A reminder

I still consider myself an "Austerian" in the sense that strategies must be put in place to reduce US government debt. My solution is not to cut spending, though, but to increase spending and to increase taxes even more.

So do I like the idea of the Republicans and Obama working together to lower taxes and cut spending? No. Taxes need to be raised. The only thing that needs to be cut is military spending.

So do I like the idea that the US Federal Government should just spend more in stimulus packages? No. Any increase in spending must be over the long term rather than the short term, and no spending increases should be implemented without tax increases.

Bigger government is needed for the US economy - OSO's New Deal

This graph from Calculated Risk has been worrying me for a while:

The most noticeable thing about this particular recession is just how long it has taken for unemployment to recover - or not recover as the case is. But this is not an isolated case. The 2001 recession took ages for unemployment to recover, as did the 1990 recession. Obviously something has happened to the US economy that has prevented quick employment recovery even while GDP recovers.

I'm still trying to work out what that is. I have at theory but that will come in another posting.

What is obvious though is that the market is just not creating enough jobs. While the cause might be debatable, the result is not.

But what is needed to fix this is not just another round of stimulus packages. What is needed is a structural expansion of government spending. In essence, the US government needs to spend more.

Of course readers of this blog might wonder if I have changed my mind from recent times when I advocated austerity. The problem is that the word "austerity" has ended up becoming synonymous with spending cuts - which is the favoured position of conservatives. While I have advocated spending cuts in the area of military spending I came to the conclusion that the only way the US could ever hope to cut enough spending to make any difference would be to destroy Medicare or Social Security (and I don't use the word "destroy" lightly - you'd be looking at cuts of over 50% to make any difference). The alternative is to raise taxes - and that is the option I have always promoted. I still define this as "austerity" since it causes pain, but it is not the preferred description of the word in these times.

What I have done, though, is change my position on the market's ability to recover properly. I would've been happy for Obama to cut military spending and raise taxes in order to run a small deficit (at the least) but do little else while the economy stumbles, falls and eventually recovers from my austerity package. Now I realise that the economy wouldn't recover - at least not quick enough to make any difference.

So here's my big government solution:

More government spending.

I would create the following long term or permanent programs:

1. Universal Health Care. This would involve "Medicare for all" and would probably increase the size of government by 4-5% percent of GDP. So you're looking at an increase in government spending from around 25% of GDP to around 29-30% of GDP. This would naturally have the effect of Keynesian stimulus but the result would be healthier citizens - something that would boost the productivity of workers. The increase in spending relative to GDP would be permanent.
   
2. Building a renewable energy infrastructure. This would involve the eventual shutting down of all coal and gas powered power stations and the building of renewable alternatives to replace them. Developing nuclear reactors based on the Thorium & Molten Salt technologies would be acceptable but I can't get over the sheer availability of deep geothermal power: they would be expensive to develop and build but once they're there they will last for many decades. To fast-track the building of these, a renewable energy sector would take at least 10 years to complete. But as we can see from the military buildup during world war 2, all it takes is the will to do it. This would radically reduce America's carbon emissions. An upgrading of America's electricity grid would also accompany this. You're looking at adding another 1-2% of GDP being spent on this over a ten year period.
   
3. Mandate and support an electric car industry. This would involve a legal framework preventing the sale and registration of carbon-emitting cars by a certain date (say 10 years in the future) but would also need substantial government investment in battery technology. The Nissan Leaf, the first real "electric car" sold to the market, still has only a short range. Inventing batteries that hold more power is essential if electric cars are to effectively replace their petroleum or lpg powered competitors. Spending on this program would also build a nationwide network of recharging stations to ensure that no electric car is out of recharging range. Not only would such a program reduce carbon emissions, they would also reduce America's dependence upon oil and mitigate the problem of Peak Oil. Add another 1% to GDP being spent on this over a ten year period.
   
