It could get ugly in the US economy before long.
While everyone has been distracted by the strength of the job market and decent consumption, the real breakdown in the US economy has come from the corporate sector, as Paul Mortimer-Lee of BNP Paribas argues in a note titled ” US Growth: Storm Brewing? “
“Why haven’t so many people, including the Fed, seen the risks that now seem too real?” asked Mortimer-Lee, chief U.S. economist at BNP.
The answer is that they looked in the wrong direction, cradled in a sense of complacency over strong job growth and solid consumption. What that view overlooked is that the threat of
comes from the corporate sector. “
According to Mortimer-Lee, falling profits in the corporate sector generally point to a recession. In this case, stagnant inflation reflected an inability of US companies to raise prices to the level necessary to maintain profits as labor costs rose.
In other words, companies pay their employees more and they cannot raise prices to keep up with the rising costs. So the profits fall. This increase, according to Mortimer-Lee, bears a striking resemblance to the period leading up to the 2001 recession, which was preceded by declining corporate profits.
âWe believe that in an economy with a large profit-oriented private sector, the rate of profit and its dynamics is a key determinant of
“While some have argued that cycles do not die of old age, falling rates of return are often a sign that the economy is very sick, no matter how old the recovery is.”
The argument about what leads to a recession is one we noted before. Businesses are responding to declining profits by reducing capital spending and investment in their businesses. If you don’t build new things, there is no need for new workers, so hiring slows down and workers start to keep their income. Consumption falls, and everything collapses.
âBut investment has been low recently. Oil investment plays a role, of course, but the bigger picture seems to us to be that previously lower corporate profitability as a percentage of GDP is starting to fuel with a lag in more investment. weak, âMortimer said. Lee wrote. “Often times such episodes don’t end well.”
Add that the stock market stumbled last August and earlier this year made companies more wary of financial conditions and you have a worrying number of clouds on the horizon.
Thus, Mortimer-Lee predicts that the risk of a recession over the next 12 months is between 40% and 50%, depending on the severity of the data entering the labor market. It’s not a majority, and therefore not the most likely outcome, but the odds are certainly going up in an uncomfortable direction.
âWe’ll have to hang on to our hats because it’s going to be a bumpy race,â Mortimer-Lee wrote. “The risk of a recession is increasing, although this is not currently our central case.”