October 06, 2003

Continued Optimism

Morgan Stanley's Richard Berner and David Greenlaw continue to be optimistic about the U.S. business-cycle recovery over the next two years:

Morgan Stanley: ...Moreover, many fear that sluggish growth will return once the impetus from the fiscal stimulus effective in July and mortgage refinancing fades.  Indeed, incoming signals have already turned mixed and fourth quarter demand growth likely will be weaker than the third, even with rising employment raising income prospects.  It was fun while it lasted, but in our view the adrenaline rush of the upswing in demand growth is over; now come strong but unspectacular gains in demand.  Yet a dip in August capital goods orders and shipments, a September decline in vehicle sales from hyper-elevated August levels, and softness in consumer sentiment and purchasing-manager surveys have all raised concerns that the deceleration might be long lasting. 

We disagree.  To be sure, those hurdles will keep the sustainability debate alive.  But as we see it, a sustainable recovery remains the most likely outcome, as four factors assure that the demand side of the equation has more legs than commonly perceived.  First, pent-up demand for capital goods and hiring is rising as post-bubble headwinds are fading (see The Drivers of Growth, and When Will the Jobless Recovery End? Global Economic Forum, July 28, 2003 and September 2, 2003, respectively).  In addition, the powerful earnings rebound now underway is a classic sign of a sustainable recovery, it will nurture an upswing in capital spending and hiring into 2004 and beyond.  Earnings growth will slow next year, but margins seem likely to plateau some 300 basis points above their tough in mid 2001, not fall (see The Earnings Sweet Spot, Global Economic Forum, September 15, 2003).  The stimulus from easier financial conditions and fiscal policy is far from over (for example, see Is the Consumer Party Over? Global Economic Forum, October 3, 2003).  Finally, the time-honored cyclical dynamics of the inventory cycle seem likely to boost production relative to final demand.  With inventory-sales ratios at all-time historic lows, the pickup in demand virtually requires accelerated stockbuilding over the next several quarters...

I'm less optimistic for two reasons. First, I trust David and Christina Romer's estimates of the impact of monetary policy, which put it as faster and bigger than past estimates--and which carry the implication that there is little additional push to the economy from interest rate reductions still in the pipeline. Second, my estimate of the productivity growth trend is higher than Morgan Stanley's--so I see a reasonable probability that the "jobless recovery" will continue, and curb the growth of consumer demand.

But it would be very nice if I were wrong this time.

Posted by DeLong at October 6, 2003 08:07 PM | TrackBack


Brad said:
Second, my estimate of the productivity growth trend is higher than Morgan Stanley's--so I see a reasonable probability that the "jobless recovery" will continue, and curb the growth of consumer demand.

But it would be very nice if I were wrong this time."

You and I both!

Posted by: Jody Dorsett on October 6, 2003 09:10 PM

I suspect you're right, though; or more right. But what's so wrong with longer term 1-1.5% growth in the already huge US economy?
Where is the evidence that "natural unemployment" is less than 6%?

I suggest that the lower unemployment of the 90s bubble was an under-remarked overemployment, with correction stickiness, causing the correction(s) to drag on. Looking at the Euro-zone countries, they ALL have much more than 6% unemployment...

Posted by: Tom Grey on October 7, 2003 01:02 AM

Its a shame their co-worker -- Stephen Roach -- doesn't agree:

"A US-centric global economy is waiting with baited breath for sustained cyclical revival.  Central to such a growth spark is the time-honored vigor of the great American job machine.  That’s been missing up until now but there are hopes this piece of the macro puzzle is finally falling into place.  Those hopes are not likely to be realized, in my view.  At work is a new “global labor arbitrage” -- a by-product of IT-enabled globalization that is now acting as a powerful structural depressant on traditional sources of job creation in high-wage developed countries such as the United States.  America’s jobless recovery could well be here to stay. (emphasis mine)

There is a critical dichotomy between those who accept this premise and those who don’t.  At one end of the spectrum is the angst of the American body politic.  Consumers and their elected political representatives remain deeply concerned about the persistent perils of a jobless recovery.  As a result, the very real and worrisome risks of a protectionist backlash are mounting in the US Congress.  At the other end of the spectrum are increasingly frothy financial markets that believe the worst is over and that hiring is now set to resume.  The theory is simple: A policy-induced stimulus to aggregate demand will eventually require the supply of new labor.  The September labor market survey has given investors great encouragement that such magic is back in the US business cycle and that the carnage on the job front has finally run its course.  I couldn’t disagree more.  Employment growth of 57,000 is puny when compared with hiring spurts of the typical cyclical recovery that often run in the 200,000 to 300,000 range.  Moreover, with nearly 60% of the September gain in payrolls traceable to increases in temporary staffing -- the fifth month in a row of solid hiring in this industry -- it’s a real stretch, in my view, to conclude that the days of this jobless recovery are now nearing an end.  Instead, I would argue that America’s increased emphasis on a relatively low-cost contingent workforce is emblematic of a new relationship between aggregate demand and domestic employment that lies at the heart of the global labor arbitrage." 


