Growth, But Not Enough

Solid is one of those words none of us wants to hear as a description of our abilities. Solid is not exciting. Solid is very middling. There is no va-va-voom in solid. But then again neither is it bad. No, solid is just dull. Very dull.

Our economy is solid.

Ugh.

Today’s reports on GDP for the fourth quarter 2010 has growth at an annualized 3.1% rate. That’s good. It just is not good enough. If you recall, the previous estimate was for growth at 2.8%, so evidently the later data has been on the plus side. The biggest contributors to the increase appear to have been a revised inventory number, which was less of a downward drag than previously thought; and a stronger business investment figure. Neither of these was the prime motor for growth, however, since the main boost came from a combination of higher personal consumption and a better trade balance. Since this is the third and final report of the fourth quarter this is the one that goes into the books. It also brings to a close the revising of the overall 2010 performance which is now settled at 2.9%, compared with the drop of 2.6% in 2009.

While that turn around appears terrific I must warn you that it is nowhere near good enough. A more typical recovery would have seen much faster growth in the first full year after a recession. Then again, the economy has gone through significant changes over the last three decades, one consequence of which is the the days of very fast recoveries seem to be over. The trajectory in the last three recessions has been for much less rapid recovery from a much longer decline. My view is that this change stems, at least in part, from the reduced emphasis on manufacturing in the overall economy. In the earlier post-war recessions, the cycle was dominated by sudden shifts in factory employment. The adjustments were quick and dramatic. But as finance, and other services, grew in importance those dramatic shifts have given way to much longer and more difficult adjustment periods. Those famous V shaped recessions have given way to elongated U’s. And the Great Recession was so deep, and so shocking, that we are still lingering near the bottom and are nowhere near climbing back to where we would have been had there been no downturn.

That, I think, is what most people overlook.

Had we avoided the downturn we would have had an economy chugging along between 2.5% and 3.0% a year. OK, but not great. Solid in fact. But we blew a great hole in that history so the long term trend line now shows a big downward dip. If we plot our actual performance against the trend line we would all notice that we are not back to where we would have been. That means we still have lost momentum to recover. And don’t forget: to the extent we wallow about beneath the long term trend line we are forgoing wealth that we will never recover. Not, that is, unless we accelerate to growth rates well above the trend line.

And therein lies our problem.

GDP growth in 2010 was insufficient to recoup our lost wealth. So that loss is permanent. In effect we have recovered in name only. The deeper reality is that we have an impoverished economy more limping than running along.

The slowness of growth last year is very worrying because there are many signs pointing to weakness at the moment. Real estate is stuck so deep in a hole that no one can credibly suggest it returns to be the boost it was during the 2000’s. Which is probably good in view of the damage it wrought. Exports are our best shot at getting medium term growth, but for that to come to fruition we need a further devaluation of the dollar and some cooperative adjustments in our trading partners to deal with their own imbalances. In particular, the Chinese, Japanese, and Germans all need to reduce their export reliance by boosting their domestic consumption. Their economies are built around excessive employment in exporting businesses which deprives us of jobs and their own people of consumer goods. Unless there is a willingness to deal with these imbalances, I doubt that our trade position will provide the boost to our GDP growth I would like to see.

So what else could?

Not much.

Business investment could be one area of extra growth, but there is little sign of a boom there. Companies are sitting on piles of cash and are not deploying it productively at the moment. This is with historically low interest rates which implies very low investment hurdle rates. If business can’t find profitable opportunities at these rates I doubt they will suddenly burst into activity any time soon.

Consumption would be another possibility for higher growth, but that too looks set for drift rather than acceleration. Households are still grappling with rebuilding their balance sheets to compensate for lost home values While the stock market has recovered, and thus boosted some family portfolios, housing was always a bigger wealth provider for the majority of people. So as long as home prices remain weak, and they have just begun to decline again, most households will look to save more than before to create a cushion against uncertainty. This, obviously, shifts a portion of income from spending to savings and thus slows GDP down. The possible offset to this slowdown would be if those savings found their way into an expansion of investment, but as I just said, there is no evidence of much growth in that sector.

The last possible area for growth would be government spending, but as we are all painfully aware the current emphasis is on reducing not increasing government activity. So, far from being a net boost, I expect the cost cutting mania now sweeping the nation to become a net drag on growth. Yes, this is dumb. And, no, it won’t change. We appear hell bent on slowing growth down.

All of this means that the outlook for GDP is not too terrific. The economy is out of the deepest parts of the hole it fell into, but it is not yet healthy enough for us to breath easily. The ugly truth is that we appear set for drift. There is no appetite for fiscal policy remedies, which leaves us reliant on the Fed’s loose monetary policy. With interest rates at practically zero we have no room to maneuver. Not that this worries policy makers. They have all moved on to the deficit and debt as their problems to solve. The fact that the best solution would have been a rapidly expanding economy eludes them.

Oh. And one more thing. Buried on today’s report is data on corporate profits. Guess what? Despite all the moaning about the administration’s supposedly anti-business attitude, and despite the gloom and doom we hear constantly from the Chamber of Commerce, profits soared. And I mean soared. Before tax corporate profits grew 36.8% in 2010. Read that agin and digest it fully. Profits boomed. Last year was the best year for profits since 1950 which was an odd year itself as business boomed after the post war recession. No wonder stock prices rose. Couple this with the news that GE is getting a tax rebate of over $3 billion on gross profits of over $14.2 billion – of which $5.1 billion was in the US – and it easy to understand why workers might be perplexed by the idea that they need to give back more in order to solve our supposed “debt crisis”.

These are boom times for capitalists. Just not for the rest of us.Today’s report simply confirms this.

Until we restore a more equable balance the economy will remain merely solid. That’s not good enough.