A lot of people asking me what I think about the economy now.
Last week economists and commentators on CNBC latched on to the employment and GDP economic reports to make the claim that the economy has bottomed and is about to boom. Let's see what the reports can really tell us.
The January employment report came out on Friday. The number of people working declined by 89,000 last month. However, the headline unemployment rate number dropped from 5.8% to 5.6%.
Immediately after the news was announced Larry Kudlow, the chief economics commentator on CNBC, pounded the table and said this was great news that "proved" that the economy was having a big recovery.
But you have to scratch your head and use common sense for a minute. Why did the unemployment rate drop when more people lost their jobs?
Well the labor department eliminated 924,000 from the workforce. Since the the unemployment rate counts only people in the work force or looking for a job it dropped. What happened to these 924,000 people you might wonder? According to the labor department they have stopped looking for jobs and have given up. Because they aren't looking for work anymore they are no longer officially unemployed.
When you look at the numbers themselves they don't really build a case that the economy has bottomed.
But what about the GDP numbers? Everyone expected the GDP to decline in the fourth quarter of 2001, but instead it grew by .2%. First I need to mention that these are preliminary GDP numbers and will probably eventually be revised downward by the end of the month when trade data comes out. Last year every preliminary GDP number came out higher than expected and was eventually lowered. The 3rd quarter numbers came in positive too, but were eventually moved down into the red.
Despite that, this GDP number is still stronger than I expected and provides us with a good snapshot of where the growth and weakness is in the economy. Let's look at it in detail. I'm including quotes from the report itself and my comments follow:
"Real gross domestic product -- the output of goods and services produced by labor and property
located in the United States -- increased at an annual rate of 0.2 percent in the fourth quarter of 2001,
according to advance estimates released by the Bureau of Economic Analysis. In the third quarter, real
GDP decreased 1.3 percent."
"The Bureau emphasized that the fourth-quarter "advance" estimates are based on source data that
are incomplete or subject to further revision by the source agency (see the box on page 4). The fourth-
quarter "preliminary" estimates, based on more comprehensive data, will be released on February 28,
2002."
As I've said these are preliminary numbers. When the report came out Mark Haines said "there is no recession." That isn't exactly true, because these numbers will probably be revised down.
"The increase in real GDP in the fourth quarter reflected positive contributions from personal
consumption expenditures (PCE) and from government spending that were mostly offset by negative
contributions from private inventory investment, from nonresidential fixed investment, from exports, and
from residential investment. Imports, which are a subtraction in the calculation of GDP, decreased in the
fourth quarter."
Corporate investment spending once again shrank while personal consumption and government spending grew. Let's see this in more detail.
"Real personal consumption expenditures increased 5.4 percent in the fourth quarter, compared with
an increase of 1.0 percent in the third. Durable goods purchases increased 38.4 percent, compared with
an increase of 0.9 percent. Motor vehicles purchases accounted for most of the fourth-quarter increase.
Nondurable goods increased 0.9 percent in the fourth quarter, compared with an increase of 0.6 percent
in the third. Services expenditures increased 1.6 percent, compared with an increase of 1.2 percent."
Personal consumption increased 5.4%. Notice that the purchases of durable goods increased by 38.4! And most of that was due to purchases of new cars. Car sales helped to increase consumer spending last quarter as consumers got attracted to 0% financing deals. This of course is a temporary phenomena that is ending as we speak. I would venture a guess that this is one of the biggest quarterly jumps in consumer spending ever.
"Real nonresidential fixed investment decreased 12.8 percent in the fourth quarter, compared with a
decrease of 8.5 percent in the third. Nonresidential structures decreased 31.0 percent, compared with a
decrease of 7.5 percent. Equipment and software decreased 5.2 percent, compared with a decrease of
8.8 percent. Real residential fixed investment decreased 6.4 percent, in contrast to an increase of 2.4
percent. "
Fixed investments in buildings, technology, and software decreased 12.8% last quarter. This is a bigger decrease from the 8.5% in the third quarter. This number is critical. When it first showed a decline in the 3rd quarter of 2000 I told you that this was a sign that the economy was entering a recession.
