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Bad Times, Not So Bad Economy: Sluggish Slowdown ?

We can all probably agree that the times are bad but how much worse are they likely to get ? What's the current data telling us and what's the outlook for the future ? As part of the answer after the break you'll find our usual assemblage of relevent readings. They cover the Current Situation, the Outlook, Housing & Saving and the Long-term challenges. We'll draw your attention to the fact that in Bernanke's latest testimony he weakened his assessment and outlook somewhat, though the phrasing was very "careful" indeed. Paul Krugman argues that we're facing an "L-shaped" economy where a so-called recovery will be long period of low/slow growth as we try to repair accumulated damaged. Given that we've been in the "Lost Decade" of negative market returns and the upturn in the economy since '01 was built on the back of the Housing ATM and loose credit we'll agree. Which raises the question of how Housing is likely to perform and what will Consumers do. It's beginning to dawn on folks that we've a long way to go with Housing and as the ATM goes bust that Consumers may be forced to reduce their spending and shift to becoming savers. That will be a huge change in demand for the future. Nobelate Edmund Phelps wraps us up with a look at how structural changes create major challenges for future innovation. Finally we'll note that everybody got all excited by a much better than expected uptick in Durable Goods orders but Mike Donnelly over at CEO Economic Update nicely deconstructs the data to point out that it's likely due to an uptick in Auto Industry production and materials replenishment. Go figure !

Housing  

Which leads us to look at a couple of charts. At the end of the week an IMF analyst  published a report that US housing prices were still at least 20% over-valued. Courtesy of BigPicture who put up the four main charts in the report we found the most interesting one to be this simulation showing the likely impact of an over-shoot on a correction. As Barry points out, whether you buy that or not, Housing is still a lot worse than most are admitting and will continue to be so for a longer than they're willing to face. Given the number of competent analysts and firms who are NOW anticpating a further 20% decline in prices in any case the potentials of an overshoot are really....really scary. At least IOHO !

Investment 

 The other major factor is, as we mentioned, what's likely to happen to investment. Which we look at as New Home spending, Commercial Real Estate (structures in the GDP accounts) and Capex. People also got a little excited by better than expected New Home Sales but if you check over at CalculatedRisk (Graphs: June New Home Sales,Graphs: Existing Home Sales) you'll find much less reason to be sanguine. And Mr. Donnelly's points on good orders are well taken. We chart all of these indicators using a 3Mo-average of the YoY% change. And indeed Orders ex-Aircraft are climbing but New Home sales, which don't count cancellations btw, continue to cliff dive and Industrial Production shows continued slowing weakness.

Current Situation

Downturn gains steam as inflation roars ahead The U.S. economic downturn gained steam Tuesday, with a report of the highest inflation since the early 1980s, more bad news for banks and automakers and a suggestion by the Federal Reserve chief that worse days are ahead.The Labor Department said wholesale inflation, driven by skyrocketing gas and food costs, rose by 9.2 percent for the 12 months ending in June -- the fastest pace since the summer of 1981, during another energy crunch. At the same time, consumers hit the brakes hard despite a massive infusion of government stimulus checks. Retail sales turned in their poorest showing in four months. Federal Reserve Chairman Ben Bernanke delivered a somber midyear outlook to Congress, saying the U.S. faces "numerous difficulties" despite the Fed's interest rate-cutting campaign, which began last September in hopes of preventing a recession. Bernanke said the Fed expected the economy to grow for the rest of this year "appreciably below its trend rate." He cautioned inflation was likely to move "temporarily higher" in the near future. That puts the Fed in a bind: Rising inflation hamstrings the Fed from cutting interest rates to jump-start the economy. The Fed had already signaled last month the rate cuts were probably at an end. "The country is in a bad spot right now, squeezed by high and accelerating inflation and a very weak economy and struggling to overcome a very severe financial shock," said Mark Zandi, chief economist at Moody's Economy.com. Bernanke Abandons June Reading on Economy, Sees Risks to Growth, Inflation

