Economy isn't THAT bad, but it isn't as good as it should be

McClatchy NewspapersAugust 9, 2011 

WASHINGTON — The downgrade of the U.S. credit rating and volatile financial markets are weighing on the American economy, which, contrary to popular belief, is still moving forward, albeit at a slower pace than economists would like.

"Things aren't as bad as people think. But they're not as good as where we want them to be, either," said Dean Croushore, a former longtime economist at the Federal Reserve Bank of Philadelphia who teaches at the University of Richmond in Virginia.

Standard & Poor's downgrade of U.S. credit last Friday — and Monday's related plunge in stock prices — were about the trajectory of American debt and budget deficits many years from now. They weren't an indictment on the current state of the U.S. economy.

The state of the U.S. economy, however, is hardly something to cheer. There've been some bright spots, most recently stronger-than-expected hiring in July. An index of services-sector activity was solid in July, and there were respectable sales numbers from carmakers and big national retail chains.

But those pluses were offset by a larger number of minuses, including sharp revisions to growth estimates for the first half of the year and a key manufacturing index that showed activity is slowing to near-recession levels.

The latest soft reading on the economy came Tuesday, when the Labor Department reported that productivity — an employee's per-hour output — dropped from April to June by an annualized rate of 0.3 percent. That's the second consecutive quarterly dip, and this losing streak hasn't happened since the second half of 2008 as the economy slid into financial crisis.

Year-over-year productivity growth is now 0.8 percent, compared with an annual rate of 2.5 percent from 2000 to 2010. It's a sign of falling efficiency in an economy that seems stuck near stall speed.

The spate of weak economic reports left economists revising downward their growth forecasts for this year and next year. The mood is darkening, with many seeing the chances of a slide back into recession heightening.

"Our view of the outlook has changed quite a bit from where it was a month ago," said Patrick Newport, an economist with forecaster IHS Global Insight, which has lowered its 2011 growth projection from 2.5 percent to just 1.7 percent and to 2 percent growth in 2012, instead of the 2.6 percent projected earlier. "The economy has lost a lot of momentum recently. The revisions to (growth) show that the economy was a lot weaker in the first half than anyone knew."

As a result, Newport and colleagues now see the economy muddling along at a rate of growth that leaves it vulnerable. A recession could follow unforeseen events that range from another oil price spike to a political misstep in Washington to a natural disaster such as a hurricane or earthquake.

The Federal Reserve on Tuesday darkened its outlook of the economy, citing growth that was "considerably slower" than expected. For the first time, the Fed announced that it would keep its benchmark lending rate near zero — where it's been since December 2008 — until mid-2013. The Fed cited "a somewhat slower pace of recovery over coming quarters" and nagging high unemployment, and it noted that "downside risks to the economic outlook have increased."

The economy is struggling to stay out of a loop in which bad economic news begets more bad news. When consumers see stock prices plunge — eroding their retirement or investment savings — their natural reaction is to curtail spending and save for rainy days ahead. This slows sales, which leads to layoffs, which leads to higher unemployment, which leads to even slower sales, and so on.

Stock prices often reflect expectations about the economy six months ahead, but the sharp drop Monday_ much of it recouped Tuesday_ seemed to understate the current health of the economy.

"Is the economy in worse shape than it seemed to be two weeks ago? We would argue not," economists at forecaster RDQ Economics wrote Tuesday in a research note, citing the stronger-than-expected hiring in July. "To be sure, the average monthly increase in private payrolls of 111,000 over the last three months is hardly a sign of strength but it is also a far cry from recession and it has been stronger than expected."

Part of why the recovery feels so sluggish is that the economy is emerging not from a typical business-cycle downturn but rather a financial crisis unlike any since the Great Depression. The financial order has been ruptured, and a recent paper by prominent economists Carmen Reinhart and Kenneth Rogoff showed clearly that no modern economy has returned to pre-crisis growth levels within a decade after a financial crisis.

It means that recovery will remain slow and uneven as consumers and businesses repair their balance sheets. Consumers are saving, usually a good thing, but at a time when the economy needs them to be spending. Businesses are playing it extremely safe.

"This is really a crisis in confidence. What's happened is small businesses are saying, 'I can't invest in my business in good conscience. I know taxes are going up because we have (outsized) deficits. I just don't know how much they're going up. I can't calculate a risk-adjusted rate of return on investing so I can't invest in my business,' " said Mark Vitner, a senior economist in Charlotte, N.C., for the Wells Fargo Economics Group, part of San Francisco-based Wells Fargo Bank.

Vitner and senior bankers recently met with businessmen from Atlanta and surrounding parts of Georgia, expressing an interest in lending to them. To their great surprise, they were told there aren't plans to expand.

"I've never heard businesses say this before. I've never had multiple businesses say to me, 'We're not interested in growing our business.' "

(Greg Gordon contributed to this article.)

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