Economic Forces Influencing Trends in US Financial Markets
Pan American Fellows Program
June 21, 2002
Adjunct Senior Fellow, Council on Foreign Relations
Senior Economic Adviser, HVB America, Inc.
US Economic Activity
Recovery is proceeding at a far more moderate pace than suggested by the sharp increase in first quarter GDP. It was distorted by a huge inventory swing that is not going to be repeated.
The much more restrained growth in real domestic final demand (simply total GDP less inventory changes) is indicative of the true underlying pattern.
Our real GDP forecast is for growth to average 2 ½% to 2 3/4% per annum over the next year, a more conservative prediction than the consensus (which has been revised down a lot recently but is still above 3%).
Note: Each page of summary points is followed by a page or two of related charts and tables.
The main reason for our caution is that there are many imbalances in the US economic situation that will impede dynamic growth.
Manufacturing has come off the bottom but is still very weak.
A tremendous decline in business fixed investment has been responsible for this weakness. This was primarily concentrated in high tech industries, especially telecoms, but has affected a wide range of capital goods producers outside high tech, too.
Importantly, there has also been a huge drop in commercial construction.
While this has not received much, if any, media attention, the magnitude and speed of the commercial real estate contraction is almost as severe as in the early 1990s, in the aftermath of the well-known banking problems of that era.
The reason why the US recession turned out to be so short and mild last year is the American consumer. Consumption expenditures and a brisk housing market were the key factors triggering the business recovery.
Naturally, the disruption that followed the 9/11 terrorist attack briefly held back spending. But by October 2001, the aggressive efforts by auto makers to unload excess inventories, through financing incentives and steep price discounting, had spurred an unprecedented spurt of motor vehicles purchases.
Early this year, the historic warm winter weather encouraged other forms of retail sales.
Those stimulants are over. More recently, retailing has settled into a more erratic pattern, with only Wal-Mart showing persistently strong sales. K-mart, by contrast, had to file for bankruptcy and has already closed down many outlets, while several other large chains are still struggling, notably JC Penny.
Household debt burdens have gone up to worrisome levels, and the personal bankruptcy rate has soared to 1.5 million over the past year. By comparison, personal bankruptices averaged just 300 thousand a year a decade ago.
Residential housing has been the main beneficiary of the extraordinarily easy monetary policy pursued by the Federal Reserve, pursued at first to cushion against recession and then to stabilize markets after the terrorist attack.
Housing starts, new and existing home sales, and home prices all reflect this.
In 2001, the median price of existing homes went up by 8%. This price inflation has slowed so far this year, but is still running about 7% except in some individual local markets hardest hit by the collapse of the dot.com bubble. But even in markets such as San Jose, CA, median prices are not falling, only the prices at the high end of the market.
The main impediment to genuinely dynamic growth in the US economy is the poor job market.
The unemployment rate climbed about 2 percentage points from the lows reached in late 2000. Close to 1 1/2 million jobs have been lost.
The labor market has been trying to bottom out this year but is hardly back to full health. Weekly initial claims for unemployment insurance compensation have come down to just under 400,000 a week, from 450,000 a couple months ago. And total hours worked, both in manufacturing and in the private sector generally, have increased moderately.
But the US is far away from generating the 250,000 per month employment gains in the service producing industries common in the late 1990s.
While most job losses have been in manufacturing, incremental demand for office space is acutely dependent on a revival in employment growth in those service producing industries.
US businesses have achieved tremendous gains in productivity, mainly by shedding workers.
Output per hour rose throughout the recession and at an accelerating pace after September, when many employers took advantage of the situation to make substantial job cuts.
With the rise in the unemployment rate tempering wage demands and worker productivity soaring, unit labor costs actually fell.
This performance may not be sustainable. But there are still numerous companies that face competitive pressures and are maintaining tight hiring standards.
US trade and current-account deficits have reached levels that are viewed as unsustainable to many policy makers.
The dollar has embarked on a significant correction that still has a long way to go.
But that will not immediately improve the external deficit.
The most important swing factor in US financial markets is the method by which the current-account deficit is financed. A prolonged period of dollar weakness threatens longer maturity debt obligations, especially corporate and mortgage-backed securities, even more than the US stock market.