Previous posts extending back to 2009 suggested that the global economic recovery from the 2008-09 “great recession” would mirror the revival after the 1974-75 “first oil shock” downturn. Industrial output has indeed followed a similar path but is now starting to diverge – necessary if economic optimists are to be proved correct.
The 2008-09 and 1974-75 recessions were of similar depth and duration. They were preceded by money / credit booms spurred by financial deregulation and loose monetary policy, and were triggered partly by a real income squeeze caused by a commodities-driven inflation spike. Both involved major financial stress – worse in 2008-09, although the UK secondary banking crisis of 1973-75 necessitated a Bank of England bail-out – and ushered in a prolonged period of further monetary accommodation, characterised by negative real interest rates.
The first chart superimposes the path of industrial output in the 1970s / early 1980s on recent performance. The two series have been rescaled so that the pre-recession peak in output equals 100 and the recession troughs (May 1975 and February 2009) are aligned. (Recent performance is measured by the CPB global industrial output series, which begins in 1991; the earlier data refer to the OECD area, which dominated the global economy in the 1970s, with current emerging-world countries playing a minor role.)
The current upswing tracked the 1970s path closely until end-2011, when progress was temporarily derailed by a second Eurozone recession. Stronger 2013 growth coupled with weakness in the earlier cycle have since more than made up the shortfall, with output now 3% above the level implied by the 1970s / early 1980s path.
The post-1975 upswing peaked in February 1980 after 57 months. The corresponding point of the current upswing was November 2013. An initial fall in output in 1980 was followed by a recovery in 1981 before a longer decline to a low in December 1982, equivalent to September 2016 in current-cycle terms.
The post-1975 upswing was derailed by a second oil price shock in 1979 and a generalised tightening of monetary policies in response to high inflation. The oil price surge reflected a loss of Iranian supplies due to revolution. In an attempt to control inflation, the Carter Administration imposed credit controls in 1980 but abandoned the experiment after the economy tanked – this partly explains the 1980 fall in global industrial output and a subsequent temporary recovery after controls were removed. US interest rates then spiked higher, contributing to the second, longer leg of the downturn.
The current upswing has not yet been subject to comparable shocks. There are, however, echoes of the late 1970s. War in the Middle East and the stand-off with Russia threaten energy supplies. Regulatory pressure is constraining bank credit supply. Goods and services inflation is quiescent and monetary policies remain loose but economies and markets may have become addicted to ever-larger doses of stimulus – a small rise in interest rates could conceivably have the same impact as a much larger increase historically.
A previous post argued that the US economy is vulnerable to another recession in 2016, a scenario that would be consistent with global industrial output continuing to resemble the early 1980s path.
A weaker outlook should be signalled by monetary trends. Global real narrow money started to contract in 1979 before the economic upswing faltered in 1980. The current message remains positive but six-month growth appears to have fallen sharply in August, based on data covering 60% of the aggregate – second chart. The global economy is expected here to expand solidly through late 2014 but slow in early 2015.
Rising US average earnings growth casts doubt on the Federal Open Market Committee’s current assessment that “there remains significant underutilization of labor resources”.
Annual growth in average hourly earnings of production and nonsupervisory employees on private nonfarm payrolls increased to 2.5% in August, the highest since May 2010 and up from a low of 1.3% in October 2012.
In her Jackson Hole speech, Fed Chair Janet Yellen suggested that the FOMC is monitoring new composite measures of labour market conditions, constructed by using statistical methods to extract common information from a large number of indicators. Economists at the Kansas City Fed, for example, have created indices of the level and rate of change of labour market activity based on 24 indicators. The level measure has been trending higher since 2010 but remains 0.6 standard deviations below its historical average, consistent with the FOMC’s judgement of still-significant slack – see chart.
Such an approach, however, ignores possible structural shifts in the component indicators – the historical average may not be a good guide to “normal” conditions now.
The choice of indicators, moreover, is important: they should reflect all aspects of labour market behaviour. A notable omission from the Kansas City Fed activity measure is the job openings rate, i.e. the percentage of available jobs that are unfilled. This rose to 3.3% in June / July, matching the cyclical high reached in 2006-07, suggesting that employers now face significant difficulties recruiting suitable workers.
