised inflation rate of 5.0%, still uncomfortably high. As 2011 continues the momentum of these high monthly figures will translate into higher annual inflation.
Since the introduction of QE2 in November 2010, the net monetary base has increased faster than inflation.
Note: A negative result implies that inflation is growing faster than the money supply, an event which indicates that a recession will occur within 1 to 36 months (with an average of 12 months).
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Federal Funds Rate vs 10 Year Bond Rate (spread)
The 10 Year Bond Rate has increased over the past few months while the Federal Funds rate remains at near zero. The April spread comes in at 308 basis points, well above the historical average.
Note: A negative result implies a highly restrictive monetary environment, an event which indicates that a recession will occur within 4 to 39 months (with an average of 22 months).
Note: If both the first and second graphs are negative at the same time it indicates that a recession will occur within 1 to 21 months (with an average of 11 months).
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Real Interest Rates
As a result of recent discoveries in this area of Real Interest Rates, I have chosen instead to report the monthly results of 10 Year Bonds Rates minus inflation, rather than the previous method of the Federal Funds Rate minus inflation.
As this recent discovery noted, real interest rates in the US dropped to -0.27% in May 2011, which means that a recession indicator has been triggered. Since recessions have occurred between 5-32 months after negative readings, we can expect another recession to begin between 2012-Q1 to 2014-Q1, with 2012-Q4 being the most likely.
Note: Real Interest Rates based upon 10 year Bonds can indicate how the value of money is determined in comparison with the market's safest investment. A negative result implies that inflation is eroding the savings of those who have invested in 10 Year Bonds, and indicates that a recession may occur between 5-32 months, with an average of 16.5 months and a median of 14.5 months.
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2011-06-17
A Recession indicator has been triggered
One measure of real interest rates went into negative territory after the release of last week's inflation figures. The history of this measurement clearly shows that a recession will follow. If my estimations are right, a US recession will occur in probably 16½ months (2012 Q4), with anything from 5 to 32 months possible.
This measurement of real interest rates is not the one I have been studying in my monthly recession watches, but another one which I have mentioned before on this blog.
The "Real Interest Rate" is usually defined as the nominal interest rate minus inflation. In the case of the US, this is usually measured as the Federal Funds Rate minus the annual inflation rate. Yet this measurement can be problematic since the Federal Funds Rate is controlled not by the market, but by the Federal Reserve Bank. So instead of using the Federal Funds Rate, I have often used the 10 year bond rate as the interest rate part of the equation. So in this case, it would be the 10 year bond rate minus annual inflation.
I initially dismissed this measurement of real interest rates because a quick glance at its history showed that recessions have occurred without this real interest rate turning negative. But after last week's inflation report, and the subsequent negative result for this real interest rate on my spreadsheet, I began to study it a bit more. Here is the data since 1954:
It's clear that there are a lot of recessions since 1954 that didn't involve this negative real interest rate. Recessions in 1954, 1956, 1970, 1982, 1991 and 2001 all occurred when real interest rates were positive. Yet this is not the whole story. What I discovered from this analysis is that while recessions can occur without negative real interest rates, whenever negative real interest rates do occur, they are always followed by an eventual recession. This occurred in 1957, 1974, 1980 and 2008.
The longest period between a negative real interest rate result and an eventual recession is 32 months, and that occurred in 2005, with the 2008 recession following it. The 2005 result may seem to be an exception to this rule, but when compared to similar recession markers from that period, the 2005 result pretty much correlates with the inflationary surge caused by Hurricane Katrina.
So what about the present? Last week US inflation for May 2011 came in at 3.4438% while Ten Year Bond Rates for that month were 3.17%, which meant that real interest rates dropped to -0.2738%. You can see this on the last graph above, with the line dropping below zero. If real interest rates rebound into positive territory for June, thus giving it a single negative month, it will be similar to the 2005 result (September 2005 came in at -0.54%, but with over 24 months of positive results after it). But if the June result continues to be negative, and if this continues into July, then the chances are that a recession will be sooner rather than later.
Of course despite the fact that data goes back to 1954, there is just not enough historical correlation to make a 2012 Q4 recession (or thereabouts) an absolute certainty.
As a tl;dr, remember this:
Whenever Negative Real Interest Rates (10 year bond rate minus annual inflation) do occur, they are always followed by an eventual recession.
This measurement of real interest rates is not the one I have been studying in my monthly recession watches, but another one which I have mentioned before on this blog.
