Moving in the right direction (but aware of the crosscurrents)

david —  October 8, 2009

No matter one’s political leaning, it seems obvious that we can draw a few basic conclusions from the current economic situation.

First, Federal Reserve chairman Ben Bernanke’s nonitary policies were successful. Most of Bernanke’s term, which began in 2006, has been spent battling the recession and indeed the possibility of depression. Therefore he was reappointed for a second term in August by President Obama. Second, President Obama’s stimulus program is working, even though it has been roundly criticized for all of the following reasons — having insufficient programs, being a budget-buster, and supplying too little or too much in the way of immediate stimulus.

Recent positive news gives us hope

Businesses are doing more with less: We learned that nonfarm payrolls fell by 247,000 in July, and 217,000 in August, the fewest since last August, indicating further moderation in the trend of job losses. These figures were less than expected and way down from the 700,000 in monthly job losses that we were experiencing at the beginning of the year. Additionally theaverage workweek increased to 33.1 from 33.0 hours, the first increase since last August. Also, nonfarm productivity surged at a 6.4% annual rate in Q2, the biggest increase since Q3 2003 and larger than the 5.5% expected increase. Manufacturing productivity rose at a 5.3% rate, the biggest increase in four years.

Good news on investments: According to the Associated Press, workers are again embracing 401(k) plans after the market meltdown and ongoing recession left many unable or unwilling to set aside some of their paychecks for retirement. According to Fidelity Investments, which is the nation’s largest workplace savings plan provider, defined contribution plans raised the amount they set aside rather than decreased the percentage of pay they put into their savings, the first time that’s happened in a year. In each of the previous three quarters, the percentage of Fidelity’s 11.2 million plan participants cutting their contributions topped 6%, exceeding the number who increased the amount going into their 401(k)s. But in the three months ended June 30, 4.7% boosted their contributions, with just 3% decreasing it. The average individual account balance rose 13.5% in the second quarter due to rising stock prices and plan contributions by workers and their employers. More than 90% of the 17,500 plans that Fidelity administers for companies have left the percentage they match unchanged since September, rather than reducing it or suspending matches altogether.

Improving news on home sales: Existing home sales rose 3.8% in the second quarter as lower home prices and government tax breaks pushed many would-be home-buyers off the fence and into the real-estate market. While down on a year-over-year basis, 39 states reported increases in second-quarter home sales compared to the first quarter. Even more surprising, as sales increased, so did home prices. Construction of new single-family homes rose for the fifth straight month, according to the Commerce Department. The pace of single-family home construction edged up almost 2% and building permits for future construction climbed nearly 6%. The confidence level in the industry this month is the highest in more than a year, according to the National Association of Home Builders. This is a comparative improvement from recent months as new home construction is still off more than 70% from the peak in January 2006. Additionally, July existing home sales were up 7.2%, the fourth month in a row of rising sales. As we have said before, housing has led the rebound from every recession in this country since 1960. Historically, existing home sales pick up first, followed by new home sales and then new home starts. This appears to be the case this time around as well.


The Paradox of Thrift: Even as we collect evidence that the recession is receding, there is worry that the recovery may be weak because consumers are reluctant to spend as they increase their savings. This is such a normal and expected phenomenon that it has even been named by economists — the “paradox of thrift.” The paradox is that what is good for the individual (saving), is bad for society in general (low consumtion). Since consumer spending has accounted for 70% of the nation’s economic activity recently, even a small decline in spending could significantly depress demand for goods and services, discouraging businesses from hiring more workers. For many consumers, the inclination to buy has been diminished by a year’s worth of worry over our investments, our faltering jobs and the stumbling economy. The days when Americans are eager to borrow against their stock portfolios and homes in order to purchase luxuries seem gone.

Turning away from credit: In a return to economic life nearly a half century ago — when people spent the money they had now, not the money they were going to get tomorrow — households must increasingly depend upon paychecks to finance spending. This is likely to curb consumption. It also may mean a shift from credit cards to debit cards for many people, as they save more. As recently as the middle of 2007, Americans saved less than 2% of their income, according to the Bureau of Economic Analysis. In recent months, the rate has exceeded 4%.

What to watch for now

Economists are looking up: In a poll by Bloomberg News, economists lifted their estimates for the third quarter GDP by 1.2% compared with July, which would be the biggest boost in surveys since May 2003. These projections followed better than expected reports in manufacturing, employment and home construction. Consumer spending is expected to rise about 1.5% from July to December. This was partially fueled by strong demand thanks to the “cash for clunkers” car-rebate program. Will this increase be temporary or have a ripple effect? The cash for clunkers program was effective and made sense. Ditto for the tax credit for first-time home buyers, this was an excellent targeted program that helped stimulate demand for homes. The cash for clunkers program is over, however, if the tax credit for first-time home buyers is extended, it will bode well for the economy. It will also be interesting to see if the momentum started by these two programs will last or dissipate.

