Over the weekend, the Barron's cover story, "Sorry, Chicken Little" by Gene Epstein, discussed some of the same items that Joe Rollins wrote about in his last post, Let's Talk Turkey. We have all heard the dire predictions from some economists, and the article below gives a bit of a different take.
Sorry, Chicken Little
By Gene Epstein
It may feel as if the sky is falling, but things aren't as bad as they seem. Our saviors: cheap oil, strong exports and inventory rebuilding.
THESE ARE HARDLY THE BEST OF TIMES FOR THE U.S. ECONOMY. But they may not be as bad as you think. The credit crisis, stock-market crash and fall in home prices have raised legitimate fears of a nasty and protracted recession. Yet the economy has often proved more resilient than is commonly thought -- and constructive factors that have gotten scant attention should help the U.S. skirt a deep recession. In fact, it's possible that the downturn could prove to be one of the briefest and mildest on record.
The main positive is the huge boost to consumer spending that will come from the decline in energy costs. Although the run-up in oil, which punished consumers in the spring and summer, made front-page news, far less attention has been paid to the benefits of petroleum's recent slide.
The wide swing in both the percentage and sheer dollar magnitude of prices has been unprecedented. Over the past 14 months, the bellwether price of crude oil has made a stunning round trip, rising from around $70 a barrel in mid-August 2007 to $147 by mid-July, and falling below $70 Thursday. Natural gas has also slid about 50% from its early-July peak. If oil's price averages around $80, consumers will get a big dose of relief. Soaring energy costs had body-slammed them in July, August and September. Hence the dismal performance of retail sales over that stretch. But beginning with the current month, the energy payback will be enormous. This economic shock absorber should help offset the cruel blows of the credit crunch and declining wealth from equities and homes.
The cavalry hasn't exactly swept in to rescue the economy. But the energy benefit could keep a significant recession at bay until reinforcements -- particularly inventory rebuilding -- arrive early next year, and as credit starts to flow more freely.
What's the most likely scenario? We're now in the roughest patch. Real -- that is, inflation-adjusted -- gross domestic product probably grew at an annual rate of 0% to 1% in the three months ended Sept. 30 and will do no better in the current quarter. Growth should then accelerate, to an annualized pace exceeding 1% by 2009's first quarter and 2% by the second. By the third and fourth quarters, something resembling a recovery will have begun, with annual GDP growth topping 3%. However, the unemployment rate will continue to rise through mid-2009. This reflects the reality that, since mid-2007, real GDP hasn't risen fast enough to prevent joblessness from climbing and won't until the end of 2009.
Such forecasts may sound surprisingly upbeat, given all the scare headlines. But they're roughly in line with the consensus of the 10 most optimistic forecasts in the latest survey published by Kansas City-based Blue Chip Economic Indicators. This organization, which surveys 50 forecasts each month, reported in its Oct. 10 release that the overall consensus now believes a recession began in this year's third quarter and will persist through 2009's first three months. However, the average of the 10 most optimistic predictions put economic expansion at an annual rate of 0.6% in both 2008's third and fourth quarters.
In a story last month ("And Now Some Good News -- Courtesy of Oil," Sept. 22), I noted that a bellwether crude price of $90 would produce an estimated overall energy savings of $150 billion over about six months. If the price holds at $80, the energy dividend could be closer to $170 billion. Assume that $75 billion of that is spent in the fourth quarter and another $75 billion is spent in 2009's first quarter, and the boost to real consumer spending from the energy dividend alone would run at an annual rate of 3.5% in each period.
Unfortunately, declining credit and decreased wealth in homes and stocks will drain away most of the gains from energy in both quarters. In fact, the net contribution from energy will be quite small when the full debit from credit-and-wealth woes is applied.
What, then, will help boost real consumer spending? For one thing, labor income should rise. The projected jobless rate of 6.2% is still fairly low by historical standards, and should be enough to lift wages and salaries. With energy prices falling and food tabs moderating, the headline consumer price index may even go negative for a few months. It should certainly be low enough to permit an increase in real wages and salaries.
What this comes down to, after due allowance for credit-and-wealth shocks, is projected growth in real consumer spending of only 0.9% in the fourth quarter and 1.5% in the first. Since consumer spending accounts for 70% of gross domestic product, this should push GDP into plus territory.
