Good Friday Morning! Except for the White House, which now has to spend its time telling people that even though the first six months of 2022 have brought us negative GDP growth, everything is fine. The social media fights over recession definitions are the most insignificant part of this moment. The real issue is this: economic data is awful across the board.
Message is clear from the negative US GDP print (-0.9%) and unfavorable miss on jobless claims:
The US economy is slowing at a significant rate. Add to that the 8.7% price change in today’s data and the bottom line is clear:
Deepening stagflation and flashing red recession risk
He’s right. I’m going to dig into the recession talk below. Still, the most accurate description of where we are right now is stagflation: low growth combined with high inflation. There’s no way to spin the current moment as a healthy economic environment. Inflation is high, growth is negative, and the Fed is trying to kill demand. His view is that we’re moving into a recession from stagflation. The White House denies all of this. I’ll dig into that below; links to follow.
Where you can find me this week
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[7/25/2022] White House predicts US economy won’t hit the recession iceberg – Conservative Institute
[7/29/2022] Democrats seek more inflation by pushing student loan forgiveness – Conservative Institute
Q2 GDP Growth is Negative, Recession fears looms, and greater unknowns.
I was walking on the treadmill at my gym yesterday afternoon. Like most cardio areas with treadmills, it has a bank of televisions up so everyone can see while doing cardio. One of my favorite things is to be on one of those treadmills during a breaking news event where everyone is covering the same story (or supposed to be).
When I was there, the televisions had a variety of news stations on. Everyone covered the same story: “Real gross domestic product (GDP) decreased at an annual rate of 0.9% in the second quarter of 2022.” That means we have back-to-back quarters of contraction, which meets the traditional definition of a recession (more on that in a bit).
Fox News was up on the left side of the tv bank, and the chyron was, “Biden Denies Recession As U.S. Enters Recession.” On the right side, ABC News covered Sec. of Treasure Janet Yellen’s press conference, and that chyron read, “Sec. Yellen: GDP Report Indicates Economy Is Transitioning To Stable Growth.”
All I could do was shake my head and laugh at both.
I can’t come up with a better juxtaposition than that. It’s where the debate is and will stay for the foreseeable future. In other words, we’re where I thought things would be a month ago. Here’s what I wrote on June 17th:
Are we in a recession? We likely won’t know for a while. The Wall Street Journal has a good piece about how the NBER makes that determination. Here’s what you need to know: the NBER didn’t declare a recession in the Great Financial Crisis of 07/08 until December 1, 2008. By that point, Bear Stearns and Lehman Brothers had already liquidated, the stock markets had crashed, Congress had passed TARP, more bailouts were getting debated, and layoffs were underway.
NBER dates the recession back to November/December 2007. Still, realistically, the Federal Reserve responded to the subprime crisis by August 2007, and you can find signs in 2006. In short, by the time we get an official declaration of a recession, we’ll likely already be talking about what the recovery looks like — in fact, had you bought the stock market the day the NBER declared the 2008 recession, you’d have been close to buying the bottom of the stock market during the financial crisis.
The irony of the NBER being very late on calling a recession is that you can bet on journalists “fact-checking” recession claims in an election year. If economic conditions continue to deteriorate, we’ll see more prominent people claim we’re already in a recession. “Fact checkers” will argue that we’re not in a recession because no official designation by NBER has been made. It’s an idiotic semantic game to play. But the media is likely to play it.
That last paragraph is where we are now. Phil Magness, an economic and political historian, shared a picture on Facebook of a quote from the White House website’s spin on what a recession is – and Facebook has fact-checked that picture. The fact-checkers are dutifully carrying the White House’s water on that point. Magness points out that Elizabeth Warren argued in 2019 that the manufacturing sector was in a recession. Politifact said her claim was “half-true” because only one quarter of contraction was in the data, and two quarters denoted a recession. You can’t make it up.
We’re in the middle of a ridiculous debate over definitions. It is true that the NBER has not declared a recession. That is also a meaningless declaration. NBER is not here to give you a statement for policy decisions; they’re debating the parameters of a historical chronology.
There is no federal statute that appoints the NBER as the official arbiter of recessions. Quite the contrary, the federal government has historically followed the conventional textbook definition. The Gramm-Rudman-Hollings Act of 1985, which attempted to rein in the deficit by triggering mandatory sequestrations in federal agencies, introduced a recessionary escape clause for tough economic times. If the Congressional Budget Office projected a recession, Congress could fast-track a vote to suspend the sequestrations. The law defined a recession as a period when “real economic growth is projected or estimated to be less than zero with respect to each of any two consecutive quarters.” The CBO could also trigger a suspension for “low growth” if the change in GDP dropped below 1% for two quarters.
