We Will Be Blindsided by the Next Recession - Here's Why

Mistakenly we focus on unemployment and inflation as telltale signs of the health of an economy. They are akin to checking if someone is bleeding or breathing to assess health. Namely, they are too little and too late as metrics. Instead we should focus on workforce fitness, and velocity of transactions. If we don't we are likely to be blindsided by the next recession, which is looming. The Fed targets an inflation rate of 2%, and during the housing market collapse we saw an example of how this mandate can fail us. As housing prices fell rapidly, a massive deflationary force, the Fed lowered interest rates and later engaged in quantitative easing, both inflationary forces, to try to reach its 2% inflation target.

The mistake, however, is that houses were the most common asset of American families. Not only were home values dropping, but thanks to the Fed the cost of everything else was shooting up; making a bad situation worse for the middle class and American homeowners.

In the recovery, the Fed has been watching the unemployment numbers, and while unemployment figures can tell you a bit about if people are hurting right now, they can't tell you anything about what might happen next.

My guess is that we have lots more people working part time who used to work full time. Also, if people who lost their full time job have shifted into service jobs, they're likely not contributing to, or benefit from, productivity gains. Productivity gains are of course the only meaningful sign of increases of real GDP.

We should be focusing on a panel of data that can be summed up as workforce fitness. Perfect workforce fitness can be defined as a situation where any person in the workforce can do any job in the economy, and zero workforce fitness can be defined as a situation where no one in the workforce can do any job in the economy. These are both unrealistic extremes, of course. Reality is in the middle somewhere, but once you start thinking in these terms the obvious comes to light. If there are people in the economy who can only successfully do one job, they are at far greater risk than people who can reasonably perform well at many different jobs. If another recession comes with massive layoffs in tow, people with low workforce fitness are far more likely to become and remain unemployed for much longer. Those with higher workforce fitness will weather the recession far more formidably without any government intervention.

Assessing workforce fitness would be matter of quantifying the workforce needs of employers, and then surveying individuals for the capacity to fill those needs. This might include things like level of education, types of jobs held in the past, military experience, income variation, and so on. (If you wanted to be forward looking and extensive you could survey venture capital and assess entrepreneurial fitness as well.) A country with a high workforce fitness rate would be a more suitable place to build a business. That is to say, if you build a business here, you're far more likely to find capable workers.

Today, more people go through career changes that ever before. Children are being trained for jobs that don't exist, and many of the simple jobs in the economy are being automated away. For this reason we must begin to look beyond unemployment to workforce fitness.

Moving on to velocity of transactions. An economy is like a giant machine. A machine that produces all types of goods and services. Inside that machine anytime something valuable happens (almost anytime), money is exchanged for a good or service. The more vibrant an economy is, the more often these exchanges happen, and the more significant the value, the large the transaction sum. The number and size of transactions can tell us how fast that machine is producing valuable goods and services. This velocity of transactions is an essential metric of the performance of an economy.

Inflation, on the other hand, is just a fancy tax.

In order to measure velocity of transactions we would need to survey, or measure directly, the size and number of transactions in an economy. We can do this on a weekly basis if we wanted to, and with the coming advent of cryptocurrencies like Bitcoin and Ethereum we might even be able to measure velocity directly. (There is also a way to estimate it using GNP and money supply.)

Velocity can tell us a lot about where we are and what's coming, but we might not fair well if we try to engineer it via interest rates as we do with inflation now. Trying to prevent a coming slowdown will temporarily postponed but worsen that slowdown. We'd be wiser to focus on workforce fitness, and people's individual abilities to weather economic shocks.

If we were measuring workforce fitness and velocity of transactions, we would see that a recession is coming in the near to midterm (six months to 3 years is my guess), and we would be alarmed by the fact that most people won't be able to weather the coming storm without support from the government.

We live in the 21st century, and we're very quickly shifting into an innovation economy. The metrics we use however, are over 100 years old. It's time for an upgrade.

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