Friday, February 20, 2009

When will the economic storm calm?

Paul Krugman writes a nice piece (hat tip, Mark Thoma) about how the U.S. economy will eventually emerge from its recessionary depths. However, it occurs to me that another question should be: when will the economy emerge from the depths? And unless one is prescient, nobody can truly answer that question. But key surveys on construction, sentiment, and manufacturing indicate that it may be a while. An excerpt from Paul Krugman's op-ed piece in the NY Times:
So will our slump go on forever? No. In fact, the seeds of eventual recovery are already being planted.

Consider housing starts, which have fallen to their lowest level in 50 years. That’s bad news for the near term. It means that spending on construction will fall even more. But it also means that the supply of houses is lagging behind population growth, which will eventually prompt a housing revival.

Or consider the plunge in auto sales. Again, that’s bad news for the near term. But at current sales rates, as the finance blog Calculated Risk points out, it would take about 27 years to replace the existing stock of vehicles. Most cars will be junked long before that, either because they’ve worn out or because they’ve become obsolete, so we’re building up a pent-up demand for cars.

The same story can be told for durable goods and assets throughout the economy: given time, the current slump will end itself, the way slumps did in the 19th century. As I said, this may be your great-great-grandfather’s recession. But recovery may be a long time coming.
I couldn't agree more: that population growth and household formation will eventually force a recovery in durable goods sales (autos) and home contruction. But furthermore, small level changes can add a lot to GDP growth.

Think about it. New home construction in January was an anemic 466k (which is an annual rate), down a whopping 17% in just one month or 56.2% since one year ago. Impressively, residential construction was just 3.1% of GDP in the fourth quarter of 2008 (Q4 2008), but still snatched 0.85% from overall economic growth (the contribution to growth table here). Since residential construction is nearing zero, small level increases of new construction means big percentage changes and large contributions to GDP growth. Same for autos.

So as soon as homebuilders and automakers get going again, then GDP (domestic production) has a chance at stabilization. But when will that happen? When will the pain stop?

Unfortunately, the headline monthly reports - like housing starts, vehicle sales, inventories, trade, home values, personal income - are all lagged reports by at least one month. Out of the big monthly reports, the employment report is the first to be released; and by the time the release occurs (Feb. 6 for the January employment report), the data is really just a quasi-monthly report because the survey ends the week including the 12th day of the month. So the BLS payroll for January is really data for the December 15 through the week including January 12th. Not a lot of help there.

However, survey reports by managers, builders, or consumers are generally released during that month and can serve to lead sectoral stabilization before it actually occurs.

The National Association of Homebuilders conducts a monthly survey of homebuilding sentiment to construct the Housing Market Index (HMI). In February, the HMI increased by 1 point to 9 from its Jan. record low. An HMI above 50 implies that sales conditions are generally good, while an HMI below 50 indicates poor sales conditions; 9 is bad. Homebuilders are worried about imminent foreclosures, and the government's ability to stem the negative effects from the housing market. Not a lot of hope for new building in the near term.

Regional Fed indices on business sentiment indicate continued stress in manufacturing (auto sales obviously included here). The NY Fed and the Philly Fed have already released their February indices; both tumbled over the month. The NY Fed's regional manufacturers said that the 6-month outlook was grim, while the Philly Fed regional manufacturers are more optimistic about the 6-month outlook. I await the Chicago PMI release, but not a lot of hope for a near-term recovery in manufacturing.

The University of Michigan released the preliminary results of its consumer sentiment survey for February. The headline sentiment index dropped to a record low of 56.2. Consumers were probably a little gloomy about the recent bump in gas prices, and sentiment for the "months ahead" dropped to its lowest level since 1980. Some found some less-gloomy results of the survey, and highlight that consumers are liking the buying conditions in housing.

Unfortunately, I don't see a lot of hope in the near term, and neither do Calculated Risk nor Mark Thoma. And furthermore, once these indicators start to increase - unless the increase is more like a sharp surge - the omen will be more of a less quick contraction rather than a recovery.

