Where are we?
from Peter Radford
It’s tough to tell exactly how the recovery in the United States is going. Since this is a busy week for data reports it behooves us to step back and set the stage.
If you recall, at the end of last year the economy was growing at around 3.0% to 3.5% at annual rates. That was a marked improvement, but not earth shattering in the context of post-war recoveries. The general opinion was that we would pick up speed into the first quarter before settling down into a post-recovery ‘normal’ period of steady growth. I was always a slight dissenter to this view because I put more emphasis on our lingering unemployment problems, the risk still abundant in banking, and the downward weight resulting from the real estate collapse. Plus the fourth quarter had one or two oddities – trade and inventories – that pulled reported growth from its underlying trajectory. So my view was that growth would stick in that 3.0% range and then fall a little as we went through this year.
It looks as if we were all wrong.
The problem with the first quarter, we sill see the initial estimate this week, is that the string of oddities has continued. This time things like the very bad weather have taken their toll, and so we should all expect a much lower growth rate than originally thought. If we use the so-called Blue Chip consensus as our guide, the original commonly accepted growth rate was somewhere near 4.0%. This was based on the idea that the recovery was still accelerating, and had not yet peaked, and that consumer demand was bouncing nicely away from the depths plumbed in the recession.
Now that same consensus is looking for a first quarter of 1.7%, with the dramatic revision due to the weather and the fact that consumers have turned much more pessimistic again.
Apparently, one bad winter, and a sudden spike in oil and food prices, have done the recovery in.
So much for robust.
This, in a roundabout way, supports my view, although I make no claim for prescience. The issue is straightforward: as long as unemployment is high, and as long as home prices are weak, households will not shake off their sense of siege completely. It won’t take much to set them back into a savings mode. Likewise, banks may be reporting solid profits – or at least some of them are – but much of the improvement is coming from changes in loss rates, and trading rather form the basic banking that engages with the real economy. This is why I still think we are in a long haul and slow recovery, rather than in the middle stages of a typical post-war bounce back.
Add in the short term rise in consumer inflation caused by those food and oil price increases, and the mood has changed quickly.
This morning’s data on real estate is illustrative.
Sales of new homes in March climbed well: up 11% from February. On its face this is solid. But February was especially depresses because of that bad weather, so a large share of the rebound is simply the working off of a mild backlog. The average between the two months gives us a better longer term measure of sales, and that is essentially flat. Couple this with the news that builder expectations are still at incredibly low levels, and that the inventory of unsold new homes, at 183,000, is stuck somewhere around its 1967 levels – i.e. at near all time lows – and any image of recovery pales away to be replaced by one of decidedly abnormal and low activity. Certainly nothing in real estate suggests a return to good growth. Right now moderate growth would suffice.
The reason I am belaboring this is that when GDP for the first quarter is announced we will all be trying to divine its import for the rest of the year. I am arguing that it may not be much of a signpost at all. It may be too riddled with quirks. That implies we are better served looking at the more frequently announced numbers to get an idea of the general health of the economy.
And those numbers support a very modest outlook.
So what are the risks or problems that prevent us from moving along at a great clip?
- The absolute size of the hole we dug back in 2008/2009. This was one mother of a recession, and it has left immense slack throughout the economy. Until that slack is picked up there is little to no incentive for businesses to invest. This is despite interest rates being at ludicrously low levels. Some analysts argue that the Fed’s loose monetary policy has had no discernible effect on investment and thus is a failure. I disagree. It wasn’t a bust. It wasn’t a roaring success either. It just was. It is tough to critique the Fed when the entire system was so close to crumbling. Let’s all remember: the private sector vanished in very short order. Were it not for the government we would have vanished along with it. Business is rightly cagey when faced with skittish consumers and goods of spare capacity. So we can take robust investment off the table as a driver of near term growth.
- Austerity budgets will cause at least short term pain. They probably will cause long term pain as well, but that’s not our issue here. Luckily for us the debate will ramble of for a while, so the impact of less government spending will not be hugely significant this year. But it will be a real and noticeable drag when it does show up.
- Unemployment is still way too high. Yes, the trends have improved, but by any standard we are a very long way from a return to normal. The labor markets are very fragile. I expect them to stay this way for many more quarters.
- World imbalances will leak over into the US economy. Particularly in the form of a continued run up in some consumer prices. There is an argument to make that the world economy is headed into a period of generally higher prices due to the rapid growth of emerging economies and the stress that puts on supply of raw materials and food. But the recent spike in prices is not necessarily indicative of where that longer term price level will be. Short term supply constraints and like the turmoil in the Middle East, and rotten harvests, are masking the long term trend. I expect prices to settle back down, rather than to escalate wildly out of control. Nonetheless in the near term this spike has illustrated jut how vulnerable consumers are.
- That is the lesson we need to absorb. Confidence is fragile. To the extent that we rely on consumption and a return to healthy levels of sustainable demand, we are a long way from cured. This past few months have taught us, vividly, that consumers are acting as if on a knife edge. They are pessimistic one day, then optimistic, and then back in the doldrums. The battering they have taken has numbed them sufficiently that they will take a great deal of persuasion before they declare the recovery complete enough to spend the way they once did.
- Banking is not yet safe. Since we didn’t reform the banks to make them less dangerous, we have to assume that they are busily constructing their next disaster. Which we, inevitably, will be expected to pay for. Like all habitual blackmailers, the banks will not reform of their own accord. They need to be forced to behave. We will not achieve long term sustainable growth whilst banks are more interested in gambling than in underwriting loans that support the real economy. This shouldn’t be hard to understand, But apparently it is.
- Imbalances within the economy lower its potential trajectory. This is a longer term effect and perhaps out of place here, but I would be remiss for not mentioning that our enormously divided economy, between the haves and the have nots, is in itself acting as a brake on growth. It is my view that when the middle class is deprived of disposable income over long periods it cannot act as the economy’s primary consumption engine. It is no secret that the American economy is now so split with respect to the fruits of productivity, and thus income allocation, that its the middle class is now no longer capable of driving spending with sufficient force to justify investment. This sets in motion a steady spiral downwards. As investment is restricted, so future income growth is impaired. This encourages short term thinking in business in the form of cost cutting and wage freezes in order to maintain profit growth. The net result being a shift in income allocation away from wages towards profits and the steady throttling back of potential growth. If this view is correct, then the very clear bias in favor of profits as opposed to wage growth that has dominated American business for the past three decades will end up reducing long term profit. The greed of shareholders will ultimately be self-defeating as they stifle the middle class and thus the very source of their profit.
This is not an exhaustive list, but one point I want to make quite clear: I don’t think that the Federal deficit or the near term bulge in US debt is a particular problem. Our response maybe. Meanwhile we have left unaddressed many of the more obvious sources of risk, like the ones listed above. So as long as were are exposed to such a list we should expect a bumpy and not very fast growth pattern. There’s just too much out there lurking to derail us, and too little policy focus on a long term strategy to reduce inequality, for us to be upbeat.
So look for a lot of sideways motion.