On 1st July 2019 the US economic expansion, which started in the wake of the global financial crisis in June 2009, entered its 121st month and thereby officially became the longest running in recorded history. A few months later, a recession free decade ended with US equity markets near historic highs, the Nasdaq index reaching 9,000 for the first time on December 26th. Are we due a recession? A recent survey by MetLife showed that more than half of Americans surveyed expected one in the next year.
Recessions are hard to predict. Most economists, commentators, central bankers and politicians famously missed what in retrospect were clear signs of a bubble leading up to the global financial crisis (GFC) in 2008. The exact timing of a recession is even harder to get right. But some economists have spent the last few years warning of an eminent topple into recession. Among those have been Austrian economists. They accuse the loose monetary policy of central banks of merely papering over the cracks in the economy and keeping an unsustainable capital structure on life support. The Austrian business cycle theory explains how manipulation of interest rates by central banks leads businesses to misallocate capital and engage in unsustainable projects and predicts an eventual crash once it is realized that the structure of production is not in accordance with true, underlying demand. Austrians will tell you that the response from central banks to the 2008 crisis prevented the necessary reallocation of capital and that the we are experiencing an illusion of real economic growth. Alongside many other economists they have been calling for a downturn for years but continue to be proven wrong. Is it time for a mea culpa from the doom mongers? Not necessarily.
The response from Global central banks to the 2008 crisis was unprecedented. The Federal Reserve cut the Fed Funds rate to zero, where it was kept for seven years before slowly creeping up towards 2.5% in 2018 – only to be cut by 3 times 25bps in 2019 in response to slowing growth. Concurrently a programme of quantitative easing was implemented, leading to an explosion in the Fed’s balance sheet from less than $1 trillion to $4.5 trillion in 2015. After an attempt to normalize the balance sheet, QE was resumed in September 2019. In Europe, the ECB followed a similar script, cutting the benchmark refi rate to zero in 2016 where it has stayed since and embarking on a QE programme which, after supposedly coming to an end in 2018, was resumed in 2019 in one of the last acts of outgoing President, Mario Draghi. The US and European economies may have enjoyed a virtually recession-free decade but is entering a second decade hooked on extreme monetary stimulus and with no exit in sight. Japan, the country who pioneered the policies of zero inters rates (ZIRP) and QE and therefore has the longest experience with the effects, has spent three decades throwing increasingly extreme policies at stubbornly low growth. After what was labelled ‘the lost decade’ in the 1990’s Japan has gone on to experience two more decades of painfully low growth while the Bank of Japan has engaged in ever more aggressive policies, including pioneering negative interest rates and direct purchase of equities by the central bank.
This is in sharp contrast to the ‘forgotten recession’ of 1921, the last US recession which elicited no monetary easing from the Federal Reserve and from which the recovery was painful but swift. Instead, the establishment of permanent easy money, now dogmatically accepted across the global central bank community, has mired the global economy in a prolonged spell of below par growth. But outright recession has been avoided. And his may be the lesson of the GFC: while expansive monetary policy is incapable of addressing the underlying problems of capital misallocation, and indeed exacerbates the problem, it has proven effective in spreading the pain over decades, not mere months. The net effect is impossible to quantify with any certainty, but anecdotal evidence of worsening living standards for many, especially blue-collar workers, suggests that booming stock and housing markets masques serious problems in the real economy.
Recessions are of course not observable. GDP growth is just a number produced by bureaucrats in statistical offices. Real GDP growth is calculated by scaling growth in total output by a price deflator measuring inflation of the goods and services making up the economy. The higher the deflator, the lower GDP growth. Should inflation exceed the growth in nominal output, real GDP growth would be negative. We have previously written about how official inflation measures may underestimate price increases. Shadowstats.com, a website that calculates US economic statistics using an alternative approach to the official figures, reports an inflation measure that for a decade has consistently been around 7% higher than the official CPI figure. Using this measure, the US has been in continuous recession for the last decade.
It is too simplistic to say that a recession-free decade proves that the doomsayers were wrong. That case would be strong if central banks had plausible exit strategies from extreme measures, but the recent backtracking from both the Fed and the ECB shows that an exit is a long way off. And as Ludwig von Mises explained, ‘the boom can last as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market.’ If Europe and the US follows in the path of Japan, increasingly desperate monetary responses may put off the crash for a while yet. In the meantime we are paying the price by being stuck with lower economic growth, eroding our potential wealth as time goes by and condemning many to unnecessary economic hardship, low wages or prolonged unemployment. At the same time, bubbles are building in housing, stock markets, debt markets and elsewhere. Those who called the 2008 crash in the housing market were wrong for years before their predictions came true. But while they were warning us, the economy was booming, unemployment was low, labour market participation was high, wages were growing. The picture is different now. This time a stuttering economy is limping towards the precipice, and the drop could be even worse when we finally get there.