From football fantasy to financial calamity,
and parts in between, economist Sean Snaith explores – and forecasts – our state of recessION, regulation, restraint and recovery.
The news that broke in January surrounding Notre Dame linebacker Manti Te’o may be one of the strangest stories to come out of college football in my lifetime. When Dr. Phil is covering a story about a finalist for the Heisman Trophy, which is emblematic of the sport’s top performer, you know something has gone terribly awry.
Manti had told several media outlets in fall 2012 that both his grandmother and his girlfriend, a Stanford student named Lennay Kekua, had died on Sept. 11. A double tragedy that would be difficult for anyone to endure, Manti’s story had additional gravitas because of the echoes of the classic novel and 1970 film Love Story. Manti’s girlfriend had died of leukemia but had earlier urged him to play on, no matter what her fate might be.
Before the bidding war on the movie rights to this story could get underway, it all came crashing down around Te’o. His girlfriend, you see, did not die of leukemia, as he had thought. She didn’t die because she never existed. She was not real. Apparently, she was a hoax perpetrated on the gullible young man by another young man and possibly some accomplices.
Manti had carried out the relationship with someone he thought was Lennay Kekua, strictly online and over the phone. He never actually met the young woman in person. The photos he thought were of her were of another young woman, and the person he thought he was talking to on the phone was not her but the perpetrator(s) of the hoax.
Incredible as this story might sound, it is a product of our technological era. And, yes, there is an economic tie. Promise.
Electronic communication enables people to assume personas that are complete fabrications. While this episode went a bit further than placing a fake personal ad on a dating site, it is nonetheless common and, indeed, has a name: “catfishing.” According to the Urban Dictionary, a “catfish” is someone who uses social media to create false identities to pretend to be someone they are not, particularly to pursue deceptive online romances.
CATFISHED BY INFLATION
OK, now about the economy.
The Federal Reserve Bank has been making news, as well, in its efforts to combat the recession, financial crisis, housing crisis and their aftermath. The Fed very quickly cut its key policy rate, the federal funds rate, effectively to zero by the end of 2008. With no room left to stimulate the economy via lowering the federal funds rate, the Fed embarked in December 2008 on a first round of “quantitative easing,” or QE1. The Fed purchased $600 billion of agency mortgage-backed securities and agency debt. They extended the program in 2009, and by March 2010 the Fed had purchased $1.25 trillion of mortgage-backed securities and $300 billion in U.S. treasury securities.
The economy did not respond to these purchases and the recovery remained weak. In fall 2010, the Fed announced a second round of quantitative easing, focusing on longer-term treasury bonds. The $600 billion purchase of bonds, dubbed QE2, was intended to lower longer-term interest rates and boost the pace of the economic recovery.
In September 2012, the Fed announced the third round of quantitative easing, QE3. This round would involve additional purchases of mortgage-backed securities, but there is no limit to the amount of money the Fed spends. Rather, QE3 is an open-ended purchase of $40 billion per month until the economy, and more particularly the labor market, improves substantially.
In December, as this “Operation Twist”—designed to twist the yield curve by lowering long-range rates and raising short-term rates—was concluding, the Fed announced it would continue to purchase longer-term treasury securities at a pace of $45 billion per month, bringing open-ended purchases of bonds to a total of $85 billion per month.
The cumulative effect of quantitative easing on the size of the Federal Reserve’s balance sheet has been tremendous. These various rounds of quantitative easing led to ongoing predictions that inflation would be unleashed and accusations that the Fed was “printing money” and monetizing the government’s debt.
As a result of all these purchases, the Fed’s balance sheet grew from $800 billion at the start of QE1 to $3.1 trillion in March, a near quadrupling in size. These asset purchases helped provide liquidity to banks and kept prices of bonds higher (and thus kept yields lower).
