Is The U.S. Overdue For a Recession?...

I will do my best economist impersonation here and answer - yes and no. The yes part has to do with age. This recovery is nearly ten years old and if we keep going past July, as we almost certainly will, it will be the longest recovery in history.

But age alone does not kill expansions. Economic excesses and unexpected curve balls out of left field do. This recovery has not been excessive; it has been slow and steady. The average annual growth the past decade has been 2.3% versus 3.6% per year in the 1990s. There are no easily identifiable bubbles today. Interest rates are still low, inflation is benign and the housing market, although much improved since 2009, is not at nosebleed levels.

The Federal Reserve has shifted to neutral on interest rates. Unless inflation gets out of hand, rates will be held steady. And what about inflation? I have always been attracted to the relationship between wage increases and productivity. If you give someone a wage increase but their productivity (how many widgets they produce in an hour) goes up by an equal amount then there is no need for companies to increase prices to maintain profit margins, and inflation stays quiet. A nice balance.

Unit labor cost is the name they give to the difference between wage increases and productivity. Historically there has been a positive correlation between unit labor costs and inflation; when one goes up the other goes up, and vice versa. Over the past eight years (see chart below) unit labor costs and inflation have on average moved very much in unison.

Damned Lies pg 1.jpg

How do unit labor costs look going forward? Productivity has been naggingly slow in this recovery. Nobody knows exactly why, maybe it’s because it takes time for new technology to become effective or maybe it’s because, as some critics charge, all this new technology (social media?) doesn’t do much to increase production.

But productivity is on the rise right now. Over the past three months productivity has jumped 3.6% and over the past year, it is up 2.4%. This is a refreshing switch from slow gains in the recent past (again, see chart). Right now unemployment is very low and we should expect companies to increase wages faster in the future to lure good hires. But if productivity also increases at a faster rate, then we are in a wonderful sweet spot, with no need for prices (or inflation) to go up rapidly.

I realize I am still avoiding the question, what about the next recession? Right now, US economic fundamentals are signaling the recovery will continue. But the wildcard is all the unexpected events like continued China/U.S. trade friction or a sharp downturn in consumer confidence. I am positive on the economy today though I have all fingers crossed due to the many uncertainties.