Posted by: Barry Ritholtz on October 7, 2003 04:20 AM

"Where is the evidence that "natural unemployment" is less than 6%?"

As unemployment fell during the 90s, it appeared to me as if inflation fell when unemployment was around the 6% region, stabilized at about 5% and rose at 4% or less (allowing for lags). Remember that the Fed was mostly fighting inflation for the 80's and 90's, so we did not get a real taste of having natural employment for any length of time. Also some of those who stopped seeking jobs will start looking again, so you can add jobs without affecting the rate so much.

Perhaps it will turn out that the internet has permanently affected the unemployment rate by a small amount through better communication between employers and job seekers.

Posted by: snsterling on October 7, 2003 06:41 AM

Imho there's a big forest-for-the-trees problem going on now in Berner's analysis. Though no one loves America more than I do, I'm very bearish on it economically at the moment.

What I fail to hear anyone mention is the frightening place we're in with regard to stimulus and the expected effects thereof. Borrowing rates are and have been for some time at the essentially "free money" level. And yet we still don't see clear recovery. The refi explosion has put however many billions into consumers' pockets. And yet we still don't see recovery. Fat, misguided business should have retooled after the bubble burst. Many did, but with layoffs, increased productivity and global labor arbitrage. Bush has has cut taxes three times. And yet no recovery. (Though the evidence is now pretty indisputable that those tax cuts are only meant as a way to put money into the affluent's pockets, and have next to no economic potency).

By all counts given the amount of stimulus, the economy should be rocking and rolling by now (even if only on the back of mountains of debt).

But it's not. Which really frightens me. Because now we're out of ammo. It's like you live next to a big river that is flooding and coming into your house. You use all the tape and plastic you can and you manage to stay dry longer than you might have. But that river's eventually going to get in because the forces are too strong.

We've used our tape and our plastic, paid for it on our credit card, and now as a nation we're left with the debt and all its economy-destroying potential, from rising interest rates to housing bubble bursts to increasing bankruptcies and foreclosures to potential bank failures because of non-performing mortgages, to a spiraling dollar-equities market decline to vigorous stagflation as Bernake begins the "hard" (money printing) reflation and debt-service process to the ensuing sucking sound of the flight-to-relative-quality of foreign investment as they watch us finally have to grapple with our stupid decisions. Add agressive globalization into the soup and it's hard to have much confidence in the future of the US economy, imho.

Posted by: Henry Beckett on October 7, 2003 10:22 AM

Henry, I disagree with your doom and gloom. We are in economic expansion. However, the idiot Bush is only collecting 16.3% of GDP as revenue. Clinton collected over 20% of GDP. You are correct about the enormous transfer of wealth from the US treasury to the very affluent who are supporting Mr. Bush with campaign contributions.

All we really need is a president who is
1) willing to collect the revenue,
2) willing to put the revenue to work to
a) build infrastructure
b) invest in worker training
c) fix health care to make American workers more affordable

This is what competent economists have been suggesting (in some form or another) since the recession first started. This is what our incompetent policy makers in DC have not even tried.

The money is there. Lord knows there are plenty of jobs that need doing. All it takes is the political will to tell the rich that they are responsible for building a better America and that they need to invest so they can continue to benefit in the future.

I often ask the question, would you rather pay 40% in taxes and make $2 million or pay 20% and only make $1 million? If you were taxed at 40%, you would take home $1.2 million. If you were taxed at 20% you would take home only 0.8 million. It is easier to make money in an economy that is healthy, with a healthy and well educated work force and basic infrastructure in place, than it is to make money in a poor country with little infrastructure.

Posted by: bakho on October 7, 2003 11:57 AM

There really is no "natural rate" of unemployment. The Fed targets an unemployment rate with its monetary policy. The Fed would like to target a lower rate but they are out of ammunition. That is why they need the pols to apply an appropriate fiscal stimulus. The pols have dropped the ball.

BTW- 4% of GDP is over $400 billion. At $50,000 per job, that could create 20 million jobs which is way more than we need. Besides, we are paying out billions in unemployment anyway. THE MONEY IS THERE. THE WILL IS LACKING.

Posted by: bakho on October 7, 2003 12:03 PM

- But what's so wrong with longer term 1-1.5% growth in the already huge US economy? Where is the evidence that "natural unemployment" is less than 6%? -

What is so wrong, is that employment will continue to fall as long as GDP growth is below the growth of population and productivity. We need to grow at 4% to simply maintain the poor employment we have now. The 60s and 90s offer ample evidence that the natural rate of unemployment is less than 4%.

If you enjoy the idea of America's middle class being continually threatened, then 1% to 1.5% GDP growth is fine. I find the prospect frightening.