It will be interesting to see the magnitude effect of the fiscal stimulus on the macroeconomy, because in reality nobody knows.

Rebecca Wilder


  1. One thing that has caught my attention is the closing number on the NYSE. Yesterday it went through the Nov. bottom to 1982 levels. The fact that the bottom didn't hold means there will be some problem until it does for further testing. I don't think we can just look at the economic indicators without factoring in the stock prices which will drive peoples financial holdings which tells them what they can afford to buy.

  2. Hi Janie,

    In the last recession, equity markets bottomed well after the economy did.

    I agree - wealth (or further destruction of) is an important draw on consumption in this cycle. However, I imagine that in relation to consumer spending, the drag form precipitously declining home equity has probably been a bigger drag than that of equities.


  3. Cycle? Elliott Wave talks of something called a Grand Super Cycle, different from the so called business cycle. Yes, it is bigger, and different rules apply. It can be measured in decades.

  4. Hey Rebecca,

    I think you've reiterated the ultimate question everyone wants to know: "when." By now every economists has reassured the country that the recession will end -- we've heard yearly estimates -- but it seems you've provided us with some indicators that will give us a more reliable approximation.

    Should we be keeping our eyes out for housing starts and vehicle sales specifically for the best indication for a turnaround? If not, which indicators?

    As far as the potential impact of the stimulus, I think you hit the nail on the head: "in reality nobody knows."

    Nice post, look forward to hearing from you,

  5. If Obama can keep a real handle on the spending in the stimulus like he said this morning, there may be a greater chance for it to work.
    Thanks for the clarification on equities/economy. I'm not sure I agree in this case but... that's history.

  6. I think within a week we will see Citicorp nationalized...just a wild out of the box prediction...and Tim Manni...there is a great visual chart of past bear markets inclusive of the current one on Calculated will put the past the present in visual perspective.

  7. "population growth and household formation will eventually force a recovery in durable goods sales (autos) and home construction"

    Of course, the US might repeat the fertility and immigration patterns of the Great Depression when the total population increase in actual numbers during the 1930s decade was almost half of the numbers of the 1920s. In the 1920s, immigration played a big role because fertility rates were already declining. In the 30s, fertility rates declined even further plus there was a decline in immigration. Additionally, Roosevelt exacerbated the population growth and demand problem in an attempt to increase jobs for US citizens under his works programs by deporting many non-us citizens, especially Mexican Americans.

    With the current poor economy, births and immigration will decrease. In addition, many legal and illegal workers in this country will return to their home countries and new immigrants will delay coming to the US because of lack of opportunity. Plus, the stimulus and TARP laws make it more difficult for immigrants to come to the US and find work. The TARP law restricts immigrant work Visas and the stimulus law requires union membership for some projects, which will prevent non-union legal immigrants from working on those stimulus projects, which will encourage emigration and discourage new immigration. Also, some US citizens will seek work outside of the US.

    With the decrease in new immigrants, the increase in emigration and with lower birth rates, household formation and population growth will not restart this economy in any reasonable period. From 1945-1950 the birth rate skyrocketed in the US due to the returning GIs. It was this huge increase in household formations and births and its subsequent continuation that kick started and sustained the US economy. Our recent population growth and household formation is especially dependent on immigrants who tend to have larger families than US born residents. The loss of new immigrants due to the lack of job opportunities will magnify our demand problem through a lack of births, population growth and household formation.

    When the war spending abruptly ended at the end of the war, it caused a decline in the US economy. The prevailing opinion at the time was that the US would see a continuing decline in its economy after the war, which it did as the war spending stopped. If not for the surge in new households and births, the US economy would probably have entered another severe recession at that time. Unfortunately, government stimulus spending does not cause long-term growth. It tends to delay recovery. Other countries that were not as aggressive as Roosevelt was on stimulus spending and government involvement in the economy saw a less severe downturn and a much faster recovery than the US during the depression years.

  8. That's one reason the FED should have kept the debit series. It is as I said: It is mathematically impossible to miss an economic forecast (no matter how that sounds). I.e., economic lags do not vary at all. I.e., MV=PT is a truism.

