The Breakdown - The Recession Discussion Is Incredibly Dumb

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.com, and Ft, and produced and distributed by CoinDex. What's going on, guys? It is Friday, July 28th, and today we are talking about, candidly, why the recession discussion is just incredibly mind-numbing and stupid. Before we get into that, however, if you are enjoying, the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dig deeper into the conversation about why this discussion is incredibly dumb, come join us on

Starting point is 00:00:45 the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. Now, today we are doing another macro day, and in some ways this is part two of yesterday's episode. Wednesday was, of course, FOMC day, and we got a 75 basis point rate hike, which led to markets being kind of euphoric. Why was that? Well, the big thing seems to have been the Fed's argument that the federal funds rate at around 2.5% was now in the range of what they considered neutral. In other words, it meant that the interest rate was no longer contributing to an overheating economy. That plus really the end of forward guidance, and the Fed's

Starting point is 00:01:33 saying that from here on out, we were going to take things meeting by meeting based on the current data, left many people interpreting the Fed as having hit and perhaps passed their peak hawkishness. Now, of course, many market participants disagree and warn that this could be an extremely volatile period, a period in which one bad inflation surprise to the upside, for example, could produce an even bigger than expected rate hike in September. This is something that Fed Chair Jerome Powell explicitly left the door open to. But even as the market got excited about a potential return of dovishness, the Fed also said that they expected a period of, quote, below-trend economic growth, which people, I think, correctly

Starting point is 00:02:14 interpreted, of course, as being Fed-speak for recession. And that brings us to the subject of today's show, the tortured, extremely weird state of the discussion about what is or isn't a recession. Let's start with yesterday's data about Q2 GDP. The Wall Street Journal writes, recession fears loom as U.S. economy contracts again. GDP fell at 0.9% annual rate. Second straight drop meets a common definition of recession. And there's that tortured language for you, meets a common definition of recession versus just saying it's a recession. Anyways, the big TLDR is that the GDP fell for the second quarter in a row. GDP fell by 1.6% in quarter 1 and 0.9% annualized in quarter 2. And you may be scratching your head and saying,

Starting point is 00:03:03 isn't two quarters of declining GDP the technical definition of a recession, well, yes, it is, as the journal says, a common definition of recession, but we're going to get to that definitional stuff in just a minute. First, let's talk about what was going on under the hood. One of the biggest drivers of the contraction last quarter was that businesses are trimming their inventories. At the end of 2021, businesses stocked up fairly aggressively. They anticipated robust consumer spending, and they wanted to get around supply chain problems that have been so intractable and tricky. The problem is that they bought the same stuff that people wanted before the pandemic and a lot of behaviors have shifted. In other words, they just didn't have the right models

Starting point is 00:03:43 to buy the right things for an overstocking period. If you're interested in this, by the way, Jim Bianco talks about it extensively in my interview with him last week. Anyways, over the last few months, realizing that they had overstocked, retailers have significantly slowed their orders to suppliers. Instead, they're fulfilling orders. from the inventory they already have on hand. The Commerce Department estimates that slower inventory accumulation subtracted two percentage points of output last quarter. Another area of decline was business investment. After expanding at a 10% rate in quarter one, business investment contracted at a 0.1% annual rate in quarter two. Also referenced in the slowdown was the housing market, which is

Starting point is 00:04:23 finally cooling thanks to higher interest rates driving up mortgages. Those higher mortgages have caused a slow down in buying and an increase in deals falling through. Finally, there is, of course, inflation-driven changes to consumer spending. People are finally shifting their spending habits to match what seems to be an intractable and persistent increase in prices. So that's what's actually going on with the GDP, but the whole discourse on Twitter and media of all types is about the definition. So as I mentioned, the definition of recession in common parlance is two consecutive quarters of negative economic or GDP growth. But in the U.S., the official arbiter is the National Bureau of Economic Research, and their definition is, shall we say, somewhat more nuance, opaque, subjective.