Monetary technicalities and nuances aside, that brings us to inflation. Or lack thereof. While many people believe the lower the rate of inflation, the better the market is for consumers, this isn’t necessarily true. The Fed’s plan, in fact, has been to use resources like the central bank to create and maintain certain levels of inflation, on an as-needed basis for the economy. The problem, however, is that after more than four years since the Fed embarked on the first round of QE, and after more than $2 trillion in asset purchases, there is no real sign of inflation taking hold in the economy.
It is as if inflation were the economy’s version of Manti Te’o’s girlfriend—a figment of the imagination, something that should exist, but upon looking deeper, just isn’t there. We know who pulled the wool over Manti Te’o’s eyes. But who or what is responsible for catfishing us on inflation?
Until more loans are applied for and approved and the economy moves closer to full employment, the impact of quantitative easing on the money supply will remain much smaller than would otherwise be the case. And the specter of inflation will remain as intangible as Manti Te’o’s girlfriend.
THE ANXIOUS INDEX
The most recent release (first-quarter 2013) of the Survey of Professional Forecasters by the Federal Reserve Bank of Philadelphia reveals that the 41 forecasters surveyed were 17.99 percent convinced a decline in real GDP will occur in second-quarter 2013. This reflects forecasters’ receding anxiety despite a recovery that has lost momentum. The avoidance of the full impact of the fiscal cliff knocking the economy back into recession may have eased these economists’ worries. The fourth-quarter 2012 anxious index (a term coined by New York Times reporter David Leonhardt) was 23.04 percent, the highest value since third-quarter 2009, as a sign of real fiscal-cliff worry.
The forecasters also reported a 15.32 percent chance that we were, as of first-quarter 2013, in a recession. According to the panel, the probability that we will fall back into recession is averaging near 15 percent through the end of first-quarter 2014, which implies the possibility of a recession in the upcoming year has decreased since the previous survey. And notably, the decline in anxiety over the future of this economic recovery comes in the wake of another weak report on real GDP growth in fourth-quarter 2012 (0.1 percent). That came after a third-quarter growth rate of 3.1 percent.
The bottom line: Current levels of the anxious index are above the average level during this economic recovery and, while they are more than 5 points lower than the previous quarter, the volatility of the index over the course of the recovery is a testament to uncertainty.
GDP OUTLOOK
2012 ended not with a bang but with a whimper. Real GDP growth was barely perceptible at just 0.1 percent. At the start of 2013, growth was likely to remain subdued as consumers adjusted to smaller take-home pay due to the expiration of payroll tax cuts. This burden on the consumer was just an addition to the ongoing struggles in the labor market and the lost wealth that has plagued many consumers, as housing prices have plunged in many areas of the country.
In this recovery, the first three full years of real GDP growth in the economy will average just 2.1 percent. This is a full 0.5 percent slower than the first three years after the 2001 recession and 1.3 percent slower than the first three years after the 1990-1991 recession.
Also, the economic policy uncertainty has hampered the GDP. The levels of uncertainty during the Great Recession were already significantly higher than during the prior two recessions. And uncertainty continues to rise, which only lowers the prospect of economic growth and job creation gaining momentum. This fact, perhaps as much as anything else, can explain why the economic recovery we are experiencing is as weak as it has been. Looking further into 2013, the pace of economic recovery isn’t likely to show an improvement. We are anticipating growth of just 1.6 percent—coming from a combination of the sequestration cuts, rising payroll taxes and very weak momentum from fourth-quarter 2012.
The full fiscal cliff may have been avoided, but spending cuts and revenue hikes will hinder growth as will the rollout of healthcare reform and Dodd-Frank financial regulatory reform. All of these will be albatrosses of uncertainty around the economy’s neck and will keep growth subdued this year.
In 2014, as uncertainty abates and wounds from the housing crisis continues to heal, real GDP growth will accelerate to 2.8 percent. Growth will remain on the rise in 2015, reaching 3.3 percent before easing to 2.7 percent in 2016.
EURO WOES
A major risk that could derail recovery is the ongoing sovereign debt crisis in Europe. Call it a train wreck in slow motion. The crisis has been out of sight for several months, as the fiscal issues and Presidential election dominated the U.S. media, Out of sight, though, doesn’t mean the crisis is over. Recent political developments in Italy may actually stoke the flames of these crises once again.
