Having been a student of the stock markets and the economy as a profession for more years than I care to mention, it always pains me when I see the beginnings of a recession in the making. After the Great Recession of 2008/9, we have come a long way back in terms of the stock market to bubble proportions, but not that far back in the economy as most of us would think. While there has been some job growth, it has been in low and middle income areas which have not contributed to the generation of wealth for most of the working class. Everyone talks about the unemployment rate which doesn’t really tell the story about how our economy is doing since it is the labor participation rate that is key to growing the economy, and that is currently at its lowest level since the 1970’s. Media pundits rave about a 4.9% unemployment rate to keep us from looking at what is really happening, but you never hear them talk about the real unemployment or should we say under employment rate or the U6 number in the BLS report. Truth be known the January labor participation rate is 62.6%, 2/10’s higher than September. The government will say the reason for this higher rate is the number of baby boomers retiring, but unfortunately that is not the entire story.
Jobs have been leaving our country for years because corporations have found cheaper tax havens and labor forces in foreign countries so they have moved many of their manufacturing facilities out of the U.S. Since we started doing trade deals like NAFTA starting in 1993, we have lost over 70,000 manufacturing factories and countless jobs depending on whether you use government or private statistics. These jobs are not coming back anytime soon unless Washington fixes the problem by lowering the corporate tax rate to entice these manufacturers to return and reopens negotiations on previous trade agreements.
The primary reason we have seen any job growth in the U.S. is because of the oil and gas industry where employment rose 40% from 2007 through 2013 compared to a decline of 3% in the overall U.S. economy. Along with those jobs came a reduction of oil imports by 50% since 2008. That party for oil is now over and therein lies the rub. The price of oil has been in decline since 2011 and has not been this low since 2002. Everyone thinks this should be good for the economy with our primary energy prices at these low prices people should have more money to spend on other things. Unfortunately, that is not the case when you consider that U.S. median income has been falling since 2007 and has recovered only slightly in the past two years while the ever increasing cost of health insurance premiums had taken away any advances.
Oil inventories are at levels last seen when Herbert Hoover was President battling the Great Depression. Not that I’m crying for them, but oil companies have lost $14 billion in 2015, their first yearly loss in 48 years. This is bad news for the oil industry as they have incurred huge amounts of debt drilling for new energy assets to bring on line. Forty two companies went out of business because of bad debt in 2015 leaving over $17 billion in unpaid obligations and larger losses are expected in 2016. It is estimated that over $2 trillion in debt has been added to oil and gas company balance sheets since 2006.
Let’s go back to 2008 when we had the credit contraction, and we had over-inflated housing valuations, combined with aggressive but lax lending practices and deteriorating credit worthiness. The elephant in the room that everyone failed to see was the unregulated derivatives market and the underestimation of lender exposure. Home prices dropped by 61% over three years according to the Case-Shiller Index. Fast forward to 2016 and we see oil prices have declined 69% in just two years. The difference between these two economic anomalies is that houses had a value even if it was only the dirt they sat on. In the case of oil and gas reserves which is what they borrow on, when these reserves are not economically viable to extract their value is zero. Are you getting the picture now? There is a huge selloff going on in energy bonds as we write these words and that is going to be difficult for many banks to handle. The loosely regulated derivative market is surely going to yield some surprises and add to the problems. No one can truly estimate the total damage of this drop in oil prices, but it wouldn’t take much to tip this country into recession even with oil at less than $20 dollars a barrel as some analysts are predicting.
Everyone says that the price of oil is likely to bounce back which may be true, but with global demand flattening out and the Chinese GDP falling to below 7% growth, who will buy the oil even at a higher price? The oil and gas credit crisis is nothing to joke about as it could be the beginning of a much larger debt problem. Reuters has said that concerns about a recession from company executives have increased 33% from 2015, the biggest rise since 2009. Bulk shipping rates have fallen off the charts, U.S. industrial production has been contracting even though the Federal Reserve is looking for an up-swing in GDP next year and Goldman Sachs is predicting it to be lower so it comes down to who you believe. To be sure OPEC will soon circle the wagons and cut production so they can support and hopefully move the price of oil back to a reasonable level of profitability for them. It won’t help as global demand will continue to slow as all of the world economies slow down.
Folks, we are in a period of deflation which is not good for anyone and in fact the Fed is actually talking about negative interest rates which is where you pay the bank to keep your money. Personally I hope we get a Donald Trump or a Ted Cruz as our next President because I doubt that any of the other choices would have the ability and courage to do what is necessary to turn our country around.