Real quarterly, annualized GDP growth rate in percent from Q1 of 2009 to Q2 of 2016
Image Credit: St. Louis Federal Reserve District Bank/FRED

It is time for me to take one of my periodic looks at the condition of the U.S. economy and stock markets. As has been my practice, every time I do one of my general surveys on the economy, I update my Leading Economic Indicators and Coincident Economic Indicators, so be sure to take a look at them.

The U.S. Economy is Still Faltering

As you might guess from the plot of real GDP growth in the plot above, our economy is continuing to teeter at the edge of the abyss, but has not quite fallen into the darkness just yet. Both my leading and coincident economic indicators are consistent with this picture. As implied by their group name, the leading economic indicators change for the better or worse before the economy changes for the better or worse. The coincident indicators on the other hand make a change for better or worse only after the economy makes the same kind of change. That is, as the GDP growth approaches a peak and is about to descend, the leading indicators will show declines in their values, while the coincident indicators will still be increasing, but their rate of increase will begin to diminish. Only after a fall into recession will the coincident indicators show a decrease in values. If you find your way onto my Leading Economic Indicators and Coincident Economic Indicators pages, you will discover they say we are almost at a peak of GDP with the leading indicators displaying decline and the coincident indicators showing slowing growth. Out of 12 leading indicators six are bearish (i.e. indicating recession), four are neutral, and two are bullish (i.e. indicating growth). Giving a score of +1 for every bullish indicator, zero for neutral, and -1 for every bearish indicator, the total score for my leading indicators is -4 Bearish. Among the six coincident indicators there are two bearish, three neutral and one bullish for a total coincident indicator score of –1 Bearish.

Please note the red line in the GDP growth plot, which is a line fitted to the data of the past two years. It shows the linear trend about which the GDP fluctuates. Now there is nothing sacred about that linear trend. It could change on a time-scale of around a year to two years, but only if something fundamental happens to change the trend. Ask yourself what has happened during the past eight years of Obama’s administration that has been beneficial for the economy. I can think of only one: the shale oil revolution that is making us energy independent. Other than that, government has only made it increasingly harder for businesses, particularly small businesses, to make a profit. It almost seems like every chance government officials have to influence the economy, they kick the economy in the gut.

There Are More Companies Dying Than Are Being Born

Back in September 2014 an article in the Washington Post, not generally renowned as a right-wing newspaper, made clear the generally hostile economic environment faced by American businesses. Entitled More businesses are closing than starting. Can Congress help turn that around?, its very first sentence stated, “Americans are starting fewer businesses, new companies are going out of business more quickly, and the new firms that do get off the ground are creating fewer jobs.” Sen. Marco Rubio, Jeb Bush, and Carly Fiorina picked up on that fact as campaign themes, and of course were immediately poo-pooed by Factcheck.org and Politifact.com. Both the Factcheck and Politifact arguments are essentially identical, and are based on a graph, which is shown below, using data up to the year 2013 from the Census Bureau’s Business Dynamics Statistics.

Their point of course was that the deaths outnumbered births only for a short period of time from 2008 until 2011 during the recovery from the Great Recession.  However, for births and deaths of firms to even get close is a marvel seldom seen. Usually company births always outnumber deaths by a very large number even during recessions, as can be seen in the graph above, but which is particularly emphasized in a similar plot produced by the Gallup organization shown below.

This is the same data as plotted in the FactCheck graph, except that it only goes out to 2011 and does not show the second 2012 cross-over in the FactCheck graph. Its contribution to the discussion is its depiction of the firms new and closed as percents of all firms. Back in 1977 it shows 17 percent of all firms were start-ups while about 10 percent of all companies died, leading to a seven percent net increase of U.S. companies. Even taking the additional Factcheck data, we see from their graph that in 2013 the companies that were start-ups were almost equal to the number of companies that went out of business, yielding almost no new companies. This is a rarity if not a first in American history.

Moreover, it is also clear from Gallup’s chart that the problem is mostly one of fewer new companies being formed, rather than firms going out of business. The percent of closed firms every year stayed relatively constant near nine percent, although there was a tick up in closed firms after the Great Recession. Converting the percentages into actual firm numbers and subtracting the closed firms from the new firms, Gallup came up with a time history of the net number of new U.S. companies in the plot below.

This plot shows the loss of companies was particularly severe during the the Great Recession, but that as late as 2011, three years from the end of the recession, the economy was still losing more than 50,000 companies per year!

So now according to FactCheck and Politifact by 2013, after being in positive territory briefly between 2011 and 2013. we have come back to approximately no new net companies again. Whoopee! Remember, at least since the 1970s until the Great Recession, the companies being born greatly outnumbered the ones going out of business.

Other Big Problems: Business Investment and the Public Debt

One reason why we are in such a terrible fix is that businesses are not investing very much. Economic growth and economic productivity are both most strongly correlated to business investment. Yet businesses have not been been investing much lately, as you can see in the graph of Manufacturers’ new orders for non defense capital goods (excluding aircraft) shown below.