I still expect Greece will ultimately leave the common currency, quite possibly in the upcoming year. But if the crisis accelerates and other countries begin to fall out of the Eurozone, the result would be further deepening of an already persistent EU recession. This would create turmoil in financial markets that would impact the U.S. economy. This could also send us back into recession.
The bottom line in the Eurozone is that one cannot solve a long-run fiscal problem with monetary policy. The purchases of debt by the ECB might quell fears of financial markets temporarily and provide strapped nations with needed liquidity; yet they cannot solve the heart of the problem, which are widely divergent patterns of government spending and taxation in Northern and Southern Europe. This liquidity is like a topical balm that might ease the pain of arthritis in the knee, but the cure would require replacement of the joint. Fiscal reform in the Eurozone will be as difficult as joint replacement, but it will ultimately be needed if the Euro is to survive.
CONSUMER SPENDING
Years ago, I suggested the shape of the U.S. economic recovery wasn’t going to be V-shaped, but rather we would have a gravy-boat-shaped recovery. The spout of a gravy boat is long and gradual, and I suggested this is how the recovery would unfold. As it turns out, the U.S. recovery has been slow and protracted.
The reason for my prognostication and for our underwhelming recovery is one and the same: U.S. consumers, who account for 70 percent of GDP were, and are, simply not in a position to lead a robust recovery. Lost wealth in the housing market and a persistently weak labor market recovery have forced consumers to continue to be cautious with spending, as they continue to nurse the wounds on their balance sheets.
In the 1970s and 1980s, average real consumption growth of 4 percent-plus characterized the recoveries. In the 1990s, the growth was on average greater than 3.8 percent. Consumption growth thus far in the recovery, as well as forecasted through the end of 2016, is expected to average just 2.3 percent, well below the consumer spending growth of previous recoveries.
Quarterly reviews of consumer spending show a pattern about this recovery that has persisted over the past several years—consumers spend at a higher pace for a quarter or two only to pull back in subsequent quarters. As the recovery progresses, I expect the pace of spending will stabilize at levels of consumption still much lower than in previous recoveries.
INVESTMENT OVERVIEW
Nonresidential fixed investment spending grew at 8.6 percent in 2011 and 7.8 percent in 2012. Businesses have been very profitable for several years and interest rates are historically low, but uncertainty has many firms moving forward on investment with great caution. Policy uncertainty has again risen over the past few months, as noted, and weighs on these investment decisions. Consequently, investment growth will be just 3.6 percent in 2013. Spending will accelerate in 2014, with investment growing at 7.0 percent, and expand at 7.8 percent in 2015 before easing to 4.5 percent in 2016.
The cost of borrowing will remain subdued for an extended period, given the Federal Reserve’s stated commitment to low interest rates through mid-2015. I expect the 10-year Treasury yield to remain below 3.0 percent until mid-2015. After this, I expect the Fed will slowly begin the process of hiking interest rates and pulling back the reins on monetary stimulus, slightly ahead of the current commitment date. The rise in interest rates will be preceded by the start of undoing the rounds of quantitative easing that has boosted the size of the Fed’s balance sheet.
Business spending on equipment and software will grow at an annual average rate of 5.9 percent in 2013 through 2016. Investment in computers and peripherals will continue to be strong after slowing a bit in 2012. Companies managing costs and implementing productivity-focused IT plans will continue to spend at a healthy average annual growth rate of 13.2 percent from 2013 to 2016.
Investment in commercial real estate experienced a burst of activity in the first half of 2012. Growth decelerated in the second half of 2012 and will continue to contract into the first half of 2013 before accelerating in the second half of 2013. Year-over-year investment in structures will decline in 2013. Investment in non-residential structures will come back in 2014 and 2015, with growths of 7.6 percent and 8.8 percent, respectively, before growth slows to 5.4 percent in 2016.
