Consciousness of Sheep
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Sometime last year we reached the high tide mark for the latest economic cycle. Between 2010 and 2018 and despite anaemic growth in the real economy, stock markets had been on an uninterrupted upward march. By the end of 2018 that had changed. Volatility was back, producing wild ups and downs as pre-programmed algorithmic trading amplified the mood swings of investors. Against this, however, jobs continued to be added in the real economy; particularly in the USA where the temporary boost from Trump’s tax cuts was working its way through. Despite this, the majority of people on both sides of the Atlantic are still worse off today in real terms than they had been before the bankers crashed the economy in 2008.
Most sailors and anglers will tell you that the exact point of a high tide is difficult to spot. The water goes slack, and stays there for 30 minutes to an hour; and it is only when the tide has visibly receded that you realise that high tide was reached some time ago. The same, it appears, is true with the economy. Current economic news and commentary is a confused mix of optimism among those who believe the tide will never go out, and pessimism among those who reckon the high tide mark was reached a year ago. In the business pages this translates into conflicting stories – often back to back in the same journal – predicting an imminent recession and reassuring us that there is no recession in sight.
Behind the current confusion is a set of contradictory indicators; some of which are ringing alarm bells while others continue to play the relaxing muzak that has kept stock markets growing for the last decade. On the alarm bell side, global shipping has dropped dramatically, indicating a general slump in demand for goods in the USA and Europe. As Will Martin at Business Insider reports:
“South Korean exports, a data set often held up as a bellwether for the health of the global economy, fell off a cliff in January, pointing to a troubling slowdown in global trade.
“Exports from the east Asian nation dropped 14.6% in the first 20 days of 2019 versus the same period last year, according to data released Monday morning. That compared to an increase of 1% over the same period in December…
“The drop was a shock to analysts, who had largely been expecting a contraction in exports, but a small one.”
In an earlier article, Martin had also warned about a slowdown in China:
“There has been a drastic slowdown in the rate at which numerous commodities are being shipped to China, suggesting slowing demand for raw materials in the world’s second economy — a sign that a wider economic slowdown is in the works…
“China’s economic boom in the past few decades has led it to become a voracious consumer of raw materials like crude oil, metals, and natural gas, and any slowdown in demand is likely to be seen as an indication of weakening overall economic health.”
Confirming these gloomy trends, William Watts at MarketWatch points to Germany’s recent surprise economic downturn:
“Investors are worried that a global slowdown led by China could begin to sap U.S. growth, but it’s Europe that’s looking a little sickly at the moment.
“Expectations that Germany, Europe’s largest economy, could post a second consecutive quarter of falling gross domestic product were on the rise after a dismal reading on November industrial production last week, which showed a 1.9% fall, defying a forecast for a 0.3% rise.”
For the moment, Trump’s tax cuts seem to be the only thing keeping the global economy from crashing. However, even the impact of these may be coming to an end. Almost unnoticed among the mainstream headlines last month, the US Federal Reserve Bank announced that it would not be going ahead with a planned rise in interest rates. As the BBC reported:
“The Federal Reserve has indicated it won’t raise interest rates anytime soon, marking an abrupt turnaround from earlier statements that suggested it would gradually increase rates.
“The US central bank pledged to be ‘patient’ citing muted inflation and recent economic ‘cross currents’.”
The previous bullishness about restoring interest rates to “normal” and winding back the billions of dollars of liquidity previously pumped into the banking sector has evaporated. In its place is fear and caution. Despite this, markets rose on the news. If there is a recession looming, nobody inside Wall Street or the City of London seems to care. And one reason for the optimism is that the business pages have at least as many journalists explaining why a recession is not going to put in an appearance any time soon.
One such is Shawn Snyder at MarketWatch, who offers three key indicators that suggest that the tide will continue to rise for some time yet:
“Importantly, while Citi’s economists believe that the U.S. economy will likely slow in 2019, perhaps to a pace of about 2% by year-end, they remain in the camp that sees this as a modest slowdown and not the start of a recession (defined as two consecutive quarters of negative growth).
“There are obviously a lot of economic data points that one can point to, but we want to highlight three leading economic indicators that we think are important: the yield curve, jobless claims, and credit conditions for both commercial and industrial firms.”
The yield curve is something of a technical matter relating to the relative returns between short-term and long-term investments in government bonds. In a healthy economy the yield curve should slope up indicating that there is a higher return on long-term investment than short-term. In 2018, however, the yield curve began to flatten. As James Chen at Investopedia explains:
“When the economy is transitioning from expansion to slower development and even recession, yields on longer-maturity bonds tend to fall and yields on shorter-term securities likely rise, inverting a normal yield curve into a flat yield curve.”
The flattening yield curve in the USA has been seen by some as an indicator of an imminent recession. But according to Snyder there is still room for optimism:
“…the yield curve is actually still in positive territory with a spread of about 19 basis points (or in plain English, the 10-year U.S. Treasury yield is about 0.2 percentage points higher than the 2-year U.S. Treasury yield). Given that the stock market tends to peak after inversion and not before, we think that the market can move higher from here.”
On the jobs front, too, things remain positive:
“If the economy were entering a recession, we would be seeing a rise in jobless claims as employers start to lay off workers. We are not seeing that. In fact, jobless claims are near 50-year lows and just fell by 3,000 to 213,000.”
The devil, of course, is in the detail when it comes to unemployment/employment data. As in the UK, US data has been altered over the years to count as few people as possible as unemployed. So, for example, people who simply drop out of the labour market entirely (e.g. older workers taking their pensions early or surviving on savings, or younger people being supported by their parents) are not counted as unemployed. Meanwhile, someone who works just a couple of hours can be counted as employed. It is likely that the true unemployment rate – if we include those who would like to (or need to) increase their hours/wages but cannot – on both sides of the Atlantic is double the official rate; which also helps to explain why wages have remained stubbornly low despite “full-employment.”
It is Snyder’s third indicator however, that is by far the most important. Banks continue to lend:
“Fortunately, credit conditions for both commercial and industrial firms remain accommodative, with the banking community willing to extend funding to corporate borrowers. While one could argue that easy credit has led to a record level of debt for non-financial corporations and could eventually pose a problem were the economy to slow noticeably, for now it portends future economic growth with credit conditions for commercial and industrial firms leading real GDP by about nine months. Based on where credit conditions are right now, we should see decent economic growth well into 2019.”
Even now, more than a decade after the 2008 crash, economists hold to the fiction that banks act as mere intermediaries; transferring money from savers to borrowers. In reality though, banks create new currency every time they make a new loan. No money is subtracted from anyone’s account, nor is any hard cash transferred from a bank vault; the new currency is simply added to the borrower’s account with a corresponding “asset” added to the bank’s balance sheet. And so, in effect, so long as the banks keep the debt spigots open, new currency keeps entering the system; allowing those with access to the markets to continue to mop it up. But note that little caveat in Snyder’s otherwise optimistic stance:
“…could eventually pose a problem were the economy to slow noticeably.”
You know, sort of like what just happened in China… and South Korea… and Germany…
In the game of musical chairs, the crisis doesn’t occur when the chairs are removed, but only when the music stops. In the grand game of economic musical chairs, the real economy is the chairs while banking sector debt provides the music. What we are seeing around the planet is the real economy chairs being removed. But in Wall Street, Frankfurt, Tokyo and the City of London the music is playing as loudly as ever. But one of these days – maybe this year, maybe next – the music is going to stop; and an awful lot of people are going to be left with nowhere to sit.
As you made it to the end…
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