And by next year, in addition to the freer flow of credit, other reinforcements should begin to arrive. The expansion phase of this business cycle produced relatively modest increases in capital investment. Thus, there's no capital overhang to work off. Manufacturing capacity, in high-tech and other industries, grew at a subdued rate. Sometime in 2009, then, capital investment could start contributing to growth.
EARLY IN 2009, inventory rebuilding could resume, to remedy the inventory liquidation that started late last year and that has pushed inventory-to-sales ratios unusually low. The only inventory overhang currently is in vehicles, and is partly attributable to a scarcity of auto loans. But as the credit crunch eases, auto sales probably will pick up. If gasoline prices don't rise, consumers may be more willing to buy the now-unwanted cars that are less than fuel-efficient. In any case, the stage could be set for inventory rebuilding of all other manufactured goods.
In addition, exports, which boost GDP growth, are rising faster than imports, which reduce it. The slowdown in the growth of foreign markets will trim export gains, as will the appreciation of the trade-weighted dollar. But net exports should keep boosting gross domestic product growth through 2009, although at a diminished rate.
A comparison with the economic landscape after 9/11 is constructive. Reflecting the general pessimism at the time, one Wall Street economist observed on Oct. 22, 2001, that with "layoffs mounting, debt burdens elevated, saving rates low, wealth effects tapped out and year-end bonuses likely to be very disappointing, I find it hard to envision a prompt rebound in consumer demand over the next couple of months." Yet, the rebound in demand was not only prompt, it was virtually off the charts. After rising at an annualized 1.8% in 2001's third quarter, real consumer spending soared at a 7% clip in the fourth. By 2002's first quarter, consumption was up by 1.4%; by the second, 2.4%.
True, as scary a month as October 2001 was for the U.S. economy, October 2008 seems far worse. For one thing, while the decline in wealth was quite large seven years ago, it was far smaller than it is now. But, remember, I'm not looking for anything like a 7% jump in consumer spending coming on top of a previous 1.8% gain. As mentioned, the projected increase in this year's fourth quarter is a mere 0.9%, against a probable 1% decline in the previous quarter. (Third-quarter estimates won't arrive until Oct. 30.)
MORE TO THE POINT, why didn't consumers fiercely tighten their belts after 9/11? A March 2005 staff report from the New York Federal Reserve seems to have the answer: "While consumption responds to permanent changes in wealth in the expected manner, most changes in wealth are transitory with no effect on consumption."
In October 2001, then, consumers must have viewed the change in their wealth as transitory, rather than permanent. How do they view the current decline? No one knows yet. I assume that there will be a substantial blow to consumption. But I don't assume that it will be nearly as great as do those who believe that all large drops in wealth, however temporary, hurt consumption.
If I'm right, then, the only quarter of contraction this time around (barring revisions) will have been 2007's fourth, in which GDP fell at an annualized 0.2%. The economy won't be great through the end of 2009, but it should do far better than the gloom-mongers expect.
Source: Barron's
Sorry, Chicken Little
By Gene Epstein
It may feel as if the sky is falling, but things aren't as bad as they seem. Our saviors: cheap oil, strong exports and inventory rebuilding.
THESE ARE HARDLY THE BEST OF TIMES FOR THE U.S. ECONOMY. But they may not be as bad as you think. The credit crisis, stock-market crash and fall in home prices have raised legitimate fears of a nasty and protracted recession. Yet the economy has often proved more resilient than is commonly thought -- and constructive factors that have gotten scant attention should help the U.S. skirt a deep recession. In fact, it's possible that the downturn could prove to be one of the briefest and mildest on record.
The main positive is the huge boost to consumer spending that will come from the decline in energy costs. Although the run-up in oil, which punished consumers in the spring and summer, made front-page news, far less attention has been paid to the benefits of petroleum's recent slide.
The wide swing in both the percentage and sheer dollar magnitude of prices has been unprecedented. Over the past 14 months, the bellwether price of crude oil has made a stunning round trip, rising from around $70 a barrel in mid-August 2007 to $147 by mid-July, and falling below $70 Thursday. Natural gas has also slid about 50% from its early-July peak. If oil's price averages around $80, consumers will get a big dose of relief. Soaring energy costs had body-slammed them in July, August and September. Hence the dismal performance of retail sales over that stretch. But beginning with the current month, the energy payback will be enormous. This economic shock absorber should help offset the cruel blows of the credit crunch and declining wealth from equities and homes.
