As we enter the New Year, the mood of some economists has eroded from optimism to caution. Some will say that we shouldn’t worry, because 24/7/365, and for the past 60 years, there has always been pessimists predicting an impending economic calamity. Even a broken clock is exactly right twice a day, so these obscure pundits will blow their own horn when they turn out to be right. You may recall a book entitled, “The Great Depression of 1990,” sold millions of copies. Of course there was no depression, but the true believers hunkered down for the non-event.
But as we enter 2016, there are a few high-profile pundits that can’t so easily be ignored. According to Citicorp, there is a 65% of a recession in 2016. JP Morgan’s economists have declared that the probability of a recession within the next three years has risen to 76%. The international banking firm HSBC (the old Hong Kong and Singapore Bank Corporation) has announced that the global GDP, expressed in dollars, is already down 3.4% for 2015. These economists also note that the recent drop in factory orders, weakening export growth, and the flattening of corporate earnings were precursors of several other recessions in recent years and cannot be ignored. Furthermore, if HSBC is correct with a 3.4% drop, then the 2015 fourth quarter GDP (when it is reported) may be very weak. These are not fly-by-night forecasters, so we can’t just listen to Janet Yellen reassure us that we have nothing to worry about. We all recall that Ben Bernanke assured us that the economy was on “sound footing” just six weeks before the Lehman Brothers collapse.
It has been said that economic forecasting is like driving a car blindfolded with someone looking out the back window giving you directions. To a significant extent, the past does determine the future. That said, the problem with looking out the back window is deciding what to look at.
Here are the key problems that I see on the horizon at this time:
- Collapse of Industrial Commodity PricesThe Keynesian economists have little or no interest in the supply chain. This branch of economic theories was developed in the 1930s, and only seems to care about “final” sales as far as the economy is concerned. So they look very hard at consumer spending, but generally ignore business spending on production materials. They also ignore the billions of dollars tied up in inventories, and the billions of dollars pulled out of the economy when businesses exhaust these inventories. As I have mention for several months, the collapse in commodity prices has resulted in mines closing all over the world. We love the low price of gasoline, but budgets for drilling for oil has been slashed for almost all of the major oil companies. Other smaller firms are facing bankruptcy. Among the semi –finished good, steel mills all over the world are shutting down because of overcapacity. Going back in the supply chain, a ton of iron ore is now about 25% of what it was four years ago. In our most recent statistics, we are seeing firms liquidating their inventories of raw materials, primarily because prices are falling This liquidation alone has resulted in billions of dollars being pulled out of the economy—almost unnoticed.
- Collapse in Farm PricesBecause of the strong dollar and record levels of production all over the world, the prices for corn, wheat, and soybeans are down. Most of the farmers will tough it out like they have for decades, but the supply chain will suffer. The seed, fertilizer, and farm equipment manufacturers are already feeling the pinch.
- ChinaTriggered by a stock market selloff in China, the New Year started off with a major decline in the equity markets around the world. The Purchasing Manager’s Index for China came it negative again for the sixth successive month, raising fears that the Chinese economy may really be much weaker than some of the statistics that are being reported. We see Chinese capital leaving the country, retail sales falling, industrial production lagging, steel production falling, and most importantly, exports declining. We know that the Chinese government fudges the numbers for GDP, so we don’t really have an accurate read on the Chinese economy. Of course, they have only been doing the world-wide “capitalism thing” for about thirty years, so they may not even have accurate measure in place to tell what is happening. And the Chinese purchasing manager’s survey? Over the past few months, we have seen it move markets when the numbers are negative. This survey was conducted by HSBC for many years, but was taken over three months ago by the state-owned news agency—for no apparent reason. Hence, the real Chinese PMI may actually be much worse that it really is. Can the U.S. economy survive a slowdown in the Chinese economy? Of course, even though they are our third biggest customer. But a full-blown recession in China would spill over to all of the rest of the world, and the U.S. would not be immune.