Starting point is 00:05:08 Their official page about this says the NBER's business cycle dating committee maintains a chronology of U.S. business cycles. The chronology identifies the dates of peaks and troughs that frame economic recessions and expansions. A recession is the period between a peak of economic activity and its subsequent trough for lowest point. So far so good, right? I mean, sort of, but it gets even more complicated. The NBER's definition emphasizes that a recession involves a significant decline in economic activity that is spread across the economy and last more than a few months. In our interpretation of this definition, we treat the three criteria, depth, diffusion, and duration as somewhat

Starting point is 00:05:46 interchangeable. That is, while each criterion needs to be met individually to some degree, extreme conditions revealed by one criterion may partially offset weaker indicators from another. For example, in the case of the February 2020 peak in economic activity, the committee concluded that the subsequent drop-in activity had been so great and so widely diffused throughout the economy that even if it proved to be quite deep, the downturn should be classified as a recession. So basically what they're saying here is that it's not just about two consecutive quarters of economic declining growth, for example, but it can be about a number of indicators, and in fact, those indicators going down very aggressively could mean that even if they only were down

Starting point is 00:06:25 for a little while, the NBER might ultimately categorize that as a recession. The definition goes on. Because a recession must influence the economy broadly and not be confined to one sector, the committee emphasizes economy-wide measures of economic activity. The determination of the months of peaks and troughs is based on a range of monthly measures of aggregate real economic activity published by the federal statistical agencies. These include real personal income less transfers, non-farm payroll employment, employment as measured by the household survey, real personal consumption expenditures, wholesale retail sales adjusted for

Starting point is 00:06:57 price changes, and industrial production. There is no fixed rule about what measures contribute information to the process or how they are weighed in our decisions. In recent decades, the two measures we have put the most weight on are real personal income, less transfers, and non-farm payroll employment. So this will obviously be significant as we talk about whether there can be a recession in the context of what seems like a strong labor market. The NBER is basically saying that non-farm payroll employment has been a key factor in how they determine recessions, which means that they might be on the side of there isn't a recession right now. But here's the real key. Quote, the committee's approach to determining the dates of turning points is retrospective.

Starting point is 00:07:33 In making its peak in trough announcements, it waits until sufficient data are available to avoid the need for major revisions to the business cycle chronology. In determining the date of a peak in activity, it waits until it is confident that a recession has occurred. In other words, the NBER is never going to call a recession as it's happening. It views its job as entirely retrospective. It's basically like the timekeepers in Loki and effectively useless for the day-to-day discussion, which might be why people are so much more focused on the traditional two quarters of declining GDP definition. But really, the question is, why does this all matter? I can't tell right now if the obsession about whether we're in a recession or not,

Starting point is 00:08:12 is strictly a media obsession. In other words, it's something that is important to different media outlets from a narrative and framing and attention-gathering perspective, or whether there is an element of a skeptical populace trying to catch the media or authorities in what they perceive as a lie or intentional obfuscation. In other words, is this discussion being driven just by media who are looking for the next narrative, or is it also being driven by people whose worldview revolves around the assumption of authorities lying to them, and that when politicians or the mainstream media say we're not in a recession, or worse, use this sort of tortured language like the Wall Street Journal did when it said a common definition of recession, they're sure then

Starting point is 00:08:51 that whatever the mainstream media or politicians are saying, the opposite must be true. I think this forms a sort of interesting Rorschach test for the state of economic and political discourse. According to a June 16th, economist in UGov poll, 56% of respondents believe that we are going through a recession. Only 22% disagreed and 22% said they weren't sure. Now, among those respondents, 70% of Republicans said the U.S. is in a recession, 56% of independents said were in a recession, and 45% of Democrats said were in a recession. Cryptotrater Chubby Corn says kind of feels like they're trying to convince us the car isn't broken down while they're pushing it.

