Wednesday, March 5, 2014

The Business Cycle Is Not Dead

The following scatter chart compares the annual growth in the 3 year moving average of the civilian labor force (bottom scale) to the annual growth in the 3 year moving average of civilian employment (left scale).


Click to enlarge.

An optimal path has been added in blue. I argue that if the business cycle was dead then we'd be sticking to the blue line like glue. It is the optimal path. The labor force and employment would always grow (or shrink) at exactly the same pace.

During the Great Recession we spent a great deal of time below the optimal path. Now we're spending time above it. It is mathematically impossible to stay above it permanently though. It is not possible to grow civilian employment at a greater rate than the civilian labor force over the long-term. Eventually we would run out of labor force.

Unfortunately, the same cannot be said in reverse. It is theoretically possible to grow civilian employment at a slower rate than the civilian labor force over the long-term. We would never run out of labor force. Sigh.

Let's zoom in for a closer look since the start of the Great Recession.


Click to enlarge.

We are late in the business cycle and are attempting to make a very large elliptical sweep in a clockwise direction. It is only a matter of time before we come back down to the blue line again. We must. It is not optional. As seen in the next chart, how we get back to the blue line is open for debate.

Let's zoom in even closer and just look at what's been going on over the past year.


Click to enlarge.

The trend diverged back in October (moving sharply to the left on the chart as labor force growth began to fail). You will note that this happened before the winter weather appeared. We therefore cannot blame the winter weather for it. This actually takes us further away from the blue line but not in a way that shows sustainable strength. In my opinion, it is simply the first crack in the cyclical dam.

Let's sum this up.

Contrary to popular opinion:

1. The business cycle is not dead.
2. The Fed has not permanently put an end to recessions.
3. The best time to invest in risky assets is near the end of recessions (not near the end of expansions).

The best we can hope for is that we gradually come back down to the optimal path in blue (the path seen in the first two charts) and stick to that blue line permanently. Growth would gradually slow as we do it. The business cycle would then be dead and the economy would be much more predictable from there on out. That's actually a fantastic outcome in the grand scheme of things, not that those expecting accelerating growth from here would like to see it.

I doubt very much that's what happens though. I expect us to overshoot the optimal path to the downside again, just like every business cycle before it. Here's the worst part. I believe that it will happen while we're still stuck in ZIRP. That will not be a party. It would shock those who believe that the Fed's ZIRP can prevent recessions, especially those who believe that long-term interest rates are currently low (and must therefore rise).

This is not investment advice.

Source Data:
St. Louis Fed: Custom Chart

19 comments:

Stagflationary Mark said...

Here's something else to think about.

Look at that first chart.

Note that over the long-term we have been moving down and to the left.

That means:

1. Slower employment growth.
2. Slower labor force growth.

Now look at that last chart.

Note that over the short-term we have been moving up and to the right (recent months notwithstanding).

That means:

1. Faster employment growth.
2. Faster labor force growth.

For what it is worth, I invest based on the long-term picture. I believe growth is slowing over the long-term and short-term cyclical arguments have little chance of changing my mind.

Sigh.

Nathan said...

Great post Mark.

Your comments reminded me of another explanation for the business cycle that seems more relevant in the era of tech bubbles.

Stagflationary Mark said...

Nathan,

What a fantastic link! Thanks for sharing.

Safety creates risk

Absolutely. An analogy I've used for years is an overprotective mother who *never* allows her son to fall. Children tend to test boundaries. That child could therfore be inclined to take more and more risks until finally the mother failed to protect. When that child does eventually fall, it could easily result in death.

Recessions are not going away; they are endogenous because zero mimicry is not an equilibrium among insects, reptiles, or humans. Expect more unexpected recessions, just not real soon, and not in subprime housing.

I immediately skipped back to the top of the post to see when it was written. It's been 3 1/2 years. The "real soon" criteria no longer applies. Bingo.

Stagflationary Mark said...

therfore = therefore! Ack.

Stagflationary Mark said...

I'd like to make an additional comment on my second chart. I think an analogy my apply here.

To me, it looks a lot like a plane in a steep climb that is slowing to stall speed (note the decreasing distance between the monthly data points). The original path is no longer an option. The new path will involve more than a bit of chaos.

Just a thought.

Stagflationary Mark said...

my=may

Using a PS3 controller to do data entry is not always optimal! ;)

Troy said...