As a matter of fact, many Keynesians lead by Larry Summers completely agree that a lack of corporate investment is precisely the explanation for our economic doldrums, a situation they call secular stagnation. Unfortunately, they are looking for the causes of the lack of investment in market failures, when there are a huge number of government failures that explain the stagnation much more credibly. Read the post What to Do About Keynesian Secular Stagnation for more discussion on these explanations.

An even bigger problem is presented to us by the total national debt, which you can see in the graph below is currently about 105.4% of GDP.

Research by the economists Carmen Reinhart and Kenneth Rogoff has shown that once the national debt of a country exceeds 90% of GDP, the denial of economic assets to the private economy just to finance the national debt progressively decreases the growth of the economy. They conclude:

Median growth rates for countries with public debt over roughly 90 percent of GDP are about one percent lower than otherwise; average (mean) growth rates are several percent lower.

And of course the lower the GDP, the less the tax revenue of the federal government and the more it will have to add to the debt with deficit financing. Even more unsettling is how payments of interest on the national debt, when combined with the mandatory entitlement spending, will absorb every single penny of federal revenues by sometime in the 2020s. I tell this sad tale in The Thoughts that Haunt Me.

The U.S. Stock Market Defying Economic Gravity — Is It For Real?

If the economy is getting ready for a fall into recession, why are the Dow 30 and S & P 500 at or close to all time highs? There can be little doubt stocks generally are at unrealistic, inflated values. The Shiller Cyclically Adjusted PE ratio, or Shiller CAPE (aka the Shiller PE) is the best way to measure stock market valuation. It is currently at a level of 27.2, which is 62.9% higher than the historical mean of 16.7.

Unfortunately for all of us with 401(k)s and IRAs, it sure seems like the mechanism inflating the stock market bubble might be close to breaking. I related in The U.S. Economy and Stock Markets, June 2016 how the biggest institutional investors in the stock market are the corporations themselves, buying back their own stock. Rather than invest profits and money borrowed at close to zero interest rates on new productive capacity, companies, in this crazy economic environment that makes it hard to earn a profit, find better use for that money in buying back their own stock.

Yet corporations are earning progressively less revenue with time, as they have been in the grip of a revenue recession for more than a year.  A revenue recession is where revenues decrease for two quarters or more. How long before corporations are in such dire straights they can not qualify for loans to buy back stock? Or, how long before corporate leadership concludes it is not wise to buy back their stock at such inflated values? The day after we reach those points in time the stock markets will fall into the abyss.

I would like to finish this essay with a note about the corporate revenue recession. At the end of May 2016, data released by the Bureau of Economic Analysis was used by many to declare the corporate earnings recession to be at an end, to the joy of many! Using the BEA data one saw all of a sudden, after a decline in revenues from a peak in the third quarter of 2014, a small tick up in the first quarter revenues of 2016. However, as Wolf Richter tells us in the post How the Fed Stopped the “Corporate Profit Recession” (and the Media Fell for it), more than a little legerdemain was required to make it so. As it turns out, that revenue tick up involved a lot more than the profits of private corporations. Involved was a polite legal fiction that the twelve Federal Reserve District Banks are actually private banks owned by the member commercial banks of their district. Therefore, the profits the Federal Reserve District banks made through open market operations were counted as earnings of private corporations. This is like saying the economy of fascist Germany in the 1930s was really capitalist because the corporations were owned by private individuals. Yet in reality all German corporations of the time were firmly under the control of the Third Reich, making a fascist economy really a form of socialism. In the same way, the Federal Reserve District Banks are firmly under the control of the Federal Reserve Board of Governors and the Federal Reserve Open Market Committee, which in turn are very much creatures of the Federal government.

The Federal Reserve Banks have made a great deal of profit from the Quantitative Easing program by means of the government given power to create money out of thin air. They then go out to buy long-term assets with that new money, which like any bond pays periodic interest to them. As Richter explains it,

But there’s a detail – a huge detail – that the media conveniently forgot to point out: whose profits are included in “corporate profits.” The BEA tells us (emphasis added):

These organizations consist of all entities required to file federal corporate tax returns, including mutual financial institutions and cooperatives subject to federal income tax; nonprofit organizations that primarily serve business; Federal Reserve banks; and federally sponsored credit agencies.

Ah yes, the Federal Reserve Banks (FRB), which include the 12 regional Federal Reserve Banks, such as the New York Fed. They’re private banks, owned by the largest financial institutions in their respective districts. And as private banks, their consolidated profits are added to US financial sector profits, and thus overall corporate profits, along with those from Goldman Sachs, JP Morgan, and your local bank down the street.

As it turns out, in the first quarter the Federal Reserve District Banks had a consolidated profit that had increased 11 percent from a year earlier to a princely sum of $24.9 billion. All of that was added by the BEA as a part of corporate profits. Without the Fed’s profits, overall corporate profits would have fallen yet again. Stéfane Marion, Chief Economist and Strategist at Economics and Strategy, National Bank of Canada, summed up the situation quite appropriately: “Bottom-line. An improvement in corporate profits that is driven by the central bank is not a sign of a healthy economy.”

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