The "Real Interest Rate" is usually defined as the nominal interest rate minus inflation. In the case of the US, this is usually measured as the Federal Funds Rate minus the annual inflation rate. Yet this measurement can be problematic since the Federal Funds Rate is controlled not by the market, but by the Federal Reserve Bank. So instead of using the Federal Funds Rate, I have often used the 10 year bond rate as the interest rate part of the equation. So in this case, it would be the 10 year bond rate minus annual inflation.
I initially dismissed this measurement of real interest rates because a quick glance at its history showed that recessions have occurred without this real interest rate turning negative. But after last week's inflation report, and the subsequent negative result for this real interest rate on my spreadsheet, I began to study it a bit more. Here is the data since 1954:
It's clear that there are a lot of recessions since 1954 that didn't involve this negative real interest rate. Recessions in 1954, 1956, 1970, 1982, 1991 and 2001 all occurred when real interest rates were positive. Yet this is not the whole story. What I discovered from this analysis is that while recessions can occur without negative real interest rates, whenever negative real interest rates do occur, they are always followed by an eventual recession. This occurred in 1957, 1974, 1980 and 2008.
The longest period between a negative real interest rate result and an eventual recession is 32 months, and that occurred in 2005, with the 2008 recession following it. The 2005 result may seem to be an exception to this rule, but when compared to similar recession markers from that period, the 2005 result pretty much correlates with the inflationary surge caused by Hurricane Katrina.
So what about the present? Last week US inflation for May 2011 came in at 3.4438% while Ten Year Bond Rates for that month were 3.17%, which meant that real interest rates dropped to -0.2738%. You can see this on the last graph above, with the line dropping below zero. If real interest rates rebound into positive territory for June, thus giving it a single negative month, it will be similar to the 2005 result (September 2005 came in at -0.54%, but with over 24 months of positive results after it). But if the June result continues to be negative, and if this continues into July, then the chances are that a recession will be sooner rather than later.
Of course despite the fact that data goes back to 1954, there is just not enough historical correlation to make a 2012 Q4 recession (or thereabouts) an absolute certainty.
As a tl;dr, remember this:
Whenever Negative Real Interest Rates (10 year bond rate minus annual inflation) do occur, they are always followed by an eventual recession.
2011-06-11
2011-05-21
US Recession Indicators - May 2011
Net Monetary Base vs Inflation (spread)
The growth of the Net Monetary base (M0 minus excess reserves) over inflation has been above the historical average since September 2010 and has increased even further with an April reading of 536. This is an increase from last month's reading of 529. Despite the high reading of 2011 Q1 over the average, GDP growth for this period was only moderate (confounding my own predictions of substantial growth).
Inflation readings in April continue to grow. The index reading of 224.433 implies annual inflation of 3.1% but the annualised monthly figure was 5.1%. Prices since December (220.186) have increased by 1.9%, which implies an annualised inflation rate of 4.6%, still uncomfortably high. As 2011 continues the momentum of these high monthly figures will translate into higher annual inflation.
Since the introduction of QE2 in November 2010, the net monetary base has increased faster than inflation. This unconventional policy by the Fed continues to provide the conditions for good economic growth.
Note: A negative result implies that inflation is growing faster than the money supply, an event which indicates that a recession will occur within 1 to 36 months (with an average of 12 months)
Note: A Decline in annual Real GDP per Capita is my definition of a "recession"
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Federal Funds Rate vs 10 Year Bond Rate (spread)
The 10 Year Bond Rate has increased over the past few months while the Federal Funds rate remains at near zero. The April spread comes in at 336 basis points, well above the historical average and safely in positive territory.
Note: A negative result implies a highly restrictive monetary environment, an event which indicates that a recession will occur within 4 to 39 months (with an average of 22 months).
Note: If both the first and second graphs are negative at the same time it indicates that a recession will occur within 1 to 21 months (with an average of 11 months).
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Real Interest Rates
Inflation in the past four months has picked up considerably, which means that Real Interest Rates in April dropped further to -3.0% - well below the historical average of 1.6%. This is now the 18th negative month in a row.
Since 1955 there have been five long periods of negative Real Interest Rates:
- 1957-12 to 1958-10: 11 months (average -1.4%)
- 1974-09 to 1977-09: 37 months (average -1.9%)
- 2002-10 to 2005-04: 31 months (average -1.1%)
- 2008-01 to 2008-11: 11 months (average -2.1%)
- 2009-11 to 2011-04: 18 months (average -1.7%)
Note: Real Interest Rates are another way of measuring monetary conditions. While inflation implies that cash by itself is losing its value, a negative real interest rate implies that cash accounts in banks are losing value as well (even while earning interest). The IMF strongly recommends that economies keep real interest rates positive to preserve the value of money and to prevent investment bubbles from occurring.
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