4. Set up a national water grid. This would involve potable water being distributed over all states and towns throughout a national network of water pipes and purification plants. This would ensure that any future droughts in the US (brought on by global warming) would not affect town and urban water supplies. It would theoretically mean water sourced from Seattle finding its way to Texas through this proposed water grid. While this would require a huge amount of work, a lot of the work would simply involve connecting up disparate water infrastructure and bringing standards up to a national level. You could probably add 0.1% to 0.5% of GDP on this over a ten year period.
5. Provide a national child tutoring strategy. This would involve the hiring of personal tutors to deliver numeracy and literacy skills to the nation's Kindergarten,1st and 2nd grade students. Each student would receive one hour of personal tutoring per week at the school they attend during the school year. While this will not have any immediate economic benefit apart from increasing the money velocity, it will eventually produce adults who are better educated and more likely to succeed at employment and less likely to end up in jail. All economic benefits. I'm not sure how much this would cost but you'd be looking at at least 0.1% of GDP being spent on this program on an ongoing basis. Additional tutoring, say in 3rd grade and above, would increase this effect even further.
   

Less money on Defense

America does not need to spend huge amounts on national defense. Of course it is important that some level of defense spending exist to defeat any potential attacker, but I am convinced that the most bloated, most inefficient and most corrupt sector in government spending is in defense contracting. Reducing military expenditure may not even reduce America's military strength, it will make the whole contracting system better.

In fact I would suggest a change in the way the whole contracting thing works. Rather than contracting out to companies who design weaponry and other military items, the government should actually do this themselves. Let's say we want to build the fictional B-5 supersonic stealth bomber. Instead of contracting out the design to Boeing, the design is actually made by government employees working in a government building somewhere. Once the design is complete, they then contract out the parts building to the defense companies - and ensure that common parts can be made by many different manufacturers in order to reward the productivity and profitability that would arise in a competitive environment. The B-5 could even be manufactured by different aerospace companies, with Boeing manufacturing some, Northrop Grumman some more, and Lockheed Martin the rest.

Higher Taxes - especially for the rich and corporations

Alongside this substantial increase in spending should be a substantial increase in taxation. I don't believe that deficits don't matter and there is a need for the debt to be paid down. Since we can no longer rely upon the market to provide enough economic growth to increase tax revenue,  the government will simply have to step in, increase spending and increase taxation. In fact I would argue that the increase in taxes should be substantially higher than any increase in spending. I would advocate not only an increase in spending (outlined above) but an increase in taxes so high that a budget surplus is created. It is expected that any economic pain generated by this increase in taxation would be matched by the economic gain of the increase in government spending (above)

There are many ways to achieve this - one way is to increase the highest marginal tax rate. Another is to introduce a Tobin Tax.

My preferred method of taxing the financial market would be to create a market capitalisation tax: public companies being taxed incrementally on a daily basis according to their market capitalisation (share price multiplied by amount of shares). In fact I would adjust the tax according to the average p/e ratio in order to punish over-investment - if the p/e ratio of the whole sharemarket is too high, then there will be an increase in the market capitalisation tax. If the p/e ratio falls down low, then the tax would also be lowered. This system would not only generate income for the government to balance its finances, but would also act as an "automatic stabiliser" for the financial industry - punishing the market if it approaches unsustainable investment bubbles, encouraging the market if it there is not enough investment.

OSO's New Deal

Of course once the spending I have outlined above runs out over ten years (with the exception of Medicare and the tutor system), we would also assume that government debt would have been paid off by the increases in tax revenue. What then? Well I'm happy, once America has reinvented its energy, transport and water infrastructure, for taxes to drop. Hopefully the success of my "New Deal" would see so much economic and social success that Norquisters, Randians and Supply Siders would descend into obscurity. It would also force political conservatives to be more centralist, where they can be far more effective at promoting non-extremist conservative policies and ideas (conservatism does, after all, still have many considerable strengths once the extremism is removed from it).

So what are the chances of this occurring? Probably none. Rather, I expect the coming downturn to turn people against Obama and vote for a crazy Republican in 2012, ensuring a Republican controlled congress as well. What they would do from there is anyone's guess, but I doubt that any polices they do enact will do anything except make things worse.