Investment in transportation equipment grew robustly in 2011 (34.4 percent), and grew again in double digits in 2012 (21.3 percent), but will decelerate to a 3.9 percent growth rate in 2013 and 2014. This type of investment will have an average growth rate of 3.5 percent during the four years from 2013 through 2016 but will be minus-1.2 percent in that final year.
Ongoing demand driven by replacement need and persistent low interest rates will bolster light vehicle sales, which will grow from 2012 levels of 14.4 million to a level slightly under 16.2 million in 2016. The automotive sector will remain one of the more solid sectors in the U.S. economy over the next four years.
Residential fixed investment growth plummeted the past six years, but there are clear signs of recovery. In 2012, residential fixed investment growth not only turned positive, but also is expected to grow by 11.9 percent (once final numbers are official). Growth will average 13.8 percent from 2013 to 2016, with a peak growth rate of 19.5 percent in 2014. In 2016, real residential fixed investment will still be more than $165 billion lower than its 2005 peak of $775 billion.
The housing market is again showing tangible signs of recovery, and while there may be echoes of the housing boom in the current markets, there will not be a replay of the housing bubble. Inventories of new homes have fallen significantly and existing inventories are being absorbed. Investors are buying distressed properties, turning them around and renting them out as opposed to flipping them. The holding periods for this new crop of investors are measured in years, rather than months or weeks, as witnessed during the height of the housing bubble. Housing prices are gaining some traction and non-distressed inventory is moving quickly.
This is sending a signal to builders to get back to housing production, and there are growing indications the recovery in housing is starting to gain momentum. I expect starts to continue to accelerate significantly in 2013, reaching more than 1.56 million in 2016.
GOVERNMENT SPENDING
The fiscal cliff has been avoided. We haven’t fallen off the cliff but now appear to be tumbling down a flight of fiscal stairs, bouncing from one crisis to the next in an interminable and seemingly perpetual fiscal crisis.
The Bush tax cut expiration was avoided for all but the highest income earners. No one, however, escaped rising taxes as the 2 percent payroll tax cut was allowed to expire, and all wage earners took a 2 percent hit on their take home pay in January.
The sequester is in effect, and while no one knows if these cuts will last beyond the end of this fiscal year, they will be a drag on the pace of recovery.
That is the nature of the beast, though, isn’t it? It is easy to run up deficits. Everyone enjoys lower taxes and more spending, especially politicians. These things win friends and votes. But correcting fiscal imbalances and addressing entitlements so the country can return to a path for fiscal policy that is sustainable and that does not lead to insolvency, well, that’s no fun at all. Higher taxes, less spending? That’s no fun at all.
The long-run solution will require significant changes to entitlement programs (Social Security and Medicare), increased revenue and decreased spending. The President’s bipartisan deficit-reduction commission authored a report laying out one potential way forward. The Simpson-Bowles report describes a set of policies that are going to be politically painful and difficult to implement, but are, by and large, just the type of changes that must take place.
Despite the apocalyptic predictions of what the sequester would entail for the economy, the fiscal impact of these cuts isn’t significant in the larger battle over reducing deficits and working down the national debt. This battle over such a relatively small act of fiscal austerity reinforces the political challenges this country faces in actually making the difficult changes that entail a true solution to our deficit and debt problems.
Even though we have run federal budget deficits from 2009 to 2012 that are nearly $5.1 trillion in total, the economy continues to grow at a sluggish pace. The debate over whether the economic stimulus act worked continues to eschew any possibility of further fiscal stimulus (aside from the actions averting the fiscal cliff). The national debt that stands in excess of $16.6 trillion ($1 trillion larger than GDP) looms large and is a growing threat to the U.S. economy. This represents a debt of nearly $147,000 per taxpayer and more than $52,800 per citizen.
In 2013, I am forecasting the federal budget deficit to shrink to $858 billion, which should continue to shrink to $683 billion in 2014, $597 billion in 2015 and $647 billion in 2016. Though I am projecting deficits to get smaller, the additional debt added to the national debt over these four years will exceed $2.7 trillion, pushing the national debt total to more than $19.4 trillion. This is assuming interest rates don’t rise faster than anticipated; higher interest rates would cause debt service to surge and raise the burden of servicing all the debt.
