Uncertainty Still Looms
A fairly widespread national economic recovery has been under way for almost a year. The pace of growth was strongest in the fourth quarter of 2009, which helped achieve a growth rate of almost 4 percent in the second half of last year. However, the economy has apparently downshifted a bit in the first half of 2010. Gross domestic product growth for the first half of the year was modest at around 3 percent.
The story of our climb out of the recession involves an evolving mix of factors. The transition last year from recession to recovery was obviously aided by federal government stimulus. Stimulus spending is still at work but with much less impact in 2010 compared with 2009. Growth in the fourth quarter of 2009 was supported by a slowing in the pace of inventory liquidations. In the first half of 2010, we experienced rising consumer spending, rather strong business investment, and very strong growth of manufacturing production.
The rising consumer activity surprised many in the first quarter of the year, but in April and May consumers seemed to put away their wallets to a certain extent, particularly in the green industry. Weather patterns across the country no doubt contributed to this slowdown in spending. According to some analysts, the strong first-quarter spending represented pent-up demand coming out of recession, and the apparent pause reflects the return of a more cautious attitude influenced by stock market gyrations and other worrisome developments. The Conference Board’s estimate of consumer confidence fell sharply in the first part of the summer, wiping out gains made during spring.
Business spending on equipment and software has been strong in the first half of the year. Again, analysts have interpreted this performance as a sign of pent-up demand following deferrals in 2009 when so many businesses put a stop on everything but essential spending. Almost every manufacturing industry posted strong growth during that period, with double-digit gains across a number of durable goods.
Employers have increased hours of work recently and also have hired part-time staff, but they have been hesitant to hire full-time employees. I suspect businesses are making every effort to squeeze as much production as possible out of their downsized workforces and are pursuing productivity gains from reorganization, automation and supply-chain streamlining. These strategies were formulated during the recession and, so far, are continuing.
A key point about these contributors to recovery to date is that each could be transitory. The economy has not yet arrived at a state where healthy and sustainable final demand is underpinning growth. I make this point not to predict a reversal of the progress made but as a cautionary reminder to avoid thinking we are out of the quagmire altogether. There are sectors that remain in a very depressed condition — housing, for example.
Recent numbers suggest a sharp slowdown of residential real estate market activity with the expiration of the homebuyer tax credit. Home sales fell sharply in late spring, with new home sales plunging to their lowest level in the 47-year history of the data. Inventory problems could weigh heavily on housing prices and construction activity for some time.
The most sobering aspect of the current economic reality is the employment picture. Unemployment peaked at just over 10 percent last October and has remained stubbornly high since then despite the economy’s growth. The most recent job creation data were also discouraging. While total nonfarm payroll jobs grew this spring and summer, much of that hiring was for temporary Census work.
However, as I have said in this column before, I believe the recovery will continue to move ahead modestly, and unemployment will gradually come down. Impediments to growth are slowly being removed. The functionality of the financial market is being restored. Private balance sheets are being repaired, and necessary structural adjustments are under way.
The past few weeks, however, have seen a slight retrenchment from the mindset of optimism and growing confidence that prevailed earlier in the year. One reason is the roller-coaster effect of recent economic indicators. More influential, in my opinion, is the heightened sense of uncertainty and risk surrounding the near-term outlook.
Roots of the Uncertainty
The first source of uncertainty is European sovereign debt. What started as a threat of default on public-sector debt obligations of certain European countries (Greece, Portugal, Spain, Italy and Ireland) has spread to European funding markets, impacting both the Euro and the dollar. Risk aversion has brought liquidity pressures onto European banks, and the concern is that continuing financial market pressures will be transmitted to our economy through interconnected banking and capital markets. There is also the potential effect on our export markets of a stronger dollar and weaker European economies.
A second source of uncertainty is ongoing state and local fiscal tightening. State-level budget gaps are expected to widen this year and in 2011 as federal support recedes. By one estimate, next year’s budget gap for all states is expected to peak at $144 billion. Closing these budget gaps means spending less and taxing more. This situation is our nation’s very immediate analog of the public finance pressures being felt in Europe.
A third area of uncertainty is commercial real estate. Banks across the country, especially small rural and regional banks (which do a lot of lending to green industry firms), are heavily exposed to the commercial property sector and face a heavy docket of loan restructurings that may require sizable writedowns. It’s not yet clear how much pain might be imparted to the overall economy by loan losses of banks and investors from the downward revaluation of commercial properties. Views vary on how severe a problem is developing and whether it will require an organized comprehensive resolution effort to avoid widespread damage to the economy.
Finally, there is the oil spill. Its lingering effects are falling most severely on those employed in commercial fishing, recreation and tourism, deepwater drilling, and businesses and suppliers associated with those industries. So far, the measurable economic effects have been mostly local and regional. As was the case in the aftermath of Hurricane Katrina, the oil spill brings two main risk factors for the national economy: the impact on energy supplies and transportation. To date, the supply of natural gas and refined petroleum products has not been significantly disrupted and key transportation facilities remain operational, although shipping has had to navigate around the slick. Thus, the economic effect at the national level has been limited. I would contend, however, that this relentless environmental disaster will be an indirect factor that holds back consumer and business confidence for some time. The spill has disheartened us all and, I believe, makes the public a little more reticent to assume a smooth recovery path.
So, to pull this together, the recovery of the national economy is proceeding but not yet with solid and sustainable underpinnings. While inflation appears restrained, the outlook from here is beset by somewhat-greater-than-normal uncertainty. There is a chance of outperforming the forecasts of moderate growth and gradual reduction of unemployment, but at the same time, there are notable risks. All deeply distressing experiences — whether national economic and financial crises, regional environmental calamities with associated economic pain, or traumas on a personal level — are followed by a strong impulse to return to normalcy. This urge also applies to our industry as well, so stay the course.
In the words of R.I. Fitzhenry, uncertainty and mystery are energies of life. Don’t let them scare you unduly, for they keep boredom at bay and spark creativity.