Will QE 3 Save Us From Recession
(Note: This original article contains all the relevant charts and graphs that were excluded from the Op-Ed. Click Here)
NEW YORK (MarketWatch) — In the wake of the June FOMC meeting minutes revealed last week, a handful of Federal Reserve members believe that more stimulus may be necessary.
And with an economy teetering on another recession and stagnant economic growth — among other problems — there is an argument to be made that the only thing preventing us from seeing an economic tragedy mirroring 2008 is an injection of federal stimulus. Unfortunately, each round of quantitative easing produces diminishing returns, creates an artificial perception that our markets are healthy and does nothing to help Main Street, which is struggling the most.
Many economists — including myself — did not think the economy was in a bad enough position to see QE3 the last time Federal Reserve Chairman Ben Bernanke spoke. Bernanke was quick to mention that while our economy is growing slower than he had hoped, America was not in such a dire economic position as to inject billions of dollars of federal money into the markets.
So, with a dismal first half of the year behind us and important economic reports for June in, our best analysis into whether QE3 is around the corner is not necessarily looking at individual data points that may offer glimmers of hope, it is only the trend, or direction, of the data that matters.
Final sales of domestic product peaked in late 2010.
The economy as a whole slid from 3% growth in the fourth quarter of 2011 to just 1.9% growth in the first quarter of 2012. With the spate of weakness in recent manufacturing reports, it is likely that we will see second-quarter gross domestic product closer to 1.5% annualized growth, a very disappointing rate of economic growth a full three years since the recession.
And to add insult to injury, looking deeper into that number, final sales peaked in 2010 following the conclusion of QE1 and have been on the decline ever since. To put into historical context, when final sales have fallen below 2% growth on an annualized basis, the economy has generally been in a recession.
Not your father's economy
Jeff Saut at Raymond James recently wrote, "Indeed, 'your father's' recession', and subsequent recovery, saw the two sectors that pulled the economy out of recession, namely autos and home building, recording strong rebounds. Beginning in 2009, autos have done their job...The laggard has been home building, but that appears to be changing."
Saut is correct. In the past, recessions have been led out of the dark days by strong recoveries in housing and automobile manufacturing. However, this is not our "father's economy." Globalization, productivity, exportation and technology have led to a conversion of the American economy from a manufacturing powerhouse to a service provider. As such, residential investment has fallen from a near 6% share of GDP to just over 2.6% today. Likewise, auto manufacturing has fallen. Meanwhile, exports of goods and services have rocketed higher from a 2.8% share in the 1950s to over 13% today.
As for housing, there have been recent upticks in existing and new home sales, although last week mortgage-purchase applications showed a continued decline even as mortgage interest rates hit historic lows. Unfortunately, while annualized growth rates provide astounding recovery headlines, the reality is that much of the activity is occurring at the very low end of homes which are being turned into rentals. This activity has a limited life and scope, simply meaning we may have hit the bottom but are far from a housing recovery.
Recent releases have been nothing short of disappointing. ISM reports show a dramatic slowing in both manufacturing and services sectors, confirming that recessionary risks are definitely on the rise.
Nothing shows this risk better than our economic output composite index (EOCI), which is a composite of several Fed manufacturing releases, ISM composites, the Chicago Fed's national activity index, National Federation of Independent Business small business survey and Chicago purchasing managers index. This composite index is a very broad measure of the overall manufacturing and business climate in the U.S. economy.
Historically, when the index has declined below 30, the economy either has been, or was about to be in, a recession. At the end of last summer, our EOCI was indicating the onset of an economic recession, and the Fed launched “Operation Twist.” The combination of support from central banks in Europe as they implemented long-term refinancing operations, the warmest winter in 65 years and a drop in natural gas and utility bills in the winter allowed the economy to bounce back from a recessionary fall.
With the degradation in the euro zone and China, it is very likely that we will see further deterioration in the EOCI in the months to come as the economy continues to struggle. Without the implementation of further balance-sheet expansion programs — most likely in August or September — to fuel some levels of consumption and speculation, it is extremely likely that a recession will take root by the beginning of 2013.
With the release of the latest employment figures, came further confirmation of an economy on the ropes. With the growth of only 80,000 jobs in the latest report, the reality is that economy is struggling to grow. And let’s not forget who this does not count.
There are nearly 85 million individuals that are uncounted in the labor force, nearly 2 million more than just a year ago. There are 7.2 million people who are “disenfranchised” who would like to have a job but can’t get one. Finally, the duration of unemployment still remains at near record levels, while the labor-force participation rate continues to plummet to levels not seen since the early 80s.
This is clearly a picture of a broken labor market. The problem is not just “jobs” but the impact of such a large mass of unemployed individuals living off government support, which impedes both economic and wage growth. Wages have not kept pace with inflation in recent years, pushing average wage earners to rely on debt and reduced savings rates to maintain their standard of living. The disparity between income and outflows has now become vastly apparent as the spread between the “rich” and “poor” has grown sharply.
The economic impact of weak employment continues to be felt as aggregate end demand on businesses keeps companies in a defensive position. The reality is that the deviation from normal employment levels is at the lowest point in history. In order to compensate for normal population growth, employment would need to exceed 250,000 jobs a month every single month for the rest of this decade just to get to “real” full employment levels. This is very unlikely to happen when you have an economy growing below 2% annualized rate.
The Fed has three basic requirements to launch additional balance-sheet expansion programs: 1) a stock market that has been, or is, declining sharply and headed for levels that will impact consumer confidence, 2) subdued levels of inflation as balance-sheet programs push commodity prices higher, and 3) an economic environment that is slowing toward recession.
The first half of the year has proven that with a euro-zone crisis pending, China’s slow growth leading to higher priced exports, a jobless rate stuck at 8.2% and an economy with no sign of improvement, Fed chief Ben Bernanke has no choice but to continue to inject stimulus into the market as early as this fall or risk another recession. Unfortunately, this short-term solution to the markets will have damaging long-term consequences to an economy that cannot create organic, natural growth.
Lance Roberts is chief strategist at StreetTalk Advisors .