- U.S. PMI is NegativeSince the end of the Great Recession was declared in 2009, ISM’s Purchasing Manager’s Index has been positive—until about three months ago. Now the index has slipped into negative territory. Unfortunately, the pace seems to be accelerating. If ISM’s PMI is negative again for the month of January, we are in bigtrouble.
- Europe is IffyGranted, the European economy has shown some resilience in recent months, and the Purchasing Managers Indexes for virtually every country (even France) have turn back to positive. But the problems of the Greek sovereign debt have not really been solved, and there will be another request for a new bail-out in about a year. Most economists attribute the apparent good numbers coming from Europe to be the result of “quantitative easing” by the central bank, NOT from a great recovery. Possible exception: Germany.
- Strong DollarConventional wisdom would assume that the recent strength of the dollar would be good for the economy. Over the long term, this is true. But a stronger dollar makes export more expensive. Obviously, this is not good for the firms that are major exporters. Another problem comes from the earnings for multinational companies. When earning from, say, a European subsidiary are converted to dollars, the earning fall, even though nothing has changed.
- Emerging MarketsAs a result of low interest rates, many third world countries took the opportunity to sell bonds at rates like, say, 5%. With American and European bonds paying only 2 or 3%, some of the world’s riskier investors bought these bonds. Now they don’t look like such a good investment. Furthermore, many countries like Brazil, Turkey, and Russia have had political problems. Brazil, the fifth largest country in the world, is now in economic chaos..
- Similar Pre-recessionAssuming that the past will be the same as the future is always problematic, but falling PMIs, falling industrial production, flattening corporate earnings, etc. are just a few of the statistics that have preceded previous recessions.
- Unemployment The current unemployment numbers are now good enough that some pundits have declared that we are now back to “full employment.” Most economist will disagree that the 5% level constitutes full employment, but these same economist do agree that much of the improvement has come from workers dropping out of the workforce altogether. In fact, the worker participation rate has decline to a 35 year low. Furthermore, part-time involuntary unemployment is still double what it was before the recession, “quit rates” remains very weak, the percentage of the working age population that is employed is still low, and wage growth remains anemic and still well below target. Many, many people feel that they have been left out of the “recovery,” and over half of all workers think that we are still in a recession.
- Laws of the Business CycleOne of the major weaknesses of the capitalistic system is the almost inevitable problem that the economy is never perfectly stable. There are bubble, like the huge supply of unsold houses in 2007. There are stupid mistakes, like the poorly regulated sub-prime loans. In the 50’s and 60’s, there were periodic large inventories of steel and rubber that were accumulated and then dumped back in the market all at once. In the 70’s, it was oil crisis. At the end of every recession, the policymakers vow to make sure that the same problem will not recur, but just like Murphy’s Law, they always miss something. Hence, the post-war economy has suffered a recession about every 7 years or so. It seems like a petty reason, but some economists are now saying that our expansion cycle, such as it is, may have run its course, and we are “due” for another recession. .
Atop all of these reasons is the ever-present threat of a terrorist attack that impacts the economic system. Granted, the California tragedy was terrible, but it had no significant economic impact. However, if ISIS succeeded in taking down another airliner INSIDE the U.S., any people would quit flying. Because we are now so dependent of air travel for business, the impact would be significant. In a different sector, If ISIS took out a portion of the power grid and left millions of people in darkness for weeks, the mood of the country would be changed forever. And, yes, we would have a recession.
Am I predicting a 2016? No, not at this time. We definitely need to see some additional data before drawing that conclusion. But I AM in agreement with the economists at Citicorp that the odds of a 2016 recession have probably risen to 65%. But the Chinese government boasts the biggest staff of trained economists (degrees are primarily from Harvard, MIT, and Stanford) of any country in the world. Furthermore, they actually listen to their economist, and try to do the right thing. They MAY figure out how to fix the Chinese economy. Someday soon, the commodity prices MAY bottom out, and start to rise. Inventory liquidation will cease, and no additional mines will be closed. The operative word is “may.” There reality is that the odds are 65% correct and the HSBC economists are also correct in saying that the 2016 recession has already begun. The post-Christmas Grinch has arrive.