" The labor force and employment would always grow (or shrink) at exactly the same pace."

complicating matters is the demographic transition we're in now.

http://research.stlouisfed.org/fred2/graph/?g=sJp

Here's a projection of age 20-60:

http://i.imgur.com/3RJ2SmF.png

showing the flat spot we're in as the boomers age out and Gen Y ages into the workforce.

initial claims / employees:

http://research.stlouisfed.org/fred2/graph/?g=sJr

is another issue; the 2004-2007 boom restored us to the 1990s good times, but it was a temporary feel-good, given the $14T consumer credit bubble that was required to create that illusion of prosperity.

Talk of 'business cycles' when we're seeing trillion-dollar-plus annual credit inflows into consumer and gov't sectors is not following the ball, IMO.

If Yellen's Fed wants to continue airdropping a trillion a year into this economy, it can.

Key question is how much is it really Yellen's to run.

Programatically, consumer credit is not off the rails, government deficits are not growing, so the status quo as-it-is can IMO continue.

Sure, the taper will kill us dead and the credit cycle will stop, and business cycle, whatever that is, these days, will return with a vengeance.

Troy said...

And I also don't see 'pent down' demand.

I see a lot of broke-ass consumers, but that's nothing another credit cycle pump can't fix.

http://research.stlouisfed.org/fred2/graph/?g=sJy

surely the US consumer has made space again for a few wafer-thin mints . .

Troy said...

Household Debt Service Payments as a Percent of Disposable Personal Income (TDSP)

Stagflationary Mark said...

Troy,

Talk of 'business cycles' when we're seeing trillion-dollar-plus annual credit inflows into consumer and gov't sectors is not following the ball, IMO.

It is mathematically impossible for *real* civilian employment growth to exceed *real* civilian labor force growth over the long-term.

That's true regardless of how many trillions of dollars you feel the Fed has pumped or will pump into the *real* economy.

Stagflationary Mark said...

Troy,

Household Debt Service Payments as a Percent of Disposable Personal Income (TDSP)

My personal ratio is 0.000%. My house is fully paid off like many millions of other Americans who are either already retired or are heading into retirement.

I assure you that if the country was filled with people as concerned about the long-term future as I am then we'd be in a Great Depression right now and no amount of money dropping out of helicopters would change that.

In fact, the more money I'd see dropping, the less likely I'd be to waste what little future *real* savings I'd have left visiting this country's many malls buying more stuff that I don't really need, then storing that same stuff in this country's great many self-storage units because it no longer fits in my larger than historical McMansion.

Pent-down demand!

Just an opinion.

Troy said...

for *real* civilian employment growth to exceed *real* civilian labor force growth over the long-term.

it think my point (not being sarcastic with that) was that employment growth isn't going to be the regime that it was 1970-2000 . . .

http://research.stlouisfed.org/fred2/series/LNU00000060

that ramp-up produced immense demand for jobs and demand for credit to establish households, these two dynamics created a somewhat erratic but consistent pull-forward as more and more boomers (and Gen X) filed into the workforce and made more goods and services.

http://research.stlouisfed.org/fred2/graph/?g=sJY

is productivity growth, another side of this story, showing that 1950-65 was a time of growth, 1965-1980 stagnation (stagflation!), and the 1980s, 90s, and 00s each had a nice dollop of added wealth production per worker.

Aside from the PC and internet revolutions, I think there's been a lot of productivity benefit with the rise of cheap-labor imports, we're essentially getting their stuff at their more efficient wage rate.


I don't mean to talk past you here, but I'm just trying to find out the thing that's going to fail, or change, to create recessionary conditions.

I think some things are going to expand not fail, like gov't spending, consumer borrowing (granted Gen Y is already $30,000 in the hole with student loans but there's still another $200,000+ available for them to shoulder).

I'm just trying to look 5 years down the road . . .

http://research.stlouisfed.org/fred2/series/FYONET
I suspect that's going to be $4T.

http://research.stlouisfed.org/fred2/series/MBST

No guess there, but sky's the limit with that.

http://research.stlouisfed.org/fred2/series/TREAST

Round 1 was $800B to $1.6T.
Round 2 is $1.6T to ? ? ?
Round 3 can be whatever Yellen wants (maybe). MMT would just make this a permanent feature of our macro economy.

Aside from inflation aka Brent, Forex is the main feedback we get with printing.

With our $500B/yr trade deficit, we could use a little weaker currency

http://www.census.gov/foreign-trade/top/dst/current/deficit.html

especially with the yuan, yen, and euro LOL

(with they've stopped updating that LOL)




Troy said...

http://research.stlouisfed.org/fred2/series/CMDEBT

another area of repression that I suspect is going to turn to the upside!