Starting point is 00:09:28 I don't know if they're going to be able to hold the facade together until 2024. And I think that tweet gets to the point that recession at this point is sort of just shorthand for economic pain, which it could be argued is more relevant from people's lived perspectives than those technical definitions. There is definitely, however, an undercurrent of animosity and a sense of being lied to or manipulated that has spread all over this discourse on Twitter. David Sachs, with 9,000 likes and counting on this one, writes, a lot of people are wondering about the definition of recession. A recession is defined as two consecutive quarters of negative GDP growth if a Republican is president. The definition is far more complicated and unknowable if a Democrat is president. Conan O'Brien tweets

Starting point is 00:10:06 the White House now says it's only a recession if you see a salamander wearing a top hat. Zero Hedge writes, all of the economists who one year ago promised inflation was transitory agree. This is not a recession. Sven Henrik writes, weird how two consecutive quarter declines in GDP was a recession each time except this time. And Charlie Bielo builds on that and says the last 10 times the U.S. had two or more consecutive quarters of negative real GDP growth. The economy was in a recession. You have to go back to 1947 to find an exception.

Starting point is 00:10:33 W.S.B chairman writes, our government told us inflation was transitory and under control. Now they are changing the definition of a recession so they can tell us we aren't in one. The American people are being gaslighted. Liquidity writes a fake quote from the White House. Well, if you look at the GDP growth on a pro forma adjusted last two-week annualized rate-run basis, the economy is certainly not in a recession. And finally, Dr. Perrick Patel, the best way to avoid a recession is simply to change the definition of a recession. In other words, skepticism and outright cynicism abound. In times like these, security of your assets should be your number one priority. If you want to offset risk as much

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Starting point is 00:12:00 Gain unparalleled visibility and maximize your potential with the leading blockchain data platform by visiting us now at Chainalysis.com slash CoinDeg. Desk. The breakdown is sponsored by FTX US. FtX US is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the US. FtXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. So what to make of all this? Well, to some extent, I'm in the Joe Wisenthal camp here. He tweets,

Starting point is 00:12:53 The recession obsession is bizarre. The economy is what it is. Inflation is way too high. The labor market in the first half grew quite rapidly. Real wage growth is negative. There are signs of cooling. What additional info is revealed by designating it a recession or not? Now, the reason that I say I'm in this camp is that it feels fairly obvious that a huge part of the discourse is being driven by the fact that this is the latest and easiest bully cudgel to beat the Biden administration and the Dems in general with. I think at least a few of the commentators I've quoted on this show would have roughly the opposite position if it were a Republican administration and power. That makes it very, very hard for me to take them overly seriously. Obsession with labels tends to be distracting from good policy responses. I want to know what's actually going wrong in the economy and based on those specifics, have debates about the right way to fix those problems.

Starting point is 00:13:41 We tend to use a lot of blunt instruments in economics, and the labels we put on things make it worse. I think that there is also real emotional manipulation on both sides of the political aisle about this. I think it's completely reasonable for people to call gaslighting on these BS, clearly obfuscating political spins that try not to use scary words.

Starting point is 00:14:00 This is exactly what got the Biden administration and the Fed into this mess in the first place. They kept picking words and phrases that could easily betray them, and every time they have. At the same time, there is clearly an extreme political incentive for the American right to convince their base certainly and as many independence as they can that things are economically terrible, and that what's more, it's because of this administration's policies exclusively. Ben Carlson puts this extremely well. He writes,

Starting point is 00:14:26 Welcome to the confirmation bias economy. Want to see a recession? Just look at GDP, rates, inflation, retail and consumer sentiment. Don't want to see a recession? Just look at the labor market, personal income, and travel and services. Where this leaves me then is that the entire discussion of recession becomes just sort of farcical and almost entirely political, which makes it worthwhile, I believe, to look at very specific questions that are more technical if we're actually trying to understand what's happening in the economy. One of the big discussion points in this farcical political debate is can there be a recession with such a strong labor market? Jim Bianco discussed this on July 27, writing,

Starting point is 00:15:03 Powell said that we are not in a recession because the labor market is too strong. This was exactly the argument used by Arthur Burns 50 years ago. However, all three of the 1970s recession started with positive payroll growth. But now we have 370K jobs. Is that too many jobs for a recession? The labor force today is 151 million versus 76 million in 1973, so it is doubled in size. The current job growth as a percentage of labor force is 0.25% of the labor force. All those 1970s recessions started at the same level of job growth as today. It's not about negative growth. It's about not overtaking the inflation rate. This was the story of the 1970s recessions. Positive nominal growth could not overtake inflation. And it could be the story now as well.

