Economic Recovery is Wishful Thinking

Last week we got a whole series of
bad reports on the state of the economy. New and existing home sales
both remain near their lowest level for the downturn, as house prices
continue to drop at the rate of 2% a month. New orders for capital goods, a key measure of investment demand, fell by 2% in April. Excluding the volatile transportation sector, new orders were still down by 1.5%.

On Friday, the Chicago Purchasing Managers Index fell by more than 5 percentage points from its April level, approaching its low for the downturn. The employment component of the index did hit a new low.

These
reports might have led to gloomy news stories, but not in the US media.
The folks who could not see an $8tn housing bubble are still determined
to find the silver lining in even the worst economic news.

For example, National Public Radio told listeners that the new home sales figure reported for April was up from the March level.
While this was true, the April figure was only 1,000 higher than a
March level that had just been revised down by 5,000. April new home
sales were 4,000 below the sales level that had originally been
reported for March. USA Today touted a "surge" in durable goods orders, which was also based on a sharp downward revision to the prior month's data.

The
media have obviously abandoned economic reporting and instead have
adopted the role of cheerleader, touting whatever good news it can find
and inventing good news when none can be found. This leaves the
responsibility of reporting on the economy to others.

Any serious
examination of the data shows that recovery is nowhere in sight. The
basic story of the downturn is painfully simple. We have seen a
collapse of a housing bubble which has devastated the construction
sector and also caused consumption to plunge.

The construction
sector is suffering from the enormous overbuilding during the bubble
years. Measured in months of sales, the inventories of both new and
existing homes are close to double their normal levels. This inventory
will ensure that construction remains badly depressed at least through
2010, if not much longer.

The plunge in house prices has sent
consumption plummeting. The problem is not consumer attitudes, as many
commentators seem to believe. Rather, the reason that most homeowners
aren't buying a lot right now is the same reason that homeless people
don't buy a lot of things: they don't have the money.

The decline
in house prices since the peak in 2006 has cost homeowners close to
$6tn in lost housing equity. In 2009 alone, falling house prices have
destroyed almost $2tn in equity. People were spending at an incredible
rate in 2004-2007 based on the wealth they had in their homes. This
wealth has now vanished.

Housing is weak and falling. Consumption
is weak and falling. New orders for capital goods in April, the main
measure for investment demand, is down 35.6% from its level a year ago.
And, state and local governments across the country, led by California, are laying off workers and cutting back services.

If
there is evidence of a recovery in this story, it is very hard to find.
The more obvious story is one of a downward spiral, as more layoffs and
further cuts in hours continue to reduce workers' purchasing power.
Furthermore, the weakness in the labour market is putting downward
pressure on wages, reducing workers' purchasing power through a second
channel.

Happy talk will not turn this economy around. The
economy needs more demand, which can only be provided by another larger
dose of stimulus from the federal government. There are easy, quick and
effective ways to boost the economy with additional stimulus.

First,
let's give more money to state and local governments so that they don't
have to lay off workers, cut back services and raise taxes. This should
be a complete no-brainer since this spending will immediately boost the
economy.

The government could also provide a large boost to the
economy by jump-starting healthcare reform with an employer tax credit
(e.g. $2,500 per worker) for firms who do not currently provide
coverage. This could quickly get us to near universal coverage as
Congress works to restructure the system to contain costs.

It
could also provide a $2,500 tax credit to employers for giving workers
paid time off. This should both increase demand in the economy and
provide workers with more leisure and flexibility at the workplace.

There
are other ways in which the government could quickly generate new
demand, but these will not be seriously discussed until there is more
general recognition that additional stimulus is needed.
At some point it will be impossible to conceal the bad news and
Congress' attention will return to stimulus. But the media's reality
defying happy talk on the economy is delaying this moment.