Gary Shilling on What Could Cause the Next Recession

Thu, Jan 24, 2019 - 10:02am

Jim Puplava recently spoke with financial analyst and commentator A. Gary Shilling on FS Insider. Shilling has a long history with Wall Street—he was fired from Merrill-Lynch for accurately calling the 1969-1970 recession, noting how important it is to be aware of the bias of many Wall Street forecasters, he said “they’re basically paid to be bullish.”

Shilling on Consumers and Employment

Surveys of consumer sentiment have recently fallen and “one very interesting point is in the last six quarters consumer spending has grown faster than after tax income...” Shilling said. People are reducing their savings rates to maintain their spending. This pattern can’t sustain itself indefinitely. Shilling believes this means “there are some warning signs in the consumer area.

Employment is a lagging indicator, it’s not giving us an accurate, up to date reading on the health of the economy. Right now, the unemployment rate is roughly around 3.9 percent and is forecasted to hit 3.5 percent, but we have to keep in mind it’s a lagging indicator. Employers don’t want to make major layoffs; they spend time hiring and training people and aren't inclined to fire staff at the drop of a hat. Shilling noted “it takes a significant drop in the economy” before you get employers saying ‘wait a minute, this is major’ with the layoffs to follow.

Two Historical Causes of Recession

According to Shilling, “in the post World War II period there have been two causes of recession:” aggressive Fed tightening or a financial crisis or shock. He noted that we’re not quite here yet, “you’re probably at least a year away before they [the Fed] get rates high enough to really bite, and now it looks like they’re pausing.” Though, the Fed doesn’t exactly boast the greatest track record when it comes to raising interest rates, Shilling pointed out that 12 out of the past 13 times the Fed has raised rates it’s lead to a recession.

The other cause of recession, according to Shilling, is a financial shock like what we saw with the dotcom bubble in 2000 or with the sub-prime mortgage collapse in the mid-2000s, “you have financial shock that precipitated recession.” Shilling noted he doesn’t see any potential bubbles right now, though he did say the long economic expansion we’ve seen for the past 10 years could come into play. “People have moved further out in that risk curve than any of us realized including the people involved, and if things start to come unglued we’ll see that all come out of the wood work."

Shilling doesn’t see the Fed tightening becoming severe enough to disrupt the economy for at least a few more quarters, possibly even a year, and there’s not one clear bubble that could act as the financial shock he described. The next recession could be caused by a combination of things, he said, “I’ve described it as death by a thousand cuts, but again it’s a difficult recession because you just don’t have one of those two standard precipitators of Fed rates high enough to kill the economy or a financial shock.”

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