If the U.S. is capable of talking itself into an economic downturn, we may be on the cusp of the first recession in history caused by a bad mood. More likely, though, the economic news will turn less dour than many people now expect, spirits will brighten, and we’ll get through this soft spot with the durable economic expansion remaining intact.
To be sure, it’s not difficult to understand why the economic mood of the country is so bad. It’s nearly impossible to avoid the media’s constant deluge of economic negativism, much of it being fed by a Wall Street community that has seen its reckless bets on sub-prime mortgages blow up. As a result, the market has undergone a hasty, though inevitable, re-pricing of risk, causing significant pain and suffering for many former masters of the universe.
Their displeasure, however, has manifested in a determined effort to convince the world that the market’s turmoil poses a threat to overall growth, the response to which must be a concerted campaign by the Federal Reserve to cut rates and bail them out. So far, this campaign is working: The Fed has cut the federal funds rate by a full point since September to 4.25 percent, with more rate cuts on the way.
Wall Street’s tactics have been less than subtle. Last Thursday, the morning before Fed chief Ben Bernanke would give a speech that essentially caved to calls for further easing, the New York Times ran a story citing Wall Street sources who questioned whether Bernanke is “tough enough” to sustain the easing process. “Toughness” in a central banker has traditionally been a matter of having the capacity to face up to difficult decisions to raise rates in order to quell inflationary pressures. But in this world turned upside down, toughness has been redefined as having the ability to get rates low enough to make Wall Street happy.
The Times, at the end of the story, did however acknowledge the self-interest that might be motivating the lobbying effort. “Wall Street traders and investment bankers are counting on drastic rate cuts to help make stock prices rise,” the Times said, in the process lifting their bonuses which were hurt by the market’s turbulence late last year.
Nevertheless, the financial heavyweights are working their hardest to persuade the public and the Fed that the economy is in trouble, so it’s not surprising that sentiments have been hurt. A critical driver of economic growth is confidence about the future. Poor sentiment can therefore have a self-fulfilling aspect, as businesses and individuals pare back investment and consumption on the chance that tomorrow will not turn out to be as prosperous as they believed it would be yesterday.
Fortunately, for all the pessimism, the economy continues to show healthy signs of life. One of the biggest stated concerns of the Fed is that the credit-market upheaval will have the effect of restricting the availability of credit, with banks reluctant to extend new loans to firms. But commercial-and-industrial lending remains robust, with growth at an annualized pace of nearly 30 percent over the last eight weeks. Since 2004, the average eight-week annualized growth rate of C&I lending is just 13 percent.
In his speech last week, Bernanke maintained that “downside risks to growth have become more pronounced,” and he cited further weakness in housing demand as “likely to weigh on consumer spending.” But during the entire housing downturn, which is now going on two years, there has been absolutely no associated penalty on consumption. Growth in the fourth quarter likely slowed significantly from the blistering 4.9 percent pace of the third. But personal-consumption spending was still on pace for growth of about 3 percent. Consumption spending correlates most closely with income growth, and during the most recent three-month period, wages and salaries were running at an annual growth rate of better than 5 percent, up substantially from levels below 0.5 percent at the middle of last year.
Another concern expressed by Bernanke — and widely perceived to represent a risk to growth — is the health of the labor market, particularly after the most recent employment report showed a 0.3 percent increase in the unemployment rate to 5 percent. Historically, however, a 5 percent unemployment rate has been considered extremely low. Over the last 30 years, unemployment has averaged better than 6 percent. During the economic revival of the 1980s, the rate never went below 5 percent.
Moreover, the jump in the unemployment rate last month was based on a decline of more than 400,000 jobs in the household survey. This survey is based on a much smaller sample than the more widely cited payroll survey, and over the past several months it has been extremely volatile. In November, household jobs grew by more than 600,000, and in September they rose by about 500,000.
The December decline in household jobs could well be reversed in the next employment report, and along with it the rise in the unemployment rate. At the same time, claims for new jobless benefits over the last several weeks have dropped from more than 350,000 to just a little more than 320,000. This level of jobless claims has not previously been associated with a retrenchment in the labor market.
Typically, recessions have been caused by tight Fed monetary policy. Every recession over the last 40 years was preceded by the Fed putting the real inflation-adjusted fed funds rate above 4 percent. Today the real funds rate is just above 2 percent, and it’s headed lower — meaning all the recent recession talk is cheap.
The current economy is working through a self-fulfilling soft spot, but the fundamentals remain sound. There’s no reason to think the economy won’t emerge in the next few months in typically vigorous fashion.