Over at The Economic Populist a few months ago I wrote a series about Economic Indicators during the Roaring Twenties and Great Depression. I examined those indicators because our current situation more closely resembles those debt-deflationary downturns, as opposed to post-World War 2 inflationary recessions. That data from the Deflationary period of 1920-1950 showed that all of those deflationary recessions followed a pattern. The CPI declined from the beginning of the recession and its YoY rate of decline bottomed immediately before the recession's end. M1 money supply followed a similar pattern, sometimes coincidentally, sometimes leading slightly. In all 6 of those deflationary recessions, once M1 and CPI began to decline at a decreasing rate, the recession was about to end.
For example, looking at the Great Depression of 1929-32:
we see that in this, the biggest of all economic contractions of the last century, like all other deflationary recessions, there was a clear pattern of M1 and CPI on the graphs --both money supply and inflation contracted at an increasing rate, then at a constant rate, before simultaneously or with M1 leading the way before CPI, both turn back up (meaning, prices and money supply are still declining, but at a decreasing rate) near the end of the deflationary recession. In other words, these deflationary recessions began to end once demand picked up. As demand picked up (recall Econ 101) inflation reappeared.
Turning our attention to our current financial crisis, which also features a debt deflation, here is the graph of the same indicators (M1 in red, CPI in blue):
When I wrote the earlier series, I noted that it appeared very unlikely that YoY CPI would bottom out before the middle of 2009 -- and it hasn't. But unless we have another collapse in the price of Oil like we did last year, it is likely that deflation will end, and we will return to inflation in a few months. Thus, if M1 continues to expand, the indicators studied from the Deflationary period of 1920-1950 suggest that the GDP might stop contracting in about Q3 2009, and start to actually grow.
But then what?
Whether the bottom of the trough of this decline in economic activity is in a few months, or if it is a year or two or more away, the fact remains that, with anemic wage growth to say the least, any incipient recovery appears doomed. For example, if our current (- 0.7%) deflation bottoms out and turns up within the next 2-4 months, how could there possibly be any significant expansion, if once again wages fail to keep up? Any such recovery would be short lived, strangled by the inflation caused by its own increase in demand. If the inflation rate agains exceeds wage growth, consumers will simply cut back again, plunging the economy into another leg down of a "W"-shaped recession.
Ah, but here's the problem: the same argument was true all during the 1980s and early 1990s, and for much of our own decade. Wages didn't keep pace with inflation then either. Why didn't a recession persist throughout the 1980s? Why didn't it persist into the middle of our own decade? In this case, the past answer serves as a prologue to the future.
Back in August 2007, I wrote a piece called Are Hard Times Near? The Great Decline in Interest Rates is Ending At that time, I pointed out that,
[w]hile from 1980 through 2006, the median income of an American household has risen only from $39,700 to $48,200 in real terms, house prices for example have shot up form nearly $125,000 to $246,500. Consumers have responded generally by taking on more and more debt. Total household debt service has risen from 16% in 1980 to 19.4% in 2006:
Fortunately for consumers, there has been a generation-long decline in interest rates since they peaked at 15.21% for the 30 year US Treasury bond in October 1981. This has allowed consumers to refinance their debts at ever lower rates every few years:
They have also been assisted by a bull market in stocks that took the S & P 500 from 102 in 1982 to 1553 in 2000, and the subsequent housing boom/bubble [that topped out by January 2006].
There are signs that this "Great Disinflation" of declining interest rates is coming to an end. Only twice in the last 27 years has the consumer been unable to refinance debt or tap into his or her stock or house ATM. ... [T]he 3rd and final time is almost certainly near.
In other words, since 1980, facing stagnated real wages, the only way American consumers have been able to significantly improve their lifestyles is either:
- to take on more debt, using assets which have appreciated in value as collateral (stock investments, housing), or
- to refinance their existing debt at lower interest rates.
When consumers were unable to do either of those things, they cut back on spending, triggering consumer-led recessions. Since 1980, this confluence of negative factors had only happened twice: in the deep Reagan recession of 1981-82, and again briefly from July 1990 to March 1991.
As of 2007, household income was still below 1999 levels. Interest rates had not receded to their 2003 levels, so refinancing activity could not increase. House prices were already in marked decline. Consumers were already starting to cut back, albeit not yet that significantly on debt. Only stock prices, by the barest of margins (.02%), were positive. I concluded then that "In order to avoid a recession, house price declines must stop, stock market gains must accelerate, or household income must increase significantly. Failing at least one these three things, if households have continued to cut back on debt, as appears likely, America will probably enter (or may already have entered) only its 3rd consumer recession since 1980."
That last conclusion was certainly proven correct! With a declining 401k value, crashing house prices, increasing Oil-fed inflation, and paltry wage gains, the recession started just a few months later in December 2007.
So, where to now? Unfortunately, the neoliberal economic paradigm is still embraced in a bipartisan fashion in Washington DC. We need not recapitulate the pedigrees of the most powerful economic advisors to the new Administration. So it does not seem that the productivity of American workers is suddenly going to be reflected in wage increases. No new asset bubble is on the horizon. On all of those counts, the news is bleak. There is no upsurge in wage growth lurking on the horizon - or even seriously considered as a public policy desideratum inside the Beltway.
In summary, from here on - with one possible exception I'll discuss below - we're not going to see any sustained recovery in the American economy until average Americans see a real and sustained increase in their compensation for labor -- for the first time in over 35 years.
But there is still a chance that consumers might be able to use one of their old tricks, one last time. In the August 2007 story recounted above, I concluded that there was "a first-order danger signal for the long term future is that long term interest rates seem unlikely to move lower ... soon." But "[i]f long term interest rates do decline again, consumers may yet have one more chance to refinance their spending for the next few years."
And lo and behold, a window of opportunity in interest rates has just briefly opened. Here is a graph of mortgage interest rates, showing the recent record decline to near 4.5%:
This interest rate (currently at 4.81%) is slightly less than the previous record low since 1980 (of 5.23%). Already it is estimated that up to 15% of all mortgages might be refinanced this year. Just on Monday CNBC reported:
The mortgage business is booming—70 percent in refinancing and 30 percent in new home purchases," Kelly King, CEO of BB&T told CNBC. "On the low end of the houses, we’re beginning to see some movement...There’s a long way to go, but there’s definitely activity."
For example, a family with a $200,000 6% mortgage, who refinance at 4.5%, will save $3000/year. Such a refinancing would be seriously stimulative to household finances.
While if lower mortgage rates persist, there will be space for an economic breather, the paradigm of my 2007 piece remains true. So long as real wages remain stagnant, any recovery which might start will be vulnerable to every uptick in inflation and interest rates, and will be shallow, weak, and probably short-lived. The Great Disinflation of Interest Rates is Ending, the long-term structural problems of our economy have become immediate problems as well, and no long-term recovery is going to take root without real wage growth.