May 5th, 2009
By: James Saft
The good news that the United States cannot keep contracting the way it has been is not to be confused with a return to robust expansion, a point financial markets eventually will grasp.
Consumers, the mainspring of the U.S. economy, will see the cash from government stimulus slip through their fingers but will still face very ugly personal balance sheets and a brutal job market. Their party is not going to get started again for some time.
And falling interest rates will have a hard time sparking investment by businesses until they become convinced that a recovery in manufacturing will do more than just take inventories from nearly empty to barely stocked.
The basic hope for the U.S. economy, that inventories are being run down so swiftly that a turn in the cycle must come, has been more or less confirmed by recent data.
The ISM manufacturing index advanced to 40.1 in April from 36.3, and especially encouraging is a sustained rebound in new orders, a leading indicator of forward demand, which having been more or less moribund in the early months of the year, now is in a sustained uptrend.
Inventories are still being cut, but this, optimists argue, is setting the stage for a recovery when managers see that their depleted stocks represent the threat of losing out on business.
There was also a surprising 2.2 percent increase in real consumer spending in the first quarter, as opposed to the shocking fall of four percent in the second half of last year.
We simply can’t fall at the same rate we have been if that keeps going. It probably will and we will probably see a sort of a recovery kicking off in the second half. Even now, billions in stimulus are sloshing through the U.S. economy. In May social security recipients will get an extra $250 and withholding rates for federal tax have been cut.
But the effect of government money will recede, and while stock markets have rallied, the balance sheets of many Americans are still very fragile. Remember too that the U.S. is aging, and many savers approaching retirement have seen zero investment gains in their portfolios over periods as long as a decade.
Their garages are full of junk they probably feel they don’t now really need, their employment prospects are as bad as in living memory and they face a very long retirement due to expanding life expectancy. Wages and salaries have fallen by 1.2 percent over the past year, an all-time record, and hardly an incentive for the average American to start splurging again.
Savings is here to stay and consumption will have to take a back seat.
TOO MUCH PESSIMISM
So, can business spending in the U.S. take the baton from exhausted consumers?
It probably cannot. First off, businesses are less interest rate sensitive than consumers, and so the effects of the official policy of driving market rates down will have less impact among them.
And while inventories are still low, so is final demand and most corporate managers, having just lived through the most gut-churning time of their entire careers, will not be likely to stick their heads above the parapet and make a lot of speculative investments in new capacity simply because things have stopped looking worse.
This may get to the heart of the problem that the economy will have in making a robust recovery: psychology. Just as people were too optimistic before the crisis, they are likely to remain too pessimistic for a time afterwards.
There is also the matter of sheer scale. Consumption is about 70 percent of the U.S. economy while capital expenditure at about 8 percent will have a hard time being the engine of a robust recovery. That 70 percent must fall and will outweigh everything else.
Perhaps the proof of a turnaround in business activity will be corporate profits, which across the economy are still falling. Corporate profits allow businesses to expand and give them the cash to do it and the evidence needed to secure credit.
And finally we have a banking and financial system that, while improving, is still not able to intermediate credit properly. That the Federal Reserve is taking matters into its own hands is on balance good, but they are likely to make some ghastly mistakes, not to mention putting their very independence in jeopardy.
Balance sheet recessions, when cutting debt is a priority, take a long time and are characterised by disappointments.
We are past the worst of the crisis, but now moving on to something not as dangerous but just as hard: building a more balanced economy.