Why the US could be facing a double-dip recession

Federal Reserve chariman Ben Bernanke has 'ruled out' a double-dip recession in the US. Unfortunately for him, the economy isn't listening. The facts suggest it's a lot more likely than he seems to think. John Stepek explains why.

Gold had another good day yesterday, while stocks sold off.

But everything's going to be just fine. Why? Because Ben Bernanke says so.

Shares edged higher in Asia this morning. Apparently it's all to do with an interview that the Federal Reserve chairman gave last night.

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What words of wisdom did he have for us, to arrest the market's decline? To be honest, it's hard to say...

How can Bernanke 'rule out' a double-dip recession?

Despite another slide in US markets yesterday, Asian markets managed to eke out a tiny gain this morning. Europe was looking fine too, until Fitch warned of Britain's "formidable challenge" in cutting its budget deficit.

News reports are putting it down to Ben Bernanke. The Fed chairman reckons that despite Friday's weak US jobs data, the recovery is intact. There won't be a double-dip recession. And the Fed may even have to raise interest rates at some point perhaps before US employment is as high as they would like. But that won't be for a while.

Oh, and he believes that the European authorities are committed to protecting the euro. And they're doing a fine job of it so far.

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"Bernanke's comment is positive for the stock market in that he is saying the economy is improving," one Tokyo-based fund manager told Bloomberg. "I don't think we have to worry about the US economic recovery. It is unlikely to go wrong." And a German fund manager piped up on Reuters: "Bernanke ruled out a double-dip recession, which is a major issue."

But wait a minute. "Ruled out"? Bernanke doesn't have a magic wand. He can't just open his mouth and somehow ban the US economy from hitting another rough patch. And anyone who didn't already realise that really should have learned something from the past few years. After all, this is the man who said that the US subprime crisis would be 'contained'.

And to be fair to Bernanke, that's understandable. Central bankers in developed world economies are not in the habit of screaming "panic!" in public, for good reason because people would. You only need to look at the fear caused by Hungarian politicians in the past week to see how careless words can batter jittery markets.

But that also means that you have to take everything that central bankers say with a hefty pinch of salt. At best, all Bernanke's doing is patting investors gently on the head and saying: "There, there, everything's going to be fine." Behind the scenes he's probably thinking "how on earth are we going to get out of this mess?"

The jobless data is even worse than it looks

And he'd be right to worry. A survey by global recruitment group Manpower shows that employers in most economies "are more likely to add workers than three months ago," reports Reuters. Sounds good. But the trouble is, "big gains are limited to booming emerging economies like Brazil, India and China."

In the US, "large-scale job creation is unlikely in coming months." The fact is that "US employers are able to meet demand with their existing workforce, and will resist adding new workers until they see credible evidence that demand is sustainable," reckons Manpower chief executive Jeff Joerres. And this survey was conducted before the Greek crisis really hit markets.

And David Rosenberg of Gluskin Sheff has been digging into Friday's payrolls report a bit deeper and come up with some worrying little details. The 41,000 increase in private sector jobs which was way below expectations was actually "exaggerated by a 29,000 boost from the birth-death model".

I'll not go into the 'birth-death' model in detail. Essentially, it's a statistical fudge that is meant to account for the creation of new businesses and the closure of old ones. The trouble is that it assumes that more jobs are created than are lost. This is fine in a growing economy. But clearly it doesn't make much sense in one that's still in the mire of a serious financial crisis.


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And as Rosenberg points out, "the declines in the financial sector, construction, and State / local governments are a vivid reminder that the parts of the economy that were most affected by the bursting of the housing and credit bubble are still licking their wounds." That means they won't be helping to revive the "moribund jobs market" any time soon.

A double-dip recession is likely - despite what Bernanke says

Meanwhile, banks just keep on failing in the States. 140 failed last year. But this year it could be even more. So far 81 have collapsed. It's little wonder that the broader economic outlook is looking bleak. The ECRI index of leading indicators which tracks what various indicators are saying about the state of the US economy has fallen in eight of the past nine weeks.

"It is now at its lowest level since June 12, 2009 just shy of breaking below zero." As Rosenberg says, "a double-dip is going to become a real likelihood if the index breaks to and through the -10 threshold".

Certainly, John Mauldin reckons that third quarter GDP could easily come in a lot lower than current hopes for a 3% increase. Why? Because much of the gain in the earlier part of the year was down to two things. First, there was government stimulus, which is gradually being withdrawn.

Secondly, inventory rebuilding. When the credit crunch hit, companies cut right back on restocking. In other words, supply fell even faster than demand. So when the crunch eased off, stocks needed to be rebuilt. That's accounted for a big chunk of the recent bounce in global activity. But as Mauldin puts it, "at some point inventories become balanced and no longer grow." The US seems to be at that stage now recent manufacturing data shows that inventories are no longer being rebuilt.

Take all that out of the equation, and suddenly you're relying on a self-sustaining recovery. And with the grim jobs outlook, that doesn't seem too likely.

So when Bernanke "rules out" a double-dip, remember that he's talking his book. The facts suggest that there's a lot more chance of it happening than he'd like to imagine.

This doesn't mean that there aren't any decent investments in the US. At our recent Roundtable, we invited a group of experts to pick what they believe are nine of the best value stocks in the States right now (if you're not already a subscriber, subscribe to MoneyWeek magazine). Unsurprisingly, most fall into the category of defensive giants with global exposure. And we can't disagree with that.

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.