This Story Unlocks the Conundrum Between Weak Data and Strong Growth

Many economic analysts (myself included) have been both pointed and consistent in warning about an economic recession, which could be severe. There are many factors that point in that direction including inverted yield curves (a bet on much lower interest rates), negative swap spreads (an indication of bank balance sheet constraints), tightening credit standards, reduced commercial lending, distress in the commercial real estate (CRE), declining industrial output, contracting world trade, increasing trade sanctions, trade disruption from the Ukraine War, Treasury bill rates below the rates available from the Fed’s reverse repo program (a sign of collateral scarcity), bubble-type valuations on the stock market, and many more.

OK, that’s a long list. So, where’s the recession? There isn’t one right now.

GDP growth in the second quarter of 2023 was 2.4% (annualized). That’s not stellar, but it’s better than the 2.2% we averaged during the long, weak recovery of 2009-2019. The Atlanta Fed projects growth for the third quarter of 2023 of 5.9%. That’s off the charts and similar to the kind of growth we saw from 1983-1986 during the Ronald Reagan recovery.

I’m standing by my recession call, and I don’t buy into the Wall Street Goldilocks or soft-landing scenarios. Still, facts are facts. How do we reconcile recession warning signs with hard data showing strong growth?

There are two drivers behind this, both of which are non-sustainable. The first factor is described in this article.

This reports the astounding growth in credit card debt. Credit card balances rose by over $45 billion in the second quarter and hit $1 trillion for the first time. These are not just expenditures.  They are balances, which means the consumers spent the money but can’t pay off the balance and are just rolling it over with their banks.

There are three problems with this. The first is that when you use up your credit line, there’s no more left. Spending can come to a screeching halt.

The second is that banks are charging 30% interest on unpaid balances. If you can’t afford to pay down principal, how on earth do you pay principal plus 30% interest? You can’t. (By the way, 30% interest doubles the amount owed every 29 months. Good luck with that).

The third factor is when debtors walk away and just default on the credit card. That’s when bank earnings and stock valuations get whacked. Banks respond by tightening credit even further.

The other driver of current growth is private infrastructure spending on hotels, housing, malls, and more. That’s largely a legacy of the Fed’s zero rate policy that only ended in March 2022. It was not until mid-2022 that rates even reached 2%.

Construction projects are typically financed with 3-year construction loans and then taken out with 10-year mortgages. The low construction loan rates in 2022 account for the construction today but refinancing the construction loans at 7% or higher today will drive those projects underwater. New project finance will hit a brick wall.

So, yes, growth is high today but there’s good reason to believe the drivers of growth are rapidly hitting the end of the line, and the recession warning factors will come to the fore. Goldilocks is a nice fairy tale, but it’s not a good description of the economy today.

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