Businomics Blog

New GDP Data, New Economic Forecast for February 2009

New GDP data came out today, and they were not as bad as we expected.  There was bad news, notably that inventories rose last quarter.  There will certainly be an inventory reversal this quarter (probably) or next quarter (less likely), which will pull GDP down.

Consumer spending fell, but not by as much as in my forecast.  And I thought I was being the optimist.  The big deviation from my expectations: business spending on equipment and software dropped a lot more than I thought it would in a single quarter.  There was supposed to be a temporary stimulus to equipment spending from a temporary tax depreciation benefit, but I certainly cannot see it in the data.  That should make us all a little more skeptical about short-term stimulus proposals, even tax-cutting proposals.

I took the new GDP numbers and revised my forecast for 2009.  Here it is:

Previously I had 2008q4 as worse than 2009q1.  I've now reversed that pattern.  I pulled some numbers down for later quarters, but I keep getting that small upturn in 2009q2.  Gee, I go into the forecast process expecting to see a small negative second quarter, but after working through each of the sectors, I come up with a small positive.  Whatever.  Take the direction in Q2 with a grain of salt, think of it as a transitional quarter that could be a little up or a little down.  I'm much more confident that we'll be seeing growth in the second half of the year.

Keep in mind how economists view recession: it's when the change in real GDP is negative.  When GDP turns up, we're out of recession even if we have not yet recovered lost ground.  That's our definition; keep it in mind.  We don't recover all of our lost ground, in my forecast, until 2010q2.  Here's the path of actual inflation-adjusted GDP:

I'll add an update on financial markets next week.

Economics Content Recommendations for Meeting Planners

You're planning a meeting.  How has the recession changed the information that your meeting attendees need?  I answered that question in a webinar for MPI, Meeting Professionals International.  Click hear to watch.  I gave my usual economic outlook presentation, then added some comments specifically for MPI members.  (I customize virtually all of my speeches.)

Some key ideas: 

• Credit availability is vital if your audience consists of business executives or owners. 
• The housing crisis isn't really actionable outside of housing and its supply chain.  Even though it's key cocktail party chatter, don't go overboard here.
• Economic contingency planning for the recovery is vital for businesses, non-profits and government agencies.

If you're planning meetings, you should already know this.  MPI is THE source for professional development in this field.

New Home Market Getting Closer to Normal

New home sales were down in December, the headlines say, but that misses the good news: we're continually whittling away at the inventory of new homes:

That horizontal line shows the long-run average.  There's no reason that a current equilibrium would equal the long run average, especially in an ever-changing economy, but it gives us a decent reference point.  At the rate at which we are working off the excess supply of new houses, we'll be down to "normal" in just two more months.

However, "normal" inventory is excessive when sales are below normal, as they currently are:

So the new home market will not feel normal for quite some time.

This approach ignores the excess supply of existing homes and rental units.  We'll get new data on that soon.  My guess: we'll see a significant drop in vacancy rates for both rental and non-rental housing.  The implication: there will come a day when the housing market looks and feels normal.  Not tomorrow, not March, but someday, probably in early 2010.

Economics Will Shift From Recession to Recovery

Marina Whitman had a great article in Tuesday's Wall Street Journal basically arguing that all the stimulus we're doing now is fine, but when the economy starts to expand, policy will have to shift quickly:

But once the world's economies are growing again, the Fed will have to contain the inflationary pressures it is now helping to generate. It will have to know when to step off the accelerator.

Business leaders can apply this logic to their own companies.  Hunkering down will have to shift to expansion.  Laying off workers will have to shift to hiring.  Conserving cash will have to shift to laying the groundwork for larger sales volumes.

We can argue about the timing of the recovery, but everyone should start some contingency plans for an improvement in the economy.  In August 2006, more than a year before the recession began, I recommended that business executives and owners begin contingency planning for a possible recession.  (Although I was not forecasting a recession at that time--sorry--I did point readers to Nouriel Roubini's dismal but ultimately accurate forecast.)

Today corporate planning should emphasize contingency planning for an economic recovery.  And the four steps I recommended in that old post work as well on the upside as on the downside.

Bank Loans Declining Despite TARP: News May Not Be So Bad

Newspapers are reporting declining loan volumes outstanding at some of the banks that took the TARP capital funds.  (articles in Wall Street Journal, Market Watch, Seattle Times, San Francisco Chronicle)

The conclusion that banks are not using their TARP money as planned is premature--but possibly true.

Here's why the judgment may be premature.  Large banks have for many years sold a service called a standby line of credit.  Corporations that normally borrow in the commercial paper market pay a small fee to a bank for the right to borrow from the bank if the commercial paper market dries up.  Usually the banks collect the fee without having to do a thing--easy money.  But when commercial paper markets dried up last summer, banks had to make loans.  They probably did not want to make many of the loans that they actually made, but they had contractual obligations.  Lately the commercial paper market has re-opened a bit, and some of the standby agreements have expired.  So the decline in bank lending may reflect the run off of loans that banks never wanted to make in the firs place.

The second reason why it may be premature is the normal cyclical pattern of bank loans. Here's what  bank loans to business look like over time:

(Thanks to the Fed of St. Louis for data access and graphics.)