NET EXPORTS
The international sector continues to be a growing source of concern with the European Union in a deepening recession that could cause the sovereign debt crisis to roil. This crisis doesn’t only threaten the EU but also the global economy. This remains the biggest risk to the U.S. economic recovery (after ongoing fiscal drama and political rancor), and the Euro crisis isn’t going to end any time soon.
The European Central Bank announced it would buy sovereign debt of countries that are in trouble. This was an important step taken by the ECB to ease the financial consequences of the debt crisis. Although the debt purchases come with austerity strings attached, in the end you cannot solve a fiscal policy problem with monetary policy, regardless of the austerity strings attached to the debt purchases. The situations in Spain and Italy continue to worsen on both the political and economic fronts.
Overall trade growth will continue through the end of the 2016 forecast period. However, real export and import growth both decelerated in 2012, as the United States and global recovery lost momentum.
Real export growth is expected to be 5.6 percent through 2012-2016, even with the slowdown in 2012, as the debt crisis that brought recession to Europe has depressed both the value of the Euro in the first half of the year (making U.S. exports more expensive) and European incomes. Real imports will expand over the same period, with an average growth of 3.6 percent. The near-term deceleration of import growth is a function of the continuing wealth effects of lost home equity faced by consumers, along with the still-weak labor market, the expiration of the payroll tax cut and deceleration in the pace of the U.S. economic recovery.
The U.S. dollar will appreciate vis-à-vis major trading partners through 2014. The strengthening is due to the deepening recession, the uncertainty stemming from the sovereign debt crisis in the EU and the continued flight to the quality of U.S. treasuries in the face of escalating uncertainty over the slowing economic recovery. Once this wave of global uncertainty abates, I expect the dollar will depreciate again in 2015 and 2016 at an average annual rate of 2.3 percent, in the wake of still-large and persistent imbalances in the U.S. economy.
The current account deficit will improve through the end of 2014 as the dollar appreciates. Current account balances will average minus-$440 billion during 2012 to 2014, with a worsening of the deficit in 2014-2016, when the dollar depreciates again. I expect net exports to average minus-$472 billion during 2015-2016.
THE UNEMPLOYMENT PICTURE
The labor market in the United States has shown continued improvement. Yet, the pace of the recovery has been underwhelming. Job creation remains weak, and the pace of payroll job growth is insufficient, given that we are still 3.1 million jobs short of payroll employment returning to pre-recession levels. The labor market is still suffering through the worst pace of job recovery following a recession since 1945.
The national unemployment rate ticked up in January to 7.9 percent. The jobs’ report again showed conflicting pictures of the labor market, with 157,000 new workers on business payroll but an increase of only 17,000 people in the household survey reporting employment.
The mixed messages in recent jobs’ and labor-market reports reinforce the need to look at more than a single metric of how the labor market is performing. Because it’s sufficiently complex and difficult to measure, the U.S. labor market cannot be adequately gauged by a single metric, such as the headline unemployment rate during this recovery. This is particularly true because in 2012 the labor-force participation rate was at its lowest point in more than 30 years. The headline unemployment rate falls as workers leave the labor force, giving a downward bias to the unemployment rate in this recovery.
The U.S. Bureau of Labor Statistics does have alternative measures of labor market weakness. The broadest measure of unemployment (U-6) takes into account discouraged workers as well as those who are underemployed. This includes people working part time but not by choice, in addition to workers who are marginally attached to the labor force (who have looked for work in the past 12 months but aren’t currently looking, yet indicate a willingness to work). U-6 remained painfully high at 14.4 percent in January, unchanged since November and down from its peak of 17.1 percent. It will take several years before we see the unemployment rate fall back into a range consistent with full employment.
By the end of 2016, the unemployment rate will dip below 6.0 percent—nine years from the official start of the recession.