Watch home prices and sales figures: Lower home prices and government tax breaks pushed many would-be home-buyers off the fence and into the real-estate market, but will this trend continue? July was the last month that builders can start new homes and have first-time buyers qualify for a new tax credit. Buyers can save 10% on the price of a home, up to $8,000 in taxes, if they complete the purchase by the end of November. Builders and real estate agents are pressing Congress to extend that credit, but if the tax credit expires, “We could see a fallback,” said David Crowe, chief economist for the National Association of Home Builders. This is absolutely something to watch the news for.

Watch jobs: With the labor force growing at an average 1% rate, the economy needs to grow around 3% just to keep the current unemployment rate steady, which could mean another jobless recovery. Again, an extension of the housing tax rebate would be a big help in creating jobs. Where Americans wind up on the spending vs. savings question will also determine job growth.

Watch the WTO-China conflict: Further job creation may hinge on the conflict between the World Trade Organization and China. Around Labor Day, China is supposed to stop many illegal activities that protect their own domestic market against imports, while ignoring rules meant to create free and fair trade overseas. This fight is very important, and is worth understanding because it may have wide ramifications.

The background is this: The U.S. won a wide-ranging ruling against Chinese trade practices that could provide massive market opportunities for American makers of everything from CDs and DVDs to music downloads and books. A recent WTO ruling went against China for forcing American media producers to route their business in China through Chinese state-owned companies. The China American Report by Adrian van Eck highlights the developments in this way: “The WTO victory comes as President Barack Obama is being pressed to be tough on trade rules with China, which many Democrats in the U.S. Congress blame for America’s soaring trade deficits and lost manufacturing jobs. The case is sensitive also for the Chinese government, which asserts the right to keep out content it finds objectionable. (An industry insider we spoke to said that they sit on the releases a number of months so that Chinese manufacturers have time to produce and sell pirate copies.) The case goes to the heart of the larger dispute over China and its rapid rise as a trade power and exporter, with some of its economic partners believing it has achieved its position in part by protecting its own market.”

Industries and companies who have a dog in this fight range from record labels such as EMI and Sony BMG; publishers including McGraw Hill and Simon & Schuster; the major Hollywood studios of Warner Bros., Disney, Paramount, Universal and 20th Century Fox, Apple Inc.’s iTunes store, etc. (An iTunes-related example: the ruling found that China was breaking trade rules by preventing companies offering music downloads to computers and mobile phones from offering their services directly to Chinese customers.)

U.S. Trade Representative Ron Kirk called the ruling a “significant victory to America’s creative industries.” “These findings are an important step toward ensuring market access for legitimate U.S. products in the Chinese market, as well as ensuring market access for U.S. exporters and distributors of those products,” Kirk said in a statement. “We will work tirelessly so that American companies and workers can fully realize the market opening benefits that this decision signals.”

Tom Allen, CEO of the Association of American Publishers, called it a “landmark ruling.” “It protects legitimate creators of valuable content and offers them fair access to this extremely important market,” Allen said. “Both these long-standing market-access barriers and widespread piracy and counterfeiting in China cause serious economic damage to publishers.”

Dan Glickman, chairman of the Motion Picture Association of America, called China’s rules for distributing American films “among the most restrictive and burdensome in the world,” but said he hoped the ruling would provide a “pathway” for U.S. films to be treated more fairly.

But what China says and what it does are often two different things. The intellectual property case is important because in good times, the world could afford to look the other way and put up with unfair trade practices. But in a global recession, governments around the world are less likely to ignore the intentionally cheap currency in China which takes jobs from other countries and intellectual property disputes which rob their domestic companies of profits which ultimately translates to tax revenues and jobs. A real resolution of these issues could help stem the flow of jobs to China and maybe bring some jobs back as the cost advantage dissipates.

These specific fights are important both for their immediate impact and for what they mean for the larger issue of fair trade with China. Watch the Obama administration and the news closely on this. The Obama administration will have to decide by late September whether to restrict imports of Chinese tires in the United States, at the risk of further upsetting the Chinese government and many large corporate contributors to his campaign. In our opinion, this will be a real test of his mettle as leader, so watch closely! We should not fear trade disputes with China. What they produce can be produced elsewhere if needed, but the demand for what we consume in America is not replaceable at this time. In other words, our leadership needs to remind China that they would not be able to replace us as customers.

Watch for Americans to feel more secure in their jobs and start spending a little more: With the aforementioned slowing in the pace of job losses, Americans may feel more secure in their jobs and therefore find a happy median between the free spending days before the “great recession” and the tight-fisted ways of today. My guess is this is what will happen if the economy continues to right itself and job losses continue to moderate.

Watch the progress of stimulus money: The stimulus money was planned to be released over a period of about two years. That time frame was initially criticized because the economy needed immediate help. Now it looks smart to have some of the stimulus rolling in as the Fed ceases some of its policies that helped save the banking industry. That should help keep the economy stable. As these issues resolve and unfold, the big test for the Fed will be whether Bernanke can avoid raging inflation as he works with the Obama administration to wind down the stimulus programs. All of this hopefully comes at a time when spending finds a happy middle ground between the old days of cash-and-carry and the overboard credit of recent years and, just so happens, as the next presidential election cycle begins.