Picking the Bottom? Good Luck.
DKW; February 3, 2009
Now that we are assured that we are in a recession, officially declared to have begun in December of 2007 by the National Bureau of Economic Research (has a panel of notable economists charged with the task of defining recessions), forecasters are offering assessments of when it will end. Best of luck, as we are dealing with two recessions, one on top of the other. The first one started in December 2007 and is much an economic recession. The second started in September of 2008 and it is a financial crisis. The first is now dependent on the second.
Note: Clear your head of the definition that a recession consists of two consecutive quarters of negative economic growth. The definition is more complex and arbitrary than that and wasn't the case for the last recession and isn't for this one.
Many projections for recovery seem to be based on timing of historical turnarounds and hope, and not on economic fundamentals. The average length in months from peak to trough for post-war recessions is 10 months. That would put the recovery overdue, but we know this turndown is a harsh one, augmented by the financial meltdown. Q3 2008 and now Q4 GDP have registered negative growth. We expect the same for Q1 2009 for reasons we will get to. That makes many feel like the recover should start in Q3 or Q4 of 2009. The possibility is not without merit, often fast and deep recessions turn quickly, but I would say it is yet without fundamental evidence.
Let's sum up the current statistics:
- Jobs losses continue to climb. The U.S. lost another 544,000 jobs in December with upward revisions to the November and October numbers. Wisconsin lost 62,600 jobs on a year-over-year (y/y) basis in December. Continued unemployment claims in the U.S. and Wisconsin have risen so high that y-axis scales on the charts have had to be enlarged. U.S. initial claims were 588,000 last week. Wisconsin initial claims were 53 percent above a year-ago and continued claims are running 55 percent higher on a four-week average basis.
- Consumers have cutback on spending. Personal consumption fell 3.5 percent in Q4 2008, after a similar decline in Q3 2008.
- Housing values are still falling. November 2008 home prices dropped 18 percent on a y/y basis, extending the 28 month run and accelerating at year-end. This only increases the losses of financial derivatives based upon housing assets. Housing inventory coverage is actually increasing because home sales are still moving lower. Not many prospects for a turnaround here as job losses climb, credit remains lethargic, and lenders assets decline.
- Durable goods orders continue to drop across the board, down 21 percent y/y. Business inventories are increasing because consumer demand is falling so fast companies can't shed products fast enough even with discounts and lower production runs.
- Auto sales continue to plummet, down to an annualized run rate of about 8 million vehicles. The Big 3 bailout plans are predicated on run rates of 12.5 to 13.0 million vehicles a year. Moreover, the UAW has quit the "jobs bank" (part of the bailout negotiations), which means laid-off autoworkers will not collect wages and will be pushed onto the standard unemployment rolls and benefits.
- Consumer sentiment moves still lower. The University of Michigan series showed it at 61 for January 2009, down from near 80 in January 2008 and near 100 in January 2007.
- Exports are up for the year through September 2008, but the global recession (the IMF has lowered global growth for 2009 to essentially zero) and stronger dollar should halt that GDP support.
- Housing and investment portfolio values, the two greatest receptacles of personal wealth, have taken huge losses, 30 to 50 percent. How does the consumer become more confident and begin to spend when their wealth, their income (job), and their well-being (healthcare insurance lost with job) are compromised.
Data point after data point is indicating a deteriorating economy. Since most of the data lags in time, this is not surprising given the current circumstances, but it does show that the trend is clearly discouraging.
So, on what does one begin to form a foundation to build an economic recovery?
At this point, I don't know.
A lot of hope is riding on the new $900 billion dollar stimulus package that is working its way through congress as this is written. The details are many, but the key criteria are that the money must be spent quickly (some dollars flowing in as little as 120 days from Bill signing, others spent on projects completed by 2010) or it reverts back to the federal government. The Bill is expected to be signed in mid-February, before Congress takes its presidents' holiday recess.
$900,000,000,000 is a lot of money, no doubt. But it is unclear if it will be sufficient to jumpstart the economy. As you can see if you go to the latest economic rescue accounting update at http://money.cnn.com/news/specials/storysupplement/bailout_scorecard/ , the feds have already spent $3.3 trillion on rescue packages, bailouts, and stimuli since December 2007.
What is happening to all this money? Well for one thing, nothing. Excess bank reserves averaged $843 billion in the first two weeks of January, an increase from $1.64 billion for the same time a year earlier. Essentially, this means banks are sitting on money and not loaning it out, mostly because the banks don't know what reserves they need to cover bad debt (which is growing each day as the value of housing and other collateral drops), they can't sell the debt downstream, and they have substantially upped the credit credentials for borrowers.
The Fed is considering setting up a "Bad Bank" that will assume much of the troubled assets and get them off the banks' books to free up some of the reserve cash. In addition, the Fed and the Treasury may guarantee new debt. This would give confidence to private investors to take the securitized bank loan debt and get the credit systems flowing again. The Fed is also thinking about buying long-term Treasury securities. This is a fiscal process that pumps more money into the system and lowers interest rates, if in fact the market has a want for the trade. (The question to address in the future is how will the Fed remove all this cash from the economy without sending interest rates sky-high. But, let's leave that one for now.)
Much of my job calls for me to find the positive message in the data and the situation. As you can surmise from the above, this is tougher these days. But let's consider this. Generally speaking, GDP growth would normally be lower at any given time without consumer spending. However, Q4 2008 GDP growth was dragged down further by the lack of consumer spending, about two percentage points lower. Perhaps, consumers in aggregate have over-adjusted in the short-term and are living below what could be considered normal means given the current conditions. The Q3 and Q4 2008 personal consumption expenditures were negative. Never in the post-war economy have personal consumption expenditures been negative for three quarters in a row. Positive consumption would boost GDP.
In addition, consider that the housing markets have been a tremendous drag on the economy, maybe as much as two percentage points of GDP growth. If the housing markets would just flatten out, GDP would get another boost. While housing prices continue to fall, home sales out west actually increased in December. Someone is seeing a bargain at these lower prices. Further, based on some work by Professor Don Nichols, Professor Emeritus, Economics Department, UW—Madison, there are some indications that the housing market may, in fact, be setting a bottom on inventory grounds. The equilibrium trend for housing starts through the 1990s was about 1.5 million units per year. Nationally, housing starts peaked in 2006 at an annual run rate of a little over 2 million units, causing the inventory overhang. Housing starts are currently running at about 600,000 units per year. Excess housing stock is being worked off by under-building and population growth. At current home building rates, excess housing stock could be worked off by early 2009. Expecting to over shoot this mark, the housing recovery may occur sometime this spring or summer if the above plays out as planned. (I don't know what the odds of that are.) Furthermore, housing affordability is also returning to rates we saw in the late 1980s on a personal income per capita basis.
Taken together, if these two items' (consumption and housing) declines could just be stemmed, economic growth numbers would turn positive.
The financial crisis is another matter. The new federal fiscal and monetary stimuli being considered as we post this will need to be implemented to cure the financial seizure. Financial solutions of this magnitude take time to work through the system, history of similar situations in other countries points to two years.
There are double the number of ifs to consider when picking this economic cycle's bottom: if consumers relax spending caution; if housing markets set a bottom; if consumers become confident with their wealth conditions; if stimuli are sufficient to change fundamentals; if credit markets free; if the auto industry will recover and in what form; and when.
Written by Dennis Winters, Chief Economist and OEA Administrator. February, 2009.