This is a repost from Forbes. 

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Hundreds of underground seismic motion detect early warnings signs of earthquakes. Economists have their own recession early warning detectors and some are going off.

Early warnings for recession include:

  • Oil prices – and other commodity prices – increased steeply before nearly every U.S. recession since World War II. What are oil prices doing now? They’ve been rising in the first half of 2018 (gaining more than 20 percent) and reached their highest level in August this week at $70 a barrel according to MarketWatch.
  • Asset bubbles precede recessions, but, of course you never know if healthy prices are air-filled bubbles or solid growth until they are pricked. Equity prices rose quickly before the dot-com bust in 2000 and housing prices went through the roof before the financial crisis of 2008. The Financial Times noted two weeks ago that profit margins seem to be peaking – reaching their highest levels in 10 years – and the SP 500 price earnings ratio has been climbing steadily from 14.87 in June 2012 to over 25 this month. 20 seems to be the Goldilocks number.
  • Interest rates also begin to act oddly before recessions, but the reasons change and the reasons matter in whether its a good signal.  Burglar sensors detect thieves and dogs moving on your patio.  When interest rates on short-term debt (say, three-month Treasuries) is higher than the interest on long-term debt (say, 10-year Treasuries) it is a sign that market actors think prices will fall and demand for loanable funds will be in the doldrums. When the yield curve inverts, it can represent a crowd sourcing for information about the business person’s expectations. The yield curve is somewhat inverted now. The gap between short and long is the smallest since 2007. The 2-year and 10-year yields on Monday, August 24, 2018 narrowed to as little as 18.3 basis points, the smallest differential since 2007, having started the year more than 30 basis points higher. This signal could be orange or red. 

And other traditional pre-recession early warning systems are flashing orange to red.

The National Bureau for Economic Research (NBER) – a nonprofit organization founded in the 1920s by economists and universities to help a modern US government maintain economic order and full employment – tracks the chronology of the U.S. business cycle. Its Business Cycle Dating Committee looks at real GDP, economy-wide employment, and real income as indicators for economic health.

  • Real personal income is not doing very well since wage growth is anemic in this expansion. But, consumer spending is growing fast – too fast? – and capacity utilization and industrial production is not particularly robust – a bad sign and a correlate to imminent downturns.
  • Since the current recession indicators are generally less perfect predictors, economists are trying out other early warning indicators. Other trends have preceded recessions and they are flashing red, like private debt accumulation. When households and corporations have access to easy credit, debt default risk increases. The pattern of 2008 seems to be repeating itself as a similar credit bubble is forming again. Now, compared to 2008 when households were using liar loans and subprime mortgages, corporations are using readily available and cheap debt to give cash from their balance sheets to shareholders as increased dividends. Too many of these extra liabilities can eventually force corporations into cutbacks, which would in turn drive down activity and cut tax revenues.

And when the recession happens, we want to know how deep it will be. Economic inequality can make recessions deeper and more prolonged.  For instance, right before the great recession (2006-2007), the nation’s bottom 40 percent of households held no net worth and consumed almost 25 percent of the nation’s goods and services. Moving up to the middle class, households in the bottom 60 percent of the income distribution accounted for 40 percent of the nation’s consumption. But when unemployment rose to over 10 percent, households in 2008 drastically cut consumption. In an unequal economy when many households have no wealth and can’t self-insure against a downturn, cuts in personal consumption are particularly drastic and the recession grows deeper.

Lastly, some economic measurements that we think of as good indicators are not always helpful. The unemployment rate is low but it may truly indicate an overheated economy with no more capacity to grow. The official unemployment rate does not include workers who are discouraged or marginally attached to the labor market. The non-inclusive definition of the unemployment rate combined with the fact that wages have been stagnant for decades indicates that the labor market is actually not robust.

One of the best indicators of a coming recession is time, and it is about time for a recession. This expansion, which started in June 2009, is the second longest ever recorded in August 2018 – 9 years and two months old. The longest was exactly ten years in the 1990s. The average length of an expansion is 4 years and 9 months. Though business economists surveyed are optimistic – most of them think the economy will go into recession by 2020 -– we know the tax cuts have not produced economic investment. Most academic and government economists know that models, including surveys of hunches, are inaccurate. Even the IMF agrees predicting is inaccurate.

The best we can do is watch the correlates to previous recessions, which right now paint an ominous picture.