Friday, May 31, 2019

Fact Check: The Truth About Recessions [UPDATED]

"ANOTHER BUSH, ANOTHER RECESSION" - That was the bumper sticker that appeared on my despondent friend's car right after the election of George W Bush.  Haha, I thought, that's not how recessions happen!

You see, I'd been to business school and was taught that there was something called "the business cycle" that determined when recessions happen.  The theory was that economies inevitably grow too fast, peak, and then shrink. It was just what happened, we were told.

Except that's not what happens.

It turns out The Federal Reserve (Fed) causes recessions.  At least every one in modern times. They decide if, when, and how a recession occurs. They can turn elections. They can drive markets.  In many ways the Federal Reserve is the most powerful government institution in the U.S.  They have more power over our day to day lives than any other branch of government.  And they are unelected.

Here's the proof:  There have been nine recessions since 1954.  Each one followed two specific Fed caused conditions:

  • A marked increase in the Federal Funds rate
  • A negative spread between the 10-Year Treasury Bond, and either the Federal Funds rate or the 1-Year Treasury.  Also known as an inverted yield curve.

There were no exceptions.  You would think that  in sixty five years at least one recession would be strictly tied to economic issues.  But not a single one occurred independent of those two deliberate Fed caused conditions.
Click on the graphs below to see them in greater detail.  Grey bars are recessions.  Or use these links to see the interactive originals:  10-Year Treasury minus Fed Funds  ,  Fed Funds Rate  (The first two recessions on these graphs had inversions in the 10-Year minus the 1-Year.)

10-Year Treasury minus Fed Funds (Yield Curve) 1954-2019

Fed Funds Rate 1954-2019

There were two times when those two conditions did not result in a recession and there were two cases when only one condition was present.
  1. 1966 had both an inverted yield curve and a Fed Funds hike, but no recession ensued.  1966 immediately followed the Kennedy/Johnson tax cuts which stimulated the economy enough to overcome the Fed caused weakness.
  2. 1995 had a flat yield curve and a rate increase, but again no recession followed. 1995 also came on the heels of anticipated tax cuts promised by the congressional election of 1994 and The Contract With America.    
  3. 1998 had an inverted yield curve, but no Fed Funds hike or recession.  1998 also followed the 1997 signing of the tax cuts first passed by the House in 1995. 
  4. 1984 had an increase in the Fed Funds rate, but no change in the yield curve.  1984 also followed the Reagan tax cuts of 1981, and preceded the promised tax cuts of 1986.
CAVEAT: The only times recessions did not occur there were recent or anticipated tax cuts.  Hopefully, 2020 will prove similarly resistant following the tax cuts of 2017.

Curiously, of those nine recessions, all but one coincided with Republican presidents.  None occurred while the GOP held both houses of congress.  All tax laws originate in congress.  All interest rate policy originates at the Fed.  Presidents originate neither.     

This is all worth noting now that the Fed has initiated both conditions following eight years of ~ 0% rates under Obama.  The tightening from .12% to the current 2.41% amounts to an increase of 1900%,  the largest ever in percentage terms.  And in May 2019 the yield curve predictably inverted.  (The graphs above only go to March, 2019 when the yield curve was still slightly positive. )

It looks like the next recession is scheduled to begin precisely as we head into the next election. It will likely begin sometime between February and September of 2020 based on past timelines.  (See CAVEAT above.)

Maybe my Al Gore supporting friend was right after all... though for all the wrong reasons!

[UPDATE 7/30/19]
The Fed is expected to cut rates at their next meeting a day from now,  but it will have no impact on the scheduled recession which is already baked into the economy.  The only thing the president can do at this point is pray his 2017 tax cuts and ongoing deregulations overcome the Fed caused weakness and avoid a recession. My money is on the Fed, only because they are experts at causing recessions, and they have way more power and experience than Trump in these matters.   


Footnote 1:  Here's why these particular Fed actions cause recessions:  The essential raw material for economic vitality, aside from humans, is credit.  When the Fed raises its Fed Funds rate, banks and lenders pay more for their own credit which ripples through the economy raising borrowing costs.  If the increase is too fast and too much, the yield curve inverts which temporarily misaligns lenders and borrowers.  Lenders want to lend at the higher short rates and borrowers want to borrow at the lower long term rates. Credit slows, and a recession follows.

Footnote 2:  Of course the Fed does not operate in a vacuum.  They would argue they are acting on economic conditions.  Still, the timing and predictability of recessions following those two Fed actions cannot be denied.

Footnote 3:  The reason this analysis only goes back to 1954 is because that is the extent of available Fed data for the 10-Year minus Fed Funds.  The 10-Year minus 1-Year does not exist as a single graph but both can be plotted on the same graph by visiting the FRED site.

Here's the result:

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