1985-1999 saw it triple (!), 2000-2009 it doubled, but Gen Y is getting into prime debt take-on age and I think we're going to see them push it to $20T as quickly as they can.

Back when money was shells or gold pieces, and Big Finance wasn't the trillion per year institution, getting a loan was tough.

Clearly the system no longer wants it to be tough to get loaned up.

Same thing with the BOJ -- they're the ones keeping the Japanes economy humming.

http://research.stlouisfed.org/fred2/graph/?g=sK4

Troy said...

http://research.stlouisfed.org/fred2/series/CMDEBT

another area of repression that I suspect is going to turn to the upside!

1985-1999 saw it triple (!), 2000-2009 it doubled, but Gen Y is getting into prime debt take-on age and I think we're going to see them push it to $20T as quickly as they can.

Back when money was shells or gold pieces, and Big Finance wasn't the trillion per year institution, getting a loan was tough.

Clearly the system no longer wants it to be tough to get loaned up.

Same thing with the BOJ -- they're the ones keeping the Japanes economy humming.

http://research.stlouisfed.org/fred2/graph/?g=sK4

Stagflationary Mark said...

Troy,

I don't mean to talk past you here, but I'm just trying to find out the thing that's going to fail, or change, to create recessionary conditions.

Sorry for sounding like a broken record but:

1, Civilian employment is growing faster than the civilian labor force. This is a mathematical impossibility over the long-term.

2. When Civilian employment is growing slower than the civilian labor force again (which it must do at some point, the math won't allow it to happen any other way), then the odds are very high that we will find ourselves in recession again.

I really don't know how else to put it. Much of our current growth and optimism has to do with civilian employment growing faster than the labor force. It cannot go on forever.

The business cycle is not dead.

Stagflationary Mark said...

Troy,

You have faith that the Fed can prop this up.

Why don't you have similar faith that the more the Fed does, the more nervous people like me become?

And when people like me get nervous, we spend less lest our nest eggs run dry before we die?

Permanervous since 2004! ;)

Troy said...

Why don't you have similar faith that the more the Fed does, the more nervous people like me become?

Mainly because boomer ants like you are far outnumbered by the grasshoppers in this economy.

When I finally sussed out what was actually powering the 2004-2005 recovery, my faith in my fellow man took a real big hit.

http://research.stlouisfed.org/fred2/graph/?g=sK6

jesus that's a beautiful correlation. I still drive-by DeLong's every so often to spam his comments with it or a variation, since basically nobody of importance actually buys this 'illusion of prosperity' thesis; 2008 was some exogenic event that happened without much relation to what had gone on before.

Many boomers are pretty set now. Many are not. But 76% of this nation doesn't really have a pot to piss in.

http://money.cnn.com/2013/06/24/pf/emergency-savings/

and don't even have savings to husband.

Troy said...

As for jobs vs. labor force, here's a graph:

http://research.stlouisfed.org/fred2/graph/?g=sK8

blue is PAYEMS (left), red is 15-64 (right)

so, job-wise we're about back to the 2008 peak, 138M.

pop-wise, we're up 6M!

And with an activity rate of 75%, that's a run room of 4M new jobs before we get to the full employment (ha-ha) of 1Q08.

4M is a year's worth of job growth @ 300,000 per mo.

Activity rate age 15-64 is 73% now and was 77% prior to the dotcom collapse, so those 4 points are worth another ~8M positions.

Jobwise, here's 3 major sectors:

http://research.stlouisfed.org/fred2/graph/?g=sKa

mfg is down 5M jobs since 2000.

construction is down 2M from the 2008 bubble even though Gen Y is hitting their 20s and they all need houses now or soon.

information is pitiful, down 1M it looks like.

This economy still has room to grow, given some more input.

And by input, I mean

[ $ ] [ $ ] [ $ ]

And if and when the job market has hired the last person looking for work, wages could go up, giving the Fed the kind of inflation their looking for, actually.

Stagflationary Mark said...

Troy,

Mainly because boomer ants like you are far outnumbered by the grasshoppers in this economy.

The grasshoppers are stuck with student debt and poor long-term job prospects in an increasingly automated and competitive global economy. Sigh.

jesus that's a beautiful correlation.

Yes, for the last recession. As seen in your chart, not so much for the one before it. That's 1 for 2. There are many ways to have a recession. You risk being the general fighting the last war.

You think the business cycle is dead. I say it isn't. Neither of us are going to change our minds. You don't expect any recessions within the next decade. I expect one this year (give or take). No point endlessly debating this with no progress being made.

If I am right, we'll know soon. If you are right, you'll have many years to say I told you so, lol.