May 2008 Archives

Here's the question I posed earlier in the week:

Will the downturn be short and shallow or deep and vicious? With all apologies to William Shakespeare, that is the question. It isn't an idle one, either, and it's difficult to answer with any degree of confidence even though it's increasingly clear the Federal Reserve has succeeded in its several months-long campaign to prevent a credit crunch from turning into a financial collapse. The quarter-point cut Apr. 30 in its benchmark interest rate to 2% is probably the central bank's last maneuver in that crusade for some time.

Even though the risk of apocalypse has been averted, the economic glass could be half empty. Perhaps most worrisome is the nearly 13% price decline in residential homes from a year earlier in 20 major metropolitan markets followed in the Standard & Poor's/Case-Shiller index. The housing market's downward momentum shows no signs of abating.

The government's latest gross domestic product report has business spending falling across the board, with outlays on residential and non-residential construction, capital goods, equipment, and software down in the first quarter of 2008. Consumer confidence is falling, too. One figure in the Conference Board's April report caught the eye of Bernard Baumohl, managing director of the Economic Outlook Group in Princeton , N.J. The proportion of people surveyed who expect their incomes to rise over the next six months fell to 15.1%, "the lowest percentage this organization recorded since 1967 when it began this line of questioning," he writes.

Still, there is a chance the glass is half full. Take the stock market. It's barely in correction territory, down less than 11% from its peak reached in October, 2007. The Bush Administration's $168 billion rebate to taxpayers will start reaching consumers soon, with at least some of that money spent at malls and big-box stores. The forward earnings of the S&P 500 are down only 5.4% at the end of April from last October's record high, according to economist Edward Yardeni of Yardeni Research. That compares to a 17.5% peak-to-trough decline during the previous profits recession at the beginning of the decade, he adds.

So, half empty or half full? The April employment report due out on May 2 could provide an answer. "Central to the outlook for the economy in the balance of this year is just how much has the job market weakened," says James Paulsen, chief investment officer at Wells Capital Management, which is part of Wells Fargo.

Certainly, last month's payroll plunge of 80,000--the biggest drop in five years--convinced a majority of private sector economists that the U.S. was in a recession or sliding toward one. (A close look at the numbers behind the 0.6% gain in GDP in the first quarter of 2008 won't persuade many economists to change their outlook.) Jobs matter.

One key measure is simply, how big is the payroll drop? The Bloomberg survey of economists for April's employment report has a consensus decline of -75,000. That figure would be consistent with a business community facing tough times but reluctant to embrace mass layoffs. If payrolls come in around consensus that would suggest a short, shallow recession, says Mark Zandi, chief economist at Moody's Economy.com. (He's forecasting a 100,000 decline.)

What if the job number jumps to the 150,000 to 200,000 level? Those figures are consistent with the job market of a typical post-World War II recession. Assuming history holds, the downturn would come to an end around the time summer shades into fall. But payroll declines in the 250,000 to 300,000 range would suggest a vicious downturn. The recovery wouldn't start until the end of the decade, Zandi says.

It's not just the magnitude of the payroll drop that matters. Who gets handed a pink slip also counts when trying to fathom the economy's direction. So far, this has been largely a blue-collar and pink-collar downturn. Job losses have been concentrated in industries such as manufacturing, construction, and retail, and it's the less-educated workers in these industries that are suffering the most on the job front. For instance, the unemployment rate for workers with less than a high school diploma is up from 7.6% in December to 8.2% in March. Workers with a high school diploma have also seen an increase over the same time period, from 4.7% to 5.1%.

In sharp contrast, workers with a bachelor's degree or higher are doing relatively well, despite massive layoffs at a number of beleaguered financial institutions. For example, the unemployment rate for well-educated workers fell a fraction from December to March—2.2% to 2.1%. Watch out if the job-loss figure spreads to better-educated and better-paid workers in such white-collar professions as health care, education, and information technologies.

In a sense, everything flows from jobs. The more confident workers are that they won't join their neighbor at the unemployment center, the quicker home prices and consumer spending revive. Of course, the exact opposite dynamic holds, too.

Well, employers didn't cut anywhere near the number of workers expected by a majority of economists. Payrolls dropped by -20,000 vs. a consensus expectation of -75,000. The unemployment rate is at 5%.

The job losses are still concentrated in construction, manufacturing and retail trade. Jobs were added in healthcare and in professional and technical services, according to the Bureau of Labor Statistics. It's still a blue-collar and pink-collar recession. For instance, the unemployment rate of workers with less than a high school education rose from 7.6% in December, 2007 to 7.8% in April of 2008. The unemployment rate for workers with a high school diploma increased from 4.7% to 5% over the same time period. But the unemployment rate is down (a fraction) for workers with a bachelor's degree or more--from 2.2% to 2.1%.

It's beginning to look like a short and shallow recession.

I got an email press release the other day trumpeting, among other things, the following:

Fannie Mae will allow borrowers to refinance up to 120% of their home value if they are currently paying their mortgages on time.

'This is a huge positive development for responsible homeowners who are faithfully making their payments, but simply find themselves in a negative equity situation due to declining real estate values,'....

Isn't it deals like this that got so many homeowners in financial trouble. It's a bad move.

This is worth noting. It comes from an analysis of today's retail sales figures by Bernard Baumohl, managing director, the Economic Outlook Group:

What did surprise us in this report was the drop in sales of gasoline. Americans spent 0.4% less on gasoline in April than the month before. Was this the result of people driving less and thus not filling up their tank as often? Or did prices actually decline last month? We took a look at the retail price of gasoline as compiled by three sources, the AAA, the DOE's Energy Information Administration (EIA), and even GasBuddy.com!

