Is the Economic Confidence Index Forecasting a Recession?

Fear, greed and hope have destroyed more portfolio value than any recession or depression we have ever been through — James O’Shaughnessy

Whether or not you support the policies and practices that brought the U.S. out of the Great Recession, one fact is incontrovertible: The current economic expansion is now the sixth-longest since James Buchanan was in the Oval Office.

At first glance, that’s no small feat. Following the deep 2007-09 recession, the economy began growing again in July, 2009.

As of May, 2015, the current expansion reached its 70th month. By comparison, the previous 34 periods of growth (going all the way back to 1857) averaged less than 40 months apiece.

However, upon closer inspection, the current expansion — tepid growth rate notwithstanding — may still have room to run. The reason why has to do with the lengthening of the business cycle over the past four decades.

The Business Cycle

The business cycle is the growth and decline in the economy as measured over a period of time. Per Investopedia, it is defined as follows:

A business cycle is basically defined in terms of periods of expansion or recession. During expansions, the economy is growing in real terms (i.e. excluding inflation), as evidenced by increases in indicators like employment, industrial production, sales and personal incomes. During recessions, the economy is contracting, as measured by decreases in the above indicators. Expansion is measured from the trough (or bottom) of the previous business cycle to the peak of the current cycle, while recession is measured from the peak to the trough. In the United States, the National Bureau of Economic Research (NBER) determines the official dates for business cycles.

For much of the history of the United States, the value of the dollar was tied to the country’s gold reserves (the “gold standard”). The approach was modified after World War II (the Bretton Woods monetary system), but gold reserves remained a central tenet of the money supply until 1971.

The Creation of the Fiat Dollar

Tying the value of the U.S. dollar to gold necessitated huge reserves of the precious metal. President Nixon formally abandoned the gold standard in 1971, officially making the U.S. dollar a fiat currency. Investopedia defines fiat money as follows:

Currency that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand rather than the value of the material that the money is made of. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith. Fiat is the Latin word for “it shall be”.

The Economic Confidence Index

Despite the longer-than-normal current economic expansion, Americans are still not feeling the benefits of the improving economy equally. As a result, Gallup’s Economic Confidence Index has begun to slide.

The collective belief that the economy has not benefited all segments of the population equally is the likely reason why the index has been on a downward arc over the past four months. Gallup explains the methodology in the following manner:

Gallup’s Economic Confidence Index is based on the combined responses to two questions, the first asking Americans to rate economic conditions in this country today, and second, whether they think economic conditions in the country as a whole are getting better or getting worse. Results are based on telephone interviews with approximately 3,500 national adults; margin of error is ±2 percentage points.

The index combines a “current conditions” score and an “economic outlook” score, then averages the two. In the week ending May 24th, 23% of Americans said the economy was either excellent or good, as compared to 29% who labeled it poor. The current conditions score, therefore, was -6. The economic outlook score was -11, as 42% thought the economy was improving while 53% believed things were getting worse. The average of the two scores ends up at -9.

Is the Economy Heading into Recession?

Eventually, yes, but probably not soon.

Even at -9, the Economic Confidence Score remains significantly better than the -21 posted in August, 2014. Although it has been sliding this year, the reported .2% first quarter growth is expected to be revised upward before it’s deemed official. Furthermore, warmer weather typically spurs economic activity, which should positively influence the variables.

In other news, the Consumer Confidence Index stands at 95.4, up slightly from April’s 94.3.

It doesn’t appear that the U.S. economy is about to enter into a recession. Interest rates remain low, housing and construction by themselves should keep things churning along in a positive direction, and as indicated, recent history has shown that expansions last much longer than they used to.

That being said, the problem with the current economy is the same one that’s plagued it for the past six years: mediocre growth. Although technically improving, it just hasn’t been fast enough or sufficiently widespread to benefit the masses. As long as that remains the case, the politicians will continue to point fingers at one another.

Let’s hope they refrain from using the middle one.