Spending and Manufacturing: Good News
We are now receiving a string of reports all pointing in the same direction: the economy is perking up. The recovery is now well under way. That doesn’t mean, unfortunately, that we are experiencing the usual post-recession surge, instead we appear to be making steady headway across the board.
The news can be summarized briefly:
Consumer spending keeps on ticking upwards. March’s rise of 0.3% suggests that there is enough momentum to carry the first quarter GDP increase into the current quarter. The numbers for February had been a concern – spending grew a mere 0.1% – and we had to wait for these march figures to see whether the steady growth seen since last November was faltering. The year end data was muddied by various aspects of the stimulus package, with things like the ‘cash for clunkers’ program potentially stimulating demand at the end of last year by bringing it forward from this year. That concern appears unjustified, so we can now project a reasonably healthy rate of spending for the next few months.
This is especially true as the income figures are also showing signs of a return to health. Wages and other forms of income are picking up across the board. This is not a statement about per-hour wages or pay scales, but rather is a reflection of the slight increase in hours being worked, and the very slight turn around in the labor markets. This evidence is very good news: it signals the turn in aggregate incomes we need if growth is to become self-sustaining and not dependent upon the stimulus. This is the first month for quite a while where incomes have risen in all sectors. Obviously we are moving away from the bottom of the cycle.
Also buried in the report is the news that taxes are rising. This, of course, reflects the increase in income. As total wages start to grow again the tax take at both the local and Federal level will also recover. The reason this is important to note is that it will start to relieve the deficits that riddle governments all across the nation. Lost in all the blather and hype about the ‘catastrophic’ deficits has been the simple observation that as unemployment grows the total wage bill within the economy slumps. That means there is less taxable income. This, in turn, drives the government deficits up. Naturally as the cycle turns back to the positive the opposite effect takes hold and deficits start to shrink without any spending cuts or tax increases being made to close the gap.
I have mentioned this before, but it bears repeating: the current Federal deficit consists of three large pieces. The stimulus accounts for a small part. The loss of tax revenues due to the cyclical downturn accounts for a larger part. And the Bush era tax cuts account for the largest part. As the economy recovers we will get rid of the first two of these, leaving us with the third to correct. Unfortunately the size and extent of the Bush tax cuts was sufficient to knock a vast hole in the government budget, so fixing that problem will need equally large counter measures. Once the recovery is well set getting the budget back to a fiscally conservative posture will require getting rid of the Bush policies which were extremely de-stabilizing. I expect a mix of tax increases and spending cuts – including in defense – to be part of next year’s budget planning.
Economics being what it is, today’s good news contains the germ of future problems. The increase in consumer spending has meant that saving dipped. This is not good. Over the medium term the economy needs to be de-levered. Debt needs to be severely reduced. Consumers will have to control spending in order to make sure that their debt doesn’t reflate back to the dangerous levels we saw during the bubble. March’s figures saw savings going the wrong way, very slightly, so this is a trend we will need to keep an eye on over the summer months.
The other good news today is that the Institute of Supply Management Index for manufacturing activity showed a larger than expected increase in April. It rose to 60.4%, from 59.6% in March. This is the highest level the index has reached since 2004 and was a much stronger result than most people had been forecasting. Evidently manufacturing is bouncing back well. More to the point seventeen of the eighteen industries covered by the survey reported increased activity which tells us that the growth is widespread and not dependent upon a specific sector. Just as a reminder: any reading on this index of over 50% tells us that industrial activity is growing, so last month’s reading is a very strong one, and suggests that we are fast approaching the point at which jobs will become more abundant.
So what do we make of this news?
That the recovery is both well under way and is taking root right across the economy. The worst is now well behind us. The next issues we face are all to do with risks to growth: the impact and timing of the Federal Reserve’s expected tightening of rates being high on that list. If we see reports like today’s repeated over the next few weeks – say into July – then the pressure to raise rates will increase dramatically. Right now I see no reason for a rate increase. Even with all this good news growth has yet to be firmly established to the degree that it needs to be tamed. Having said that the debate about higher interest rates is bound to begin soon.
Meanwhile let’s enjoy the good news.
