"If the U.S. economy does go into a recession, it will have been the most widely predicted recession in history. We’re still holding off from predicting a recession because there is a danger that such prophecies could be self-fulfilling because consumers could get scared off by such talk."

- Anirvan Banerji

One by one, many blue-chip economists are starting to opine that the U.S. economy is either in or sliding into what may be the most heavily forecast recession in recent memory. Their predictions could be self-fulfilling if they spook consumers into closing their pocketbooks and companies into delaying investments. However, as economists are wont to say, those prophecies of doom could be self-negating if they persuade the Federal Reserve to cut interest rates further and if election-year politics doesn’t block Congress and the White House from a compromise on some kind of economic stimulus.

All economists agree that the U.S. economy has slipped into a slow-to-no-growth mode, but it’s still too soon to say whether growth is turning negative. Only the National Bureau of Economic Research can do that, and usually only long after the economy has recovered. But the obvious slowdown in the U.S. economy is already beginning to affect the growth of the container shipping trades outside of North America, which through most of last year remained immune to the slow-growth virus.

Once again, the old adage "when the U.S. sneezes, the world catches a cold" is starting to prove true. Containerized trade with the U.S., whose economy slowed sharply in the last quarter, has slowed much more than that of the rest of the world. The intra-Asia trades, powered by rapid growth in China, India and the Middle East, remain strong. Meanwhile, the Asia-Europe trade, which has sopped up much of the new vessel capacity that was delivered last year, is only now beginning to shows signs of catching the slower-growth bug.

That could change, of course, if U.S. growth turns negative. But leading indicators of the economy, which have been signaling a U.S. slowdown, don’t yet signal a recession. The index of industrial prices compiled by The Journal of Commerce and the Economic Cycle Research Institute began turning downward last spring, which signaled a slowing trend in the growth of the world’s industrial economy.

"It’s a very clear indication that we are in a global industrial slowdown," said Anirvan Banerji, director of research at New York-based ECRI. But the index, which usually signals a change in the trend of global industrial production by an average lead time of eight months (Story, Page 16), has not yet started signaling a recession.

"The industrial part is only one piece of the puzzle," Banerji said. "If the U.S. economy does go into a recession, it will have been the most widely predicted recession in history. We’re still holding off from predicting a recession because there is a danger that such prophecies could be self-fulfilling because consumers could get scared off by such talk."

There is, or course, a very real danger that the U.S. could fall into recession. By last fall, most Americans thought the U.S. was already in a recession or would soon be falling into one. "Businesses were petrified at this point," Banerji said. But this could also have the opposite effect. Instead of reinforcing the slowdown, it could prove self-negating. "This time around, there has been so much gloom and doom about how weak the American economy is, especially in Europe, that there has been a big drop in the dollar, which has stimulated exports, which has helped to sustain the economy," he said.

He compared the current talk of recession to the scare talk of a Y2K computer meltdown as the world approached the millennium. "Companies and governments spent so much money to avoid the problem that, in the end, nothing happened," he said.

The same thing could happen now if the Fed continues to prime the economic pump with lower interest rates and the U.S. government enacts a stimulus package in time to halt the slowdown. "It’s all about the timing of the stimulus, not about the details," he said. "Economic stimulus could be very potent right now if it is done in time." But he said the timing still looks "a little dicey."

Certainly, there is no dearth of economists who say that the U.S. is already in recession. "It looks to me like we’re already slipping into recession in the first quarter," said Michael Andrews, chief economist of PIERS Global Intelligence Solutions, a sister company of The Journal of Commerce. He is forecasting U.S. gross domestic product growth at 2.2 percent for the year as a whole, but warned that there are serious downside risks to this outlook, with a "more than usual degree of uncertainty" surrounding it.

Andrews said he may lower this forecast because there are no signs that the housing recession is bottoming out and there are signs that the credit crisis that started with the subprime mortgage fiasco is spreading to corporate loans, auto loans and credit card debt. "Nobody knows how bad this is going to be or how badly the banks are going to be hit with losses," he said. He cited a litany of negatives in the outlook for consumer spending, including high energy prices, declining house prices, slumping stock prices that hit household wealth, the weakening of labor markets with the first job losses being reported, and the consequent decline in growth of labor income.

