Published on
The Guardian/UK

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.

In 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.

The 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.

The 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.


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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.

The 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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