It's Difficult to Be Candid and Frank About This Economy

It's Difficult to Be Candid and Frank About This Economy
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According to statistics compiled by the Federal Reserve, Americans went on a debt binge in November and December 2017 to a degree unprecedented in decades. For Economists hoping at long last for signs of an economic turn out of the malaise, the surge in largely credit card use would appear to qualify. Adding to revolving debt to such a large degree is at root a collective step into the risky.

But what kind of risk? 

Let’s first start with the numbers. The Fed one month ago had initially figured revolving consumer credit balances rose by $11.2 billion (seasonally adjusted) in November. That was a big gain. With this month’s update for December, that estimate was revised upward to an enormous monthly change of +$24.8 billion. Outside of the statistical discontinuity for January 2006, it was the largest increase in dollar terms in the entire series going back to 1968 when credit cards first became a thing.

Not to be satisfied with the one, the Federal Reserve also estimates that in December Americans did it again. The aggregate outstanding revolving balance rose by another $25.8 billion. That two-month total of $50.6 billion isn’t just the largest expansion of credit cards, it’s way out of line with anything we’ve seen for decades.

These figures represent outstanding balances in the aggregate. The Federal Reserve reports separate estimates for monthly “flow.” In those terms, revolving credit advanced a total of $11.0 billion and $5.1 billion, respectively. What that means is that we aren’t exactly sure when US consumers borrowed so heavily since the unadjusted data and seasonally-adjusted data match only on each December. It suggests that at some point in 2017, likely in November and December, consumer credit exploded higher.

In more appropriate percentage terms, it was an astounding 5.2% increase in just those two months. The last time revolving credit rose by anywhere near the same proportions in two consecutive months was in August and September 1995 (+4.9%). Before that, May and June 1984 (+6.0%).

These are period comparisons that optimists very much wish to make. That’s what 1995 and 1984 both represent, the unshackling of prior negative factors associated with previous recessions and recovery dynamics.  This is, after all, their claim; that after enough time the global economy in 2018 is finally healed to the point that it can resume economic growth at something more like normal rates. To do so, it will have to accelerate from last year’s disappointing results, and consumers stepping heavily into risk like revolving consumer credit is one way that can happen.

And it’s a huge problem. The economic statistics just don’t match the narrative. Not even close.

Take the labor market. Last year was not just a bad one for US workers, it was worse than has become normal. You will hear very often that the economy created 2 million jobs last year, which is, according to the BLS, true (2.17 million, actually). It’s a number that President Trump has held up as some sort of political achievement even though he campaigned, and won, largely by pointing out how skewed these statistics (particularly the unemployment rate) have become.

Nobody stops to ask, is 2.17 million even good? It sounds good, impressive even. And since it’s not negative like recession, it must be a booming number. But two million payroll gains in 2017 isn’t the same as 2 million in 1995, or 1984.

In more appropriate percentage terms, the Establishment Survey calculates an annual gain in US payrolls of 1.49% last year. In 1995, US payrolls increased by 1.86% and that was a bad year! The year before, 1994, the Establishment Survey had increased 3.4%, or more than double the gains of 2017. Ninety-five was the worst year for jobs of the later nineties (1993-2000).

And comparing last year to 1984 is just not fair. Thirty-three years before that paltry 2.17 million, the jobs market surged by 4.2%. To match that, payrolls would have had to have gained 6.1 million in 2017.   

Not surprisingly, the income statistics compiled by the BEA, a separate government agency, the one responsible for GDP, are equally disappointing even though that’s not how they are being characterized.

Since the purpose here is to try to get a better understanding of risky behavior brought up by the splurge in consumer credit, I’ll use those as points of comparisons. In the twelve months through December 2017, Real Disposable Personal Income (DPI) per capita increased by 1.4%. That was a very low number, but even it overstates the gain due to calculations of the prior December and inflation via oil prices (base effects). Real DPI per capita in the two years up to and including December grew by all of 0.7% total (not per year). Incomes, in real terms, have been essentially flat going back to that last downturn.

Things aren’t much better nominally, either. In the same two-year period, January 2016 through December 2017, DPI per capita rose by 4.2%. Back in September 1995 when revolving credit had jumped in similar capacity, DPI per capita in the prior two years had increased 8.9%. Incomes rose by 18.6% between July 1982 and June 1984; 9.5% in real terms.

