In September 2011, the Economic Cycle Research Institute (ECRI) predicted America would enter into a new recession within six to nine months. Between August 2011 and mid-December 2011, the S&P 500 fluctuated at or below its 360-day moving average. Then, in mid-December the broad market rallied through January and into April. Skeptics of the recession call pointed to earnings reports, better jobs numbers and the stock market rally. Note, however, that all those data points cited as evidence of growth are coincident or backwards looking telling us nothing about the future.
What the critics failed to recognize was that the most recent stock market rally was, for the most part, a reaction to Fed policy to keep interest rates low. Fed policy juiced bank balance sheets with liquidity (cash), but with the velocity of money at an all-time low, it was clear none of the Fed cash was making it into the economy via loans. Why? Consumers and businesses in the post credit crisis era have an aversion to debt (hoarding cash and paying down debt) as well as increased credit standards by banks.
Banks, especially investment banks, are in the business of making a return on their capital. Instead of making loans to consumers and businesses, the banks put the cash to work in risky assets, like the stock markets, since they couldn't earn much of a return on the all-time low interest rates engineered by the Fed. And, we're now just beginning to see some of the problems of bad bank decisions, such as JPMorgan's derivative losses estimated at up to $5 billion (thanks London Whale). What other problems may be lurking out there, we just don't know.
Now, the data is coming in and it is clear that ECRI appears to be right. ECRI co-founder Lakshman Achuthan has taken a beating for his recession prediction in the face of a rallying stock market. But the stock market, largely reacting to Fed monetary policy, is not the real economy. Over the long-run, the equity markets do tend to follow the real economy (GDP), but often depart from "reality" as we've seen in the past. The U.S. is heading into a recession in 2012, and now the stock market is finally catching on.
It seems that some in the financial press are coming back and agreeing that, indeed, America is headed back into a new recession. Great video at this link.
And, there's nothing anyone can do about it. This recession will be the 48th since 1790. In a free market economy, there is a business cycle and there is precious little that government policy makers can do to stop it. They can try to make it less painful, but no president of any political party can effectively manage the business cycle. Political pundits, elected officials and candidates with little formal economics training consistently fail to note this fact, and the electorate is still willing to accept that politicians play a central role in the economy.
What's wrong with the economy is that real income growth has stalled. The decline in real wages is a long-term trend that started decades ago. Today, consumers have less real income than they did 20+ years ago. Most families need two full-time wage earners to afford healthcare, education and normal living expenses. The jobs that used to fill the middle class have been largely outsourced to low-wage nations, and employers pursuing a globalization strategy have no reason to give American workers a raise. Education is critical to getting ahead in America, but the rising cost of a higher education will soon separate us into a nation of "have's" and "have not's" unless something is done.
Cutting taxes on businesses won't do that much, because employers don't hire ahead of demand increases (rising revenue). Right now, U.S. companies have trillions of cash sitting on the sidelines, not because they are taxed too high, but because they don't need to add capacity to meet the tepid demand for what they are selling (industrial capacity utilization at ~78% is still below the pre-recession average of ~80%). The real solution here is to cut taxes on individuals and employers need to give their workers a raise.
But, there's that debt bomb ticking away...
That's a topic for another post.