The U.S. economy is a highly complex, multifaceted mechanism. Accordingly, it is extremely difficult to predict. It is so difficult, in fact, that economists have been the subjects of numerous jokes over the years. Economic predictions are frequently unreliable, despite the fact that many economists prognosticate with great confidence.
Economists routinely sift through mountains of data to determine their forecast. Recently, I spoke with Richard Yamarone, an economist with Bloomberg who, earlier this year, was perhaps the first to proclaim that another recession was on the horizon. Yamarone’s contention is that a recession in the United States is a certainty by year-end. Part of his reasoning is that since 1948, whenever real GDP fell below 2% on a year-over-year basis, the economy ultimately slipped into recession. With America still reeling from the Great Recession of 2008, perhaps Yamarone has a case.
Politically, a double-dip could send many Washington incumbents packing. Economically, a double-dip would translate into higher unemployment and could introduce the potential for a Japanese-style deflationary scenario. At least that’s what the Fed was claiming last year when we stood at this same precipice.
The Business Cycle: A Primer
When the economy expands, unemployment falls as businesses hire to meet the growing demand. At some point, and for a variety of reasons, demand ultimately slows and the economy begins to contract.
As the economy contracts, unemployment rises, GDP falls and eventually we reach the bottom of the cycle. Expansion and contraction may last for as little as a few months or up to several years. In fact, between 1854 and 2009, the shortest U.S. expansion lasted 10 months while the shortest contraction was six months. The longest expansion was 120 months and the longest contraction was 65 months. Since WWII, the average economic expansion has lasted 42 months and the average contraction 16 months.
There is a strong psychological component to the business cycle as it is subject to the whims of the individual. Furthermore, it is influenced by world economies. In effect, when individuals feel bad about the economy they tend to delay major purchases. To the contrary, when times are good, people spend more. Both of these can be self-perpetuating, which is part of the reason why the business cycle pendulum has wide swings in both directions. Therefore, maintaining a steady economy is more ideological than obtainable. Ideally, if all major purchases could somehow be made with consistency and regularity, the business cycle would be rather flat. However, due to human emotions, government involvement, military conflicts, weather, etc., this is unrealistic. Hence, the gyrations of the business cycle remain.
The Business Cycle: Antagonists
As previously mentioned, the business cycle is influenced by a number of factors, notwithstanding government policies. Prior to FDR, the U.S. government assumed a much more hands-off approach. For example, when the banking crisis of 1907 hit, the private sector, namely J. Pierpont Morgan, stepped in to rescue the economy. However, by the time the Great Depression arrived, Morgan was no longer around. There was also a concern that too much power had been vested in one individual. Therefore, in response to a strong public outcry, government was compelled to act. America was searching for answers and in the early 1930s, noted British economist John Maynard Keynes provided them. Keynes believed that during slow economic times, the government should step in and employ the unemployed. FDR welcomed this idea with open arms as evidenced by his “New Deal” economic plan. Since then, government involvement in economic affairs has been the rule rather than the exception.
It is in the darkest of times that politicians find their greatest opportunity. In fact, it was Otto von Bismarck who in the late 1800s postulated, “A man who has a pension for his old age is much easier to deal with than a man without that prospect.” He went on to say, “Whoever embraces this idea will come to power.” Need I say more?
The business cycle ebbs and flows based on GDP. Gross domestic product is the primary measure of the economy and is defined as the “total market value of all goods and services produced.” Moreover, it is comprised of four distinct, but interrelated parts. They are: consumer spending, industry spending, government spending and net exports. You might think of it as: C + I + G + Ex. The sum of these parts is the key metric for measuring our economy.
Unemployment Rate: The Fallacy Behind the Figures
The unemployment rate is measured by the Bureau of Labor Statistics and is published on a monthly basis. At the time of this writing, the rate was 9.1%. The unemployment rate has been higher than 8.8% for 28 months since April 2009.
There are actually two unemployment rates: the “official” rate and the “unofficial” rate. The official rate is the rate quoted most often by the media. The unofficial rate attempts to include those individuals who have stopped looking for employment. Obviously, this number cannot be accurately determined, but suffice it to say that the unofficial rate is always higher than the official rate. The divergence between the two may also increase as the economy worsens and people become more discouraged.
A healthy economy is heavily reliant on the labor market. Clearly, the more individuals who are employed, the greater the output will be. Therefore, putting people back to work is perhaps the single most important economic issue today. Until we reduce the unemployment rate, robust economic growth is unlikely.