Recession On The Horizon

Economic trends do not look promising, at least for working people.

The UN publication World Economic Situation and Prospects 2016 highlights the dramatic slowdown in economic activity in the years following the world recession.

Looking at the 20 leading developed economies we see that average growth fell from 2.8 percent over the period 3^rd quarter 2002 to 4^th quarter 2007 to 1.3 percent over the period 1^st quarter 2010 to 2^nd quarter 2015.  At the same time, growth became more unstable as shown by the rise in volatility. Consumption growth and investment growth also fell dramatically with volatility increasing. Trends were similar, although not as drastic for the 20 leading developing nations.

The UN study paid careful attention to the collapse in investment.  The authors note:

The global financial crisis has had the most pronounced negative effect on investment rates. . . . After an early recovery in 2010-2011, the growth rates of fixed capital formation have sharply slowed down since 2012, exerting downward pressure on productivity, employment and growth. The growth rates of fixed capital formation nearly collapsed since 2014, registering negative quarterly growth in as many as 9 large developed and developing countries and economies in transition. . . .

Investment in productive capital has been even weaker than the total investment figures suggest, as dwelling and intangible assets account for the majority of investment in developed economies. According to OECD data on fixed capital formation, investments in intangible and intellectual property assets together represent the largest share of fixed capital formation in a number of developed economies in 2014, including in Germany (47.2 per cent) and the United States (42.3 per cent). Acquisition of intangible assets, such as trademarks, copyrights and patents, may increase financial returns to firms without necessarily increasing labor productivity or productive capacity.

Especially noteworthy is that despite their lack of investment in plant and equipment, non-financial corporations have resumed their borrowing.  As the authors of the UN study explain:

A growing disconnect between finance and real sector activities is evident in the data: fixed investment growth nearly collapsed, while debt securities (a financial instrument to raise capital) issued by non-financial corporations increased by more than 55 per cent between 2008 and 2014, representing a nearly 8 per cent increase per year [as the table below shows].

This is noteworthy because it means firms are largely going into debt to engage in mergers and acquisitions, stock repurchases and dividend payments. If world economic growth continues to slide, many of these firms are likely to find themselves in serious debt difficulties.

For most of the post-recession period, world growth was sustained by the high rates of growth in the third world, in particular China.  However, the decline in growth in the developed world eventually produced a slowdown in Chinese exports and growth, which caused a decline in Chinese demand for commodities, triggering a dramatic slide in commodity prices and rates of growth in many developing economies.

The slowdown in third world growth is gathering speed.  One factor is the growing capital flight from the third world.  As the economists Joseph Stiglitz and Hamid Rashid explain:

The real worry, however, is not just falling commodity prices, but also massive capital outflows. During 2009-2014, developing countries collectively received a net capital inflow of $2.2 trillion, partly owing to quantitative easing in advanced economies, which pushed interest rates there to near zero.

The search for higher yields drove investors and speculators to developing countries, where the inflows increased leverage, propped up equity prices, and in some cases supported a commodity price boom. Market capitalization in the Mumbai, Johannesburg, São Paulo, and Shanghai stock exchanges, for example, nearly tripled in the years following the financial crisis. Equity markets in other developing countries also witnessed similar dramatic increases during this period.

But the capital flows are now reversing, turning negative for the first time since 2006, with net outflows from developing countries in 2015 exceeding $600 billion – more than one-quarter of the inflows they received during the previous six years. The largest outflows have been through banking channels, with international banks reducing their gross credit exposures to developing countries by more than $800 billion in 2015. Capital outflows of this magnitude are likely to have myriad effects: drying up liquidity, increasing the costs of borrowing and debt service, weakening currencies, depleting reserves, and leading to decreases in equity and other asset prices. There will be large knock-on effects on the real economy, including severe damage to developing countries’ growth prospects.

This is not the first time that developing countries have faced the challenges of managing pro-cyclical hot capital, but the magnitudes this time are overwhelming. During the Asian financial crisis, net outflows from the East Asian economies were only $12 billion in 1997.

The US financial sector is one of the main beneficiaries of this capital flight.  However, the inflow of funds tends to drive up the value of the dollar to the detriment of US manufacturing, investment, and employment.

It is hard to see positive signs for the world economy.  In fact, many analysts are now predicting recession for the US.  The economist Michael Roberts has long argued that key to “the health of a modern capitalist economy is . . . the direction of average profitability of capital, total business profits and its impact on business investment.” In other words, a decline in profit rates will eventually lead to a fall in total corporate profits and then investment.  When that happens a recession is not far behind.

As Roberts describes:

[R]ecently some mainstream economists have paid the movement in profits a bit more attention. . . . And . . . the economists at the investment bank JP Morgan have started to use profits and profitability as a guide to the likelihood of an oncoming recession.

