There has been much talk that the US economy is heading back into recession. ‘Double-dip’, ‘deflation’ and ‘ice age’ are words that have been taken up in the financial press. Indeed, the UK’s Guardian newspaper reckons the world is about to ‘blow up’!
I remain unconvinced that the US is heading into recession in the next 12 months. In previous posts, I have argued that the best measure of the health of a capitalist economy is profit, both its overall level and its rate relative to the stock of capital held in the economy (see Profits lead the way, 28 April, 2011). In this measure, the US economy has clearly recovered from the Great Recession of 2008-9, which ended (on this measure) in mid-2009 (see my more considered post, Is America recovering?, 7 February 2011). But this profits recovery has not been translated into a significant rise in investment by capitalist corporations yet and, as a result, the US unemployment rate remains very high and the net increase in employment is very weak. Also, it appears that the growth in overall profits is beginning to slow. That would suggest that soon the rate of profit will peak and start to turn down, signalling the likelihood of another slump down the road.
But not yet – my view has been that the process of deleveraging after the Great Recession has reduced the ability and willingness of the capitalist sector to increase investment and employment (see my post, Deleveraging and the economic recovery, 7 July 2011). So economic growth in the major capitalist economies is likely to be much weaker than in previous recoveries. But that does not mean these economies will slip into a new recession right now.
Are there other more ‘high frequency’ ways on top of profits, investment and employment that can tell us whether the US economy is dropping back into recession? One possible shorter-term way of telling whether the US economy is heading into recession right now is to look at surveys of business activity in the US. Surveys are not great measures of an economy because they are just that – surveys. But combined with other data, like profits, investment and employment, they can be useful more up-to-date guides as to where an economy is placed. The best survey of business activity for the US economy is provided by the Institute of Supply Management (ISM). The ISM survey covers both manufacturing and services companies on a monthly basis. It computes the number of companies that consider their businesses are growing against the ones that don’t. If the ISM score is above 50, there is growth in the sector; if it is below 50, there is contraction in the sector.
What does the ISM survey for US manufacturing show? Currently, the ISM index is above 50, which suggests there is still growth. But there has been a significant slowdown from a peak of over 60 just some four months ago. That suggests a very sharp turnaround from boom heading towards slump. Well maybe. It clearly shows why many economists reckon the US economy has entered a ‘soft patch’. However, as the graph below shows, it is not unusual for the ISM manufacturing index to be in the range of 50-55 without falling into recession.
Maybe a better measure is the rate of change in business activity. I’ve adjusted the ISM manufacturing index to look at its rate of change. As the graph below shows, on that measure, US manufacturing is not yet in recession mode.
But manufacturing is only 20% of business activity in the US capitalist economy. Most businesses provide various services: retailing, professional services, finance, marketing, trading etc. The ISM non-manufacturing survey covers this part of the capitalist economy. So I have combined the two surveys on manufacturing and non-manufacturing into one measure. Again, this shows that the US economy is not yet in recession.
And when the rate of change in the combined ISM is measured, it shows that the US economy is now pretty much in the same range as it was in the period of recovery after the previous recession of 2001.
We can look ahead by measuring the ISM survey on new orders that manufacturers and services companies are getting. This is a good leading indicator of the way the economy is heading. My measure of combined new orders for manufacturers and non-manufacturers shows that there is a slowing in the growth of new orders, but there is still growth. It is not indicating recession quite yet.
Finally, the rate of change of the index for combined new orders shows that the US corporations can still broadly expect some growth in sales that are commensurate with low growth in the economy, but not a recession.
A lot of measures and lot of graphs based on surveys of business. But combining these results with the current data on profits, investment and employment suggests a ‘double-dip’ recession is not imminent. But watch this space.
Michael Roberts Blog 
I’m inclined to agree with your assessment that the US is unlikely to slide into recession in the next 12 months.
I do have a couple of questions though.
How much of the recovery in profitability was the result of the Quantitative easing programme and the reduction of costs such as wages due to redundancies?
It now seems that most of the QE was diverted to speculation and life support for the banks and is now behaving as an inflationary drag on recovery. The cost reductions in wages are a one off measure that can be instantly emulated by competitors.
What, if any, will be the impact of these on the probability of a double dip recession?
The recovery in profitability in the financial sector was undoubtedly helped by QE. Nearly all the extra monetary easing kept interest rates low and boosted margins for the banks. Also the Fed purchases of treasuries and agency debt was just what the doctor ordered for the financial institutions.
But outside that sector, in the ‘real economy’, it was cost cutting (laying off labour and stopping investment) that did the trick on profits.
You are right that there is limit to cost cutting and revenues have to start rising to keep profitability up. And companies must invest if they are to compete. That’s why profits may rise from here but profitability won’t. If there is a new recession, it will be because profits have dropped back, not vice versa.
Reading your prediction some months ago that the US would not enter a recession until something like 2014 or later left me wondering how your analysis could be so far off.
The ISM surveys are backward looking data. More important is the trend, which supported by orders/deliveries in decline, clearly points to a renewed recession. One cannot examine the US economy in a vacuum and must consider it in the context of the global economy. The decrease in economic activity in Europe and very recent reports coming out of China, Singapore and Hong Kong, for instance, clearly indicate a global slowdown of significant proportions.
My hunch is that at some point in the medium term the determination of a recession will be determined to have arrived perhaps as early as June of this year and certainly no later than the 4th Quarter, 2011.
Don
Yes, the ISM data are after the event, but then so are all stats. At least, the new orders component of the iSM survey can give you some view ahead. That suggests that we are not yet in recession mode as new orders are still rising. As for the trend down, we shall see.
Of course, you are right about the rest of the world, where we see the same slowing of growth. But I’m not sure that we have seen the end of the recovery from the Great Recession yet. The Great Recession fits into this downphase on the profit cycle at about the same point as the recession of 1937-8 in the last ‘winter’ period of the Kondratiev cycle. If that turns out to be right, then we still have another short-term up cycle to complete before we descend again. But we are in uncharted waters, because the 1937-8 recession was replaced by an upturn based on an arms race to a world war. That is not on the agenda over the next few years. So it is more like going to the bottom of the Great Depression of 1880s and 1890s. But more of this in my book.