Deconstructing the U.S. Economy: The Non-Recovery

By: Eric Sprott

We are now in the 5th year since the “official” end of the Great Recession (the National Bureau of Economic Research (NBER), which officially dates U.S. recessions, said the recession ended in the second quarter of 2009), but it hardly feels like a recovery. Nonetheless, the media, sell-side economists, central bankers, the IMF, etc. all claim that the U.S. economy is now firmly out of the woods.

President Barack Obama said in his State of the Union speech that he believes 2014 “can be a breakthrough year” for the U.S. economy and the IMF, which raised its forecast for U.S. GDP growth in a report titled “Is the Tide Rising?”, now predicts growth of 2.8% in 2014.1

However, a closer look at the data suggests that things are not improving and that the U.S. economy remains frail. Many point to the unemployment rate as a sign that things are getting better. Indeed, it has been declining steadily for many years and now stands at 6.7%. However, what many seem to forget is that the unemployment rate is declining for the wrong reasons.

Yes, the U.S. has been adding new jobs, but a large share of the decline in the unemployment rate can be explained by discouraged workers leaving the labour force.2 This effect can be seen in the falling participation rate. Many argue that this decline in the participation rate is structural and is caused by population aging. This explanation is superficial and misleading.

Figure 1, shows the contribution to the total participation rate for various age groups. As shown in Figure 1, since January 2005, the participation rate has fallen by 2.9% (from 65.8% to 62.9%). Of this decrease, 1.3% and 4.7% were driven by the 16-24 and 25-54 age groups, respectively. The rest was offset by a 3.1% increase in participation by the 55+ cohort.

FIGURE 1: CONTRIBUTION TO U.S. PARTICIPATION RATE (%)
maag-03-2014-T1.gif
Note: Sum of individual components adds up to total participation rate.
Source: Bloomberg, Sprott Calculations 

This is reflective of a deep problem, as it suggests that baby boomers are failing to make ends meet and have to work for longer or even come out of retirement, and that the future workforce, those in their prime working years, are leaving the labour force.

Interestingly, without the “3% contribution” from the 55+ cohort, the labour force would have fallen below 60% for the first time since 1971, a period when the participation rate was starting to expand, driven mainly by women entering the workforce.

But that’s not all; many of those in their early 20s, seeing how hard it is to find a job, are staying in college for longer, amassing outrageous levels of student debt in the process. This is obviously not a sustainable solution. Delinquency rates on student loans (the bulk of them insured by the U.S. Government) are now at all-time highs (Figure 2). Most of these student loans have been securitized and sold to investors with the Government’s stamp (sound familiar?).

FIGURE 2: STUDENT LOANS % 90+ DAYS DELINQUENT
maag-03-2014-C1.gif
Source: Bloomberg, Sprott Calculations 

For all the rest (ages 25-54), the participation in the labour force has also been declining, although at a slightly slower pace. Nevertheless, the average U.S. consumer is still worse off than it was before the Great Recession. Real disposable income per capita (Figure 3) is lower than it was at the end of 2005 while, over the same period, health care costs have increased from 10.0% to 11.5% of GDP (Figure 4), thereby reducing funds available for discretionary spending.

FIGURE 3: REAL DISPOSABLE INCOME PER CAPITA
INDEX 2005 Q4 = 100
maag-03-2014-C2.gif
Source: Bloomberg, Sprott Calculations 

FIGURE 4: HEALTH CARE SPENDING AS A % OF GDP
maag-03-2014-C3.gif
Source: Bloomberg, Sprott Calculations
 

Not surprisingly, lower disposable income and discretionary spending levels for the average American are reflected in declining retail sales growth (Figure 5 shows the year-over-year growth rate in retail and food services sales).

FIGURE 5: RETAIL AND FOOD SERVICES SALES
YEAR-OVER-YEAR GROWTH 
maag-03-2014-C4.gif
Source: Bloomberg, Sprott Calculations 

Moreover, since the summer of 2013, when the Federal Reserve lost control of the bond market (see our article “Have we lost control yet?”, June 2013)3, we have seen a clear deterioration in demand for credit dependent purchases. Since these purchases are mostly made on credit (mortgages, car loans), increases in interest rates have made them unaffordable to many customers. Thus, because of the large and sudden increase in interest rates, housing sales have slowed significantly, as can be seen in Figure 6. Similarly, car sales growth has been on a declining trend since it peaked in mid-2012 (Figure 7).

FIGURE 6: U.S. HOME SALES
YEAR-OVER-YEAR GROWTH 
maag-03-2014-C5.gif
Source: Bloomberg, Sprott Calculations 

FIGURE 7: US AUTO SALES
YEAR-OVER-YEAR GROWTH 
maag-03-2014-C6.gif
Source: Bloomberg, Sprott Calculations 

On the supply side, things do not look rosy either. The U.S. composite PMI has been more or less flat for the past 3 years (Figure 8) and has suffered a sharp decline since its August 2013 “peak”. Other indicators, such as the durable goods new orders have been growing at a declining pace (Figure 9).

FIGURE 8: ECONOMY WEIGHTED MANUFACTURING & NON-MANUFACTURING COMPOSITE PMI
maag-03-2014-C7.gif
Source: Bloomberg, Sprott Calculations 

FIGURE 9: US DURABLE GOODS NEW ORDERS 
YEAR-OVER-YEAR GROWTH 
maag-03-2014-C8.gif
Source: Bloomberg, Sprott Calculations  

To conclude, numerous indicators of the state of the U.S. economy point to a non-recovery:

  • The participation rate is low and supported by baby boomers working more or coming out of retirement. 
  • Students (the future labour force) are defaulting on their loans in record amounts. 
  • Disposable income is still below its pre-recession level. 
  • An ever increasing share of disposable income is being spent on health care, crippling discretionary spending.
  • Higher interest rates are further depressing discretionary spending (home and auto sales). 
  • All of which is resulting in anemic business and economic activity.

Claims that the U.S. economy is suddenly rebounding have been made before. They are misleading at best and fallacious at worst. It would not be surprising to see further deterioration, which would force central planners to initiate additional unconventional intervention (i.e. Quantitative Easing).

Post-scriptum:
Wow! In a recent Bloomberg article, Andrew Gracie, an executive director at the Bank of England (BoE), was proposing that in the event of a bank failure, regulators could suspend derivatives contracts affecting the failed bank on a global basis.4 He further argues that “The entry of a bank into resolution should not in itself be an event of default”. In other words, the solution proposed by the BoE to deal with a bank that fails and that has entered in a mountain of derivatives contracts is to suspend the market.

But this misses the point. As usual, regulators try to patch things up instead of proposing true solutions. What they are effectively proposing is to suspend reality, yet again, and pretend that there are no problems. This is even worse than suspending mark-to-market! How ironic that the same regulators who allowed this to happen are the ones who ask the market to suspend reality.

 

1 http://www.imf.org/external/pubs/ft/weo/2014/update/01/
2 See the January 2013 Markets at a Glance,“Ignoring the Obvious”: http://www.sprott.com/markets-at-a-glance/ignoring-the-obvious/
3 http://www.sprott.com/markets-at-a-glance/have-we-lost-control-yet/
4 http://www.bloomberg.com/news/2014-03-04/boe-seeks-derivatives-pact-to-prevent-a-repeat-of-lehman-cascade.html
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