They first noted that global profit margins have been drifting lower for the past two years, mainly driven by a falling profitability in emerging capitalist economies as the great commodity price boom reversed and China’s economy slowed sharply.

And now “DM (developed market) margins have begun to fall as US corporations come under pressure from the rising dollar and the concentrated hit to the energy sector,” JPM noted.  In another note, JPM economists looked at overall US corporate profits and calculated that “corporate profits were likely down 11% annualized last quarter, and down 7% over year-ago levels.”

They “now put the probability of a recession starting within three years at a startling 92%, and the probability within two years at 67%”. However, they temper this result by pointing out that profit margins are still historically high so there is room for a fall without economic contraction and also the expectation that the US Fed will not continue with its rate hikes as quickly or as far as previously planned. On that basis, their forecast of a US recession is “beginning within three years at about 2/3 and within two years at close to 1/2″. 

It is difficult to predict economic turning points, but the trends appear clear—the long post-crisis expansion is nearing its end.  Tragically, few people have benefited from the expansion and our social structures are far from sufficient to see us through the new approaching recession.

 

Wealth Inequality: Race and Inheritance

 

The Wall Street Journal’s Real Time Economics Blog recently looked at wealth inequality.  The first chart taken from the post shows wealth differences by race and age of head of family.

Racial differences (White versus Black and Hispanic) dominate whether looking at average or median net worth, and the gap grows as the head of the family ages.  Median figures are especially sobering, showing the limited wealth generation of representative Black and Hispanic heads of families regardless of age.

And then there is inheritance.  This second chart looks at the relationship between inheritance and wealth generation.

Inheritance was divided into ten groups.  WARNING: THE TENTH GROUP, WHICH RECEIVED THE LARGEST INHERITANCE, IS NOT SHOWN.

As Josh Zumrun, the author of the blog, explains:

The bottom 10% of inheritors received an inheritance averaging only about $2,000. Families receiving this much inheritance aren’t that wealthy.

But among families that received a $35,000 inheritance, their net worth is over half a million. Families that received a $125,000 inheritance are worth $780,000 on average and those that receive a $200,000 inheritance are, on average, millionaires. (The top 10% of inheritors, not pictured in this chart, inherit $1.6 million on average and have a net worth of $4.2 million.)

The take-away is pretty simple: Wealth inequality is real, with strong racial determinants, and is also, to a significant degree, self-reinforcing.

Threatening Trends in US Trade

The US government continues to press ahead negotiating new trade agreements.  And the US trade deficit in goods continues to grow.

According to the US Census Bureau:

For 2015, the goods and services deficit was $531.5 billion, up $23.2 billion or 4.6 percent from 2014. Exports were $2,230.3 billion, down $112.9 billion or 4.8 percent. Imports were $2,761.8 billion, down $89.7 billion or 3.1 percent.

While the trade balance covers both goods and services, the trade in goods dominates; trade in services totaled only 24.1 percent of total U.S. trade in 2015.

The figure below shows the US monthly trade balance.  As we can see monthly trade deficits reached their peak in the period before the start of the Great Recession.  Then, as the economy collapsed, demand for imports rapidly fell.  Over the last few years, the monthly deficit appears quite stable.  Of course, this stability still produces a large annual deficit, which means each year the US adds to its overall foreign debt.  If interest rates do start to climb, foreign debt payments will quickly become substantial.

 

However, this apparent stability hides a new exploding deficit in the trade of non-oil commodities.  Oil prices have been falling for some time.  That decline, along with new production in the US, has produced a significant fall in the value of petroleum imports, as we see below, from a high of $50 billion a month in 2008 down to less than $15 billion a month in 2015.

Subtracting the value of oil imports from our goods trade deficit yields a dramatically different picture of US trade dynamics.  The deficit in non-oil goods increased by $108 billion in 2015, from $547.7 billion to $655.9 billion.  As the next two figures show, the non-oil goods deficit is fast approaching record levels, whether measured in dollars or as a percent of GDP.  And this growing deficit means job losses for US workers.

 

As Robert Scott explains:

Most U.S. goods trade consists of manufactured products. In 2015, manufacturing constituted 86.9 percent of total U.S. goods trade, and 94.3 percent of total trade in non-oil goods. Because manufacturing is such a large employer, rapidly growing trade deficits in non-oil goods are a threat to future employment in this sector. The growing trade deficit in manufactured products rose to 3.8 percent of GDP, only 0.7 percent (7 tenths) of a percentage point below the maximum reached in 2005. The manufacturing trade deficit also reached a record high of $681 billion in 2015, well in excess of the previous peak $619.7 in 2007. Rapidly growing manufacturing trade deficits were responsible for most, if not all, of the 4.8 million U.S. manufacturing jobs lost between December 2000 and December 2015, and there’s every reason to believe that these job losses will continue if the non-oil trade deficits keeps growing.

And, with the likely approval of new so-called free trade agreements, those deficits are likely to keep growing.