Is The US Trash Indicator Predicting Another Recession?

Is the U.S. economy headed for a new recession before it fully recovers from the last one? There's no better indicator to watch than trash.

Just as those who do not believe China's official gross domestic product figures follow the country's ever-declining electricity output as a better gauge of what's really going on behind the scenes, the limitations to GDP are prompting economists in the U.S. to turn to a lesser-known economic indicator -- the change in carloads of trash that are being shipped off by rail to landfills across the country.

Logically, the correlation between trash and GDP is that the stronger the economy, the more stuff people buy. And the more people demand, the more waste they produce. Obviously, when they buy new things, they tend to throw out old ones.

Among the 21 categories of items shipped by rail, none have a tighter correlation to GDP than waste.

Economist and Bloomberg Brief contributor Michael McDonough created this interesting chart that compares rail shipments of waste and scrap (reported by the Association of American Railroads) to the U.S. GDP.

The direction of carloads of waste for the third quarter makes this graph worrisome.

The U.S. economy grew at only 1.9 percent in the first quarter of 2012 and a tepid 1.5 percent in the second quarter.

The sharp drop-off in that blue line, indicating waste carloads, looks a lot like the drop-off in 2009 - and we all know what happened then.

Two railroad companies also mentioned a decline in waste shipment.

Norfolk Southern Corp. (NYSE: NSC) talked of "reduced shipments of municipal solid waste" in its second-quarter earnings conference call, while CSX Corporation (NYSE: CSX) said "aggregate shipments will remain challenged" in the construction sector.

If garbage proves a somewhat accurate coincidence indicator, then this chart is warning us that the U.S. economy is on pace to recreate the economic collapse last seen after Lehman Brothers went under.

While Federal Reserve Chairman Ben Bernanke told Congress in July that the Fed doesn't see "a double-dip recession," the central bank tends to be overly optimistic about the economy.

In June 2011, officials predicted the U.S. would grow between 3.3 percent and 3.7 percent this year. After seeing a string of gloomy economic data, policymakers lowered their forecast for 2012 in June to between 1.9 percent and 2.4 percent.

And it's not just the Fed.

In a recent Wall Street Journal survey, economists on Wall Street put the chances of a recession in the next 12 months at a reassuringly low 21 percent. But the sad truth is: Economists rarely foresee recessions. In August 2007, they put recession odds at 28 percent. Within four months, the economy had fallen into what became the worst recession in more than half a century.

That leaves us with one question: Is garbage a better predictor of where the economy is heading?

Alexi Savov, a professor at New York University's Stern School of Business, also made the case that the amount of trash we produce is a better measure of consumption than traditional tools, according to a paper published in the Journal of Finance in 2011 titled "Asset Pricing with Garbage."

Although Savov was using this theory to explain a phenomenon in asset pricing, he did echo McDonough's view that using garbage as a proxy for consumption works better.

Consumption is a broad measure of wealth. "When you are making lots of garbage, you are rich. When you stop making garbage, you are poor," Savov wrote.

World Bank urban specialist Dan Hoornweg's comment in a report on the state of trash in cities, to some degree, also confirms the correlation between trash and the health of the economy. "The fastest way to reduce solid waste volumes is to have a recession," Hoornweg wrote.

In 2010, McDonough used almost a decade's worth of data to prove that waste has an 82 percent correlation to U.S. economic growth. It was the best correlation of the 21 shipments that are categorized by the AAR. According to Bloomberg, metals have a 79 percent correlation and lumber has a 73 percent correlation.

As McDonough explains to Marketplace, trash provides a broad-based indicator of economic activity: "It's holistic because it's not isolated to a single part of the economy. It's people throwing things out, it's buildings being demolished - it's everything. ... I mean, if you're going to build a new building, there might be a building that's already there. If you buy a couch, you might be throwing out an old couch. If you go out to McDonald's and you buy something, you're going to throw something out."

McDonough notes that the concept of using trash as a proxy for GDP did not create a leading indicator, but a coincidence indicator because you have to wait for people to throw things out. But what makes the trash figures such a sensitive signal is that the AAR releases railroad carloads data on a weekly basis, whereas the Bureau of Economic Analysis updates the GDP figure only a month or two after the quarter ends.