The US economy is not recession-proof


Happy New Decade! Here’s some cheer to start it off, in the form of this CNBC headline: Don’t look now, but Goldman Sachs is saying the [US] economy is nearly recession-proofThis sounds to our ears like an echo of the sort of hubris seen during the last time we waved in the twenties. We know where that ended up. Before you get too wound up and start screaming about vampire squids, the CNBC article might have oversold Goldman’s bullishness. For starters, the article appeared on December 31 but is based on two notes that came out in October and January 2019. The October note concerns the scaremongering that surrounded the inversion of the yield curve for Treasuries — that is, the period in late 2019 when the cost to the US government for borrowing at two-year maturities was higher than borrowing for the next ten. In the past the inversion has served as a bellwether for recession. No longer, according to the note (our emphasis): The median US economic forecaster now estimates a 35 per cent probability that a recession will start in the next 12 months. This number has doubled over the past year as growth has slowed, the yield curve has inverted, and the Fed has cut rates. And since forecasters tend to be cautious in adopting recession as a baseline, 35 per cent may be a conservative estimate of the perceived risk. However, we see several reasons why standard models—and thus forecasters— may be overestimating recession risk at present. Many models rely heavily on the flat yield curve and the low unemployment rate, which have been useful recession predictors in the past but may be less meaningful today because of the much lower term premium and the much flatter Phillips curve. We wrote at the time of the brouhaha surrounding inversion that we didn’t buy the argument that, just because it had been a decent harbinger of doom in the past, it spelled disaster this time around. Things have changed, not least the injection of trillions of central bank money into the bond markets since the advent of QE. Goldman’s own probability of a recession in the year from when the note was published was 25 per cent, compared with the 35 per cent average. The reason being that they rely less on data such as unemployment rates and the yield curve, and more on core inflation and private sector financial balances.It has since declined to 20 per cent — a low chance, but not recession-proof.Goldman did however claim in the January 2019 note, which delved into the causes of a century’s-worth of US recessions, that the economy was now less exposed to some of the sources of earlier downturns.And the conclusion? (Our emphasis). A review of the last century of US recessions highlights five major causes: industrial shocks and inventory imbalances; oil shocks; inflationary overheating that leads to aggressive rate hikes; financial imbalances and asset price crashes; and fiscal tightening. The first three causes of recession have become structurally less threatening, in our view. Better inventory management and the shrinking output share of the most cyclical sectors have reduced the impact of industrial fluctuations. The decline in the economy’s energy intensity and the rise of shale have reduced the impact of oil price shocks. And better monetary policy has led to a flatter and more anchored Phillips curve, reducing the risk of inflationary overheating… …Overall, the changes underlying the Great Moderation appear intact, and we see the economy as structurally less recession-prone today. While new risks could emerge, none of the main sources of recent recessions—oil shocks, inflationary overheating, and financial imbalances—seem too concerning for now. As a result, the prospects for a soft landing look better than widely thought.Unlike Goldman, we do not have the misfortune to have to attach probabilities to recession risk. But the massive amount of state money still swirling around markets — coupled with the rise in all sorts of -isms, all of which have their roots in a mistrust of and anger at the system that preceded the crash — are the hallmarks of a different world order. Old risks might have diminished, but new ones are on the rise. 


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