Good news: Economy may grow. The bad? It won't last

McClatchy NewspapersJuly 2, 2009 

WASHINGTON — Here's where things stand with the longest recession since the Great Depression: The good news is that economists are revising forecasts, expecting an imminent return to growth. The bad news: The growth may not be sustainable, and the nation could sink back into a recession not long after emerging from this one.

The economy has been mired in a deep recession since December 2007, the unemployment rate keeps climbing and the financial sector, while on the mend, remains dangerously fragile.

"The perfect storm of financial market meltdown, credit market freeze and economic contraction seems to be passing, but the U.S. economy remains afloat, albeit battered," the Securities Industry and Financial Markets Association wrote in late June.

In a subdued forecast, the association's economists see economic shrinkage slowing to a 2 percent annual rate for the quarter that ended Tuesday. These analysts, mostly from Wall Street firms, project that growth will resume from July through September, but only at an annual rate of eight-tenths of 1 percent, accelerating to a 1.9 percent annual rate in the final three months of this year.

From there, the economy will gain steam, but will grow at only a 2.1 percent rate next year, the association predicts. Government stimulus spending and the need for businesses to restock after months of shedding excess inventory will fuel the growth.

"Our group, like everybody else, anticipates that the economy right now is transitioning from a steep decline, pulling out of that downdraft," said James Glassman, the chief economist for JPMorgan Chase & Co.

Glassman said that growth wouldn't be robust enough to halt the rising unemployment rate, which he projects could go up from its June rate of 9.5 percent to around 10 percent. He said that the jobless rate might begin to fall by next spring or early next summer.

That means that the next year is unlikely to feel much like a recovery, and it'll be about 12 more months before Americans begin to feel secure about their jobs.

"There won't be enough job growth until 2011 to meaningfully reduce unemployment. It will be a slog," said Mark Zandi, the chief economist for forecaster Moody's Economy.com in West Chester, Pa.

This sluggish rebound is what Alan Levenson, the chief economist for investment manager T. Rowe Price, calls "dyna-minimalism." He thinks that businesses and households have saved and paid down debt enough to position the economy for a dynamic recovery, but "the minimalism comes in the trajectory of recovery that I expect, which will be restrained by this longer tail of financial-sector restructuring even after the 'real' sector has restructured substantially, and the more restrained outlook of credit expansion going forward," Levenson said in an interview.

He means that lenders will be tougher about making loans, limiting consumers' ability to spend and thus braking business growth. Consumer spending drives about two-thirds of U.S. economic activity.

"As sharp a recession as we've had, we would expect to see a much more rigorous bounce back than I am forecasting," Levenson said, blaming today's extraordinary financial conditions for the weak outlook.

This recession, which was brought on by a near-freeze of credit across the globe, didn't follow the usual business cycle, so the unfolding of the recovery will be equally unpredictable.

"The things that normally happen in the business cycle: consumption starts to eat up the slack and very quickly turns into production, which then demands more investment," said Marty Regalia, the chief economist for the U.S. Chamber of Commerce.

Translation: Consumers must buy enough to reduce businesses' inventories, forcing them to reorder, thus inducing manufacturers to make more goods. Manufacturers must buy more raw materials. All these goods move on trucks, trains, ships and planes, and as this happens the gears of the economy shift into higher cycles.

However, many economists fear that government stimulus spending will drive economic activity, not the consumer. That opens the possibility that once the government's billions of dollars slow to a trickle, another dip into recession could follow.

"The economy has got to be running on its own by the middle of next year, and it has got to be running on its own in a long-term sense," Regalia said. He worries that falling stimulus spending, higher interest rates and rising inflation could combine to choke off recovery by late 2010 or early 2011.

Regalia fears that the unemployment rate will top 10 percent by early next year and stay high, dampening vital consumption.

"I'd say we're going to be looking at 9-plus all of next year and into 2011," he said.

That scenario would leave the U.S. economy vulnerable to shocks from energy prices, natural disasters or other surprises.

"When you are growing weakly . . . when the economy is not hitting on all cylinders, it becomes more susceptible to problems we all know are going to come up. We just don't know in what form," Regalia said.

Mounting U.S. budget deficits and expanded lending by the Federal Reserve have many economists worried that inflation down the road may be harder to tame than the Obama administration thinks.

Investors continue snapping up U.S. Treasuries because they're a safe bet in uncertain times. Once the global economy returns to growth, however, investors who are worried that inflation will erode the value of their investments may demand higher returns for purchasing U.S. Treasuries. That could force up interest rates, snuffing the recovery.

By next year, the Obama administration and the Fed may have to choose between higher inflation and fewer jobs.

"Success in public policy . . . is defined by jobs and not price stability. Therefore both domestic and foreign investors are concerned that even slightly higher inflation will be accepted by public policy makers in an attempt to provide a few more jobs," John Silvia, the chief economist for Wachovia, wrote in a June 29 research paper.

The Fed raises interest rates to tame inflation, at the expense of economic growth. President Barack Obama has refused on several occasions to say whether he'll reappoint Ben Bernanke to another term as Fed chairman; Bernanke's current term expires Jan. 31. The uncertain outlook for who'll helm the Fed is adding to the anxiety that inflation may be permitted to rekindle over the next few years.

"Our basic expectation . . . is that inflation will rise and the dollar will decline in value as the economic stimulus programs remain in place just a bit too long to be comfortable for investors," Silvia wrote.

ON THE WEB

Silvia's analysis: "Credit Cycle: Breakdown, Adjustment and Rebuilding in the Financial Sector"

The Securities Industry and Financial Markets Association's midyear forecast

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