The calm between storms

The stability of a 9.7 percent unemployment rate repeated three times can be expected to enhance consumer and business confidence or “animal spirits” in the coming months.  Recall that the measure of “animal spirits” of the obscure economist that I channel is

A = - (U – UMEAN)/Sigma(U)

where A is “animal spirits,” U is the unemployment rate and UMEAN is a 48-month exponential moving average of U, and Sigma(U) is its standard deviation over that period.  The idea is that that people make normalized judgments of current conditions based on what they’re used to, as suggested by adaptation level theory, and that the thing that most influences confidence levels is folks’ perceived job insecurity.

Making a freehand forecast of unemployment suggests that “animal spirits” will rise to about the zero level in time for the next Presidential election, and that the next collapse of confidence (which we believe is the signature of a serious business slump) will not occur until about 2013-2015. 

Our recession probability model forecasts virtually no chance of a slump in the next 12 months.

This is not to suggest the economy is healthy.  As regular readers know, I subscribe to the hypothesis of The Fourth Turning that we are heading toward a period of extreme change characterized by a complete collapse in the social contract and the legitimacy of the current government.  See this post and links for more.  From an economic perspective, the extreme inequality of income and wealth we have now is the strongest indicator that the system no longer works for most folks the way it used to.  In short, the ruling class—led by Wall Street—is now bleeding America to death.  There will be no lasting recovery without equalization of pay scales across corporate America, and fundamental reform of the financial sector to prevent the Fed from simply being a money machine for an elite few.

I’m including a chart on labor market volatility to underscore the dynamics of why confidence will increase in the next secular exhilaration.  The labor market’s volatility as measured by Sigma(U) will peak soon and begin to decline; labor market volatility tends to peak before “animal spirits.” Once unemployment falls below its adaptation level in about 2012, and A rises above zero the diminished labor market volatility will boost confidence sharply.

Without a rebalancing of aggregate demand through greater equality of incomes and more progressive taxation, America may sink into a neo-feudal state in which its worst authoritarian qualities will come to the fore, and in all likelihood extinguish the best of what America has been. 

What will the quality of the current expansion phase be?  I have to believe it will be characterized by muted growth.  Investment has collapsed, and “Knightian” or fundamental uncertainty has entered the picture with regard to the fiscal future of America.  Americans are still over-consuming; consumption must fall.  Government is tapped out—so where will the demand come from?

Instead of foolishly insulting them Krugman-style (although this could be part of the political cover game, Krugman just being a tool) we should be offering the Chinese opportunities to spend their trillions of reserve dollars on American businesses and real estate.  Make them offers now and we’re better off than we will be after the dollar collapses.  How unhappy are they in Montgomery, Alabama, that Hyundai decided to build a plant there?  Not very.  And we might remain friends and avoid World War III or IV or whatever your number is by promoting Chimerican symbiosis.  When was the last time we were at war with Great Britain?

My judgment is that the next downturn is likely to be worse than the last one.  Gird yourselves.