As the election year progresses, we are exposed to wildly diverging predictions about the future of the American economy. The Democrats are telling us that in President Obama’s capable hands, the American economy keeps improving every day – despite the constant efforts by Congressional Republicans to derail the Recovery Express. On the other hand, the Republicans keep warning us that a second Obama term could crush the American economy with unrestrained spending on entitlement programs. Meanwhile, in (what should be) the more sober arena of serious economics, there is a wide spectrum of expectations, motivated by concerns other than partisan politics. Underlying all of these debates is a simple question: How can one predict the future of the economy without an accurate understanding of what is happening in the present? Before asking about where we are headed, it might be a good idea to get a grip on where we are now. Nevertheless, exclusive fixation on past and present conditions can allow future developments to sneak up on us, if we are not watching.
Those who anticipate a less resilient economy consistently emphasize that the “rose-colored glasses crowd” has been basing its expectations on a review of lagging and concurrent economic indicators rather than an analysis of leading economic indicators. One of the most prominent economists to emphasize this distinction is John Hussman of the Hussman Funds. Hussman’s most recent Weekly Market Comment contains what has become a weekly reminder of the flawed analysis used by the optimists:
On the economy, our broad view is based on dozens of indicators and multiple methods, and the overall picture is much better described as a modest rebound within still-fragile conditions, rather than a recovery or a clear expansion. The optimism of the economic consensus seems to largely reflect an over-extrapolation of weather-induced boosts to coincident and lagging economic indicators — particularly jobs data. Recall that seasonal adjustments in the winter months presume significant layoffs in the retail sector and slow hiring elsewhere, and therefore add back “phantom” jobs to compensate.
Hussman’s kindred spirit, Lakshman Achuthan of the Economic Cycle Research Institute (ECRI), has been criticized for the predictiction he made last September that the United States would fall back into recession. Nevertheless, the ECRI reaffirmed that position on March 15 with a website posting entitled, “Why Our Recession Call Stands”. Again, note the emphasis on leading economic indicators – rather than concurrent and lagging economic indicators:
How about forward-looking indicators? We find that year-over-year growth in ECRI’s Weekly Leading Index (WLI) remains in a cyclical downturn . . . and, as of early March, is near its worst reading since July 2009. Close observers of this index might be understandably surprised by this persistent weakness, since the WLI’s smoothed annualized growth rate, which is much better known, has turned decidedly less negative in recent months.
Unlike the partisan political rhetoric about the economy, prognostication expressed by economists can be a bit more subtle. In fact, many of the recent, upbeat commentaries have quite restrained and cautious. Consider this piece from The Economist:
A year ago total bank loans were shrinking. Now they are growing. Loans to consumers have risen by 5% in the past year, which has accompanied healthy gains in car sales (see chart). Mortgage lending was still contracting as of late 2011 but although house prices are still edging lower both sales and construction are rising.
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At present just four states are reporting mid-year budget gaps, according to the National Conference of State Legislatures; this time last year, 15 did; the year before that, 36. State and local employment, which declined by 655,000 between August 2008 and last December – a fall of 3.3% – has actually edged up since.
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Manufacturing employment, which declined almost continuously from 1998 through 2009, has since risen by nearly 4%, and the average length of time factories work is as high as at any time since 1945. Since the end of the recession exports have risen by 39%, much faster than overall GDP. Neither is as impressive as it sounds: manufacturing employment remains a smaller share of the private workforce than in 2007, and imports have recently grown even faster than exports as global growth has faltered and the dollar has climbed. Trade, which was a contributor to economic growth in the first years of recovery, has lately been a drag.
But economic recovery doesn’t have to wait for all of America’s imbalances to be corrected. It only needs the process to advance far enough for the normal cyclical forces of employment, income and spending to take hold. And though their grip may be tenuous, and a shock might yet dislodge it, it now seems that, at last, they have.
A great deal of enthusiastic commentary was published in reaction to the results from the recent round of bank stress tests, released by the Federal Reserve. The stress test results revealed that 15 of the 19 banks tested could survive a stress scenario which included a peak unemployment rate of 13 percent, a 50 percent drop in equity prices, and a 21 percent decline in housing prices. Time magazine published an important article on the Fed’s stress test results. It was written by a gentleman named Christopher Matthews, who used to write for Forbes and the Financial Times. (He is a bit younger than the host of Hardball.) In a surprising departure from traditional, “mainstream media propaganda”, Mr. Matthews demonstrated a unique ability to look “behind the curtain” to give his readers a better idea of where we are now:
Christopher Whalen, a bank analyst and frequent critic of the big banks, penned an article in ZeroHedge questioning the assumptions, both by the Fed and the banks themselves, that went into the tests. It’s well known that housing remains a thorn in the side of the big banks, and depressed real estate prices are the biggest risk to bank balance sheets. The banks are making their own assumptions, however, with regards to the value of their real estate holdings, and Whalen is dubious of what the banks are reporting on their balance sheets. The Fed, he says, is happy to go along with this massaging of the data. He writes,
“The Fed does not want to believe that there is a problem with real estate. As my friend Tom Day wrote for PRMIA’s DC chapter yesterday: ‘It remains hard to believe, on the face of it, that many of the more damaged balance sheets could, in fact, withstand another financial tsunami of the magnitude we have recenlty experienced and, to a large extent, continue to grapple with.’ ”
Even those that are more credulous are taking exception to the Fed’s decision to allow the banks to increase dividends and stock buybacks. The Bloomberg editorial board wrote an opinion yesterday criticizing this decision:
“Good as the stress tests were, they don’t mean the U.S. banking system is out of the woods. Three major banks – Ally Financial Inc., Citigroup Inc. and SunTrust Banks Inc. – didn’t pass, and investors still don’t have much faith in the reported capital levels of many of the rest. If the Fed wants the positive results of the stress tests to last, it should err on the side of caution in approving banks’ plans to pay dividends and buy back shares – moves that benefit shareholders but also deplete capital.”
So there’s still plenty for skeptics to read into Tuesday’s report. For those who want to doubt the veracity of the banks’ bookkeeping, you can look to Whalen’s report. For those who like to question the Fed’s decision making, Bloomberg’s argument is as good as any. But at the same time, we all know from experience that things could be much worse, and Tuesday’s announcement appears to be another in a string of recent good news that, unfortunately, comes packaged with a few caveats. When all is said and done, this most recent test may turn out to be another small, “I think I can” from the little recovery that could.
When mainstream publications such as Time and Bloomberg News present reasoned analysis about the economy, it should serve as reminder to political bloviators that the only audience for the partisan rhetoric consists of “low-information voters”. The old paradigm – based on
campaign funding payola from lobbyists combined with support from low-information voters – is being challenged by what Marshall McLuhan called “the electronic information environment”. Let’s hope that sane economic policy prevails.