Loan volumes always decline in recessions (the shaded areas on the chart).  So did it make sense to try to stimulate lending at a time when lending always falls?  It's possible that lending fell by less than it otherwise would have thanks to TARP.  We don't know that is the case, but it's possible.

There's a reason to be skeptical about TARP, though.  As I noted in an earlier post, bank examiners at the local level are singing a different tune than their leadership in Washington DC.  The agency heads say that they want banks to lend, but the examiner walking into a Main Street bank to review its condition emphasizes liquidity and preservation of capital, which means "don't make loans."  I'll be nervous until all the regulatory agencies get their field staff in line with their leadership.

My take: I think that credit availability outside of real estate development is at the very tight end of the normal range, or perhaps a bit tighter than the tight end of normal.  Many Main Street businesses that had credit lines last year still have their lines.  However, it's a lousy time to have to change banks, and it's not a great time to ask your current bank for an increase in your line.  And that is negative for the economy overall.

Construction Outlook Gloomy According to Architectural Activity

Non-residential construction has been a bright spot in the economy.  It dipped last summer, but recovered in the past few months.  The bad news, though, is that architectural activity suggests another round of declines for construction.  After all, the architect works before the contractor starts his job.  Here's what the American Institute of Architects reports:

This decline is associated with tight credit conditions for real estate development, so it's not necessarily in addition to the credit crunch, but perhaps caused by the credit crunch.  So pencil in gloomy numbers for construction for the rest of 2009.

Automobile Sales Unsustainably Low

Calculated Risk has some interesting charts about automobile sales, concluding that the current sales rate is unsustainably low.  I agree.

Last August in a blog post I voiced a similar sentiment with a slightly different approach.

Neither CR nor I see an immediate turnaround, but I think I'm more optimistic than he is.  I think sales could start upward this spring or summer.

Japan's Depression and Zombie Lending

With the United States in recession, some folks are wondering if we might enter into a "lost decade" as the Japanese did the in 1990s.  There are several important differences between the U.S. today and Japan back then, the most dramatic being Japan's "Zombie lending."  Remember that zombies are the living dead.  The best American examples (outside of Creole legends) were the savings and loan institutions of the 1980s.  They had more liabilities than assets, but were permitted to live on.  In Japan in the 90s, companies that were essentially bankrupt were allowed continued access to credit.  The modern equivalent: sub-prime borrowers protected from foreclosure by public policy.

There's a new academic paper on the subject of Japan's Zombie lending.  Here's the abstract:

Large Japanese banks often engaged in sham loan restructurings that kept credit flowing to otherwise insolvent borrowers (which we call zombies). We examine the implications of suppressing the normal competitive process whereby the zombies would shed workers and lose market share. The congestion created by the zombies reduces the profits for healthy firms, which discourages their entry and investment. We confirm that zombie-dominated industries exhibit more depressed job creation and destruction, and lower productivity. We present firm-level regressions showing that the increase in zombies depressed the investment and employment growth of non-zombies and widened the productivity gap between zombies and non-zombies.

The authors are Ricardo J. Caballero, Takeo Hoshi and Anh K. Kashyap.  The full paper is available here.

One of our banking industry's strengths is that it writes off bad loans and stops throwing good money after bad.

Economic Forecast Updated January 2009

The worst part of this forecast update is history.  The fourth quarter is still a forecast, because we won't have official GDP data for another couple of weeks, but the monthly numbers we have are looking worse and worse.  As I mentioned recently, exports, are diving.  Then we got worse-than-expected news on December retail sales.  We knew it would be bad, but not quite this bad.

Looking forward, we still have a lot of monetary stimulus in the pipeline.  In my book, I described a very reliable phenomenon.  When the Fed starts to stimulate the economy through monetary policy, there will be an article in the New York Times or the Wall Street Journal (or both!) saying that monetary policy no longer works.  There will be no mention in the article about time lags.  Then the Fed's actions will kick in, surprising the pessimists.  We'll also see consumers kick in, as I mentioned in a video, as implied by the charts in a prior post.

So here's my economic outlook:

The early quarters of recovery are sub-par.  We will not have the usual make-up-for-lost-growth experience, because the economy's usual "low gear" is housing construction.  The overhang of excess supply will dampen new construction.  The key turnaround will be in consumer discretionary spending.  I think the fiscal stimulus package will occur too late to trigger the turnaround.  After the economy gets going, the public works elements of the stimulus package may offset reductions in defense spending.

If I'm right, then late 2009, or early 2010, the Fed will either raise interest rates sharply, or let inflation accelerate.  I believe they'll raise rates, but one of my respected colleagues makes a strong argument that the Fed won't raise rates, they'll let inflation get going.  That's a real risk, but I'm sticking with higher interest rates as the more likely event.

I know plenty of folks can't believe that this recession will end soon.  Let me note first that my forecast isn't very optimistic, because of the lackluster recovery.

Second, behavioral finance research has confirmed "recency bias."  People tend to overweight recent information.  I think that's part of the doom-and-gloom mood right now.  People are forgetting that we always get over recessions.

Exports: The Grim News That Worsens the Recession

For the past couple of years, exports have been the strongest part of the economy.  Now that sector has succombed to the global recession.

The sharp drop of the past few months is worse than I had foreseen.  At this point, there's no strong industry in the private-sector economy.  That doesn't mean the recession will last forever, but it looks worse than it did just a couple of months ago.