"The real damage will be in the first half, and the second half should start to pick up when the fiscal stimulus being contemplated begins to hit, with some help from the Fed," Andrews said.

The weak economy will act as a drag on the growth of containerized imports. He is forecasting 3.5 percent growth in imports for the year, which would actually represent a turnaround from the decrease of 1.1 percent last year. He said this forecast is predicated on the start of a recovery in the second half, which is still far from certain, so it may be revised downward. The weak dollar is still acting as a brake on imports, as are high energy prices, but slow economic growth is the biggest drag. As the economy recovers, imports will start to grow more rapidly in 2009, when he expects them to increase by 7.8 percent.

The weak dollar will continue to fuel exports, but Andrews expects the growth rate to slow to 10.5 percent this year from last year’s 16.2 percent surge, as global growth begins to slow. Andrews said world GDP, excluding the U.S., grew 4 percent in 2007 and will grow by 3.5 percent this year, before picking up to 3.8 percent in 2009.

Other economists are equally pessimistic about U.S. trade growth this year. "Imports are not going to rebound this year because of further weakness in the U.S. economy, and exports are ratcheting back as our trade partners weaken," said Global Insight economist Paul Bingham. "This forebodes a much more dismal view of total (U.S.) port activity in 2008 compared to 2007."

Bingham said a number of global leading and coincident indicators are signaling a slowdown in Uexports as well as imports. "The peak-of-the-world boom that we saw in 2007 has played out, and the trend is increasingly downward. We can see that in such things as coming off $100-a-barrel oil, the further decline in the U.S. dollar and in the signs of weakness in some of the major world economies." He said the credit problems that began with the subprime crisis in the U.S. are spreading to other countries, and this is weakening the demand for U.S. exports.

"The ratcheting back of U.S. exports, which have helped sustain the economy, could easily lead it into recession," he said. Global Insight changed its outlook for the U.S. economy in the last month to predict that it will fall into recession. "Then the question is: How deep and how long?" Bingham said that if the U.S. is in a recession, it will be deeper and longer than the 2001 recession, which was sharp and short, and there was an absolute drop in trade volumes. "It looks like we’re getting to that point in 2008," he said.

Whether or not the U.S. actually falls into recession, container volumes in the U.S. import trade are unlikely to recover for some time because of the severe slump in the housing market. When times were good, it accounted for huge amounts of import cargo, including everything from bulky furniture, which takes up a lot of room in containers, to machine tools and textiles. "Some of the unit volume imports like furniture have been hit the hardest, and this has had a disproportionate impact on unit volume demand," Bingham said.

Peter Leach can be contacted at pleach@joc.com.

JoC-ECRI index is a key indicator of industrial price trends

Tallow? Isn’t that what candles were made of in the 18th century? How can the price of tallow, the rendered fat of cattle or sheep, signal whether the modern global industrial economy is trending up or down? You may be surprised by the answer.

It turns out that in this day and age, tallow is an important raw material in the production of soaps, detergents and a wide variety of chemicals. The price of tallow, a raw material in industrial production, is very sensitive to changes in demand.

That’s why tallow is one of the 18 industrial commodities that are tracked by the index that is compiled every weekday by The Journal of Commerce and the Economic Cycle Research Institute. The JoCECRI Industrial Price Index has a remarkable record as a barometer that can forecast broad trends in the world’s industrial economy. When he was Federal Reserve chairman, Alan Greenspan checked it daily as a signal of changes in demand for industrial raw materials.

The economic theory behind the index is called the "bullwhip effect," for lack of a more academic title. "This index is designed to be a leading indicator; if demand starts to slow, the index starts to turn down in advance," said Anirvan Banerji, director of research at ECRI.

It is based on an economic theory first explained 50 years ago in a study of the cycle of shoe leather and hides by Ruth Mack, an economist with the National Bureau of Economic Research. "There is a very simple reason for the way commodities like shoe leather behave," Banerji said. When Mack did her study, shoes were expensive products that the average consumer would only replace in good economic times. They were not an impulse buy, as they often are today.

