I tried to find a “mainstream media” article that objectively and insightfully evaluates the state of the US economy as of the end of the second quarter without success. So, I’ll take a shot at it.
First, I want to highlight that “this time, it’s different”. The US and global economies are recovering from a global pandemic situation last seen more than 100 years ago. The global economy is more integrated than ever. Viruses spread faster than ever. Businesses and governments have more information and ability to change quickly than ever before. The economic contraction was sharp, far more severe than the Great Depression or the Great Recession. The health care experts were unable to immediately evaluate the threat or recommend public policies. Nonetheless, “they persisted” and the medical, travel and economic recovery was far quicker than ANYONE expected in March, 2020 or December, 2020 or September, 2021 or January, 2022.
Second, I apologize for the required details involved to evaluate the simple question, “are we in a recession?”. Unfortunately, there is some judgment involved, as we have to evaluate three factors. Is there a clear downturn versus the trend rate? Is the downturn of significant length? Is this a widespread downturn, effecting most sectors of the economy?
Einstein said “be simple, but not too simple”.
https://wiki.c2.com/?EinsteinPrinciple
Sir Walter Scott noted the “tangled web we weave”.
https://nosweatshakespeare.com/quotes/famous/oh-what-a-tangled-web-we-weave/
The Ancient Greeks noted “many a slip twixt cup and lip”.
Cheech and Chong rambled on with ” recession, repression …”
https://www.lyricsfreak.com/c/cheech+chong/santa+clause+and+his+old+lady_20745568.html
Total Economy Level
At the aggregate level, we clearly have a peak. Do we have an extended downturn? Not yet, based on the total. The rapid recovery from the second quarter 2020 bottom could not be sustained. A significant slow-down in the growth rate was expected. Typical annual real GDP growth in recent years has been only 2%, so the difference between “extended expansion” and “recession” is thin.
Components
Macroeconomic theory focuses on aggregate demand and aggregate supply. Real, inflation adjusted, gross domestic product (GDP) is a measure of the productive output of a nation. The demand side is split into consumption, investment, government and net exports. I’ll go one level deeper, reviewing 9 components of GDP.
The business cycle is influenced by the relative sizes of the components of GDP and their relative variability from quarter to quarter and typical changes as the business cycle moves from expansion to decline to recovery.
From most to least correlated with the business cycle, with their current percentage share of GDP (sums to more than 100 because imports are a negative factor and changes in private investment can be negative), the 9 components are: Change in private inventories (1%), Residential Investment/Housing (5%), Business Investment (14%), Durable Goods Consumption (9%), Imports (16%), Non-durable Goods (food, energy) (15%), Services (45%) !!!!, Exports (8%) and Government (17%).
Overall, I see 4 sectors as “maybe” trending to a recession and 5 sectors currently at “no”. Unfortunately, the two most sensitive, Housing and Business Inventories, are in the “maybe” category, along with non-durable goods consumption and government consumption.
It is critical to look at the longer-term trends and context to evaluate short-term changes. There is significant month-to-month and quarter-to-quarter variability in the final numbers for GDP and especially for the initial estimates, like those we just saw for the second quarter of 2022. Significant revisions are made for 6 months, which is why the NBER committee which officially declares recessions is typically waiting longer to make a final call than everyone desires. Hence, I won’t usually share a long-term graph, a short-term graph, annual percentage changes and quarterly percentage changes annualized for each component. The media tends to focus on the preliminary quarterly percentage change annualized as the “gospel”. This is unwise. Let us begin to review the 9 main components.
Durable Goods (9% of GDP, 4/9 Volatile)
Durable goods demand spiked by an incredible 20-30% during the pandemic, fueled by government transfers and fewer opportunities to consume services. Demand for durable goods has flattened at this 20% higher level, it has not declined. In my view, this sector is not signaling recession.
Non-durable Goods (15%, 6/9 Volatile)
Non-durable goods consumption jumped by a real 12% during the pandemic and has essentially remained at this elevated level. We have two quarters at slightly lower consumption levels, so I rate this as “maybe” moving to a recession. Focus on the “big picture”. Both durable and non-durable goods consumption increased by historic percentages during the pandemic period and have remained at that elevated level 2 years later. It is not surprising that this demand has flattened or fallen off a bit. The surprising feature is the willingness of the American consumer to voluntarily spend much more money on “things” during the pandemic and maintain that level of spending as service opportunities returned, government transfers ended, and savings were drawn down.
