In Part 1, I noted the more relevant link between the trade economy and economic performance overall, particularly in contrast to the growing dichotomy in the employment segment or jobs market. The Establishment Survey appears to be showing “strength” (at a reduced standard for what constitutes jobs recovery) at odds with other surveys and certainly with these additional economic data points.
Retail sales are a fair proxy of translating household income into economic activity, but there is an additional marginal factor. Businesses often, particularly heading toward slowdown or recession, maintain production and staffing levels. This is especially true where economic signals are not clear; for example, where prices are distorted by some kind of interventions. In other words, if businesses are not sure whether their current sense of overcapacity is only temporary, or transitory, they may absorb that economic bump for the sake of operational consistency.
That usually becomes an inventory management process, providing us with a second primary marginal economic indicator. There have been several historical examples where a downturn in domestic trade does not translate directly into a more durable recessionary process (1998-99, 1986-87). The ebbs and flows of economic reality don’t always lead to contraction.
The one exception occurs where there is a mismatch between inventory and sales that extends beyond perceptions of transitory weakness. If sales experience an ebb, should there not result a relatively close flow, then the trade economy undergoes a re-assessment. In fact, that evaluation period often takes the form of mini-cycles relating to inventory overstocking.
In any case, softening sales that are not equalized by production levels, and thus inventory holdings, will eventually lead to forced inventory shrinkage. The occurrence of both softening sales and inventory adjustment of this type is trade recession; certainly not robust recovery.
There can be no doubt about the recent softness in sales activity. Historically, trade sales have rarely been as consistently “bad” as they are now. The downturn in activity has not only been quite severe in size, but this has unfortunately persisted regardless of QE’s or Twists.
In response to that, manufacturers have clearly been careful about building inventory over and above sales. That explains, in good part, weakness in areas like durable and capital goods orders and activity.
Further up the supply chain, however, there appears a large divergence between sales and inventories. While wholesalers have begun to cut back on inventory, leading to the rash of Q2 GDP estimate downgrades in recent days, retailers seem stuck looking for the transitory flow to appear in sales.
In terms of jobs, then, the lagging indication comes from this inventory adjustment. Should retail sales not pick up soon and much closer to inventory growth, the entire supply chain will begin to contract much further than it already has. Retailers full of inventory will have to begin discounting to move it out, reducing orders and sales for wholesalers still further, then penetrating to already chastened manufacturers.
The inventory/sales divergence is now well over one-year in duration, making the idea of “transitory” far less likely with every passing month. QE 3 & 4 have not made any discernible dent, at least in an upward manner, and I believe businesses are beginning to admit as much (the allusions to overcapacity being good evidence of that).
We should not forget that stocks advanced to new highs more than two months after the eurodollar market almost completely collapsed in August 2007. Economic data in the latter part of 2007 was not exactly robust either, but faith in the Federal Reserve and monetary policy pulled down a veil of recency bias that kept this price divergence from being fully recognized – at least temporarily.
QE-proponents want to use flawed employment measures (before revisions) and stock prices as the only signals of economic improvement, but stocks do not feed families (record stock prices consistent with record SNAP?). It is highly inconsistent to see the economy in such a downturn as asset prices proceed unconcerned, but, as mentioned above, such temporary blindness is not at all unprecedented. If there is anything proportional to the size of monetary intervention, it may well be this blindness.
As to the question of domestic trade as a proxy, there is nothing here that shows a recovery gaining traction; the opposite appears far more compelling. Given that it has been more than four full years of waiting for said traction, perhaps the term “recovery” should be completely disregarded in the first place. That would make this extended downturn more consistent with the actual economic context, particularly as the domestic economy remains captured and mired in the structural deficiencies of previous attempts at monetary management.
If the Federal Reserve intends on tapering QE, it is not about the real economy. They can point to the partial picture of the Establishment Survey as the deciding factor, but in the end, given such monetary impotence, it will always be about bubbles.
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