Although the Gramm-Rudman-Hollings Act succumbed long ago to the profligate pressures of deficit spending, its “two consecutive quarters” standard may be the closest thing to an official definition of recession. Derivative language still appears in the federal statute books, and it has long been used as a basis for other counter-recessionary measures governing federal employment. Canada and the U.K. also employ the two-quarter definition to designate the onset of a technical recession, further attesting to its legitimacy.
So, you can take the view that we’re in a recession. Or the opinion of the White House that we never know until the NBER declares it (which is something no Democrat has ever done in the past). Alternatively, you can take the view of Seth Mandel: “It’s not a recession unless it’s from the Recession region of France otherwise it’s just sparkling misery.”
I like the Wall Street Journal’s description of the NBER’s role in this: “Think of the panel as a coroner performing an autopsy—it doesn’t make assessments in real time but instead sifts through data to retroactively determine when expansions and recessions begin and end.”
Where do I stand? I laid down my marker on June 24: “We’re already in a recession.” I believe that the NBER will eventually declare a recession and claim that the peak of the post-COVID recovery was Q4 2021, with the recession beginning in Q1 2022. That’s a pretty aggressive call, I fully admit. I don’t expect the NBER to step into this debate until December 2022 (post-election) or sometime in Q1/Q2 of 2023.
The most accurate position might be the one I started with in the intro: we’re in a stagflation environment, moving into a recession. No matter how you shake it up, things are bad.
One other note, because it’s a question I’ve gotten, “will we enter a depression?” That’s impossible to tell, and as the WSJ points out, the NBER doesn’t make calls on things like that:
A depression is “a more severe version of a recession,” says the San Francisco Fed. During the Great Depression, from 1929 to 1933, inflation-adjusted output fell nearly 30% and the jobless rate hit nearly 25%, according to a speech by former Fed Chairman Ben Bernanke. However, the NBER says it doesn’t differentiate between recessions and depressions.
We’ve only had one depression in US history. Recessions are more common, and some of those are very deep. A depression is a different ball of wax; if we hit that territory, you’ll know. No one alive today has ever experienced anything close to the depression. A jobless rate of 25% would shock the modern world. For reference, the height of COVID-19 unemployment was 15%, and the peak of the double-dip recession during Reagan’s first term was 11%.
Where do things go from here? That all depends on the Federal Reserve. They raised rates 75 basis points this week, as expected. And while the Fed statement about the economy was hawkish in tone, Jerome Powell sounded like a dove at times. As a result, markets soared on the idea that tightening conditions and rising rates would slow down.
As I suggested last week, the Federal Reserve could slow its roll as we head into the midterms. I expect the following CPI report in August to be lower than the July report. The primary reason for that is that gas prices dropped for the majority of the month. That drop slowed towards the end, but the decline cannot be discounted. It will likely generate a better CPI report (a similar dynamic played out earlier this spring).
If I’m wrong on that, all bets are off. But I don’t believe I am. If the Federal Reserve slows the rate hikes, markets will respond and skyrocket. We’ll likely see Democrats claim they’ve solved inflation, and things are improving, just in time for the midterms.
But Mr. Powell sounded much less hawkish at several points in his hour-long presser. It was especially striking to hear him say that current interest rates are close to “neutral,” meaning they are no longer accommodative. But even after Wednesday’s 75 basis-point increase, the fed funds rate is only 2.25%-2.5%. The inflation rate in June was 9.1%, which means real rates are still decidedly negative.
Not to be unkind, but when the fed funds rate was 2%-2.25% in October 2018, Mr. Powell said “we’re a long way from neutral” on interest rates. The inflation rate at the time was a mere 2.5%. Times and circumstances change, but the meaning of “neutral” can’t possibly have changed that much.
The Fed chief insisted more than once that he and his mates are determined to return inflation to their 2% target. We hope so. And it seems likely that inflation at annual rate will decline from 9% in the coming months as oil and other commodity prices have fallen. Slowing growth will also contribute.
But the lesson of the 1970s is that ending the anti-inflation fight too early leads to inflation that falls from its heights as the economy slows but still stays uncomfortably high at a new plateau. Then it rises again as the economy recovers and reaches new heights. Then do it all again, until the tightening medicine has to be far more severe than it would have been had the Fed stayed the course earlier.
It’s always a mistake to read too much into immediate market moves such as Wednesday’s. But if they’re right that the Fed is signaling an early end to tightening, then the danger is that we’re watching a false dawn in the anti-inflation fight.
What would that mean? I’ve seen some investors/traders sketch out the following scenario: The Fed slows down its tightening from September through the end of the year. Inflation plateaus a bit but doesn’t drop. After the elections, the supply chain and European energy crises reappear, driving up commodity prices (again). Inflation ramps back up while the Fed is standing in place.
We get the scenario painted by the WSJ above; meanwhile, inflation is higher, and the Fed’s progress gets erased. They then have to raise higher rates to deal with increased inflation pressures. That forces a weakened economy into a deeper recession because that’s the only tool available to stop inflation.
