Shilling: A U.S. Recession May Have Started This Quarter

A U.S. recession probably started in the current quarter. First quarter real GDP growth, 3.2% at annual rates, was temporarily inflated by a jump in inventories, which contributed 0.65 percentage point to growth. This was no doubt unintended and undesired due to weaker-than-expected sales by manufacturing wholesalers and retailers and the resulting jumps in inventory-sales ratios (see chart below). So a reduction in growth by this much is expected in the second quarter, and likely more due to the weakening economy, unless undesired inventories pile up and only postpone liquidation and its negative effects on the economy until later.

inventory sales ratio

Also in the first quarter, imports dropped 3.7%, perhaps due to earlier strength to get ahead of looming import tariffs. This added 0.58 percentage points to GDP since imports are subtracted to get the total. At the same time, exports jumped 3.7% due to a one-time leap in soybean exports, again to get ahead of tariffs, and this rise is unlikely to be repeated amidst global economic weakness and impending tariffs by China. The combination of import and export changes added 1.03 percentage points to GDP, and this help will no doubt be absent in the second of succeeding quarters. Unusually robust increases in state and local government spending added another 0.41 percentage point to overall growth.

Consumer Spending

Meanwhile, consumer spending growth has been slipping from 3.8% annual growth in the second quarter of 2018 to 1.2% in the first quarter. Retail sales fell in February and again in April and would have been much weaker without higher gasoline prices pushing up service station sales in recent months. Weak growth in household income in recent months suggests further softness in spending in the future. Consumer spending accounts for 69% of GDP, so softening outlays suggest a peak in economic activity.

The New York Federal Reserve’s recession model shows an increasing probability of a recession in the next 12 months. Industrial production has fallen in three of the last four months. Meanwhile, capacity utilization is falling and is far below the levels that stimulate capital spending. When unutilized capacity is ample, there's little incentive to add more. Among other recession signals, U.S. bank demand for consumer, commercial and industrial loans is falling. So, too, is residential mortgage demand.

income loans recession

Trade War Effects

Then, of course, the already economically-depressing effects of the ongoing trade war with China, which is raising tariffs for both countries and spawning uncertainty, could escalate into a serious global economic crisis. Trump’s hike in tariffs on $200 billion of Chinese goods to 25% from 10% on May 10 induced retaliation by China on $60 billion of U.S. exports.

That brought the U.S. total to $250 billion and Trump is threatening to slap tariffs on the remaining $300 billion in annual imports from China. China’s exports, a crucial component in her overall economic growth in recent decades, grew earlier at 20% to 30% annual rates. Recently, growth has plunged and in April exports fell 2.7% from a year earlier.

This looks like a knock-down, drag-out fight that goes far beyond the trade issue. China under its de facto President for Life Xi Jinping is challenging America’s top position on the world stage and needs Western technology to do so. Meanwhile, Trump wants to limit China’s advance, and his demands for less mandatory tech transfer as the price of U.S. firms doing business in China as well as a stop to outright tech theft are steps in that direction...

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