Call me goofy, but I am not ready to join the “recession is over” parade just yet. While the economy has hit bottom, it is likely to stay bouncing along that bottom for many months at least. A rapid and sustained recovery beginning this fall is an improbable scenario.
In a spirit of fairness, we will begin by looking at the four main arguments supporting a near-term end to the recession. The first, and strongest, is the healing of the financial markets. The Standard & Poor’s stock index is up 12% for the year and 40% from its March lows. The flow of credit between banks has returned to normal as evidenced by the cost of borrowing. The yield spread between three-month LIBOR, which represents the costs of funds for large banks, and three-month Treasury bill yields has fallen from an astronomical 4.6% in October 2008 to 0.29% last week. Yield spreads between Treasury bonds and bonds issued by corporations and smaller governmental units have narrowed, making it cheaper for these entities to borrow. While there are still exceptions—it’s still next to impossible to securitize mortgages without a government guarantee—the financial markets are back to business as usual.
The second argument is that the $787 billion of stimulus to be provided by the economic recovery act has barely begun to flow. As more projects come on stream, the stimulus package will provide a substantial boost to growth. The stimulus, though, is just that, “something that incites to action or exertion or quickens action.” The question, that only time will answer, is whether stimulus-induced growth will be sustainable, or simply limited to projects whose jobs evaporate when they are completed.
The third argument, put forth cogently by FTN Financial Chief Economist, Chris Low, is that the traditional leader of economic growth—inventory rebuilding—will come to the rescue again. Inventory fluctuations were once a primary lever of economic decline and recovery. In the past, suppliers, caught by surprise, often needed many months to work off excess inventory when bad times hit. Then, equally surprised, they had to rebuild inventories quickly when good times started to return. The process tended to lengthen recessions with longer layoffs, but quicken recoveries with faster re-hiring. “Just-in-time” inventory management, imported from Japan
The fourth argument is in the interpretation of the data. Several recent government and private sector reports have been widely cited as evidence of an economic rebound.
· Housing starts in June rose by the largest percentage since 2004.
· New home sales increased 11%, the most since 2000.
· Pending sales of existing homes have risen nearly 20% from their January low.
The story on the employment front is similar.
· Initial weekly applications for unemployment insurance have been below 600,000 for the last five weeks, after having been above that level since the last week of January.
· Most importantly, job losses in July were the smallest since August 2008.
Government agencies and private groups pour out an endless stream of economic reports every working day. In each report, one number or percentage, the so-called “headline” number, stands out and seems to tell the whole story. But underneath it are mounds of detailed information that tell a more nuanced tale. Often, their interpretation is not merely a result of honest differences of opinion but of political, ideological, and financial motives. Also, the numbers themselves are far from reliable. They are seasonally adjusted, based on incomplete samples, and subject to frequent revisions. Finally, there’s the question of which data provide insights into the future and which merely offer a look in the rearview mirror.
With all these caveats in mind, let’s take another look at the data noted above.
· Housing starts rose 3.6% in July, but, at an annualized rate of 583,000 units, they are barely a third of the average for the last 10 years and a quarter of the boom period, 2004-2005.
· Pending sales of existing homes have also risen, but they remain down more than 13% from the pre-recession average.
· The four-week average of initial unemployment claims has fallen to 555,000, from a recent high of 659,000, but that’s still terrible by any but the most recent standards. From the end of the last major recession in the early 1980s to the beginning of the current recession, the four-week average of initial claims averaged 354,000 and never hit 500,000, except for one week at the peak of the 1991 recession.
· Job losses in July showed major improvement at “only” 247,000 compared to 741,000 in January. But the worst month for job losses in the 2001 recession was October with 325,000, and there were only two other months when losses exceeded 200,000. The worst month in the 1991 recession was February with 306,000 jobs lost, but again job losses exceeded 200,000 in only two other months.
To the extent this data is reassuring, other data is less so. As is well known, our economy runs on consumer spending, which accounts for 70% of Gross Domestic Product. And the consumer is still not spending. The Commerce Department reported recently that retail sales were down 9% between June 2008 and June 2009. On an annualized basis, that’s a difference of about $405 billion. Spending was down in almost all categories:
· Furniture & home furnishings: -12.6%
· Electronics & appliances: -11.5%
· Building materials: -13.0%
· Clothing: - 6.2%
· Department stores: - 9.4%
· Non-store retailers: - 6.7%
Consumer spending is off because consumer income is off. Wages and salaries paid to US workers in June were $6.24 trillion on an annualized basis. They have dropped every month since peaking at $6.58 trillion in August 2008. Had wages and salaries continued to increase at their pre-recession pace, they would have been about $6.69 trillion in June. That difference of $450 billion pretty much accounts for the drop in spending.
There is another dynamic at work too. Americans are paying down debt and saving at record rates. According to Goldman Sachs (and who could question them?) consumer and non-financial company debt fell 0.7% in the first quarter this year, marking the first contraction since 1952. The Federal Reserve reported that total consumer debt excluding debt secured by real estate, after rising steadily for decades, has fallen $80 billion since peaking in July 2008. We still owe more than $2.5 trillion, about where we were in October 2007. As the chart below indicates, we would have to cut another $550 billion more to turn the clock back just five years.
Personal savings has spiked recently as well. The Commerce Department reported that Americans socked more than $500 billion away in June and $680 billion in May. Since May 2008, we have been saving about 4% of our disposable income a month, double what we saved in the boom years.
The increase in savings leads to a key question: Will we go back to our old free-spending ways when the recession finally does end or is our newfound frugality permanent? Retail sales increased every quarter for seventeen years before the recession struck. “Never bet against the American consumer” was economic dogma. But things are different now. Americans have been scared into saving and two powerful forces—one demographic and the other economic—could keep that trend in place for a long time.
The demographic trend is the aging of the Baby Boomer generation. The older people get and begin to contemplate imminent retirement, the more prone they are to save, regardless of economic conditions. A recession can only reinforce this tendency. The economic trend is deflation, or at least the lack of inflation. The most serious previous recession since the 1930s occurred at the beginning of the 1980s. That recession, unlike today’s, was accompanied by double-digit inflation. Inflation discourages saving because it erodes the value of money. Who wants to put $1,000 in a CD if two years later its buying power has been reduced 30%? When the value of money is rising or stable as it is now, savers have a powerful incentive even if interest rates are low. Having been burned by the precipitous fall in stock prices and the even more catastrophic destruction of home equity, simply maintaining the cash you have is appealing.
I hope I am wrong. I hope the recession really is ending and recovery is beginning. If so, dear readers, you will have every right and my cordial permission to call me Mr Goofy from now on.