Services (45%, 7/9 Volatile)
The very large (44% of GDP) services sector was slower to recover from the pandemic, but demand for services remains quite strong, even though the percentage growth rate is lower than during the initial recovery period.
Business Investment (14%, 3/9 Volatile)
Business investment was above trend in the two years before the pandemic and has resumed its solid level. No recession indicator here.
Housing (5%, 2/9 Volatile)
New housing investment grew by 50% between 2012 and 2016 and then remained at that level for the next 4 years before the pandemic. Long-run supply and demand factors indicate a “need” for more housing construction in the US to make up for the “missing” construction from 2008-2016. New housing construction did not decline with the pandemic, it increased by 15% in real terms! As with durable and nondurable goods consumption/production, this would not have been predicted in March, 2020 by anyone. Residential construction has levelled off 15% above 2019, equal to 2007 before the Great Recession. The increased mortgage interest rates indicate that demand will soften and this sector will decline somewhat in the second half of 2022, so this is a “maybe”. The long-term shortage of housing supply provides a floor for this sector.
Business Inventories (1%, 1/9 Volatility)
“Supply chain issues” have restricted the accumulation of business inventories since the pandemic began. The unexpected spike in demand for durable and nondurable goods and residential construction lead to shortages. Worries about supply chain resiliency have led to higher targeted business inventory levels. Retailers have overstocked some product categories as the recovery has slowed and are being forced to discount prices to move these goods. Overall, this is a slight “maybe” recession indicator. I think that businesses would like to have 20% higher inventories overall.
Exports (12%, 8/9 Volatility)
US exports continue to solidly recover from the pandemic.
Imports (16%, 5/9 Volatile)
Although imports act as a reduction in the calculation of GDP, they tend to decline when the US economy declines. Import demand remains high, not indicating a recession.
Government (17%, 9/9 Volatile)
A majority of government spending is accounted for as a simple transfer, not part of the annual production of goods and services.
Government production activity grew quite significantly from 2014 to 2020. It has since declined by less than 1%. I rate this as a “maybe” indicator of recession, even though government activity is typically a countercyclical indicator, rising when recession arrives.
Summary
Services (45%), Business Investment (14%), Exports (12%), Imports (16%) and Durable Goods (9%) are NOT in recession. Housing (5%) and Non-durable Goods (15%) point towards recession, while Government (17%) and Business Inventories (1%) show warning signs. If I were a member of the NBER board, I would not designate a recession in the first half of 2022 as of today.
For the second half of 2022, a recession is possible. The Fed raising interest rates is already affecting the housing industry. But businesses continue to report solid to record profits. The stock market has declined by a bear market 20% but may or may not have found a bottom. The global risks from Russia’s attacks on Ukraine and China’s Covid lockdown strategy remain. Consumer confidence is weak, especially in a partisan world. Business confidence is weaker than in recent months, but most measures remain marginally positive. The labor market is at its strongest position in 50 years, supporting consumer demand. Higher than expected inflation has slowed consumer spending, but not to recession levels. Consumer savings and debt levels remain positive. Business debt levels have increased, but most businesses locked in low debt interest rates during 2020-22.
Why So Positive?
- Governments operate with expansionary fiscal policy, ensuring that aggregate demand is adequate. There is a risk of too much stimulus and “modern monetary theory” excesses, but so far this is not a risk in the major economies.
- Central banks are more effective. They provide credit in downturns, increase interest rates when required, coordinate with each other and pressure banks to hold adequate capital.
- Governments and central banks take proactive steps to avoid currency crises,
- After the Great Recession, lending in the US housing market is more reasonable.
- Businesses have worked through many challenges in the last 15 years and are well positioned to prosper.
- The overall economy is increasingly based on services more than manufacturing, mining and agriculture. The operations leverage of manufacturing facilities is a smaller factor in the world economy.
- Labor power is lower. Cooperation with management is stronger.
- Demand for labor is high. US has record open jobs and voluntary quits. The effective minimum wage has increased from $8-10 per hour to $12-15 per hour without major business disruptions.
- Trade is lightly restricted.
- Global economy is multipolar, relying on US, EU, Japan, China, India, Middle East, etc.
- Technological progress continues. Better goods and services. Better processes, trade, transportation, markets, communication and insights.
Good News 