The Sucking Sound of Air Leaving the Economy

I’ve refrained from commenting much on the state of the economy over the last couple of years because it seems to have been largely irrelevant to the direction of many widely followed markets. While bonds, particularly the highest quality bonds, have continued to rally over time, par for what you’d expect in an economy facing deflationary pressures, on a day to day basis, bipolar risk on/off reactions have held sway. And even though there is no reason to expect anything better that a weak recovery in the wake of a balance sheet recession afflicting the world’s advanced economies, a peculiar tendency to look to ordinary recessions for comparisons plus undue faith in the confidence fairy has led many commentators to draw trend lines through improving data series and declare it to be a recovery. However, we seem to be at or may even have passed an inflection point, and policy makers seem remarkably unprepared to take action.

nWhile the result may indeed be a technical recovery, with official unemployment at over 8%, and U-6, the broad measure of unemployment, showing more deterioration of late than the headline figure (it’s now at 14.9%), there was hardly much cause for cheer. Both in 2010 and 2011, improvements in economic performance that were hailed as real recoveries faltered. With youth unemployment high, working young adults saddled with high student debt loads, household formation low due to more multi-generational households and older adults contending with diminished wealth thanks to hits to home prices and retirement savings, consumers were not able to be the drivers of renewed growth unless their wage and employment situation improved in a marked fashion. And that just isn’t happening.

What seems to have happened in the last week is that enough “unexpected” data releases, accompanied by a “recession is on” call by the widely-read ECRI, have led some analysts who were on the recovery side of the fence to rethink their view. The ISM manufacturing index went into contractionary territory in June. Some commentators tried arguing that the weak jobs release of last week really wasn’t so bad, since it showed an increase in hours worked and more temp hiring, which they argued would be converted to permanent jobs. But a report by the National Association for Business Economics undermined that hope. Its survey showed that companies had cut their hiring plans. 39% of the respondents intended to add staff in the next six months back in March; as of June, that’s fallen to 23%. continuing bad manufacturing results out of Europe, an “unexpected” 0.5% fall in retail sales (the third monthly decline in a row, and April’s negative result was revised downward) show a broader picture of serious weakness (note Michael Shedlock’s early warning on a sharp falloff in auto sales). Similarly, we’ve been skeptical of reports of a housing recovery, based on widespread evidence of large amounts of “shadow inventory” (as in price improvement was due to manipulation of supply). That was confirmed last week by reports from CoreLogic and Realtytrac. Some analysts expected spending to get a boost as gas prices fell, but the one-two punch of a mild winter (less snow) and a scorcher summer means higher food prices, which may substantially offset the relief provided by lower fuel costs.

This grim news comes as the IMF trimmed its growth outlook a tad, but warned that “rapid policy action” was needed to keep things on track. Of course, some of the increased willingness to use the “R” word is the usual suspects, like Bill Gross, trying to increase pressure on the Fed to Do Something.

Nouriel Roubini is predicting 1.2% growth at best for the second quarter. Ed Harrison pointed out on his Credit Writedowns Pro service that manufacturing ex autos is already in recession and that inventory building on the basis of the expectation of continued demand is the only thing that is keeping the US out of an actual recession. We’ve had falling disposable income with households initially treated as a blip (they went into savings and/or increased credit card debt). But as Ed also points out, without a change in incomes, you eventually see the decline translate into a fall in retail sales. And that’s where we seem to be now.

The way out of it would be to have government spending make up the slack. but that remains anathema; indeed, DC is fighting over how much to blunt the impact of the so called fiscal cliff, the cut in stimulus that will result if Bush tax cuts and recessionary spending measures expire at the end of 2012. Even if the full 3-5% GDP hit is forestalled (my tax mavens point out that large sections of the tax code are renewed each year, so the drama may be a tad overplayed), the continued talk of a Grand Bargain suggests that bloodletting from an already weakened patient is still on. And this cheery scenario of course does not consider the big uglies lurking in the wings, like a Eurozone crisis of some sort (Creditanstalt 2.0) or an attack on Iran (even with a new pipeline reducing the importance of the Strait of Hormuz, it’s still an important choke point, and Saudi refineries are also within striking distance of Iranian missiles).

As I keep saying, it would be better if I were wrong, since I live in the real economy, but if you want a happy ending, you may need to go to the movies.