More Evidence of Recovery

Not that we need any more evidence, but the last two days have produced a couple of data points to support the general theme of near to medium term growth. Naturally last week’s GDP figures are definitive with respect to the general picture. Of more interest is the data that allows us to determine whether the recovery is getting more momentum is any specific sector of the economy.

Yesterday’s data was a mixed bag, but well within the bounds of expectation. For instance, the Institute of Supply Management index for conditions within the production to sales supply chain of large and medium sized companies ticked up again to hit 53.0% – last month’s figure was 52.6%. The index measures the activity level of companies – are their orders rising or falling? Are they having difficulty getting hold of raw materials? etc. A reading above 50% indicates that over half of the companies in the survey are facing expansionary pressures: the economy is growing. The index has been increasing steadily for a few months and confirms all the other evidence we have that factories are beginning to lift production from the very low levels of late last and early this year.

In contrast the data for construction spending was quite disappointing: it showed that spending fell last month by 0.2%, after having grown the previous month 0.8%. I don’t think this is a surprise: construction spending has been volatile lately and the commercial real estate segment of spending is about to enter a truly disastrous phase. Anecdotal evidence and reports from the banking industry show that we will shortly see a wave of defaults on large commercial projects: well over half of all commercial real estate loans coming due for re-financing are against buildings where the drop in property values has produced negative equity for the borrower. The implies a wave of losses for the banks, and acts as a massive dampener on new projects. So we can expect both that spending will decline more, and that bank losses will mount.

Today we had two more pieces of information: factory orders and new vehicle sales volumes.

Both showed some strength.

Factory orders jumped up 0.9% in September – the latest month for which we have data – after having fallen 0.8% in August. Orders are notoriously ‘chunky’ with large items having the ability to shift the index sharply month to month. Overall though the trend is steadily in the right direction and backs up the supply chain data from yesterday. Clearly manufacturing is rising from the bottom.

The auto sales data is also strong. This news was surprising given that last week’s GDP figures had led most people to believe that the cash for clunkers program had brought sales forward from this quarter into last quarter. This sales data suggests this effect was not as pronounced as was feared. Most of the big car companies announced increases – GM sales were up 4.7% in October, while Ford sales rose 2.6%. Only Chrysler, which remains in disarray as it awaits its fate under the leadership of Fiat, had a drop in sales. If this sales strength is maintained it augers well for consumer spending through year end. That will provide some support to the fourth quarter GDP numbers and help keep the economy growing into the new year.

So, taking all this together we can simply say that the recovery is well under way and seems well spread. The weak spots are not surprising and the shape of the recovery is exactly what we would expect.

The big issue remains just how soon will the recovery generate jobs.

There is much speculation in the main stream media that next year looks very mixed: most growth is due to government intervention rather than self-started. I agree with this position but draw a different conclusion. I see the 2010 problems as confirmation that we need another round of stimulus.

The results of the stimulus so far have been almost exactly what we expected. The notion that it failed because unemployment is still rising is foolish – the point was to stop the rot and prevent devastation. That has been achieved. If we wanted to turn things about more quickly the original stimulus had to be much larger. Ironically the calculations used back during the debate over the nature and size of the stimulus package are the best evidence we have that the result of that debate was wrong: everything has worked out as planned. And it was insufficient as we also expected.

Paul Krugman has recently been beating this drum: to support his case he recalls that during the Clinton years we had average GDP growth of about 3.5% per year for eight years straight. It took this entire period of excellent growth to reduce unemployment from its 1992 peak of 7.4% to a low point of 3.9%. Since it is not really healthy for the rate to drop much below 4.0% – inflation tends to pick up when unemployment goes too low – the Clinton years successfully pushed unemployment down from a recessionary peak to a very comfortable low: but it took the entire eight years. In our current situation, with unemployment much higher than it was back in 1992, last quarter’s GDP is clearly not enough to produce much of a kick in job growth even if we keep it up for several years. We need faster growth if we want unemployment to drop any time soon.

The obvious way to get faster growth is more stimulus.

The cost would be higher Federal deficits over the short term. But they seem acceptable given the huge loss in wealth implied by long term higher levels of unemployment. The problem runs more deeply than opponents of stimulus claim: the longer unemployment stays stuck the longer employers will postpone other forms of labor related expenditure; they will simply dip into the job market to find the skills they need they will not invest in training. This kind of effect means that the quality of our labor pool will deteriorate. That, in turn will diminish productivity in the future. So not only are we losing current wealth, but we are damaging our ability to grow quickly later on.

It is this long term impact that needs to be limited and reduced.

Hence the call for more stimulus.

I doubt whether there is sufficient political will to generate such an additional stimulus – there was, after all not enough courage to get the original package right. Most often opponents of government spending cite the rising deficits as the reason for their position. This is nonsense. There is no evidence at all that the bond market fears rising deficits, and they would be the obvious first place to look for signs of such fear. On the contrary, US bond rates and spreads are all fairly consistent with a settled outlook. So the opponents of more deficit spending have nothing concrete to support their position – they rely on ideology rather than analysis.

Given the combination of timidity and ideologically motivated opposition I don’t see how we can contrive a lower unemployment rate any time soon. The Republicans seem to be willing to oppose anything that would boost Obama’s success – no matter how much the country would benefit; and the conservative Democrats who are holding up progress on getting more stimulus have nothing of substance to support their position. Add in Obama’s own tepid policy approach and we seem mired in no-man’s land.

That’s a shame for anyone looking for work, since we could act to prevent more harm.

So much for change. So much for patriotism.