Recession may be ending, but repairing the damage could take years
By John W. Schoen
Senior producer msnbc.msn
updated 12:48 p.m. PT, Tues., Sept . 29, 2009
Confusion about the outlook for the economy abounds, and consumers, who are responsible for the bulk of economic activity, may be the most puzzled about it.
Despite all the talk of "green shoots" on Wall Street, consumers have good reason to be skeptical. With much of the economy still badly battered by the worst downturn since the Great Depression, it remains to be seen how strongly the economy will emerge from that slump.
On Tuesday the Conference Board, an industry group, reported that its index of consumer attitudes fell to 53.1 in September from a revised 54.5 in August. The news surprised Wall Street, which had been expecting the index to rise to 57.0.
Part of the surprise came from conflicting signals from last week's widely watched University of Michigan survey, which found consumer confidence rising in August.
Consumers who see the glass as half-full seem to be responding to recent positive reports about the recession coming to an end. The University of Michigan survey tracks changes in whether consumers are hearing “good news” or “bad news" about the economic outlook. In August, that index took a big jump.
No wonder. There's been plenty of good news lately about the economy, and some data due out later this week are expected to add to the evidence that the longest, deepest postwar recession is coming to an end.
"From a technical perspective, the recession is very likely over at this point," Federal Reserve chairman Ben Bernanke said earlier this month. "It's still going to feel like a very weak economy for some time because many people will still find that their job security and their employment status is not what they wish it was."
Many private economists expect that the official barometer of economic growth, the gross domestic product, will post gains in the second half of the year — thanks to a multitrillion-dollar pump-priming by the federal government over the past year. But there are widespread doubts about whether the engine will keep turning strongly enough to produce jobs after the government's stimulus spending is over.
Those fears showed up in the latest Conference Board survey: The index of people who described jobs as "hard to get" rose to 47.0 from 44.3. And the gauge of "jobs plentiful" fell to 3.4 from 4.3, the lowest since February 1983.
Even those who see the recession ending concede that it will be years before the job market brings employment levels back to anything close to a "normal" economy. That’s because each of the four major sectors that produce economic growth still face major headwinds.
Here’s a look at each sector:
Because consumers account for about 70 cents of every dollar’s worth of U.S. economic growth, it’s hard to have a recovery unless households are spending. Some economists believe that, as the recession ends, consumers are getting more confident and will soon return to their traditional role as the main engine of economic growth.
The latest data on the housing market and retail sales seem to back that up. Existing home sales have risen in four of the past in six months, and new home sales have risen for four straight months. Retail sales bumped up 2.7 percent in August, the biggest gain in three years. Recent gains in the stock market have helped households rebuild battered investment savings, easing some of the financial gloom that cut into consumer spending.
But those gains are from basement-bottom levels; home sales are still off more than 25 percent from their 2005 peak. Car sales, which also picked up in August, are still well below levels seen for most of the decade.
September auto sales will be reported Thursday and are expected to show a 20 percent drop from levels in August, which were boosted by the federal "Cash for Clunkers" program. Housing sales also could drop after Nov. 30, when an $8,000 federal tax credit for new home buyers, is set to expire.
With or without government incentives, consumers can’t spend money they don’t have. Some 14 million workers are without a paycheck; many of those who relied on credit card debt or home equity loans during the past decade can no longer tap that spending power. And while job losses appear to be easing, most economists expect the unemployment rate to remain stubbornly high, and possibly climb more.
“We are digging out of a very deep hole,” said Julia Coronado, a senior economist at BNP Paribas. “Until we see (job gains) of 125,000 or 150,000 (a month), the unemployment rate is going to be drifting higher.”
After cutting payrolls to the bone, employers won’t be in a hiring mood until they’re convinced the recovery is solid and sustainable. That’s going to take more than a few quarters of positive GDP growth.
“(Employers) have pared down, they’ve cut back and they’re pretty lean right now and you’re going to see pretty big jumps in productivity,” said John Engler, president of the National Association of Manufacturers. “I think it’s going to be a very slow recovery, but as it comes back I think you’re going to see a lot of increased production without a lot of hires.“
A weak housing market could also slow the recovery in new hires as job seekers who want to relocate run into roadblocks trying to sell their homes.
“In the U.S. traditionally there’s a lot of labor mobility,” said David Blitzer, an economist with Standard & Poor's. “And as you begin to see a little improvement in the economy it’s not clear that the new jobs will be where the old jobs were. But it will be very difficult for people to move to take the new job because they’ll be stuck with the house where the old job was.”
Notice how many items are back-ordered these days? As the recession deepened, businesses cut back inventories to the bone, afraid to get stuck with unsold goods if consumers stopped buying. Now that the economy seems to be finding a bottom, production is expected to ramp up smartly to restock those depleted inventories.