The chance of avoiding another downturn is now almost impossible

10 Year bond rates for June 2011 came in at 3.00%. Inflation figures for the same month are due on 2011-07-15 (Friday next week).

In order for the US Real 10 year bond rate to remain positive, June inflation needs to have an index reading of 223.496 - which implies a monthly deflationary result of -0.6%. At this point there is very little evidence of a deflationary hit in June (eg soaring US dollar, credit crunch, large drop in sharemarket value).

Take a look at my spreadsheet.



June's potential recession avoiding index result of 223.496 is shown there in green. Any inflation index result of 223.497 or higher will result in column N (real 10 year bond rates averaged over three months) moving into negative. This presages a recession. When the inflation data comes out Friday next week, a coming downturn will be confirmed.

For those of you who are spreadsheet minded, here are the details:

• Column C data from here.
• Column D equation (at 701) is =PRODUCT(((C701-C700)/C700)*100).
• Column E equation (at 701) is =PRODUCT(D701*12).
• Column F equation (at 701) is =PRODUCT(((C701-C689)/C689)*100). (This is the "headline inflation" result).
  
• Column I data from here.
• Column J equation (at 701) is =SUM(I701-F701).
• Column N equation (at 701) is =AVERAGE(J699:J701).

Recession Measurement

A while ago I chose to use as my recession indicator a decline in annual real GDP per capita. The reason for this is twofold. Firstly it can be derived from official figures (ie St Louis Fed) as opposed to the more nebulous proclamations from the NBER. The second reason is that simply measuring real GDP doesn't cut it in an annualised form since, by that measurement, there was no recession in 2001 and the 1970 recession wasn't too bad at all.

The thing is that population always affects economic growth. If an economy is expanding and population along with it, chances are that economic growth is being driven by an expanding consumer and producer base - more people means more potential consumers and more potential producers.

• Nominal GDP = the actual numbers. This ignores inflation and population.
• Real GDP = nominal GDP adjusted by inflation. This ignores population.
• Real GDP per capita = Real GDP per head of population.

Of course the question arises as to whether you should measure annual changes or quarterly changes. Again there is nothing really "wrong" with doing this, but it does create problems in defining recessions. If we measured quarterly declines in real GDP per capita, we would end up having recessions in 2005 Q2, 2003 Q1, 2000 Q1, 1988 Q3 and 1986 Q2 amongst many others. So while I don't measure with the NBER I do listen to what they say - and measuring declines in annual Real GDP per capita do match up quite closely with NBER proclamations. The exception to this relationship appears to be a single quarter recession in 1956 Q3 which the NBER doesn't include on their list.

As you can see there are very close correlations between the NBER pronouncements and annual declines in real GDP per capita. The differences (apart from the 1956 Q3 blip) seem to be in measuring the start date - the NBER measurements always start between 1-3 quarters before annual declines in real GDP per capita - and in measuring the length.

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).

Real Interest Rates are predicting an upcoming recession

Best to read this first. Then read this.

Also remember 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.

I played around with my spreadsheet even further and averaged out the real interest rate (10 year bond rate minus inflation) over a three month period to see what that would achieve. The results seem far more promising than merely measuring monthly results:

July 1954 - May 1961

Fairly clear here in the fifties. Our first result is a negative reading measured in March 1957 and lasts for three months. A recession follows in October of the same year. A further deterioration in the real interest rate occurs during the recession and it is possible that this may have prolonged the recession already in swing.

May 1961 - May 1971

Nothing here in the sixties to help us. The Beatles were probably responsible.

May 1971 - May 1981

Two huge results for the disco decade. Our second negative result in October 1973 leads to a recession in January 1974. There is a long period of recession and negative interest rates that lasts until October 1975. Rates remain positive for a while but return to negative again in November 1978, which is our third result. A long period of negative interest rates follows before a recession hits in April 1980. As with the previous recession, as soon as the rates return to positive the recession is over.