Starting point is 00:15:47 Powell knows this, but is spinning. Now, I think an even more interesting discussion as regards the labor market is how strong is it really? Remember, Powell was discussing his desire to see labor markets return to where they were pre-pandemic, but there are reasons to think that that's never going to happen. Here's a thread from TXMC. Powell said today that we'd all love to return to a pre-pandemic labor force, but I'm not so sure that's possible. While he and other government officials keep citing a strong labor market, the underlying data belies of fragility. It's true the labor force has been growing, but it still remains far behind real progress. As of now, the labor force is just 610,000 bodies short of the 2020 peak, but that ignores lost trendline

Starting point is 00:16:26 growth over two years. Accounting for this, we're still 3.5 million workers short. Currently, we have the fewest unemployed Americans wanting to work since 2001. We aren't multiplying quickly enough to backfill exiting workers, and expectations that labor will bounce back to prior growth are hopium. The number of job openings is basically all-time highs, but as we've explored, the number of available unemployed is at 11-year lows. At some point, talk of labor strength must be relabeled as overheated business demand that necessarily won't be fully met by physical human workers. It goes beyond improving wages and benefit packages. Demographics are unavoidable. We're in the midst of a tectonic transformation

Starting point is 00:17:05 with generational inertia. Demand must be satisfied by innovation or labor will likely fail to fill the void. As available labor shrinks into high demand, the denominator for unemployment weakens, holding the rate low and masking the changes beneath. We may be watching an economy that hasn't recognized its most valuable commodity, people, is in diminishing supply. Now, there's also an even simpler skepticism of the strength of labor markets as articulated by Lynn Alden. She writes, suppose I run a business with 100 employees and then face a weak economy or demand for my business products. To fix this, I can fire two of my employees, or I can cut everyone's pay by 2%, which is better for the economy in terms of demand. Inflation-adjusted wages are growing slower than inflation.

Starting point is 00:17:47 They're at multi-year lows. You should look at total labor-inflation-adjusted wages, not just the unemployment rate when determining recessionary conditions in the health of the labor market. Her point simply is that when you take into account wages, the labor market doesn't look as strong as it does just based on topline unemployment. So anyways, where does this all leave us? Well, here's my advice. First, absolutely recognize and call out gaslighting and newspeak from official sources. But as you're doing so, recognize that whatever party they're from, their political opponents tend to have an equal and opposite incentive to convince you of the horror of whatever the official side is saying isn't so bad. Number two, dig into the specifics beyond the top line labels.

Starting point is 00:18:27 What's more interesting than whether it's a recession or not is what's driving those patterns and how things are likely to change. And three, at least right now, recognize that as relates to Fed policy, none of this is likely to matter. The Fed has made it clear that their decisions begin and end right now with the inflation numbers. They're going to keep driving rates up and tightening until they believe that inflation has been fully squashed out. When it comes to a shift in their posture, this labor stuff and designations of recession

Starting point is 00:18:55 or not are all secondary. They've even gone so far as to redefine how price stability must be the foundational pillar for both sides of their dual mandate. Remember, Powell isn't concerned about elections, at least not really. He's concerned about his legacy. He wants to be Volker 2, not Burns 2. So there you have it, my official hot take on the recession discussion being incredibly dumb. Hopefully you find that useful. Maybe it's me who's incredibly dumb.

Starting point is 00:19:19 Either way, I appreciate you hanging out and listening. And I also appreciate my sponsors, nexus.io, chain aliceists, and FTX, for letting me ramble. Until tomorrow, guys, be safe and take care of each other. Peace.

The Breakdown - The Recession Discussion Is Incredibly Dumb

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