Tuesday, October 26, 2010

The Second Gear Economy

Over the last month and a half, I've looked at a macro picture of the US economy twice. The first conclusions are here. The second set of "looks" is contained in the following four posts: link, link, link, link. All of these show an economy that is growing very slowly. Let's review the basics:

Consumer spending is advancing at about a 1.5%-2% rate every quarter. Consumers are buying necessities, some non-durable luxury goods and durable goods, but not in massive amounts. A high savings rate indicates people are being frugal.

Manufacturing -- one of the primary early drivers -- is slowing. The eastern seaboard Fed districts are the primary cause of this. While the last Empire state number was positive, the latest Philly number was neutral. Industrial production dropped .2% last month and capacity utilization is still very low.

Services: this is an area of the economy that is growing, but slowly. The non-manufacturing ISM numbers are slowing, but still show readings about 50, indicating expansion. The new orders and business activity indexes are also slowing, but are also showing readings above 50.

Investment: business is investing in plants and equipment, essentially replacing worn out capital. Some of this recent increase is the result of delayed investment -- businesses now making investments they intended to make that were put off because of the recession. But some of this is also retooling for increased demand from overseas as well.

Lending: this is also weak. While there are signs of slight increases in the form of increased competition for loans an lower rates relative to the cost of funds, businesses are still reluctant to borrow. Some cite political uncertainty, some cite business uncertainty. I think the primary reason is the lack of demand.

Prices: there is some indication that recent price spikes in the commodities markets are starting to hit producers, but we're not seeing this emerge in CPI yet. With unemployment high there is no pressure from wage increases.

So far, the economy has expanded more or less in line with what I wrote last year in the fits and starts expansion. A combination of manufacturing, consumer spending, exports, inventory restocking and stimulus spending got the economy out of the recession. However, that period is now over; the economy needs a "kick in the pants." Instead, this is an economy stuck in second gear. There is growth, but it is slow. Most importantly, there is no one driver of growth that will pull the other sectors out of their malaise. That is, there is no sector that will take the lead. Everyone is waiting for something to happen, but no one wants to stick their neck out and commit until someone else does.

There are elements that are lining up for growth. Consider the following points:

1.) A high savings rate that would allow consumers to go on a buying spree,
2.) Record low mortgage rates and low home prices that should be encouraging home buying,
3.) Strong growth from overseas that should keep exports high and encourage more exports.
4.) The continued need to upgrade some elements of production.

However, the economy needs a spark to get there. Personally, I think that spark has to be a few months -- say, 4-6 -- of good job growth, say in the range of 150,000-200,000. Consumers and businesses need a clear sign that the worst is over. And the best sign for that would be an improving labor market -- that is the primary piece of the puzzle that is missing right now. Until that change, we're probably stick in second gear.