It may already be happening. Industrial production is up 1.8 percent in the past two months. Economists looking for a boost in business investment also note that companies deferred purchases of new computers and other equipment, so they eventually have to buy new ones. After peaking at 17 percent of GDP in 2006, business investment fell to just 11 percent in the first half of this year.
But strong business investment won’t be sustained until it’s clear there is strong consumer demand for more goods and services, according to David Roche, global strategist at Independent Strategy Limited.
And even if demand does come back, businesses still have lots of excess capacity to meet it after deep cuts in jobs and production during the recession. As of August, U.S. factories were running at just 67 percent of capacity, down from average levels of 80 percent for the past three decades.
“With all the excess capacity out there, I think it would be very difficult to see a big capital spending boom,” said Gary Shilling, a private economist and consultant.
As consumers closed their wallets, Uncle Sam opened his with one of the biggest spending programs in history, roughly $1.5 trillion in less than a year. Some $700 billion went to shore up shaky banks; another $787 billion paid for tax cuts and a surge in spending on new roads, green technology and a host of other projects designed to pump dollars into a shrinking economy.
A separate alphabet soup of money transfers from the Federal Reserve added another $1 trillion, much of it to guarantee loans and buy up bad investments from banks that couldn’t sell them, freeing up cash for them to lend.
The strategy seems to have worked, and much of the planned direct government spending is still in the pipeline. The hope is all that federal spending gets the gears of the economy turning again with enough momentum that as the federal spending spigot starts to slow down, other sectors of the economy will take up the slack.
But that plan comes with potential pitfalls. At some point, the Federal Reserve will have to unwind its trillion-dollar infusion of cash or risk igniting another asset bubble or nasty round of inflation. If it unwinds too quickly, it risks setting off another panic in the financial markets. If it leaves its policy in place too long, bankers will assume they can keep making risky loans and sell them to the Fed if they go bad.
“I believe they will continue to wind those (Fed backstops) down gradually,” said William Isaac, a former head of the FDIC. “We need to take sort of baby steps: take them down a little bit, see what happens, and take them down some more. Because we need to wean the markets off of these things. We can't keep them there forever.”
The government’s direct spending is being funded entirely with borrowed money, which is fine as long as investors keep buying U.S. Treasury debt. If they begin to lose their appetite, that could force interest rates higher, creating a big problem for businesses and consumers who need to borrow money.
Much of the hundreds of billions in federal spending has also been siphoned into a hole that diluted its impact: the growing chasm in state and local government budgets.
State and local spending
About half of government spending comes from state and local governments, which can’t borrow money when they get in a bind. And today, state and local governments are in an historic bind.
All but two states face budget shortfalls; in all, the deficits amount to about $168 billion, or about 25 percent of total state budgets. That number is expected to rise to $350 billion by 2011, according to the Center on Budget and Policy Priorities. If the Obama administration’s health care plan relies on Medicaid to cover more uninsured households, states could face a bill for tens of billions more.
As a result, the impact of the federal stimulus spending has been blunted by the sharp drop in state spending.
“The falloff in local and state revenues for roads and bridges was so precipitous that the federal money really kind of got us back to about level,” said Engler of the manufacturers' group. “There was really no net significant gain there.”
Local governments, which rely heavily on property taxes, also face budget shortfalls over the next several years as falling home prices force them to lower property assessments.
That means cutting spending and laying off workers, a process that is already under way.
The last component of GDP — net exports — has actually been a drain on growth because the U.S. imports more than it exports. But the gap has been narrowing, and a continued pickup in exports would ultimately add to the economy’s overall growth.
Much of the gains for U.S. exporters have come from the declining value of the dollar, which makes U.S. goods and services more competitive in overseas markets. U.S. exports jumped to roughly $1.8 trillion from $1 trillion in 2001, when the last recession ended.
But U.S. exporters may not be able to rely much longer on a weak dollar to expand their business.
The common refrain you hear is, ‘Well, if we cheapen up the dollar, it will make it better for the trade deficit,” said Stephen Stanley, chief economist at RBS Greenwich Capital. “That’s a mantra that I'm not sure is really borne out over time.”
A continued slide in the dollar could bring some nasty side effects. The most worrisome is a rise in interest rates as overseas investors demand a higher return on U.S. Treasury bonds to make up for the eroding value of any investment denominated in dollars.
“The U.S dollar is on the weak side, and that’s great for our exports for now,” said Todd Buchholz, former director of White House economic policy from 1989 to 1992. “But there’s a narrow gap between helping the economy and being so weak that it becomes a crisis.”
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