Given the political dynamics of that storied election year, the recessionary clouds that started forming in late 2000 crept in on little cats’ feet. The current would-be recession, by contrast, has arrived with more fanfare than Lindbergh on Broadway. Media politics? Readers can make their own judgment.
To discover what fate actually awaits us, we turned to a distinguished panel of local economic experts and asked them to read the tea leaves as best they could. We and they acknowledge, of course, that economics is as much art as science.
Gereral Trends
Gordon H. Sellon, Jr., senior vice president and director of research for the Federal Reserve Bank of Kansas City, is no Chicken Little. “Recession fears for the U.S. economy have not materialized,” says Sellon, “and first half growth estimates have been revised upward by many forecasters.”
Sellon believes that in the second half of 2008, growth will be spurred by the tax rebates, an accommodative monetary policy, and continued strength in exports. He concedes that housing will likely be weak into next year, but that the drag on economic growth should diminish over time. Fallout from the sub-prime mortgage crisis has, Sellon argues, caused a more general tightening of credit conditions that will restrain growth over the next several quarters.
“There will be no recession,” agrees Chuck Krider, a professor at the School of Business of the University of Kansas, “but with such low economic growth the number of persons unemployed will continue to modestly increase and for many it will feel like a recession.” Krider believes that GDP for the second half of 2008 will remain in the 0.5 to 1.5 percent growth range with inflation stubbornly sticking above the Fed’s 2.0 percent target. Business profits will likely see small declines, mainly due to rising energy costs.
The main drags on the economy, Krider asserts, are the rapid increase in energy prices, serious food inflation, continuing declines in housing prices and construction, and the inability of the financial system to quickly resolve the sub-prime mortgage crisis. As a result, banks have not yet been able to return to financing normal business expansions even though interest rates remain historically low.
“The good news,” contends Tim Michel, market investment executive with Bank of America Private Wealth Management, “is that U.S. inflation fears are exaggerated.”
As Michel observes, leading indicators of inflation have been declining since 2006, and “core” inflation continues to surprise on the downside. High food and energy prices may actually be exerting downward pressure on the “core” rate because the weakening economy is putting downward pressure on unit labor costs and wages. This, in turn, prevents consumers from paying higher prices for other things after they have paid for food and energy.
On the negative side, adds Michel, oil prices are still elevated, the real estate markets are still under pressure, and while the credit markets have shown signs of stabilizing, they are not yet anywhere near normal.
Bank balance sheets remain swollen with unwanted assets, Michel says, and, at least for the remainder of the year, there is reason to be concerned about the ability of banks to lend.
“In the short term,” Michel concludes, “we still believe that once the global growth slump feeds into the energy markets through lower oil prices, equity markets, starting with the U.S., should start their ascent.”
Energy
“The biggest threat to the economy over the near term is the continuing surge in energy prices,” argues the Fed’s Gordon Sellon. “If energy prices continue to rise, there is considerable risk of a slowdown in growth later this year as consumers cut back discretionary spending.”
Sellon didn’t find much dispute on this issue. Doug Houston, a professor at the School of Business of the University of Kansas, chose, however, to look beyond the “short-term market churn.”
As Houston observes, many pundits are repeating the forecasting mistakes made in the late 1970s when conventional wisdom assumed that energy prices would continue to soar due to ever-increasing scarcity. Houston believes otherwise: “Energy prices in my judgment will fall, and benchmark oil could be in the $70-$90 per barrel range within two years.”
Houston is of the opinion that we have not yet received the full measure of market-based conservation and fuel substitution activities that will soften oil demand globally, even in China and India. Then too, Houston continues, higher prices provide massive incentives for finding and extracting more oil.
Bill Greiner, UMB’s chief investment officer, is not quite so sanguine. As he notes, total world oil consumption grew by 800,000 barrels per day in 2007 and is expected to grow even more this year. As our economy slows, the growth in worldwide oil consumption appears to accelerate. This, Greiner, lays at the feet of China and other “developing” economies. That said, he believes oil prices are nearing a peak, or at the least, the rate of price acceleration should slow in comparison to the past year.
Chuck Krider expects a modest decline in the price of oil to the $100 per barrel to $120 per barrel range.
Agriculture
Jason R. Henderson, vice president and branch executive of the Omaha Branch of the Federal Reserve Bank of Kansas City, believes that the agricultural sector “is set to enjoy a bountiful year.”
Henderson reports that robust ethanol demand and record export activity, fueled by strong global incomes and a weak dollar, have underpinned record high crop prices.
Rising production costs, however, present challenges. Henderson explains that farm input prices, primarily fertilizer and fuel, have surged, and record energy prices threaten to trim crop profits going forward. The sharp gains in ethanol production are expected to ease as well.
Still, according to KU’s Doug Houston, farmers should be pleased with their “harvest of ethanol subsidies” in the near term. No fan of the nation’s ethanol policy, he believes it has grossly distorted the market prices of many agriculture commodities and done nothing to reduce global warming gases.
The reason our economy slows or contracts, observes UMB’s Bill Greiner, has to do with “excesses”—in this case, an excess of housing inventory. This excess will not evaporate quickly, but the problem, he believes, is now at least “measurable.”
Today, it may still take twice as long as normal to sell a home—10 months to the previous average of 5 months—but at least that number has stabilized. Single-family housing starts are currently running at 674,000 units annually. This, Greiner observes, is about as low as this number has been for more than 30 years.
Additionally, housing prices have moved downward. The most recent data suggest that nationally, housing prices have declined by about 8.2 percent over the last 12 months.
“So,” Greiner concludes, “inventory controls appear to be working.” In sum, inventory levels have stopped rising, pricing is coming down, and starts have slowed significantly. All of this will help reduce the pressure on the housing problem.
Bob Litan, vice president, research and policy, the Kauffman Foundation, believes that housing prices nationally will continue to drop over the next six months. Litan contends that until the housing market shows some signs of stabilizing, consumer confidence is not likely to bottom out, nor is consumption likely to tick up significantly.
Litan also sees more losses in the banking sector. The next big wave, he believes, will be among regional and smaller banks, and he thus expects credit to be tight, not only for housing, but also for other uses. In addition, he expects a modest tightening of monetary policy to combat rising inflationary pressures.
“What does all this add up to?” asks Litan. “My guess is either shallow recession, or if the economy manages to grow, it will do so weakly and recovery will be spread out over a longer period than we have seen in the last three recessions.”
Opportunities
Bill Greiner believes that the key to improved economic health is consumer sentiment, which historically goes hand-in-hand with the employment picture. An improved housing market hinges on improved employment numbers.
With unemployment now at 5.5 percent, Greiner believes there needs to be a sustained improvement prior to the housing market regaining its feet.
Doug Houston sees a real opportunity in the current energy crisis to build
a consensus for nuclear energy and to un-tether the economy from fossil fuels.
He also believes that the bulk of the value that innovations in information
and communication technologies have not yet been harnessed. This would
mean some nice productivity boosts in the U.S. economy. “It’s no time to be a
pessimist about the future of the U.S. economy,” Houston asserts.
