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Dazed and Confused

Irwin M. Stelzer

At last, some good news about the U.S. economy. Sort of. The government’s Bureau of Economic Analysis (BEA) reckons the economy grew at an annual rate of 4 percent in the second quarter of the year (data subject to revision). If that rate continues, five years of a lackadaisical recovery would be replaced by a growth rate more consistent with past recoveries. The government also revised its estimate of a 2.9 percent decline in the economy in the first quarter to a less-disastrous drop of 2.1 percent. But hold the bubbly. Put the quarters together and the -2.1 percent first quarter combined with the +4 percent second quarter means that the tepid growth rate that has characterized the economy for too long was essentially unchanged in the first half of the year.

The real question is whether the 4 percent reported growth rate is a new normal, the first step on the long road to a rapidly growing economy, or a one-off fluke. As always, the evidence is mixed. The bad news is that 1.7 percentage points of the second quarter spurt were accounted for by a build-up of inventories: real final sales of the stuff the economy produced were up only 2.3 percent. In the past, growth based on churning out goods that piled up on retailers’ shelves or in wholesalers’ warehouses has slowed as production was cut back to allow a draw-down of the inventory overhang. As one Texas oilman told me in a year in which drilling activity slowed, “You don’t plant ‘taters when you have a cellar full of ‘taters.”

Then there is the role of catch-up. Goldman Sachs is telling its clients that estimates suggest that “Catch-up from the effect of adverse weather in Q1 … added about one percentage point to Q2 growth.” So the pile-up of inventories and a one-time offset to weather-related sluggishness combined to account for 2.7 percent of the 4 percent second quarter growth.

Finally, there are several factors creating the oft-cited headwinds that are retarding growth. Corporate profits are running below expectations. Continued fiscal tightening by the federal government will have a dampening effect on future growth, probably offsetting any increase in spending by state and local governments. And the wave of regulations that the president has unleashed by asserting an expanded version of his prerogatives – using his pen, as he puts it – is driving up energy costs and adding to the uncertainty created by the upcoming mid-term elections, now only 94 days away. That’s a short time for corporate decision makers to hold off investing until they find out whether Republicans will seize control of the Senate and constrain the president’s ability to increase regulatory and cost burdens on private-sector actors.

Add these factors to the uncertainties facing corporate boards, and it is a surprise that they don’t rein in spending even more:

  • Hamas rockets and terrorist tunnels aimed at the destruction of Israel,
  • Putin’s support of separatists in Ukraine, and his vision of an expanded New Russia,
  • The uncertain effect on European economies of new sanctions on Russia,
  • Still another default by Argentina, and
  • The complete collapse of politicians’ interest in reforming our tax structure to make our companies more competitive with overseas rivals, and our entrepreneurs more willing to risk their capital.

Before returning the champagne to the wine cellar, consider this somewhat cheerier set of facts:

  • The BEA revised its estimates of growth in the third and fourth quarters of 2013 from 4.1 percent to 4.5 percent, and from 2.6 percent to 3.5 percent, respectively.
  • Business investment in the second quarter of this year rose by 5.5 percent after rising a meagre 1.6 percent in the first quarter. Policy makers have been hoping that corporations would replace cash-hoarding with spending, and they might be getting their wish despite all the uncertainties listed above.
  • Investment in housing rose by 7.5 percent after two quarters of decline, suggesting that the housing market might be heating up after cooling earlier in the summer.
  • Consumers remain cheerful enough to continue snapping up new vehicles. A prominent Los Angeles dealer told me his only problem is that he can’t get enough of GM’s giant Suburbans to satisfy his customers’ demand.
  • The manufacturing sector expanded in July for the 14th consecutive month.

Add to this plethora of data what we learned about the job market at week’s end. Some 209,000 new jobs were created in July, extending the streak of above-200,000 new jobs to six months, the longest such run since 1997. The unemployment and labor-force participation rates, and the number of long-term unemployed were little changed from levels at the beginning of the summer. Most observers characterized the news on the jobs front as not so hot as to force the Federal Reserve Board to bring forward its plan to raise interest rates in mid-to-late 2015, and not so cold as to compel it to end the gradual reduction of its bond-buying stimulus. A Goldilocks report in the jargon of Wall Street.

The central bank’s monetary policy committee is now concentrating on selecting from among the many tools in its kit which ones will push interest rates up without aborting the recovery. Investors know an increase is inevitable, but are hoping that with nineteen million Americans either un- or underemployed, the labor force participation rate at historically low levels and wages more or less stuck, Fed chairwoman Janet Yellen, who is extremely sensitive to the social consequences of joblessness, will not bring forward the inevitable tightening. My guess is that the Fed will stick with its mid- or late-2015 date rather than heed the calls of those Fed governors who are arguing that the economy has already achieved lift-off and that the bank should push rates up earlier, perhaps very early in 2015. These dissidents believe Yellen is wrong to believe that faster growth will bring millions back into the labor force, reducing upward pressure on wages and therefore inflation. Instead, the inflation hawks fear that by waiting too long to raise interest rates, the Fed is repeating past errors, and storing up inflationary pressures.

So here is where matters stand after a confusing, mind-boggling, data-rich week. The economy is neither as strong as the headline 4 percent growth rate suggests, nor as weak as the first-quarter 2.1 percent shrinkage of the economy indicated. The jobs market continues to recover, but at a rate not so rapid as to force the Fed to raise interest rates sooner than it has planned. Some day Yellen will enter a policy meeting humming, “The party’s over, now you must wake up, all dreams must end.” But not for another year.

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