Economy's Momentum Still Carries the Day
From the July 15, 2007 Sunday Times
July 16, 2007
by Irwin Stelzer
Headwinds vs momentum. That just about summarises what is going on in the US economy. Some weather watchers say the headwinds are close to gale force. The uproar in the subprime mortgage market has the rating agencies becoming more picky; lenders such as Barclays and Lloyds TSB taking a longer look at borrowers before handing over money; and even the red-hot private-equity dealmakers paying a bit more for the loans that finance their takeovers.
Oil and petrol prices remain at levels that are pinching consumers’ pockets, and driving up the cost of doing business. Inflation is tame (up only 1.9% from last year) if you look at the “core” prices, excluding food and energy, as Federal Reserve Board chairman Ben Bernanke continued to do last week in a speech that economists at Goldman Sachs characterised as “very academic”. But Fed members apparently neither eat nor drive, according to consumers who find that inflation in food and energy prices is hurting them.
Then there is the housing market, with foreclosures up 87% from last year’s level and prices falling. Consumers notice when petrol prices rise because they have to fill their tanks every week, and they notice when house prices fall because they have less to boast about at dinner parties. Those prices continue to fall under the pressure of rising unsold inventories. The spring selling season proved a damp squib: potential buyers are holding back in anticipation of still lower prices, and higher mortgage rates are making home ownership more expensive. Prolifer-ating “for sale” signs are upsetting reminders of the soft market.
High petrol prices, falling house prices, worries about the rising cost of food, and a generally unsettled mood resulting from continued problems in Iraq – those are the headwinds and they are blowing with some force, enough to have stalled the economy earlier in the year.
But its momentum seems to have reasserted itself. Some 132,000 new jobs were created last month, including 12,000 in the construction sector as the commercial-property market continues to flourish. In the past year, 1.75m workers have been added to the nation’s payrolls. The unemployment rate, at 4.5%, remains close to a six-year low.
The service sector showed strength in June for the third successive month. And the manufacturing sector, which was very soft in the first quarter, is growing at its fastest rate in over a year. Most important: new orders are showing real strength, and the weaker dollar has exports booming.
Which may explain the general optimism among economic forecasters. On average, the 60 economists surveyed by The Wall Street Journal expect the economy to grow at rates of 2.5% and 2.8% in the third and fourth quarters respectively, and 2.9% in 2008. The 51 forecasters surveyed by Blue Chip Economic Indicators forecast that the economy will grow at a rate of 2.8% in the final two quarters of the year. With even the 10 gloomiest expecting growth to come to a not-unhealthy 2%, analysts no longer expect the Fed to cut rates soon, despite the slump in housing.
Bernanke and most of his colleagues are more worried about the danger of renewed inflationary expectations than about an impending recession.
With just about every American who wants to work having a job, many businesses are finding that they have to increase pay in order to lure workers away from other firms, or to induce those not in the active workforce to get off the sofa and take a job. They are also finding that it is becoming harder to offset rising pay by increasing productivity, so unit labour costs will soon head up.
That will add pressure on businesses to raise prices. Restaurants, for example, have been hit not only with rising wage bills, but soaring food costs, in part because misguided energy policy has diverted acreage from food production to fuel production. So restaurants are raising their prices – and getting away with it. Consumers now find it costs more to fill their tanks for the drive to their favourite eaterie, where prices are well above last year’s level.
Equally worrying to the Fed is that signs of pressure on capacity are mounting in several important sectors, a situation that Bernanke is known to monitor closely.
Boeing has announced that capacity to produce its new 787 Dreamliner is booked solid until 2014 (677 are on order, and JAL’s 35 planes will be outfitted with bidets), refining capacity is stretched so far it is unlikely petrol prices will drop even if crude oil prices drop – itself unlikely because there is insufficient excess production capacity to provide a cushion against supply interruptions in trouble spots such as Nigeria and Venezuela.
In the past, American consumers could count on the world markets to provide workers and production capacity to supplement that in the US. That is no longer certain. Tighter border controls are reducing the flow of cheap labour from Mexico, and more vigorous enforcement has employers more reluctant to risk jail by hiring low-paid illegal immigrants. Labour costs are rising in places such as India, reducing the cost-saving possibilities of out-sourcing. The recovery of the world’s major economies is sopping up overseas production capacity.
In sum, house prices are down, but share prices are up. The prices of some things consumers buy are up, but so are incomes. The credit market has its problems, but the ratings of only a small portion of the bonds backed by subprime mortgages has been downgraded. And junk-bond defaults are at a historic low.
It looks as if momentum,at least so far, is trumping the headwinds.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.