    The FED's best technicians agree that bank debits & legal reserves, parallel gdp (nominal, real, and the deflator).

    If they had studied these relationships, the U.S. wouldn't have, and would not ever have, economic bubbles (as long as the full faith and credit of the government was unimpaired).

    These economists would have also found that the fed's reconstruction of legal reserves and the monetary base had a number of years where their calculations were in error.

  9. The 1966 housing industry’s collapse resulted in the still unprecedented, and unrepeated, Congressional action of:

    authorizing the Federal Reserve Banks to make their credit facilities available (discount window), through the member banks, to the (1) mutual savings banks and the (2) savings and loan associations.

    Only the investment banks were given this safety net in the current down turn.

  10. The segmented control of the credit markets can be accomplished through indirect rather than direct control (not the FED or the TREASURY); by reducing the volume of time deposits held by the commercial banks, and by reducing the over-all volume of bank credit.

    I.e., the Board of Governors has the power to selectively change the time deposit/demand deposit mix (each deposit classification ceiling).

    The proper public policy calls for establishing deposit rate ceilings for the commercial banks (not the non-banks). Existing ceilings should be lowered-gradually.

    This would reduce bank costs, increase bank profits; and stimulate an increased flow of funds through the savings and loan association and the mutual savings banks (the financial intermediaries).

    It would increase the supply of loan funds in the long-term markets, and lower long-term interest rates.

    There would then be no need for the massive infusions of government credit (& other emergency measures), to relieve the unavailability, & cost of affordable mortgage money.

    Because this will never happen, we will have to nationalize the banks.

  11. In 1966, the FED was forced by the Viet Name War, to pursue a tight money policy & allowed CB credit to grow at a 6% reduced clip, relative to 7% in the preceding 10 years, or the 5% since World War II.

    During the same period S&L mortgages grew $3.8b in 66, compared to $8.9b in 65, $10.4b in 64, & $12.1b in 63.

    On the other hand, CB non-farm mortgages expanded by $5.5b in 66, $4.5b in 65, $4.2 in 64, & $4.6 in 63.

    The inequitable distribution of available credit during the housing crisis of 1966 was the direct result of the 5 successive raises in interest rate ceilings for the CBs beginning Jan 1, 1957, culminating in the disastrous increase to (5 ½) percent on Dec 1966--which was unique in that it was the first one that allowed CBs to pay higher rates than the thrifts could competitively pay (i.e., in order to bail out New York City banks & because market rates had risen & they could not replace their large negotiable cds).


    Jul 20, 1966 was the first reduction in interest rate ceilings (REG Q) on time deposits since Feb 1, 1935.

    A second reduction was made in Sept 1966. The reversal and restoration of a rate advantage to the financial intermediaries gradually stimulated residential construction and the housing market gradually recovered (and time deposits in commercial banks dropped from 105% of demand deposits to 98% of demand deposits which had a favorable effect on CB profits).

    Raising interest ceilings on time deposits simply allowed the banks to increase their expenses with no concomitant increase in income. The earning assets held by the commercial banks, from a system standpoint, are not the result of the growth of time deposits.

    The sequence is not from time deposits to earning assets, rather the sequence is from earning assets and new demand deposits (these two come into being simultaneously), and from “old” demand deposits (which the public has savings ) to time deposits.

    Note: The DIDMCA of March 31st 1980created the legal basis for the addition of 38,000 commercial banks to the 14,000 we already had and the abolition of 38,000 financial intermediaries.

  12. I liked Milton's comments on recovery based on people in the system, but birth rates down, immigrants going back to home country, new ones not coming, etc.

    I would also add, I wonder the change in psyche between people needing the newest thing all the time to "hey I can do without that new widget, my life didn't end without it". How long is this thought change for a significant percentage of people and are we there yet? My wife and I have always been thrifty and felt it was all those mall shoppers that kept this bubble going. I'm sure manufacturers are horrified at this change in thinking.

    Brant, east of Atlanta, GA


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