This number represents corporate investment in technology and the growth of corporations themsleves. When this number shrinks it means that companies are disinvesting themselves from the economy. They are cutting costs. When this number grows they invest in equipment and technology which helps the economy grow.
This number is what drives real and sustainable economic growth and until it goes positive there will be no strong economic recovery. Growth is built on investment, not debt. Consumers cannot use their credit cards and continue their strong spending habits forever without this number eventually going positive.
"Real federal government consumption expenditures and gross investment increased 9.5 percent in
the fourth quarter, compared with an increase of 3.6 percent in the third. National defense increased 9.3
percent, compared with an increase of 3.2 percent. Nondefense increased 9.9 percent, compared with an
increase of 4.2 percent. Real state and local government consumption expenditures and gross investment
increased 9.0 percent, in contrast to a decrease of 1.3 percent."
And finally defense spending grew 9.3% in the fourth quarter, which of course helped spur economic growth. Government spending grew 9.5% in the fourth quarter. The era of big government and budget deficits is back.
Government deficit spending cannot create long term economic growth. It can provide a temporary short term lift to the economy, but the growing deficit and debt cannot go on forever and will have to eventually be paid back with higher treasury bill rates.
In the final analysis the economy had surprising strength in the 4th quarter due to consumer and defense spending while corporate investment and expansion continued to drop. Until corporate investment expands there is no reason to believe that the economy has bottomed or is on the path to real sustainable growth. The consumer spending was mainly due to the temporary 0% car sale campaigns and more credit card debt.
Stephen Roach, the head economist at Morgan Stanley, has noted that all but one recession since the end of WWII was a "double-dip" recession in which the economy had a recession with a quarter or two of temporary growth in the middle of it. If our economy turns back down it will be because consumer spending finally falters. For the past year consumer spending has not been fueled by job expansion or wage increases. It has been fueled by credit card debt and home mortgage refinancing. These are sources of fuel that can't continue for the rest of this year. If corporate expansion and investment spending do not pick up then consumer spending will drop and the economy will enter several quarters of recession that will be worse than the negative growth of the 3rd quarter.
There are reasons to think that corporate investment will continue to be weak. First corporations themselves heavily went into debt in the late 1990's and are still in debt. Witness the telecom sector and companies such as Kmart, Xerox, and Kodak to name a few of the worst examples. More importantly the late 1990's saw an investment bubble that must be worked off. Companies simply invested in excess and that is the chief reason the technology sector is as weak as it is today. And few technology companies or CEO's see a large recovery in their sector this year. Just this past weekend Bill Gates said there would be no recovery until 2003.
In the final analysis financial commentators and economists are simply way too optimistic on the economy. Thanks to Greenspan's 1990's debt and stock bubble the economy faces horrible risks that could materialize by late spring and early summer. At best the economy will grow, but very weakly due to these problems. Perhaps it can grow below 1% in the second half of this year. Worse - which is more likely - it will shrink again and then rebound for real next winter. Right now the economy is going through what looks to be a dead cat bounce that is fueled by the increase in consumer and defense spending that came in the 4th quarter of last year. We are not yet on the path to real sustainable growth.
That is not a reason to despair. Recessions and economic slowdowns are a part of life. They work off the excesses of debt, which paves the way for the next real economic boom and bull market in the stock market. The problem now is that, because those excesses of the past were so large, they will take longer than usual to work off. Look at the stock market for example. Most bear markets last 6 months. However, this one has been going on for almost 2 years and has seen declines that can be only compared to those of Japan in the 1990's or the US in 1929. The very size of the stock market bubble is the cause for the magnitude of the decline and ineffectiveness of interest rate cuts from stopping it last year. Likewise, the burden of enormous corporate and personal debt cannot be waved away with a magic wand. It will more time to work it off and until it is the economy will face the risk of getting worse. At the very least it will put a lid on growth. It is another legacy of Alan Greenspan's loose money and repeated bailouts of the 1990's.
Those same commentators who believed that the biggest bull market in history would end without causing a bear market are now claiming that a decade of debt and economic imbalance can be worked off with one of the shortest recessions in history. They are nuts.
from timingwallstreet.com |
