A pillowy-soft landing
A recession is unlikely despite American families getting poorer in the past year.
Central bankers have hiked rates thick and fast for the past year to try and quell inflation. Bond traders had forecast an American recession was incoming. But, even though American families are poorer than they were a year ago, it hasn't arrived. Inflation-adjusted household net worth has fallen 7% in a year. In the past, this has been a decent recession indicator. But it hasn't worked this time because the labour market is strong and unemployment has stayed low.
American families are poorer in real terms because inflation has been high. Over the past year, the net worth of American households dropped 2% in nominal terms. That drop becomes 7% after adjusting for higher costs. This means that families can buy less and have less money to spend. And when one person spends less, another's income falls.
Historically, the change in household net worth has been an excellent recession forecaster. Of the eight recessions the US has had since 1960, only one didn't intersect with a drop in household net worth: 2020.
But, there hasn't been a recession because demand and the labour market have been strong. The robustness of nominal aggregate demand—an estimate of total spending—was, in turn, driven by the government's deficit spending and bank lending. Using data from the Federal Reserve, I estimate that total spending is up 7% in the past year. That's in line with the uptick in the government deficit to 7%. When the state spends more than it collects in taxes, that adds new money to the economy, stimulating spending.
While the deficit has added money, credit has also flowed. Families, companies, and landlords have borrowed more. In the past year, banks lent out money equal to another 5% of GDP. That level of new loan creation is around historic highs. Demand for new loans has been strong because incomes are up, and folks are confident they can repay (see: Laughing all the way to the bank in Vol. 3, No. 14). This matters because when banks lend, they also create money. And that new money has helped people and firms to spend and added to demand.
Unemployment is still low because companies have expanded, and there are plenty of jobs. After-tax profits at American firms rose 30% in 2021 and another 4% last year. Bigger profits mean more business, so firms hire workers to support expansion. Also, profits are either reinvested or paid out, increasing spending further. The evidence of this is in the number of jobs there are. Almost two positions are available for every American searching for one—around historic highs. With plenty of jobs around, people don't need to curtail spending. Nor do they worry about their ability to repay debt. If they get the sack, they can find a new workplace.
Unemployment will stay low, and households will soon feel richer. The labour market will remain strong because banks will continue to lend. Economic expansion and demand for new loans are unlikely to hit the wall. Analysts expect big American companies will continue to earn more. Using consensus estimates for each firm in the index, I forecast the S&P 500's earnings will rise 21% in the next year. Fatter top and bottom lines support new jobs.
And as inflation drops, households will start to feel more prosperous. With the extra income, savings rates will climb. As the government spends and banks lend, that will add money to the economy. This extra cash will help increase the private sector's net worth. It looks like it'll be a pillowy soft landing.