DKW, August 13, 2010

It's been a few too many months since I've updated this offering. It hasn't been that the economy hasn't been doing notable things, or that I have had nothing to say. It's just that I didn't get them down on paper. So, following is a belated update on what has happened in the economy over the last few months and what I expect to happen in the coming few months.

First, let's give credit where credit is due. If you read this on a regular basis, you will note that back in February I predicted not a "U" shaped recovery, or a "V" shaped recovery, or even a "W" shaped recovery (double dip). I predicted a "v---------" (square root sign) recovery. If you read this at the time, you would have "heard it here first". I'm just saying. (I am taking credit for this not out of vanity, but out of the fact that being a forecaster and being right happens so seldom.)

The pace of economic growth in the U.S. has definitely slowed over the last six months. Finally, after four quarters of negative growth, unprecedented in post-war history, the U.S. Gross Domestic Product (GDP) turned positive in the fourth quarter of 2009. Quarter four (Q4) GDP grew at 5.6%, a robust number. Q1 and Q2 of 2010 were also positive, at 3.7% and 2.4%, respectively. This pattern of GDP growth coming out of a recession, of a pop in growth and then a slowing, is not unusual.

We would like to see U.S. GDP growth in the 3.0 – 3.5 percent range to indicate that the economy has enough momentum to keep growing and also create enough new jobs to absorb our growing workforce. We also want to see economic growth broad-based across all driving sectors (consumption, investment, exports) and industries.

The growth we are seeing at present is coming from the industrial sector. Capital investment on new machinery and IT upgrades and infrastructure expansion overseas, particularly in East Asia, is helping U.S. manufacturers. Industrial production is up. The July ISM Manufacturing Index registered 55.5, off the highs, but still very much expansionary (above 50 indicates growth). The ISM Non-manufacturing Index was also well into growth territory, at 54.3.

Other sectors of the economy are not acting so boldly. Consumer spending is flat, literally. In June, both personal income and consumer spending registered 0.0 percent change from May. Consumption cannot increase (now that the credit bubble has burst) without increased income that comes mostly from increased earnings that comes from higher employment.

We are definitely not seeing growth in the construction sector. June construction spending was down 7.9 percent from the abysmal year-ago figures. Enervative residential and commercial construction are weighing down the gross index. Pending home sales dropped in June as the new home tax credit incentive expired.

Job gains are lethargic at best. July U.S. jobs registered a 131,000 loss. More than that many job losses were due to the ending of census workers' stint. Private employment actually increased by 71,000 jobs. While encouraging, it is not enough job gain to significantly impact the large number of unemployed people, much less absorb the growing workforce. We need to see national monthly job gains at 250,000 to 300,000 to make progress towards cutting into the unemployment rate and increasing income and spending sufficiently to boost GDP growth to the 3.5 percent range. Even with job gains on that order, it would still take years to reach pre-recession job levels. Wisconsin's June jobs numbers were also less than desired, down 8,200 on total non-farm jobs and down 1,000 for the private sector. Even health care jobs in the state, which have been the bright star through the recession, only managed to add 600 jobs in June.

Unemployment rates for the most part are moving sideways, at just under ten percent for the U.S. (seasonally adjusted) and just under nine percent for Wisconsin. Companies are not laying off people in droves as they were a year ago, but they aren't really hiring either. The employment ramifications of the recession and lack of job growth thereafter have put us in new territory with regard to the duration of unemployment. The average length of a continued unemployment insurance claim is now 34.2 weeks, a level not before seen. Job openings have increased faster than job gains, but employers are finding it difficult to match applicants' skills with jobs' requirements.

What's Expected?

As of late, China's economic growth has slowed and the U.S. dollar has gained against the Euro, making U.S. export products less attractive. Economic recovery in Europe has also braked and the sovereign debt problems of Greece, Ireland, Portugal, Spain and others have yet to be completely worked out. In the U.S., banks continue to work out bad debt on their balance sheets and aren't interested in loaning money. U.S. banks are carrying $1.2 trillion over and above their required reserves. And why not? If the economy appears uncertain, you have a lot of questionable debt on your books, and the Fed is giving you free money to buy their paper at a greater-than-zero return, where is the incentive to act less than prudent?

Small companies complain they can't get loans from the banks (see above) to meet the orders they do secure from bigger companies up the supply chain. Big companies are stating record profits brought about by cost-cutting and "correct" sizing for lower demand schedules. Meanwhile, they are hoarding cash and buying back stock. And why not? If your profits are up, your expenses are down, your shareholders are happy, and you are sitting in a highly liquid position to exploit the first sign of opportunity, where is the incentive to force new product into a flat market? If you do expand, where are you going to do it, in the lethargic economies of the west, or the promising economies of the east?

The money being invested in capital equipment in the U.S. is to further modernize and replace old equipment. Such investment, almost by definition, diminishes the demand for labor.

All this amounts to a lot of concern about jobs. Without job creation, income will suffer and consumption will suffer. As a result, hiring in the U.S., with its large consumption sector, will see feeble gains.

We are in a quandary as to what will get the economy jump started. Will more stimulus help? Tax cuts? Both? What about the budget deficit? Debt? This is, indeed, a sticky wicket.

Seeing as how this is the greatest recession of our time and an election year, ready fixes are not available and brilliant solutions may be delayed in coming.


All that being said, I do believe we will continue in an economic growth mode. Industrial production, while slower, is still advancing. The private sector is hiring. Global markets are expanding. I believe the pace of our economic expansion will continue to be tortoise like – slow but sturdy. While it will be reflected in the numbers, it may not be felt for awhile on main street.

There are a number of risks to the outlook: European countries could fail to solve their fiscal predicaments; U.S. housing stocks could continue to batter bank and federal balance sheets; and U.S. consumption could fail to materialize, perpetuating high unemployment.

Under the above scenarios, it is possible we could experience a "W" shaped outcome. In which case, I would abrogate my bragging rights above.

Written by Dennis Winters, Chief Economist and OEA Administrator. August, 2010.

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