Wednesday, June 10, 2009

Leaves of Three

One thing about politics that really annoys me is when people try to talk down the economy or exaggerate its negatives in pursuit of their own political agendas. Democrats were notorious for doing this during the Bush years and there are certainly some Republicans who appear to be engaging in the same tawdry tactics today. When it comes to the success or failure of the economy, I'm strictly non-partisan. I always want the US economy to be strong and growing. It's good for the country, good for the world for that matter, and, strictly from a personal point of view, good for me and my family.

So I would very much like to embrace the emerging optimistic view that the economy has turned the corner and that recovery is already underway. But there a number of troubling signs that the economy's "green shoots" that people are talking about will not sprout and bloom, but soon wither. Three signs to be exact.

1. The recent uptick in the price of commodities is viewed as a sign that the global market has confidence in a recovery. But at this point, it's not clear if rising commodity prices are a mini-boom driven by rational expectations of growth or a mini-bubble driven by people's need to put their money somewhere (WSJ-sub req):

China is one: Even if its nascent economic recovery falters, it will likely keep gobbling commodities. China has more than doubled its gold holdings since 2003 and is accumulating bigger inventories of crude, copper and other materials -- both for future use and to protect against the potential decline in value of its massive dollar holdings, says Bart Melek, commodity strategist at BMO Capital Markets.

Global liquidity is another. The ratio of global money supply to gross domestic product has never been higher, according to Morgan Stanley economists Joachim Fels and Manoj Pradhan -- supporting what they call a "global liquidity cycle" that puts cash into the hands of investors who bid up assets. Similar cycles supported the tech-stock and housing bubbles in the past decade, the economists say.

Or the most recent commodity bubbles of the last few years in oil and metals. Maybe the rising commodity prices are based on demands from China and other developing countries. But I suspect that they're more a result of the need to invest that excess global liquidity. At some point, if the economic fundamentals aren't there to support the higher commodity prices, that bubble is going to burst or at least deflate.

2. Although the latest unemployment numbers were greeted by some as positive news since the US lost fewer jobs than in previous periods, it's hard to see much light at the end of the jobs tunnel right now. While it is true that an upturn in employment lags during a recovery, jobs are a factor that can either help ignite or extinguish said recovery. Based on the forecasts through 2010, it appears more likely that we will see the latter effect. Unemployment at 10% to Depress Consumer Spending:

Surging unemployment in the U.S. will delay a recovery in consumer spending and mute the rebound when it does materialize, according to a Bloomberg News survey.

The jobless rate will climb to 10 percent by the end of 2009, 1.6 percentage points higher than projected at the start of the year, according to the median forecast of 62 economists surveyed from June 1 to June 8. Household purchases will drop this year more than previously estimated.

And we all know how important consumer spending is to the American economy.

3. Which bring us to the third and probably most worrisome sign that economic recovery may be a long ways off. Not only is consumer spending being dampened by the bleak unemployment numbers, but even those consumers who do want to spend may no longer be able to tap into the usual resources to do so. On Borrowed Time: Consumer-Led Recovery (WSJ-sub req):

Despite recent frugality, consumers have barely dented their debt load. The Federal Reserve will offer a fresh peek at that mountain on Thursday, when it releases its "flow of funds" data for the first quarter.

By the end of 2008, households were on the hook for $13.8 trillion in debt -- nearly matching the $14.3 trillion output of the entire U.S. economy, not adjusted for inflation, that year.

Households are shedding debt; they're just not doing it very quickly. They owed roughly 130% of disposable income at the end of 2008, down only slightly from a record 133% in the first quarter of 2008.

An old saw about U.S. consumers is never to underestimate their willingness to spend beyond their means. The debt-to-income ratio first crossed 100% during the 2001 recession, when debt-fueled consumer spending helped spark a recovery. It kept rising post-recession as super-low interest rates encouraged still more borrowing. And it rose even after the Fed raised rates, as consumers piled into mortgages to chase rising home prices.

Money is easy again, but unemployment is far higher and wage growth slower than at any time during the 2001 recession.

Households have also now suffered the bursting of two bubbles -- housing and stocks -- carving $12.9 trillion from their net worth since the second quarter of 2007. The recent market rally should bolster household balance sheets, the flow of funds data might show. But real estate is still the biggest household asset, at 36% of net worth, and prices haven't stopped falling.

Finally, credit is still far tighter than at any point during the 2001 recession, according to a Citigroup index of financial conditions.

It's difficult to imagine this situation improving any time soon. Housing prices may stabilize and people will continue to save more and borrow less, which theoretically would free up more debt for them to incur in order to spend. But given the lay of the economic land today and in the foreseeable future, a surge in consumer spending doesn't seem likely to occur in the coming months.

Consider me skeptical that the economy has reached a turning point and is on the road to recovery. This is one time where I would very much like to have my skepticism proven to be unfounded.

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