The cavalry hasn't exactly swept in to rescue the economy. But the energy benefit could keep a significant recession at bay until reinforcements -- particularly inventory rebuilding -- arrive early next year, and as credit starts to flow more freely.
What's the most likely scenario? We're now in the roughest patch. Real -- that is, inflation-adjusted -- gross domestic product probably grew at an annual rate of 0% to 1% in the three months ended Sept. 30 and will do no better in the current quarter. Growth should then accelerate, to an annualized pace exceeding 1% by 2009's first quarter and 2% by the second. By the third and fourth quarters, something resembling a recovery will have begun, with annual GDP growth topping 3%. However, the unemployment rate will continue to rise through mid-2009. This reflects the reality that, since mid-2007, real GDP hasn't risen fast enough to prevent joblessness from climbing and won't until the end of 2009.
Such forecasts may sound surprisingly upbeat, given all the scare headlines. But they're roughly in line with the consensus of the 10 most optimistic forecasts in the latest survey published by Kansas City-based Blue Chip Economic Indicators. This organization, which surveys 50 forecasts each month, reported in its Oct. 10 release that the overall consensus now believes a recession began in this year's third quarter and will persist through 2009's first three months. However, the average of the 10 most optimistic predictions put economic expansion at an annual rate of 0.6% in both 2008's third and fourth quarters.
Unfortunately, declining credit and decreased wealth in homes and stocks will drain away most of the gains from energy in both quarters. In fact, the net contribution from energy will be quite small when the full debit from credit-and-wealth woes is applied.
What, then, will help boost real consumer spending? For one thing, labor income should rise. The projected jobless rate of 6.2% is still fairly low by historical standards, and should be enough to lift wages and salaries. With energy prices falling and food tabs moderating, the headline consumer price index may even go negative for a few months. It should certainly be low enough to permit an increase in real wages and salaries.
What this comes down to, after due allowance for credit-and-wealth shocks, is projected growth in real consumer spending of only 0.9% in the fourth quarter and 1.5% in the first. Since consumer spending accounts for 70% of gross domestic product, this should push GDP into plus territory.
And by next year, in addition to the freer flow of credit, other reinforcements should begin to arrive. The expansion phase of this business cycle produced relatively modest increases in capital investment. Thus, there's no capital overhang to work off. Manufacturing capacity, in high-tech and other industries, grew at a subdued rate. Sometime in 2009, then, capital investment could start contributing to growth.
EARLY IN 2009, inventory rebuilding could resume, to remedy the inventory liquidation that started late last year and that has pushed inventory-to-sales ratios unusually low. The only inventory overhang currently is in vehicles, and is partly attributable to a scarcity of auto loans. But as the credit crunch eases, auto sales probably will pick up. If gasoline prices don't rise, consumers may be more willing to buy the now-unwanted cars that are less than fuel-efficient. In any case, the stage could be set for inventory rebuilding of all other manufactured goods.
In addition, exports, which boost GDP growth, are rising faster than imports, which reduce it. The slowdown in the growth of foreign markets will trim export gains, as will the appreciation of the trade-weighted dollar. But net exports should keep boosting gross domestic product growth through 2009, although at a diminished rate.
True, as scary a month as October 2001 was for the U.S. economy, October 2008 seems far worse. For one thing, while the decline in wealth was quite large seven years ago, it was far smaller than it is now. But, remember, I'm not looking for anything like a 7% jump in consumer spending coming on top of a previous 1.8% gain. As mentioned, the projected increase in this year's fourth quarter is a mere 0.9%, against a probable 1% decline in the previous quarter. (Third-quarter estimates won't arrive until Oct. 30.)
MORE TO THE POINT, why didn't consumers fiercely tighten their belts after 9/11? A March 2005 staff report from the New York Federal Reserve seems to have the answer: "While consumption responds to permanent changes in wealth in the expected manner, most changes in wealth are transitory with no effect on consumption."
In October 2001, then, consumers must have viewed the change in their wealth as transitory, rather than permanent. How do they view the current decline? No one knows yet. I assume that there will be a substantial blow to consumption. But I don't assume that it will be nearly as great as do those who believe that all large drops in wealth, however temporary, hurt consumption.
If I'm right, then, the only quarter of contraction this time around (barring revisions) will have been 2007's fourth, in which GDP fell at an annualized 0.2%. The economy won't be great through the end of 2009, but it should do far better than the gloom-mongers expect.
Source: Barron's
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