Things Could Get Worse Before They Get Better

Things Could Get Worse Before They Get Better
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The California legislature in its latest session has proposed something like 130 different bills aiming to address what is being called a housing crisis.  AB 352, for example, is a possible amendment to Section 17958.1 of the Health and Safety Code that would permit the building of “efficiency units” of as little as 150 square feet. Other bills intend to be more exclusively the usual offering of financial aid.

After ten years of so-called recovery, an estimated 38% of the state’s 18 to 34-year olds are still living at home with their parents.  It is not a housing crisis, for that is the symptom. 

For much of the first part of the lost decade since August 9, 2007, the proverbial millennial stuck in their parents’ basement was an intuitive cliché.  The thirties gave us the emblematic vision of the poor sap stuck in a bread line, while the Great “Recession” has hit particularly the young and college educated who have been reduced to getting their bread in the house they grew up in.  It has been, as Pew Researcher Richard Fry noted in a report last year, “part of the private safety net.”

The incidence of this phenomenon has risen, however, in the past few years rather than abated.  More Californians as Americans are stuck in this predicament than ever before, significantly more even than during the first few years of “recovery.”  This has, of course, confounded many people largely social scientists who can’t detect the cause.  After all, the unemployment rate has fallen to an unbelievably low level and all social science expected that when recovery happened young adults would be dying to get on with their adult lives.

“But California has its lowest unemployment rate since 2007, and millennials still aren’t moving out.”

That was the perfect summation of this conundrum written by one California news channel in May this year.  The Federal Reserve can relate, with the minutes of its latest policy meeting (the end of July 2017) released this week showing what seems to be a great deal of confusion about the unemployment rate.  By all orthodox count, inflation should be roaring by now; inflation, in fact, should have been roaring long before now just as millennials were freed from their economic prison.

The Census Bureau provides us with some overall sense and timing. The agency tracks household formation, and though the series dating back to 1964 is broken by several discontinuities, it does give us a good sense of these factors.  Starting around October or November 2008, predictably, the growth in the number of American households started to decelerate.

Again, that makes sense given that economic conditions at that time were inarguably atrocious; and not just bad but so bad they conjured fears of, and outright comparisons with, the Great Depression.  A depression is more than just a bad recession. For several years even after its official end, the estimated count of households remained almost constant despite a rising population.  There were just over 112 million in October 2008, and as late as March 2011 there were 111.9 million. 

Around that point there did seem a glimmer of hope, a (lagged) renaissance perhaps provided by the sentimental, conventional take on QE2.  The number of American households jumped by 3.2 million in the space of just 19 months.  By October 2012, the estimate stood at 115.1 million and what appeared to be real recovery potential.

The month before that, though, the Federal Reserve had committed to a third round of quantitative easing.  To this day, most people aren’t really sure why. In the mainstream narrative, the problems of 2011 coming to a head in the summer of 2012 were a European issue. 

When contemplating at the end of 2011 what was at the time an unthinkable possibility of a QE3, that was exactly how it was framed.  The recovery was supposed to be on track throughout that upcoming year, but officials had become concerned that there might not be enough of a buffer against Europe and presumably its PIIGS problem.  As CNN described the dilemma very early in January 2012:

“Even Bernanke is worried about European sovereign debt problems spilling over to the U.S. economy. In November, the Fed took steps along with five other top central banks to make it cheaper for banks around the world to borrow U.S. dollars, in an effort to put an end to Europe's crisis and stabilize global financial markets.”

The major economic statistics did seem to comport with that idea.  Real GDP in the form of its “final” estimates (meaning the third initial calculation released three months after the end of the respective quarter) were for the first three quarters in 2012: 2.2%, 1.5%, and 2%, respectively.  Then in Q4 2012 contraction, -0.1%. 

That was the extent of it, as by Q1 2013 growth had been restored and in the media thanks to QE3 (and then QE4).  The next three quarters were seemingly recovery-ish and described in the most charitable of possible terms:  2.5% in Q1 2013 followed by 1.7% in Q2, and 2.8% in Q3.  For the first run of GDP figures, the uncertainty was held to just the one quarter, swiftly and decisively dealt with and leaving the impression that they were surely just European complications.