The reverse scenario from the White House is this: we’ve hit peak inflation, pricing pressures are easing, and the Fed can raise rates more slowly to avoid a hard crash. We’ll get slow growth, but not the train wreck predicted by chicken-littles. In short, the White House is putting all its money in the “soft landing” theory of Fed monetary policy.
A choose your own adventure in economics and politics.
There are other variables at play here. Do we get more COVID-19 surges that impact the economy? What happens to China’s economy? Does the CDC make monkeypox the next great scare to impact the economy? Does China do anything more than saber rattle over Taiwan? Where does the food shortage crisis end up? Does CPI act according to expectations? Do any natural disasters (hurricanes, floods, etc.) impact the economy?
We don’t know the answers to these questions, nor does the Fed or White House.
To some extent this inflection point isn’t surprising. The recession that began with pandemic lockdowns in 2020 was the deepest and shortest on record, and the recovery that followed was exceptionally strong, quickly restoring economic output and unemployment to prepandemic levels. Thus, the recovery phase was bound to be short as well. This doesn’t mean the expansion is over: It does mean it will be much more subdued going forward.
Yet this inflection point is, for a different reason, worrisome. It isn’t a short-term blip; it was deliberately engineered by the Federal Reserve to reduce inflation. The Fed has raised interest rates this year from near zero to a range between 2.25% and 2.5% and plans to raise rates further. On Wednesday Fed Chairman Jerome Powell said “We think we need” this slowdown. “We need a period of growth below potential in order to create some slack so that the supply side can catch up.”
Potential refers to what total capital, labor and technology can supply without strains that add to inflation. Yet second quarter GDP was actually 2% below where the Congressional Budget Office projected it would be at this time back in January 2020. Employment is also 2% lower than it predicted, i.e. about 3 million jobs. At the same time inflation is running at a 40-year high of 9%. Taken at face value, this means potential today is lower than the pre-pandemic trend would have predicted—a sign of the damage done by events of the last two years.
A key question is how lasting that damage might be. Much of it may reflect temporary disruptions to supply brought on by the pandemic, such as shortages of semiconductors holding back production and raising prices of automobiles, or more costly energy linked to Russia’s invasion of Ukraine. If and when those disruptions resolve, potential could rebound.
Other disruptions seem longer lasting. The unemployment rate is roughly where it stood in early 2020 but employment is smaller because the labor force has shrunk; as a share of the working age population, it was 62.2% in the second quarter, compared with 62.7% predicted by the CBO two years ago. The main drivers appear to be retirements, a slowdown in immigration and Covid-19. None seems likely to reverse soon.
Moreover, high vacancies and rapid wage growth suggest unemployment can’t be sustained at so low a level. Mr. Powell said Wednesday he thought the natural rate of unemployment—the level consistent with stable inflation—is “materially” higher than before the pandemic. If actual unemployment has to rise to that new natural level to bring down inflation, then a recession is likely unavoidable.
Mr. Powell, and others, hope that’s not necessary. Firms may simply eliminate open positions rather than lay off workers in response to cooling demand. People may return to the work force.
In this case, an end to a recovery need not automatically lead to a recession and an end to economic expansion. The U.S. could, instead, be in for a prolonged period of growth below its normal potential rate, which is likely under 2%. Former Fed governor Larry Meyer calls this a “growth recession.” But the final result is the same: The U.S. will have a smaller and less vigorous economy than it should, because of the disruptions that the last two years have wrought.
Links of the week
At the center of a proposed swap for Brittney Griner is Viktor Bout, likely the highest profile Russian in U.S. custody. He has been called “one of the world’s most prolific arms dealers,” and Russian officials have been pressing for his release since for more than a decade. – New York Times
White House braces for grim news on economy: Senior administration officials are hitting the airwaves and arm-twisting reporters in private, imploring anyone who will listen that the economy is still healthy. – Politico
What Will Democrats Say If Their MAGA Candidates Win? Liberals are backing Trump-allied candidates because they think they’re easier to beat in general elections. What happened to MAGA being an “existential threat to democracy”? – Matt Lewis, The Daily Beast
Steve Scalise reflects on baseball shooting five years later – Washington Examiner
Kavanaugh suspect wanted to kill three justices – News Nation Now
At This Manhattan Middle School School, Sixth-Graders Are Asked To Surveil Friends and Family for ‘Microaggressions’ – ‘This Book Is Antiracist’ is key element of curriculum at Lower Manhattan Community Middle School – Washington Free Beacon
Families With Young Children Led Exodus from Major Cities During COVID – Economic Innovation Group – Adam Ozimek and Connor O’Brien
In Show Of Pro-Abortion Brutality, Gov. Gretchen Whitmer Just Slashed Care For Pregnant Women From Michigan’s Budget – Margot Cleveland, The Federalist
Twitter Thread(s) of the week
Satire of the week
Man With Gender Studies Degree Terrorizes Party – Reductress
Thanks for reading!