Monday, April 4, 2011

The next chapter: whither the Expansion?

- by New Deal democrat

I've been blogging now for about 6 years. The first chapter of my blogging involved documenting the turn from housing bubble to housing bust in real time, while positing that the economy was "not Doomed yet." By the end of 2006, when the yield curve inverted, it was apparent that we had become Doomed and that some type of replay of the 1929 scenario was likely. Even so, to paraphrase Mark Twain, "history may rhyme, but it doesn't repeat." Thus when the crash came I focused on whether it would turn into a deflationary spiral, or would hit bottom without the worst happening. By about April 2009, it was apparent that the economy would most likely bottom in about the summer, and that the worst case scenario had been averted.

As most readers of this blog know, this last assertion cut against some deeply entrenched ideological beliefs. Once we had a 1929 style crash, Doomers thought, there must be an inevitable slide into full-on depression, with 25% U3 unemployment and ever worsening conditions for the vast majority of people. Thus, for the last two years, almost all of my blogging energy has been put into documenting that history did NOT in fact repeat. The economy bottomed, real income bottomed, industrial production bottomed, consumer spending bottomed, the unemployment rate bottomed, and finally the number of people holding jobs bottomed. Every single one of those measures of the economy has been up for at least one year, or even close to two. With the exception of employment and unemployment, almost every other metric (including real income) has regained at least half the ground lost during the Great Recession.

I am officially closing that portion of my blogging career. Although the Pied Piper of Doom and his acolyte Doomettes continue to glory in their ignorance (last week he demonstrated that he does not know how mortgage insurance works, nor how the FDIC collects its assessments), as far as I am concerned, you can stick a fork in them. They're done. Even Mish (remember the L-shaped recovery and the state tax revenues that weren't increasing?) and David Rosenberg ("The End of the End of the Recession") have thrown in the towel, although they just can't help being bearish.

The Recovery is trying its best to turn into a self-sustaining Expansion, Oil and world events be damned. In other words, it is time to open a new chapter. What does the expansion look like? What are its defining features? What are the biggest threats to continued improvements?

So far, the quintessential feature of the Expansion has been the powerhouse recovery in manufacturing and exports. Month after month, the ISM and the Chicago PMI, among other measures, show the strongest expansion in manufacturing in decades. Much of that is going overseas in exports. This growth is responsible for a large share of the V-shaped recovery in the GDP and in Industrial Production. At the same time, fewer and fewer employees are needed to manufacture items, which are increasingly assembled via machines and robots.

Another hallmark of this expansion has been the continued deleveraging by households, generating hundreds of billions of dollars in savings which are gradually being unleashed into consumer spending. Real retail sales continue to grow at a rate in excess of 5% a year, equal to the highest rate of growth during the last expansion - but without the toxic byproduct of debt.

On the other hand, that a vast chasm of inequality has opened in society, that it is being exacerbated by an increasing share of inherited wealth and increasing lack of social mobility, and that neither large political party shows any interest in addressing the problem, means that even though corporate America is enjoying record profits, none of the real improvement is filtering down to average workers. Real median wages have made no progress whatsoever since the end of the recession. The expansion moves faster or slower, depending on whether workers temporarily have more real disposable income or less. There is no sign of that changing. Nor will it change until there is a change of mindset within the Beltway. The odds are, that change in mindset will have to come from outside the current power structure of the two existing political parties.

The biggest threat to the ongoing expansion in the next several years is probably Oil. Whether or not "peak oil" has occurred on a global basis, it is clear that the supply-demand balance is tight. Economic growth leads to increased demand for Oil, as to which there is very little excess supply, resulting in a near-vertical price spike. We had a mini-spike last spring, and we are having a bigger spike now. A big enough spike will cause the economy to sink back into a recession. Against this are new finds off the coast of Africa and Brazil, new technologies opening up the shales of North Dakota, the vast increase in natural gas production, and continuing efforts by automakers to increase fuel efficiency including conversion away from gasoline entirely. At some point all of those together will reach critical mass and bring an end to this era of the choke collar hold of Oil on economic recovery.

Another brake on the expansion, that bears signs of watching as to bottoming, is construction. New home sales are bouncing along the bottom, and nonresidential construction continues to decline, albeit at a slower pace. The bust in housing prices will bottom just as it topped, one metropolitan area at a time. As I pointed out the other day, in at least one such area - southwestern Florida - the bottom may already be in.

An even bigger, but less immediate threat is the fact that the imbalance of power between the financial class and the rest of society remains completely unaddressed. Nothing of significance has been done to rein in risk-taking by now even bigger Too Big to Fail institutions. All of the same poorly aligned incentives are still in place. Unless there is a fundamental change, eventually there will be a Great Recession 2.0 - and it is extremely unlikely that the public will tolerate 2008-style bailouts for a second time.

Even if the next recession should hold off for another seven or eight years, we need an average of something like 250,000 new jobs a month to be created during that entire time for all of 8 million plus laid off during the Great Recession to find employment before that time. Yet so far we are on track to as paltry a job-creation record during this expansion as during the last one. We need a modern sports sedan of a fiscal policy, but Beltway Washington is instead reverting to the high collars of the horse and buggy era. That the Doomers have been shown to be relentlessly wrong does not mean that the Obama Administration and Congress have done enough.