Household formation didn’t respond in that fashion, though.  If there were 115.1 million households in October 2012, somehow by August 2014 there were still just 115.0 million.  The recovery in narrative moved on but the population figures didn’t agree (the same was true, relatedly, for estimates of the total labor force; in October 2012, the official count of the labor force was 155.5 million and by August 2014 it had barely grown, reaching just 156.1 million).

While the media was busy writing the most glowing stories about the US economy in 2012, it was an election year after all, the Census Bureau was busy conducting its quinquennial Economic Census.  We often think of economic statistics like GDP as being exhaustively comprehensive, and more than that completely objective.  Gross Domestic Product is presented as an economic accounting. 

These are statistics, however, taken from sample surveys and populations.  The Bureau of Economic Analysis (BEA), the government agency responsible for GDP, does all it can in terms of accuracy and analysis.  But as anyone who ever took an introductory statistics class knows, larger sample size leads to more robust results.  The best possible is to survey the entire population, but that isn’t ever going to be realistic in any economy let alone one of this size and complexity.

The initial run of each quarterly GDP figure takes into account a manageable sample.  It is augmented each year by benchmark revisions using more comprehensive data and surveys.  These annual revisions are further expanded by the Census Bureau’s Economic Census, which filters into a great many economic accounts every five years.

But it doesn’t happen immediately.  It takes nearly the whole year to conduct the survey, and then several years afterward for the full sense of the results to find their way into all the benchmark revisions of all the subaccounts that feed into GDP and others.  The 2012 Census wasn’t mostly incorporated until the benchmark revisions made in 2014, and the fullest extent of revisions until 2015.

In GDP terms, the differences were striking.  The trouble in 2012 was found to be far more than just the one quarter of anomalous weakness. While Q4 2012 was revised higher to eliminate the contraction, it was barely so at +0.1%; Q3 2012, the quarter preceding it, was revised lower to just +0.5% coming awfully close to the common definition of recession. 

The quarters following this near-recession were also brought down, too, as weakness seems to have lingered well into the next year.  GDP in Q1 2013 was nearly 2% but still less, while in Q2 it was barely more than 1%.  In total, these revisions display five consecutive quarters of growth less than 2%, including those two very close to zero. The average during those five quarters was just 1%, more than a year with very little expansion.

Unlike the original stories written of recovery and monetary policy prowess, these drastic modifications never made the news.  It’s understandable to some small degree, as why would many people care about 2012 GDP in the middle of 2015? These kinds of benchmark revisions in the past had meant very little, altering at most the degree of growth in any particular period.  Very few people pay attention to the details behind the GDP numbers as they are released, let alone a seventh set of revisions to them. 

This was different, however, especially given the circumstances.  There were from the start doubts about recovery, given already by 2012 the “new normal” moniker that unlike past instances was pejorative.  Coming so close to a re-recession so soon after the Great “Recession” would have been a major problem, one that economists just dismissed as impossible. The US economy was not truly different from Europe’s in that the latter did fall into outright recession in 2012 and linger in a reductive haze for many quarters after.  If there was a difference it was the smaller matter as to the degree of downturn in each, not that Bernanke’s Fed had skillfully avoided that fate.

You can, I hope, appreciate why there might have been such great reluctance on the part of more than millennials to more than just leave their “private safety net.”  Economists and all the experts on TV or the internet were saying one thing while on the ground conditions were totally different.  It was a rerun of just four years before when mostly the same experts and policymakers claimed there was no need to be concerned even though there was every reason to be. Who to trust?

To the idea of recovery, it was all “unexpected.”  In reality, it wasn’t; at all.  The yield on the 10-year US Treasury Note had been moving back toward 4% in early 2011, but by the time Mario Draghi made his (infamous) promise about the euro (European problems?) in late July 2012 it had dropped below 1.50%!  It wasn’t unique, either; eurodollar futures importantly were even more pessimistic on the US, not Europe’s, economy than UST’s.  The June 2017 contract that was priced at around 94.00 in February 2011 (indicating expectations for LIBOR in June 2017 to be just about normal) had been by July 2012 bid up past 98.25, getting to 98.40 by May 2013.

To economists, especially those acting as policymakers, this was all very confusing.  The recovery was to them proceeding at a slow but steady pace apart from a minor hiccup (with headline data to match).  These important and much deeper markets (especially when compared to stocks) were suggesting nothing less than its end.  The majority of people affected by it reacted more like these markets, and now have the statistical evidence, too.

