Upbeat News – Maybe
This morning’s release of the Conference Board’s Index of Leading Indicators brings us more good news: last month was the fifth straight month that the index gained. Yes the August increase of 0.6% was weaker than either July (0.9%) or June (0.8%), but it keeps the upbeat rhythm going and helps to confirm the growing sentiment that the recession finally ended in the third quarter.
By now there is, of course, no surprise in this. For several weeks now it has been clear that the economy reached its nadir sometime this summer and is now slowly edging away from the abyss.
The Conference Board also publishes two other indices that are supposed to track the economy one coincidentally and one with a lag. Both those are showing the same trend. The Coincident Index has now stopped declining and is essentially flat, while the lagging index is still falling, but now at a much slower rate.
Things are evidently looking up.
Up to what?
Here the difficulty arises.
I have written before about the variety of interpretations concerning the direction and strength of the economy from here on out. Depending upon your degree of inherent optimism we are now rebounding nicely, or we are teetering on the brink of falling backwards. Neither position will be exactly correct and the most likely course for growth seems to be ‘patchily and slowly upward’.
The current phase of growth depends heavily on a combination of inventory adjustment – businesses re-stocking depleted shelves – and the administration’s stimulus plan. Take those two elements away and we are still mired in recession. In other words the economy has not yet entered a self-sustaining growth cycle where consumption is sufficient to drive job, incomes and hence spending growth.
The degree of optimism built into anyone’s forecast at the moment depends entirely upon their view as to what happens when the ‘training wheels’ of inventory adjustment and stimulus plan are taken away.
My own view is that once those effects fade, as they will towards the middle of next year, the risk of a second contraction – renewed recession – remains high.
I say this for two major reasons that are inter-linked:
- Unemployment hangs very heavily over us and will continue to exert a negative drag on spending.
- Related to this: the economy has accumulated enormous excess capacity, which has to be used up before we can return to a more normal cycle of expansion.
As long as that capacity overhang exists business can expand and meet growing sales without either investing in new factories and other forms of capital, or, and this is crucial, investing in an expanded labor force. So the outlook for job growth is spotty to say the least. In fact I think it likely that unemployment will continue to edge up throughout this year even though we are out of recession. Last week’s unemployment data – new claims for unemployment insurance – concerns me. That fact that we seem stuck and are still losing half a million jobs every week or so gives me great pause. There is no sign whatever of the private sector re-hiring. On the contrary belt tightening still seems to be the order of the day.
Setting aside the obvious attendant human misery that this unemployment trend is creating, we need to focus on the drag this places on the recovery. It appears as though businesses are still in a defensive mode. If this is the case throughout the next few months then there is no way that a recovery can become self sustaining: as each business seeks to preserve its own profit it acts to diminish the sum total of all profits – a cut cost for you is lost income for me. This is what caused us to sink so low, and it could be sufficient to sink us again.
In other words the private sector still is fearful enough that it could self destruct and derail the recovery next year some time.
Think of it this way: businesses have to make guesses about their future sales – let’s dignify this and call them ‘forecasts’ – they then make decisions about buying raw materials and hiring workers based upon those forecasts. So the economy of late 2010 depends heavily upon business expectations today. To a very large degree those expectations become self fulfilling: if the forecasts were for higher sales then the act of tooling up to meet those expectations creates much of the growth – the new jobs and raw material purchases generate incomes which, in turn, create the sales that the businesses were forecasting.
Economists have a fancy name for this: ‘Say’s Law’, which roughly translates into the supply side mantra that ‘production will create its own demand’. This idea lies at the heart of classical economics. The problem comes when expectations are for insufficient sales: then it seems that Say’s Law breaks down and, instead we enter a Keynesian world that he called ‘the paradox of thrift’ – cuts lead to more cuts and so on downwards. This is the exact opposite of what the classical textbook predicts.
So business expectations are vital to the recovery, and a key variable informing those expectations is the availability of disposable income which, in turn, depends highly upon job growth.
Advocates of a more robust recovery are clearly predicting a much stronger uptick in employment. I just don’t see anything to support that view – remember that the last two recoveries have also seen very weak job growth, and it was one of our major criticisms of the Bush era that it simply failed to generate enough jobs. Clearly the US economy has a different tenor than it did a few decades ago and those job growth surges so characteristic of earlier recoveries are no longer ‘normal’.
So, while there are many anecdotal signs of jobs ‘out there’, the aggregate story remains both dull and challenging.
We will get more information on Thursday when the weekly claims for unemployment insurance numbers are published. Most people are forecasting another drop, but the relevant question is whether that drop is large enough to undermine my more cautious outlook.
Stay tuned.
