Pitfalls Litter the Road to a Decade of Prosperity

If the Federal Reserve Board’s monetary gurus — technically, the Open Market Committee — were given to exuberance of the sort some pedants might consider irrational, at the conclusion of last week’s meeting they might have declared the dawning of a decade of growth and prosperity.

Central bankers don’t say such things, of course, or even think them. Instead we got the following: “Information received since the Federal Open Market Committee met in March suggests that economic activity has continued to strengthen and that the labour market is beginning to improve ... Financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the committee anticipates a gradual return to higher levels of resource utilisation in the context of price stability.”

So things are looking up for the American economy — light at the end of the tunnel, or even emergence from it. True, the ever-cautious Fed, in support of its decision to keep short-term interest rates at close to zero, also said that although household spending is picking up, it is still constrained by “high unemployment, modest income growth, lower housing wealth and tight credit”.

Two of these seeming negatives are in fact good news. “Modest income growth” is a lot better than falling income, and “tight credit” is inducing consumers to use some of that increased income to pay off debt, and to fund their increased spending from money they are actually earning. This is the rebalancing of the economy away from heavy reliance on consumer debt that economists have said is necessary to the sustainability of the recovery and the long-term health of the economy.

“Lower housing wealth”, a problem for those whose mortgages exceed the value of their homes, is also not unambiguously bad news. It may well mean the housing bubble has finally been pricked, and the basis has been set for at least a modest recovery, of which more in a moment.

News on the earnings front remains positive. Caterpillar, the world’s largest maker of earthmoving equipment and therefore a good indicator of trends in the construction industry, reports robust earnings: Jim Owens, the chief executive, says it has seen a sharp bounce-back in orders and earnings, and adds that neither his dealers nor his customers foresaw “the V-shaped recovery” that is now upon us. Ford, which bet the company by mortgaging every asset it had to avoid the embrace of the government and be free to develop models consumers would buy, earned its fourth consecutive quarterly profit ($2.1billion, its best in six years) and is expected to be in the black for the entire year. Whirlpool, the largest appliances manufacturer, rode sales rises of 65% in Latin America and 60% in Asia to a more than doubling of first-quarter net earnings, continuing the trend of overseas earnings increases.

These anecdotes comport with the latest data. First-quarter GDP rose 3.2% as consumers showed up in shops to absorb some of the products that made up the inventory build-up of the fourth quarter of last year. Orders for durable goods (excluding the volatile aircraft component) rose 4% in March after a 2.1% increase in February. No surprise, then, that consumer confidence is at its highest since the financial crisis wiped out a good part of their wealth in September 2008.

But don’t pop the champagne corks just yet. There are three clouds on the economic horizon, one more than a little dark. The first is the jobs market. The haemorrhaging of jobs has stopped and some new jobs are being created, but too few to bring down the unemployment rate, at least now or soon. Indeed, there is talk of an unemployment rate of about 10% being the “new norm”.

The second possible problem is the housing market. It is difficult to pierce the fog of contradictory data. Sales of existing and new homes are up, and house prices remain above year-earlier levels for the first time in three years. Richard Smith, chief executive of Realogy, a property firm that operates in all 50 states, says activity at the top end of the market is “phenomenal”. And on a recent trip to Phoenix, one of the property markets hardest hit, I was told that developers are getting bargain prices on lots where gas, electricity and other infrastructure have been installed by companies that have gone bust: the survivors are anticipating a revival of the homebuilding industry.

Here comes the inevitable “on the other hand”. The tax credit for home- buyers expired last Friday, there is a large overhang of unsold homes, foreclosed properties continue to put downward pressure on prices, and banks are tight-fisted with new mortgage commitments. Robert Shiller, a Yale professor and a close student of the housing market, doubts there will be a double dip but expects the sector to perform less well than the overall economy, especially if the unemployment rate remains stubbornly high.

Finally, and most important, lying in wait to ambush the recovery are the president’s tax increases on “the rich”, the costs of healthcare “reform”, a cost-increasing energy bill that is ready to be introduced, a Congress seemingly determined to make a whipping boy of the not undeserving financial sector, and defaults by some cities on their debt. Then there is the possible financial crisis in euroland as Greece is forced to restructure its debt, wiping billions off the balance sheets of the German, French and other banks that hold Greece’s IOUs, and making investors still more nervous about sovereign debt.

Already there is talk of America becoming another Greece later this decade if we do not bring our deficit under control. Default on US government bonds is not on the cards — the printing presses stand ready to provide a bailout. But the threat of inflation could at some point loom large enough to prompt investors to demand higher rates for their money. That would certainly bring any emerging decade of prosperity to a screeching halt.