Posted by: anne on October 7, 2003 12:28 PM

bakho -

I think we are in agreement more than you stipulate in your opening sentence. Before elucidating I must point out that you refuted none of the economic broadstrokes view of the situation as I see it. To say "we are in an expansion" is at best unclear, and at worst misses the point. Not even the most mendacious Bushies can claim this "expansion" is anything more than a business cycle upturn, and a damn weak one at that, especially given the amount of stimulus thrown at the problem. But a simple GDP growth argument misses the broader point, which I think gets to where we agree: Where the GDP goes is vitally important for exactly the reasons you cite: The money is there, the jobs are there, America still has the best financial systems and entreprenurial support in the world.

But where's the investment in our future? Where's the investment in education, the environment, energy dependency reduction, all kinds of infrastructure, health care expenditure efficiency? At present the "investment" is going to fatten the rich people the Bushies like and to kill people they don't like. We're not even "investing" to be able to pay off our entitlement obligations when they come due.

Now, it's sort of obvious to say that if we just elect someone else who's willing to do the right things everything could theoetically turn around and get us back on track. So with that part of your argument I agree (Go Dean!).

But there's one big hurdle: the ignorance of the American voting public. They're responsible for getting themselves into this fracaso. That's to me the the biggest challenge facing us: to get people to understand how the policies of the people they vote for will affect their lives. (How could anyone with children in public school, who pay for health care, either as an employer or a citizen, who make less than $300,000/yr, who breathe air or drink water, who hope to retire someday, who hope to pass on a better or safer world to their children vote for these Bush crooks?)

So go forth and discuss with non-millionaire clueless Republicans how policies affect their day-to-day lives and the implications for their own and their childrens' futures. Often, if everyone comes into the conversation with an open mind, awakenings can be evoked and minds changed.

So I agree, the will is lacking. We've got to change that, and quickly. Four more years of this Fascist administration and congressional majority and we'll probably be looking at the reinstitution of slavery, with Tom Delay and Trent Lott leading the charge and Rush Limbaugh handling marketing.

In the meantime, back to economics for a second: I want to hear someone make a convincing argument about why the US is the best place to invest one's hard-earned money over the short- to medium-term.

Posted by: Henry Beckett on October 7, 2003 01:13 PM

Where is the investment in our future?

Great question. This is the message that needs to be driven to the voters.

I think that most voters "get it". The CBS/NYT poll Oct 3 gives Bush 37% approval on economy and 56% disapproval. 32% give jobs and the economy as the top priority. 37% say right direction, 56% say wrong track.

How would you rate the condition of the national economy these days? Is it very good, fairly good, fairly bad or very bad?
Very good 4%
Fairly good 39
Fairly bad 37
Very bad 19
Don't know 1

Do you think the economy is getting better, getting worse or staying about the same?
Getting better 24%
Getting worse 29
Staying the same 46
Don't know 1

People may not know why Bush policy is not working, but we do know it is not working.

Posted by: bakho on October 7, 2003 02:55 PM

As for the voters, Mr Bush did not run on tanking the economy. He ran on tax cuts and prosperity. How were voters to know he would ignore sound economic advice and launch a major flattening of the US tax code? Now we know.

If he does not deliver, he will not be reelected.

Posted by: bakho on October 7, 2003 02:59 PM

Polls have shown public opinion toward President Bush souring over his handling of the economy and Iraq. But an item tucked away in last week's CBS News/New York Times poll adds insult to injury. Despite three tax cuts in as many years, only 19 percent said Bush's policies made their taxes go down. Forty-seven percent noticed no effect, while 29 percent perceived that their taxes have gone up.

See we do get it. Tax cuts are for the wealthy.

Posted by: bakho on October 7, 2003 03:10 PM

All great arguments, and let's hope your numbers hold up or improve by election time! (And there's no indication this administration is capable of doing anything right, so hopefully you'll be spot on.)

Posted by: Henry on October 7, 2003 05:57 PM

On question of what will sustain trend or above trend growth: 1: look at the income data, without tax cuts or morgage refinancing consumer does not have ability to sustain good spending.
2: in our open economy question that seems to be ignored by almost everyone one is that because of international leakages, second round or Keynesian multipliers of monetary and fiscal policy much weaker than historical norms. over past decasd one third of growth in real final domestic demand filled with imports. We are doing a poor job of stimulating our economy but a good job of stimulating Chinese economy.

Posted by: Spencer England on October 8, 2003 06:16 AM

But Spencer why is that? The investor class invests in the global market. The best returns on investment are overseas. Plus the steel tariffs have made it attactive to expand steel parts production overseas where there is access to cheap steel. Giving the money to the investment class is a poor domestic stimulus. Very little of the tax cut money goes to the lowest levels of the population that are most likely to spend it in ways that stimulate the economy.

A much stronger domestic stimulus could be had by investing directly in the future of our domestic economy (workforce training, infrastructure, healthy workforce). This is why the administration tax cut policy is not working to create jobs.

Posted by: bakho on October 8, 2003 06:22 AM
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