Time To Worry?

Not yet: The U.S. economy still has plenty of strengths going for it.

By Stephen Happel

It’s tough being an optimist for the next few quarters when it comes to forecasting the U.S. economy. But let me give it a shot.

U.S. GDP growth in first quarter 2007 was .6%—not a pretty number. Naturally, everyone pointed to the housing sector. Yet a significant part of the slowdown was the result of unexpected inventory adjustments and slower consumer spending. However, the revised second quarter growth rate was a booming 4.0%. Consequently, growth over the first half of 2007 turned out to be an annualized 2.3%.

The Blue Chip consensus forecast in September for overall growth in 2007 was 2.0%. In other words, these 50 top forecasters in consensus anticipated growth over the second half of 2007 to be an unremarkable 1.7%. I disagree for a variety of reasons.

Before I go into why, keep two points in mind. First, since the sharp downturn in the U.S. economy in 1982, the U.S. has experienced only two minor recessions (1991 and 2001). Real GDP growth averaged 3.3% from 1982 to 2002, and a number of economists today (including Ben Bernanke) refer to the post-1982 era as the “Great Moderation.” The U.S. economy is remarkably more stable than at any time in its history and rebounds more quickly from shocks.

Second, since 1987 the world economy has not experienced a recession. Think about that! Over this 20-year period, worldwide real GDP growth has averaged a strong 3.7%. This bodes well for the U.S. economy, since free trade is sweeping the world.

U.S. Economic Strengths
Coming back to the present, over the past year the housing problems have subtracted 1.0% from U.S. growth, whereas previously housing was adding 1.0%. This explains why growth today is closer to 2.0% than 4.0%. So where has the strength of the U.S. economy been?

Let’s start with the consumer. Nearly 70% of GDP is consumer spending. After a five-year run-up, it finally slowed down in the fourth quarter of 2006 and the first quarter of 2007. Then it rebounded in the second quarter. Those predicting slow growth or recession believe that consumer spending will be tepid the next several quarters for a number of reasons: Houses no longer can be used as ATM machines to withdraw cash for a host of purchases, rising energy costs will eat into discretionary income, and labor markets are about to go into the tank. Maybe.

Another factor contributing to the U.S. growth has been the sharp increase in exports due to the weakened dollar. Estimates are that net export growth has contributed 1.4% to real GDP growth over the past year.

A third area of strength has been corporate earnings. They grew at double-digit levels from 2003 through 2006 and contributed to the commercial building boom the past three years and to the strong employment numbers. Remarkably, in August 2007 the Bureau of Labor Statistics originally reported a loss of 4,000 non-agricultural jobs, then revised it upward to over 80,000 new jobs!

Finally, remember that the Federal Reserve stepped forward with a big rate cut in September and cut the federal funds rate again at the end of October. It recognizes that raising rates at this time in order to fight inflation will have negative consequences right now.

Positive Signs Heading into ’08
So, is it a time to worry? Again, maybe. The housing numbers seem to get worse every week. Corporate profits were projected by the Blue Chip crowd to increase only 3.4% in 2007. American consumers are hesitant. Jobless claims are on the rise, and the stock market has had some terrible weeks.

But take heart. Never underestimate the American consumer, especially baby boomers. We love to spend and will continue to do so until we drop. Yes, the overall employment numbers are down, but jobs are still being created, and this serves as the backbone of consumer spending. Even with the decline in housing prices, household net wealth is near record highs.

Also, the world economy remains strong, and with the weak dollar, U.S. export growth will continue to flourish. Prices of U.S. imports are edging up, helping to shrink the trade deficit.

The Fed will continue to cut rates, as a credit-led recession seems a reasonable possibility. Leading American banks are establishing a fund to trade mortgage-backed securities, thereby giving greater transparency to this market and reducing the chances for a credit freeze throughout the economy. Expect all kinds of government action to protect a host of people from losing their homes due to the fallout of the sub-prime mess.

All things considered, I would not be surprised if growth in the last two quarters of 2007 comes in at 3.0%. If so, overall growth in 2007 will be in the 2.5% range rather than 2.0%. After the stock market crash of 1987, the recession of 1991, the Asian contagion/Russian bond default/long term capital management collapse of 1997-98, the dot-com crash of 2000, and the recession of 2001 with 9/11 thrown in, many forecasters predicted major recessions, yet they never materialized.

It is not a time to be Pollyanna. But it is also not a time to worry yourself to death over an impending plunge in the U.S.