There’s Always A New Recession Lurking

Former Minnesota Gov. Tim Pawlenty and newly minted Presidential candidate thinks that a new recession is coming. He’s right, of course. There’s always a new recession coming. There have been 33 economic contractions in the U.S. since the mid-1800s, according to NBER, and it’s a safe bet that number 34 is waiting in the wings. As Richard Fisher, president of the Dallas Fed, recently remarked: “I devoutly hope our next downturn won’t come for quite some time, but it surely will come eventually.”

A recession could start tomorrow, or five years from now. The challenge is developing some insight that improves the odds of calling the next turning point in the economic cycle with something better than random odds. Pawlenty’s forecast can be dismissed as political commentary, of course. After all, he’s formally announced his candidacy and so he has a vested interest in sowing doubts about the economic outlook under the stewardship of the current President. It doesn’t help that his analysis is a bit thin on the details. But even if Pawlenty’s motives are suspect, his conclusion isn’t beyond the pale.
Alan Blinder, an economics professor at Princeton, also worries about the economy, although he’s cautiously optimistic that growth will prevail, as he explains in today’s Wall Street Journal.
Calling turning points in the business cycle is tricky business, of course, even for respected economists. The future’s always uncertain and that makes fools of everyone eventually. Yet there are a number of productive approaches to evaluating the odds that a new recession is approaching. In fact, countless volumes have been written on the subject. The challenge for investors is paring the list down to a manageable list for monitoring and evaluating this risk. One that deserves to be on the short list is keeping an eye on consumer spending, which accounts for 70% of the economy.
A few years ago, Joseph Ellis offered an intriguing take on how to analyze this critical factor, offering details in his book Ahead of the Curve: A Commonsense Guide to Forecasting Business and Market Cycles. In essence, Ellis says that the annual pace in real (inflation-adjusted) personal consumption expenditures (PCE) has a strong history of dispensing early warning signs of approaching recessions. He also notes that real average hourly earnings of nonsupervisory workers sheds light on changes in PCE’s trend.
With that in mind, how do these metrics stack up these days? The trend in real PCE continues to look strong, as the chart below shows. But there’s a warning sign in the recent weakness in average hourly earnings. The basic message seems to be that if inflation continues rising, the economy could be in trouble.

The next update on consumer price inflation is scheduled for release on April 15. As we discussed yesterday, the market’s inflation forecast appears relatively stable. But some analysts worry that the stability will be short lived and so inflation is headed higher, a change that would put more downward pressure on real wages, which in turn could bite into consumer spending. If so, there’s’ at least one reason for thinking that the risk of recession may be inching higher.
Update: For a technical note on an alternative methodology for calculating real hourly wages (a methodology that Ellis recommends in his book), please read this addendum.