The job openings rate has been a better guide to wage pressures in recent years. Average earnings growth switched from a falling to rising trend in 2012 soon after the openings rate crossed above its historical average. The Kansas City Fed activity measure, by contrast, was 1.4 standard deviations below average in 2012. Nominal earnings expansion was above 4% in 2006-07 when the openings rate was last at the current level.
Faster earnings growth may contribute to the FOMC adopting less dovish language in its policy statement next week, supporting expectations of an interest rate increase in early 2015.
Japanese money growth remains weak but may be regaining momentum. Along with a fading impact of April’s sales tax rise, this suggests better economic performance in early 2015.
QE enthusiasts expected money growth to balloon in 2013-14, supporting a strong economy. A post in April 2013 explained that this was unlikely. Annual growth of broad money M3 was 2.5% in August, unchanged from March 2013, just before the Bank of Japan (BoJ) launched full-scale QE. Narrow money M1 expansion has been similarly static – 4.2% versus 4.1%.
Examining six-month rather than annual changes, M1 and M3 grew solidly during the second half of 2013 but slowed sharply from year-end – see first chart. With consumer prices boosted by April’s sales tax rise, the six-month changes in real M1 and M3 turned negative, warning that the economy was likely to disappoint forecasts – second chart. GDP fell by a much larger-than-expected 1.8% (7.1% annualised) in the second quarter and hopes of a strong third-quarter rebound have faded.
Six-month M1 and M3 growth, however, bottomed in July, recovering modestly in August. The sales tax rise, meanwhile, will drop out of six-month consumer price inflation in October. Real money growth, therefore, should resume this autumn, in turn implying a revival of economic momentum during the first half of 2015.
Currency-adjusted, US equities have outperformed Japanese stocks by 10% year-to-date, consistent with a large real narrow money growth gap in favour of the US in early 2014 – third chart. This gap is on course to narrow significantly, suggesting that the relative attraction of the US market is waning.
The global longer leading indicator* followed here rose in July, supporting optimism about near-term economic prospects.
The leading indicator fell between June and December 2013, correctly signalling an economic slowdown during the first half of 2014. Six-month industrial output expansion peaked in December 2013, falling through June 2014 – see chart.
The leading indicator rebounded strongly in early 2014 and has remained solid more recently. Industrial output growth recovered in July and should move higher through late 2014.
The indicator has been boosted by a rising emerging E7 component, suggesting that emerging-world economic news will surprise positively.
A post last week noted that global real narrow money expansion moderated between March and July, a trend that may have continued in August, judging from weaker US data. Real money typically moves slightly earlier than the leading indicator, and is less subject to revision. The central view here is that the global economy will expand solidly through late 2014 but slow in early 2015.
*Global = G7 developed plus E7 emerging economies. The indicator is derived by transforming and aggregating OECD country leading indicator data.
US narrow money rose strongly during the first half of 2014 but slowed in July and probably contracted last month, judging from weekly data through 25 August. Barring a strong September rebound, this suggests that the economy will lose momentum in early 2015.
Changes in real narrow money expansion precede economic growth fluctuations by about six months, according to the monetarist forecasting rule followed here. This relationship is strongest empirically in global data but is also informative at the country level.
Six-month growth of US real narrow money rose significantly between November 2013 and June 2014, suggesting strong economic performance during the second half – see previous post. Six-month industrial output expansion reached a 46-month high in July and July / August business surveys have been buoyant, with the new orders components of the ISM manufacturing and non-manufacturing surveys achieving their best levels since 2004 and 2005 respectively.
Monetary strength, however, reversed abruptly last month. Narrow money is likely to have contracted by about 0.75% in nominal terms, with six-month real growth falling to its lowest since November – see chart.
Monthly money supply changes are volatile and the August fall could be reversed in September. A bumper increase, however, would be required to push six-month real narrow money growth back up to its mid-year level.
Narrow money is held mainly for transactions purposes and changes usually occur ahead of spending variations, explaining its leading properties. US spending plans, in other words, may be turning more cautious, perhaps because of approaching Federal Reserve policy tightening.
Slower US real narrow money expansion suggests that the global measure tracked here will moderate further in August – see Wednesday’s post.