Economy Bottomed Out? No End in Sight

Many economic analysts have seized on several recent economic reports to claim that the economy has bottomed out and that the upturn is in sight. This analysis badly misreads the data.

The first number to spur the optimism was the big 22.2% jump in new housing starts
from January to February. That is impressive, except that the February
number was only 4.5% above the December number. Looking more closely,
we see that new housing permits were up by 3% in February, exactly
offsetting the decline in January.

other words, houses that were not started in January due to the weather
were instead started in February. The January downturn was due to the
weather and the February uptick was therefore an artifact of weather.
Weather also explains the upturn in February housing sales data.

Analysts also touted the relatively good chain stores sales data for March. While sales were not great compared with year ago levels, they were quick to point out that they could have been worse.

factor that many analysts seemed to miss was that many stores have gone
out of business over the last year, while very few new stores have
opened. This means that the same absolute level of retail sales for the economy as a whole should mean a big jump in business for the chains.

The other item exciting the optimists was Wells Fargo report that it earned $3bn in profits in the first quarter of 2009. This was enough to cause Time magazine to pronounce the end of the banking crisis.

problem with reported bank profits is that banks have enormous
discretion over when they choose to recognise losses. Their discretion
is even larger now that the Financial Accounting Standards Board has
suspended mark-to-market accounting. This means that Wells Fargo
and other banks have the ability to manipulate their financial
reporting so that they can show profits whenever it is convenient. The
losses will appear later.

The other item exciting the optimists was the run-up in the stock market
from its earlier lows. This one is best left for children. Tea leaves
would provide a better measure of the economy's prospects than the
gyrations of the stock market. Remember these are the same people that
pushed the Nasdaq share index over the 5,000 mark back in 2000. Most
investors never saw the housing bubble or the problems that sank Bear
Stearns, Lehman Brothers or AIG. If they have any understanding of the
economy now that it would be a remarkable new development.

A more serious analysis would note that the economy is shedding close to 700,000 jobs a month,
a pace that will almost certainly continue through April. An economy
that is about to turn around does not lose 700,000 jobs a month.

optimists point out that employment is a lagging indicator; the economy
will begin growing before the economy starts creating jobs and the
unemployment rate begins to fall. This might be true when the economy
is losing 100,000 jobs a month. It doesn't make sense when the economy
is losing 700,000 jobs a month.

Before the economy turns around
the rate of job loss must slow. At this point, there is no evidence
this is happening, although the economy clearly cannot lose 700,000
jobs a month for long.

The other reason this pace of job loss in
noteworthy is that it corresponds to a substantial loss in demand. In
addition to the job loss reported in April, employers also shortened
the working week for those who did not lose their jobs. The US Labor
department reported that aggregate hours worked fell by 1% in March. If
the wage bill is falling at the rate of 1% a month, then workers are
going to be reducing their consumption. This is not the basis for an
economic turnaround.

The economy cannot and will not keep falling
forever. But it takes real sources of demand to drive the economy
forward. In past downturns, a burst of consumption, especially on cars
and housing, was the factor driving the economy forward. With the huge
baby boom cohorts having just lost most of their wealth in the housing
crash and stock market plunge, a new burst of consumption seems
unlikely. These households desperately need to rebuild their savings in
the few years they have left until retirement.

In the short-term,
the government will be the main source of demand growth. In the longer
term, we will need to get our imports and exports closer to balance,
which can only be done by a sharp fall in the dollar's exchange rate.
If the optimists understood economics, they would know that they have little optimism about at this point.

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