All showed gasoline prices increased sharply in April. So the explanation behind the fall in gasoline spending had to be a decline in consumption. Indeed, what is showing up in the data compiled by the EIA is that demand for gasoline has been flattening out the past year. Clearly, the price of filling up a tank has now reached the pain threshold for an increasing number of drivers, forcing them to either take public transportation or replace their gas guzzling SUVs with more fuel-efficient autos.

Pop quiz for all you political junkies out there: Who said this?

"Our excessive dependence on OPEC has already taken a tremendous toll on our economy and people.... It's a cause of the increased inflation and unemployment we now face. This intolerable dependence on foreign oil threatens our economic independence and the very security of our nation. The energy crisis is real. It is worldwide. It is a clear and present danger to our nation. These are facts and we simply must face them."

Was it President George W. Bush? John McCain? Barack Obama? Hillary Clinton?

Well, get out your bell-bottoms--or at least that cardigan sweater--if you guessed President Jimmy Carter. On July 15, 1979, the 39th President made these remarks sitting in front of a fireplace dressed in a cardigan. The fireside chat later became known as the "malaise" speech, although he never actually used the word. However, he did talk about a crisis of confidence:

"It is a crisis that strikes at the very heart and soul and spirit of our national will. We can see this crisis in the growing doubt about the meaning of our own lives and in the loss of a unity of purpose for our nation."

No Way Around Sacrifice
What would solve that crisis of confidence? What the philosopher William James called the "moral equivalent of war": the goal of energy independence. The nation, according to Carter, needed to make "the most massive peacetime commitment of funds and resources" and to "mobilize American determination and ability to win the energy war." Carter said he could "not promise that this struggle for freedom will be easy" and stated forcefully that there was "simply no way to avoid sacrifice." Whew!

Several aspects of Carter's speech stand out. First, his florid language highlights how different today is from 1979. Americans are paying through the nose for gasoline, but there are no gas lines. We all complain about the high cost of energy, but it's mostly measured in terms of squeezed household budgets--not in a loss of national will. Being smart about energy usage isn't an act of patriotism, it's seen as common sense personal finance.

Yes, some politicians are lobbying for the return of the windfall profits tax on oil companies that Carter called for in the speech, but there's little groundswell of support three decades later. Even proposals for a gasoline-tax holiday can't get much support.

Still Pursuing Energy Independence
To be sure, the language of war and sacrifice is commonplace now in the years following September 11. But it's directed at the occupations in Iraq and Afghanistan, where soldiers (and their families) are taking real risks and making real sacrifices.

Still, as the old saying goes, history may not repeat itself but it frequently rhymes. For instance, it was during this speech that Carter announced the creation of the Energy Dept., which quickly evolved into a massive, hidebound bureaucracy. And it was after September 11 that President Bush created another giant, dysfunctional bureaucracy, the Homeland Security Dept.

It's also striking how much hasn't changed in three decades. Politicians are still calling for "energy independence" even though the economy is now more dependent on foreign oil than ever--certainly much more than in 1979. The economy remains vulnerable to the price manipulations of OPEC nations and other oil producers.

And Carter's desire for the creation of alternative energies--"from coal, from oil shale, from plant products for gasohol, from unconventional gas, from the sun"--still resonates. (Although coal is less popular now, thanks to concerns about global warming.)

And while "malaise" seems to be off-limits for politicians and commentators alike, the national mood does appear to be unusually sour in a crucial election year. You can't turn on cable TV without hitting on a show worried about cultural decline and rampant individualism.

Carter's Ideological Shift
That said, the most intriguing aspect of Carter's 1979 chat may be that it was a transitional speech marking an ideological shift in how to run an economy. With the benefit of hindsight, it appeared to be the last gasp of government-centered domestic economic policy.

Carter's concrete proposals largely reflected the "managed capitalism" approach of the 1950s and 1960s. It was a time when capitalist competition was restrained, Big Business developed a close relationship with government, and unions gained power within companies and the corridors of Washington. It worked remarkably well for a while, but the belief in the wisdom of government elites to smartly organize an economy foundered on the rise of international competition, the Vietnam War, the oil shocks of the 1970s, a plunge in productivity, the hallowing out of American manufacturing, a series of currency crises and, most importantly, runaway inflation.

Aspects of his talk contain hints of the ideology that replaced managed capitalism: A strong belief in free markets and deregulation. Think Ronald Reagan, Margaret Thatcher, and the economics department at the University of Chicago. According to the free-marketeers, economic problems would disappear if government backed off and let the magic of markets work. And indeed, the unleashing of free-market capitalism in the 1980s and 1990s nurtured entrepreneurial innovation and business productivity.

The Ultimate Energy Hybrid
But the wheel of history has a habit of turning whether we like it or not. Now, like Keynesian liberalism before it, the credit crunch has exposed the ideas that have held sway in Washington as also bankrupt. "The current conservative, free-market cycle that commenced with the Reagan presidency, with all its achievements, seems to have long since foundered in the oil seas of gross excess," writes Charles Morris, author of The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash.

Indeed, the shift toward reregulating the financial system could spill over into how we treat oil. Imagine, for instance, a call to raise energy taxes significantly. High prices would encourage technological innovation. But instead of government directing the innovations, Silicon Valley, Route 128, the Beltway high-tech corridor, and maybe even the oil companies themselves would seize the opportunities to coin money by going green.

Think of it as the ultimate energy hybrid--the kind of bold government action favored by the Man from Plains coupled with the reliance on market forces championed by his critics. Carter may not have the last laugh, but he might smile at the thought.