It is very interesting to note that the June 2017 contract went off the board just over two months ago at 98.7198.  The recovery did not end; it never was.

As pitiful and perhaps immoral as all that, it has happened again. 

Very similar to the circumstances in 2011 that produced the downturn in 2012 (the answer is in the CNN quote above showing that it wasn’t ever Europe, as the brief reference to “make it cheaper for banks around the world to borrow U.S. dollars” actually proves), the “rising dollar” that began in 2014 has been revealed to have produced another serious downturn in 2015-16. 

And once more, its full extent was not estimated and clearly demonstrated until almost two years later (though the 2017 Economic Census is just now underway, and who knows what that might further expose down the road).  It was the last benchmark revisions that showed like 2012 two consecutive quarters (Q4 2015 and Q1 2016) of just about zero growth followed by extended weakness atypical to the usual symmetry of cycles.  

The combination of further benchmark revisions related to the downturn in 2012 as picked up only in the Economic Census, plus this next downturn in 2015, has in many accounts beyond just GDP dramatically altered the view of the economy. As I defined it for durable goods revisions back in May:

“A better way to start describing the change is by referencing just the size disparity then to now. As stated above, in April 2015 using the benchmark set in May 2014 it was believed durable good shipments [for March 2015] were $177.6 billion; a month later, also for March 2015, the new estimates suggested it was only $171.7 billion; a year after that, $164.5 billion; and as of today, $162.8 billion. That’s a difference of nearly $15 billion for one single month. You can’t ignore almost 10% of activity that never happened.” 

Industrial Production had been thought on a very slow recovery trajectory in early 2015, with estimated production levels for the month of June 2015 just about 5% above production levels in November 2007. Several benchmarks later, IP for June 2015 was instead almost 2% below November 2007.  The title for my article quoted above about durable goods revisions was The Disappeared Economy.

The true economic state in America has never been presented accurately going all the way back to 2007, and so social scientists who trust the word of economists on the subject of economy stop investigating economic causes for why there are more young adults living today with their parents than ever before.  To many, the economy is recovering because that is what they have been told, yet these and so many other people in similar situations don’t act like it is. The unemployment rate is 4.3%, but what does that actually represent? 

Rather than recovery, the revised statistics more accurately describe circumstances where the margins of people on the wrong end grow, and the degree to which this increasing proportion falls behind does, too.  The condition is getting worse, not better. 

It is not strictly an issue for the unemployed who don’t count in the labor statistics, or just young adults stuck at Square One.  The issue is opportunity and more so perceptions of it. Even those who are employed and have been able to move out of the basement still might be (rightly) pessimistic about what their lives can be like over the next decade if it is anything like the last.  We used to take for granted what economic growth truly meant; many people today have forgotten what growth, real growth, was like while far too many have never once experienced it.  Hopelessness is just the start. 

The problem goes way, way beyond habitation.  It is a symptom of growing social problems that accompany real and extended economic dysfunction.  History is unanimous on the verdict of economies stuck without progress. Fractures in social life that in a robust economy might seem manageable, even minor, in lingering malaise explode.  Long simmering tensions that remained easily below the surface when opportunity was real suddenly become all that matter when hope is whittled down to the nothing of the latest economist claiming how good everything is. 

An entire generation of our people has grown up hearing repeatedly how things are getting better, the economy is growing again.  If this is “better”, can you blame them for giving up (that puts it a bit too harshly) or acting out?  There is no mystery at all to the deepening mistrust of institutions and establishments, the fraying of the social fabric or the political paradigm.  The world seems to be coming apart because a lost decade has left so many behind, far too many, and the “elite” rarely if ever acknowledge it is possible even when the data is altered more and more against their denials. 

You don’t have to tell tens of millions of Americans that eurodollar futures have been suggesting a bleak and despondent future for years, or that the bond market has confounded economists, and continues to confound them now, for the same reasons.  They need no benchmark revisions to declare and correct to what they have known and felt all along. They have already lived it and it seems they expect to keep living it - until they, too, reach the breaking point a small part already has.

 

Unless policymakers and politicians get themselves wise to the economy as it really is and has been, this is going to get much worse before it gets better.  

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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