May 1981 - May 1991

Nothing here in the eighties to help us.

May 1991 - May 2001

The nineties doesn't help us either.

May 2001 - May 2011

The 2000s provides us with the fourth and last result. Rates turned negative in January 2008 and a recession follows in April.

2005 does provide us with a near negative result: 0.06% in October that is most likely associated with Hurricane Katrina (the monthly inflation increase in September 2005 was the 5th highest on record). In fact it is this 2005 result which forced me to reassess my study two weeks ago on real interest rates based upon the 10 year bond rate (which is not averaged out over three months) and caused me to predict a recession in 2012 Q4.


From the four results, I have deduced the following information:

• Once the results turn negative, a recession occurs, on average, 8½ months later.
  
• The median is 6 months.
  
• Results vary between 4 months and 18 months.
• The highest unemployment rate during the recession is, on average, 1.8 times the unemployment rate of the month when real interest rates turn negative.
• The lowest increase is 1.32 times; the highest increase is 2.03 times
  

As you can see from the final graph, above, real interest rates have plummeted in recent times. Here is a graph encompassing the past three years:

The final result - May 2011 - has a reading of 0.26%. This is very close to a negative reading and, therefore, another recession.

In order for a recession to be averted, ten year bond rates must increase or annual inflation must drop. Playing around on my spreadsheet shows me that if the Ten Year Bond rate is 3 basis points lower than the annual inflation rate (eg Bond rate of 3.17%; Inflation rate of 3.2%), then US real interest rates (10 year bond rate minus annual inflation, averaged over three months) would sit at 0.01%, still a positive result. Any result of 4 basis points lower or more would end up giving an negative result.

What are the chances of a negative result for June? Fairly high. 10 Year Bond Rates are, according to my stock ticker, at 3.04%. If bond rates stay at May's result (3.17%), then the inflation index would have to read 223.74 for a positive June result. This would imply a 0.5% drop in prices from the previous month.

Realistically, therefore, we are looking at a negative June result. Which would mean the following:

• A recession starting between 2011 Q4 and 2012 Q4, with 2012 Q1 the most likely.
• If unemployment remains at 9.1% in June, then the new unemployment peak during the upcoming recession will be between 12.0% and 18.5%, with 16.7% being the most likely result.
  

Disclaimer:
Of course I need to point out that all the information I have extrapolated is based upon four results of negative real interest rates occurring between 1957 and 2008. It may be that this time around things might be different: the recession may take a much longer time to occur; the rise in unemployment may be lower than anything beforehand; the length of the recession may only be short. Nevertheless I do believe that the data is on my side and that, barring any miraculous June result that would turn conditions around, another recession is highly likely to occur, with an unemployment peak higher than any other postwar period.

Sources and methodology

For negative real interest rates:

St Louis Fed: 10 Year Bond Rate GS10
St Louis Fed: Inflation Index CPIAUCSL

For Recession:

St Louis Fed: Real GDP GDPC1
St Louis Fed: Population POP

I define a recession as an annual decline in real GDP per capita.

Here's a screenshot of part of my spreadsheet to help make sense of it all (my methodology)

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.

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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).

Data Series:
St Louis Fed

AMBNS
EXCRESNS
CPIAUCSL
GDPC1
POP

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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).

Data Series:
St Louis Fed

FEDFUNDS
GS10
GDPC1
POP

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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.

Data Series:
St Louis Fed

GS10
CPIAUCSL
GDPC1
POP

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Archive of Historical graphs.

Real Interest Rate historical graph archive.

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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.

Credit Market Debt as percentage of GDP

Sources:

Credit Market Debt: TCMDO

GDP: St Louis Fed.


All figures are quarterly.

Cost of oil consumption to US economy

Sources:

Oil Consumption: EIA

Oil Price: St Louis Fed.

GDP: St Louis Fed.

Recession defined as decline in annual real GDP per capita.

All figures are quarterly.