In short, the economic climate at least insofar as labor and consumer incomes are concerned has been nothing like those prior periods. Not even close.

The same is obviously true of broader economic statistics, as well. Real GDP in 2017 grew by either 2.50% (Q4/Q4) or 2.25% (average SAAR). Neither was a particularly good result, though slightly better than the prior two years (the downturn).

In 1995, real GDP increased 2.28% (Q4/Q4), which, like the labor market numbers, was the worst year of the later nineties. In 1994, GDP was up 4.13%, and in 1996 4.45%.

Real GDP grew by 5.63% in 1984, after rising 7.83% in 1983.

In other words, rapidly rising consumer credit in 1984 needs no explanation. In 1995, it was a year of economic misstep, an isolated case of weakness in an otherwise robust trend. Consumers responded in one sense positively to it, borrowing to make up for lost income and growth with the quite reasonable expectations it was a temporary trend to bridge the gap until the economy regained its footing.

That’s what economists would argue is going on now, except that unlike 1995 there is no basis for that expectation. Though overall it was the worst of those years, “worst” only in the context of that time since incomes were still growing at a decent rate and employment was far more robust even in a bad year. There was consistency at a higher level even given some uncertainty.

In 2018, by contrast, all hope is pinned on what will surely happen tomorrow as completely different from today and yesterday. There must be a complete break, which as a basis for expectation is a whole other thing.

Another explanation for what we are seeing in consumer credit is the other kind of risk-taking, the bad kind. American consumers, with incomes stagnant for several years now in a row, are left with only two choices. The first is to reluctantly borrow in the hopes that maybe this tomorrow narrative actually happens one of these days; a last resort mindful of the fact all the TV experts have been saying the same thing year after year after year. They were so sure about it in 2016 for 2017, too.

The second option is to completely and fully retrench; cut back on everything and go into bunker mode. Nobody likes this second choice as it is usually reserved for the worst cases. Especially at Christmas.

Some may argue that Americans were just pre-spending their forthcoming tax cuts. That’s possible, though unlikely. The trend in the Personal Savings Rate has been sharply lower for several years, too, taking a really sharp turn in the second half of 2016. It was during that period where this latest “reflation” idea, the third since 2009, of rising economic fortunes took root. The savings rate therefore suggests that Americans are doing whatever they can, but that income and economic growth just aren’t coming.

Eventually the narrative runs out of room.  The savings rate was 6.2% in October 2015 when the downturn really started to produce those usual negative economic effects. For December 2017, just 2.4%.

The longer it goes on without real economic acceleration, the more certain people become that it has to happen. Not that it could probably happen, or maybe might happen, but that it will happen with absolute certainty. It’s the late stage devolution into rationalization that characterizes the same kind of bubble behavior we’ve witnessed countless times before. This is not positive risk-taking conduct.

The most obvious of those prior bad acts, as they refer to them in a courtroom, was the dot-com era. That’s not to say the economy was bad at that time, as noted above it surely wasn’t. But there was a pervasive belief that become a dead-lock certainty nothing bad could ever happen, and that any stumble would be brief and minor. It was a huge discounting of economic (and monetary) risk.

One big reason for it was Alan Greenspan, or at least the legend of the maestro. Speaking in Chicago in May 1999, the Federal Reserve Chairman put it this way:

“Any evaluation of the international financial crisis of the past two years would be incomplete without an understanding of the extraordinary strength of the U.S. economy that has acted as a buffer for much of the rest of the world… Now that there are tentative signs that we may be through the worst of the crisis abroad, an issue to which I shall return shortly, it would be useful to address the benevolent, but bedeviling, question of how the American economy, at least to date, has managed to remain an oasis of prosperity, in sharp contrast to badly sagging economies in the developing world, recession in Japan, and tepid growth in much of Europe. And, can we project how long our economy will be able to provide support to the rest of the world?”

Implicit in his question is the idea that nothing bad would happen to the US economy for the foreseeable future. It was a kind of blinding faith widely shared, particularly in the NASDAQ. There was plenty of reason to be concerned, but what the US had going for it, in the maestro’s formulation was:

“Owing to advancing information capabilities and the resulting emergence of more accurate price signals and less costly price discovery, market participants have been able to detect and to respond to finely calibrated nuances in consumer demand. The process of capital reallocation has been assisted through a significant unbundling of risks made possible by the development of innovative financial products, not previously available.”

