Wanted: Something to make a slow economy grow faster

McClatchy NewspapersAugust 11, 2010 

WASHINGTON — The Obama administration and the Federal Reserve are searching for an engine to pull the economy forward faster amid a sluggish economic recovery that's losing steam.

For the better part of two decades, the U.S. economy has been powered by rising global trade, abundant cheap energy supplies, low borrowing costs and soaring home and stock prices that created wealth, which fueled consumption and production.

Today, however, the economy's slow growth is sputtering. Forecasters project moderate growth at best for the second half of this year. No one's quite sure what drivers will emerge to propel the bruised and battered economy forward.

"It's very much an open question right now," said Mark Vitner, senior economist for Wells Fargo Securities in Charlotte, N.C.

The economic uncertainties rattled Wall Street on Wednesday. The Dow Jones Industrial Average of 30 blue-chip companies fell 265.42 points, or 2.5 percent, to close at 10378.83. The broader S&P 500 fell 31.59 points, or 2.8 percent, and the technology concentrated Nasdaq fell 68.54 points, or 3 percent.

With unemployment high, consumers pessimistic and investors anxious, how's the economy still growing at all?

Part of the answer is inventory replenishment. After burning through their inventories on store shelves or warehouses in 2009, companies have restocked in anticipation of an improving economy. The most recent government data on second quarter economic growth showed a huge surge in imports_ at an annual rate of 28.8 percent — as part of this process.

However, the benefits of inventory replenishment are expected to fade in coming months, and other positives may moderate too.

One of them is business investment, a rare pleasant surprise this year. Investment in software and computers was put on hold last year amid uncertainty, and began to pick up late last year. From April to June, business investment in equipment and software grew at annualized rate of 22 percent. That strong pace may not last, however.

"Based on some of the surveys we've done on our members, business investment, while positive, is not going to be growing as fast," said David Huether, the chief economist for the National Association of Manufacturers. "Business investment won't be as much as a driver."

Manufacturing output is likely to keep growing, he said, but at a moderating pace, as demand dips.

Another bright spot is growth in exports, which Huether said have grown in double digits for four consecutive quarters, 10.3 percent from April to June in the latest reading.

"That hasn't happened in over two decades, and that is especially encouraging for (U.S.) manufacturers, since well over a quarter of what we make we sell overseas," he said.

However, while exports boost GDP, imports reduce it, and in the second quarter imports grew at a pace that was more than twice as fast as exports. And U.S. exports slipped 1.3 percent in June, the government reported Wednesday, underscoring fears that the economy is weakening.

In normal business cycles where growth contracts, then rebounds relatively fast, a key driver is pent-up demand for goods and services. When there's pent-up demand, businesses and consumers who've sat on the sidelines begin spending again and make up for lost time.

"We didn't see that this time around, partly because of the wealth evaporation. You usually don't see . . . the net wealth loss — big, big losses in wealth," said Martin Regalia, the chief economist for the U.S. Chamber of Commerce.

By his calculation, Americans have lost $14 trillion in wealth between the plunge in stock prices and falling home prices. About $5 trillion of that has come back with last year's rebound in stocks and this year's slight gains.

Consumers, who drive 70 percent of U.S. economic activity, are still shell shocked.

"We probably have $10 trillion lost in people's net worth and until we start seeing that repaired, people are going to be hesitant about borrowing more," Regalia said. "People are going to try to save a little more and spend less . . . and none of that contributes to short-term growth. Good stuff, but in the short run it doesn't help the economy grow."

Not all analysts are so gloomy.

"There is a widespread impression this is the weakest recovery in the postwar era. While the speed and character of this recovery is disappointing compared to many postwar recoveries, it is not the worst ever," wrote James Paulsen, the chief investment strategist for Wells Capital Management, in an Aug. 5 analysis of the economy. "Actually, in its first year, the contemporary recovery has outpaced the last two recoveries in terms of real GDP growth, job creation and profits!"

"During the first year of the current recovery, real GDP has risen by 3.2 percent, compared to a 2.6 percent first year gain in real GDP during the 1991 recovery and only a 1.9 percent rise in real GDP in the first year of the 2001 recovery," Paulsen wrote. "Many may also be surprised the contemporary recovery has produced better job results (even if they are still disappointingly weak) than was achieved in either the 1991 or 2001 recoveries."

Historically, recoveries unfold like this: the economy slows, a dip in inflation follows, and the Federal Reserve lowers lending rates. Banks follow suit. Lower borrowing costs entice businesses to expand and consumers to take out loans for cars and houses. It all propels the economy out of contraction and back into growth.

This time, however, the U.S. economy is emerging from a financial crisis, the largest since the Great Depression of the 1930s. Banks still aren't lending, consumers aren't spending, and employers aren't hiring enough to make the recovery hum.

That's normal for a recovery from a massive financial crisis, said Carmen Reinhart, a University of Maryland economist who co-authored the book "This Time is Different," which chronicled financial crises over 800 years. What these crises share in common, she and Harvard economist Ken Rogoff conclude, is a huge debt build-up sparks the crisis and takes years to work off.

"Debt overhangs are not things you work out of very quickly, and that is sort of the ball and chain we are dragging around here," Reinhart said. She likens the U.S. recovery to the lost decade of the 1980s for debt-ridden Latin American nations, and the 1990s in Japan.

"Were going to be paying for this in terms of lower growth in the future, the near future," she said.

Home purchases are one measure of how out of whack things remain. The Fed's benchmark lending rate has been between zero and a quarter of a percentage point for almost two years. That's helped to bring mortgage rates on 30-year fixed loans down to the lowest level in decades, 4.49 percent for the week of August 2.

Yet the National Association of Realtors recently reported that its index of pending home sales in June was down 19 percent from a year earlier, at a level not seen since 2001. Low rates aren't attracting buyers — or buyers aren't able to obtain credit because of tighter lending standards. There are almost 4 million homes on the market nationwide, equivalent to a nine-month supply.

Most economists now expect a bottom for the housing market sometime in 2011, but recovery in that sector is likely to be muted at best.

"Once it gets going, it's not going to be growing at the pace it was in 2003, 2004 or 2005, but I think we will see a fairly durable recovery in housing," said Huether, of the manufacturer's group. "It's not going to be a huge source of growth . . . But just as important, the spillover effect of people using home values as their checkbook, I don't think is in the cards any time soon."

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