Orders up but why? Durable good orders were up a dizzying 2% in June excluding transportation and the market thinks capital investment and production is off to the races.  Unfortunately I think it's a head fake. Remember June's Industrial Production report?  We had a big 0.5% gain, but that was a bizarre number for one reason. The entire gain was from truck production up 9% for the month. Truck sales are down 35% and heading lower. The automakers used up all their material making the 9% gain in trucks and a 3% gain in autos, and in June they ordered 5% more metal.  That's why durable goods orders increased. Why GM, Chrysler and Ford want to continue to pile up inventory is beyond me.  Overall manufacturing inventory is up 6% y/y and wholesale inventory is up 7%. (see chart) But retailers can't sell it and don't want it, that's why retail inventory is shrinking.

L-shaped Outlook

This Economy Has "L-ish" Prospects - Home prices are in free fall. Unemployment is rising. Consumer confidence is plumbing depths not seen since 1980. When will it all end? The answer is, probably not until 2010 or later. Barack Obama, take notice. It’s true that some prognosticators still expect a “V-shaped” recovery in which the economy springs back rapidly from its slump. On this view, any day now it will be morning in America. But if the experience of the last 20 years is any guide, the prospect for the economy isn’t V-shaped, it’s L-ish: rather than springing back, we’ll have a prolonged period of flat or at best slowly improving performance. You might be tempted to take comfort from the fact that the last two recessions, in 1990-1991 and 2001, were both quite short. But in each case, the official end of the recession was followed by a long period of sluggish economic growth and rising unemployment that felt to most Americans like a continued recession. Thus, the 1990 recession officially ended in March 1991, but unemployment kept rising through much of 1992, allowing Bill Clinton to win the election on the basis of the economy, stupid. The next recession officially began in March 2001 and ended in November, but unemployment kept rising until June 2003. These prolonged recession-like episodes probably reflect the changing nature of the business cycle. Earlier recessions were more or less deliberately engineered by the Federal Reserve, which raised interest rates to control inflation. Modern slumps, by contrast, have been hangovers from bouts of irrational exuberance — the savings and loan free-for-all of the 1980s, the technology bubble of the 1990s and now the housing bubble. If the current slump follows the typical modern pattern, the economy will stay depressed well into 2010, if not beyond — plenty of time for the public to start blaming the new incumbent, and punish him in the midterm elections. To avoid that fate, Mr. Obama — if he is indeed the next president — will have to move quickly and forcefully to address America’s economic discontent. That means another stimulus plan, bigger, better, and more sustained than the one Congress passed earlier this year. It also means passing longer-term measures to reduce economic anxiety — above all, universal health care.

  • Philly Fed State Coincident Indexes for June Here is the Philadelphia Fed state coincident index release for June. Compare these two maps. This first map is the three month change for June 2008. The U.S. is turning red. This is what a recession looks like based on the Philly Fed State coincident indexes.

No Recession? No Inflation? Don't Make Me Laugh! The anticipated bear market bounce in Financials has led to the usual fools' chorus that the worst is behind us, the economy is on the mend, and a recession is avoided. If their song sounds familiar, it is because you heard the same tune with the home builders, and the same melody with the duoline insurers. For those with their head in the sand, here is a broad and varied look at where the economy is contracting. Note that this isn't a cherry picked list of negatives -- it is the crème de la crème of corporate America, ranging from consumer to finance to industrial to transports, and includes such stellar names as Apple, Toyota, American Express, UPS, Catepillar, Costco and JPMorgan. (There's not a slouch in the bunch!) How's the economy doing? You tell me:

Housing, Saving, Economy 

New 20% Down Payment Model Makes Americans Savers From Profligate Spenders The U.S. housing crisis may accomplish what years of parental hectoring couldn't: Turn Americans from spenders into savers. Spending will fall because homeowners can no longer use rising real estate values to borrow cash -- $837.5 billion in 2006, according to a report by former Federal Reserve Chairman Alan Greenspan and senior Fed economist James Kennedy. With mortgage lenders requiring down payments of 20 percent, the average household, which puts away less than 1 percent of after- tax pay, will have to save 10 percent for 10 years to buy a home. The housing market shaved almost 1.6 percent off gross domestic product growth in the first quarter and cut in half the growth rate of consumer spending, which accounts for more than two-thirds of the economy, said Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pennsylvania. ``The loss of housing wealth is the difference between a recessionary economy and a growing economy,'' said Zandi, an adviser to presumptive Republican presidential nominee Senator John McCain. ``Consumers have powered the global economy for the past 25 years. For the foreseeable future, maybe the next 25 years, the savings rate will move higher.'' The worst housing crisis in at least a quarter century still has a long way to go, Zandi said. It will take until 2015 for the median home price to return to its July 2006 peak of $230,200, while home sales and residential construction will never again reach the record highs of 2005 and 2006, he said.

Bernanke, Frank Forge Improbable Alliance Over Meltdown in Housing Market After Federal Reserve Chairman Ben S. Bernanke detailed to a U.S. House panel yesterday the Fed's new efforts to toughen mortgage-lending rules, Representative Barney Frank praised him and panned his predecessor. That comment, a swipe at former Fed Chairman Alan Greenspan, underscored how Frank and Bernanke have become allies in dealing with the worst housing recession in 25 years. It's an unlikely combination. Frank is a gruff, wisecracking Democrat from Massachusetts, and Bernanke is a soft-spoken former head of Princeton University's economics department who has written macroeconomics textbooks. What Frank, the blunt, Bayonne, New Jersey-born chairman of the Financial Services panel, and the scholarly Bernanke have in common is that they are ``brilliant men who really enjoy public policy discussions,'' said Susan Bies, who served as a Fed governor until 2007. Their embrace of policy making has forged a working relationship that Frank said has been strengthened by the housing meltdown. ``We both recognize reality,'' Frank said in an interview in his Washington office last month. ``We also have respect for the institutional role that each one plays.'' The two have cooperated in the effort to curb mortgage defaults, strengthen consumer protection and restore market confidence. The Fed has written rules to stem abuses in mortgage and credit-card lending, a move long urged by Frank. Frank's panel, in turn, has advanced legislation to strengthen lending regulations and stem foreclosures.

Office Investment Office investment is one of the three key components of non-residential investment in structures that will probably decline in the 2nd half of 2008 (and into 2009). The three key areas are: office buildings, multimerchandise shopping, and lodging. This graph shows the investment in each of the categories in nominal dollars. See here for investment as percent of GDP. My estimate for a possible investment bottom are marked in red, green and blue and labeled "possible bottom". The most recent office boom was smaller as a percent of GDP than the late '90s boom. However the booms for malls and lodging were larger this time - and the busts, on a percentage basis, will probably be larger for malls and lodging too. All three categories will see declines in investment later this year.

Strategic Outlook

In Search of a More Dynamic Economy Some economists instinctively feel that the present downturn is the effect of structural shifts in the economy, not a shift in aggregate demand. They doubt that a central bank should retard effects it cannot prevent. If employment is down because of shifting structures, gearing the money supply to attempt to prop up employment would generate ever-rising inflation. Inflation expectations would break loose from their moorings and the attempt would fail. Some central banks are refraining from rate cuts.We have a difference of opinion and of policy. But the structuralist case needs to be argued. What are the primary forces of a structural nature? And, crucially, what are the non-monetary channels through which these forces have structural impacts on the economy – on the size of the labour force and the natural rate of unemployment? Things fall into place. We will have a bout of inflation. Employment will be weak. Much investment will go abroad. Innovation may hold up. Yet I believe we need an economy of even greater dynamism to regain prosperity.

Posted by dblwyo on July 28, 2008 09:57 AM |

Comments

I'm not sure why some of those government reports have sounded so optimistic. I'm not a big fan of lowering standards just to make one feel better. That's not an achievement. Just tell it like it is.

Posted by: Lin the Drapery Designer | July 28, 2008 02:15 PM

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