There is nothing in that passage that turned out, in the longer run, to be accurate – especially the “significant unbundling of risks made possible by the development of innovative financial products.”  It’s an extraordinary statement in its own right, made all the more so by what happened subsequent to it (starting not long after he spoke these words).  He praises the eurodollar without, of course, fully grasping its full set of implications (this despite being gifted the lessons of LTCM just months before and the “international financial crisis” that came with it, meaning offshore “dollars” and balance sheet capacity). He came out of the Asian flu more confident when he should have been shaken to his very core.

In other words, things were going to be good in America for a really long time because…things were really good then and how could it possibly be otherwise even if we don’t fully understand how and why?

In our current predicament, the setup is flipped around but there still remains this one constant. Things have been bad for a very long time, but now they are going to turn good even though nobody really knows how or why. Tax reform? The unemployment rate that didn’t mean anything in 2015, 2016, or 2017? Globally synchronized growth (which is just another euphemism for how somebody else’s economy will break out, we just can’t tell you who)?

The economy is getting so much better because Greenspan’s disciples say so. That’s the one piece that doesn’t change, Economists who don’t know what they are doing but aren’t afraid to tell the public a completely different story. Many people still listen because there is no alternative. It’s driving social disruption, which has had rather than a cleansing effect instead a hardening one.

What I mean is this difference in rhetoric. It was bad in 2014, more so than in 2011. In 2011 so close to the panic and Great “Recession” there was no basis for anything other than caution. The mainstream in 2014, by contrast, was full of the same kind of economic rhetoric we find now, but almost reasoned in comparison. There wasn’t this shrillness and desperation three years ago, more an expression of (mistaken) relief than anything.

The reason it seems to get worse with each cycle is downstream behavior. There is a palpable determination especially among policymakers and the so-called establishment to undercut and discredit the forces that drove Brexit and Donald Trump’s candidacy. The economy was worse by every measure in 2017 than 2014, but you wouldn’t know it because of what happened largely in 2016 politics.

To put this in perspective, former Federal Reserve Chairman Ben Bernanke, Alan Greenspan’s immediate successor, spoke last June at the ECB’s conference in Sintra, Portugal. Admitting to his audience there was a point to Trump, Bernanke said:

“Whatever one’s views of Donald Trump, he deserves credit, as a presidential candidate, for recognizing and tapping into the deep frustrations of the American forgotten man, twenty-first-century version. That frustration helped bring Trump to the White House.”

But what are those frustrations? Bernanke makes plain that they are, in his view, illegitimate. He follows up on mere observation of this political shockwave by editorializing in his own biases, “I’m hardly the first to observe that Trump’s election sends an important message, which I’ve summarized this evening as: sometimes, growth is not enough.” He even goes so far as to call Trump’s vision of the economy, the one that got him elected, “dystopian.”

There it is; the economy is great but, somehow, we got Trump anyway. It must have been for reasons other than the good work he himself claims for himself. The economy has to be good now, even if it isn’t, and great tomorrow otherwise maybe there was something behind Brexit and Trump after all. It’s much easier for Bernanke to rationalize, and for others like him to do so, even if in the process they feed the same rationalizations of far too many others while at the same time nurturing their ultimately self-destructive behavior.

Markets are supposed to be efficient. That’s what people like Bernanke believe (except when they don’t; eurodollar futures and UST’s, to name the big ones). Stocks in particular are priced, as Greenspan also said in 1999 in a different setting (I referred to this speech last week), by “the judgments of millions of investors, many of whom are highly knowledgeable about the prospects for the specific companies…”  The estimations about those prospects, however, are derived in large part from the interpretations of the Bernanke’s and Greenspan’s. The overall characterization and base economic setting is still done by a small group of biased incompetents.

Sometimes the Bernanke’s of the world just aren’t being honest, even with themselves. Don’t like Trump or growing populism in Europe and elsewhere? Try being frank and candid about this economy. That’s where it starts, though it would have been better to do that before the credit card bills were in the mail.  As for the Dow, well.

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

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