"If consumers felt things were a little tight, then they would get their shoes repaired and postpone the purchase, so that meant that shoes were moderately cyclical in terms of demand," Banerji said.

Shoemakers caught with too much inventory of shoe leather when demand started to slow would cut back on production and on orders for leather, which is made from cattle hides (which are one of the 18 commodities tracked by the JoC-ECRI index). But even as the demand for shoe leather slowed, the production of beef did not because it continued to be eaten by consumers, and so the surplus of hides continued to pile up at the slaughterhouses because they were a byproduct of beef production. The result? Hide prices plunged, Mack’s study showed.

The study showed how small shifts in demand growth at the consumer level are amplified through the supply chain into big swings in price at the wholesale level. "It’s called the bullwhip effect because a little flick of the whip at the wrist will produce a big arc at the end of the whip," Banerji said. "This bullwhip effect is responsible for the big swings in commodity price, but it also gives us a tool because demand shifts are manifested in the movement of prices of commodities where the supply doesn’t change very much in the short term. This is the information we use to form an early-warning indicator."

The JoC-ECRI Industrial Price Index is a predictor of broad trends in industrial demand. When charted against the Baltic Exchange Index of dry bulk freight rates over the period from 1985 to 2002, the JoCECRI index has proved to be an accurate indicator of the trend in those rates (See chart, Page 18). It has foreshadowed up- or downturns in the Baltic index by an average lead time of eight months.

In the years since 2002, the Baltic Exchange Index has been skewed by what Banerji calls the "once in-a-lifetime" secular trend of rising demand from China, which has overwhelmed some of the smaller cyclical fluctuations in the Baltic index that could have been predicted by the JoC-ECRI index. That has not affected the ability of the commodity price index to predict underlying changes in overall demand, even though Chinese demand has tended to offset any downturn elsewhere.

The JoC-ECRI Industrial Price Index was created in 1985 by Geoffrey H. Moore, the renowned economist who pioneered the study of business cycles at NBER, where a committee of economists that he established is still the official judge of when the U.S. economy goes into and out of a recession.

Banerji and ECRI’s managing director, Lakshman Achuthan, worked for Moore at NBER, which was then part of Columbia University. In the 1980s, The Journal of Commerce, which had long maintained its own commodity price index, asked Moore to update the index, which at the time was still using 1967 as the base year for its prices. Moore and his team, including Banerji and Achuthan, developed a new index of prices based on a rotating group of 18 commodities that was launched in 1986. Moore and his team of researchers left NBER in 1996 following a change in its direction by Columbia University and founded the Economic Cycle Research Institute.

The index is updated every few years to adjust the weights of key industrial commodities to reflect their importance in today’s U.S. economy and prune those that no longer play an important role. It was revamped most recently on Jan. 2. The new index eliminated polyester, whose use in the U.S. has plunged, and added the price of natural gas, an increasingly important energy source. The index has been revamped twice previously, in 2000 and 2004, since it was introduced in September 1986.

The JoC-ECRI index differs from other commodity indexes in several ways. It is not a weighted average, but a pure reflection of prices. It does not include agricultural commodities or precious metals such as gold or silver, but only materials that are used in industrial production, such as nickel, tin, aluminum, plywood, benzene, cotton, burlap and crude oil.

In addition, half of the commodities in the index are not "exchange-traded" commodities, which means that their prices are not established on the floors of any of the world’s commodity exchanges. This serves as a reality check on the prices of the other half, so that the index cannot be skewed if a hedge fund or a speculator tries to manipulate the price of a commodity, as the Hunt brothers tried to do in 1980 when they bought half of the world’s deliverable supply of silver.

"Why would an index like this, which is only updated once a day, and is of no use in futures trading, survive? Because it is structured as a composite leading indicator, not as a weighted average, which is what all the others are," Banerji said. "It is a leading indicator of the turning points in demand. It leads those turning points 94 percent of the time."

Peter Leach can be contacted at pleach@joc.com.