Monday, August 5, 2013

Why the Economy Could... Pop!

(By Roger Altman, Time Magazine, 12 August 2013)

It is easy to imagine that because Washington is mired in political gridlock, the rest of the country is stuck too. This may explain why surveys show deep pessimism over the nation's Economic Outlook. Such sentiment made sense after the scary financial collapse of 2008, but it doesn't anymore. In fact, after five years of struggling against headwinds triggered by that collapse, the U.S. is making a surprisingly strong comeback. It's the great untold story of the summer of 2013: a combination of cyclical recovery forces and uniquely American strengths are revving up growth. The U.S. economic outlook is as strong as it has been in more than a decade.

Yes, too many Americans are out of work and have been that way for too long. And yes, household incomes, adjusted for inflation, are still below 2007 levels. Indeed, this is the country's biggest job--to repair labor markets and get incomes moving up again. The U.S. needs growth in order to make that happen, and that's where the news is good. Confounding so many skeptics, the U.S. is actually shifting into higher gear. Growth for this year's second quarter, just reported at 1.7%, beat expectations but is well below the rate we should see at this time next year. Indeed, the Federal Reserve Board, not known for going out on a limb, recently raised its 2014 forecast for real growth to the 3%-to-3.5% range. And the country will likely see two to three more years of good growth, which would produce millions of new jobs and begin to raise incomes. This is one reason the U.S. stock market recently reached all-time highs.

The U.S. is the only developed country with a story like this to tell. Europe, unfortunately, is facing a long period of economic stagnation. Its financial crisis came later, and southern Europe is laboring under the burdens of sick banks and weak competitiveness. Meanwhile, Japan, where the population is falling, hasn't seen meaningful growth in years and isn't likely to see it now.  What is allowing the U.S. to rev up when others cannot? For one thing, the 2008 financial collapse and the deep slump that followed forced this country to make big changes. A severe financial crisis, whether at a corner grocery store, a multinational corporation or an entire nation, always leads to some restructuring. But the U.S. has restructured dramatically. Households have shed debt and are now ready to use their credit cards again. The banking system and the auto industry have been completely revamped. American business has become more efficient, and cost differentials with China are narrowing. U.S. manufacturing has stopped shrinking and is actually beginning to expand. 

At the same time, the U.S. continues to enjoy built-in advantages that other nations lack: a growing population and the prospect of further immigration, big and flexible housing and stock markets, the most dynamic energy sector in the world, a huge and resilient consumer market and unparalleled technology leadership.  Now, five years after the worst economic crisis since the Great Depression, the American economy is gathering steam. Over the medium term, Americans are going to see growing job opportunities, higher wages and better asset values. To understand how this economic rebirth will unfold, it's important to understand the five big factors driving it.

Factor No. 1: How Housing Came Back From The Dead

A big driver of this Economic comeback will be the housing market, which is now entering a powerful, multiyear upswing. Housing works like a trampoline. When it is pushed down far enough and long enough, it will eventually snap upward very powerfully. That move is happening now.  You can see this in prices, which are 12% higher than they were a year ago, according to CoreLogic, an analytics and data-services firm. Each of the 20 largest metropolitan markets is registering year-over-year gains, something that hasn't happened since 2005. New housing construction and renovations don't just generate construction and related jobs. They also boost the manufacturing of appliances, pipes, wiring and other goods. And they drive services, including plumbing, electrical work, trucking and mortgage lending. This is why, according to Goldman Sachs, the housing rebound alone can add a half-point of annual GDP growth. And it could produce more than half a million new jobs a year over the next few years, according to Ameriprise Financial.

It was the depth of housing's fall that laid the foundation for this upturn. Single-family housing starts, for example, averaged 1.5 million from 2000 to 2004, before the bubble. After the bust, housing starts plunged to an annual rate of about 500,000 for nearly three years. New-home sales fell to a third of what they had been before the collapse. In relative terms, housing hadn't been so weak since the 1930s.  Now the tide has turned. On the supply side, the massive post-2008 overhang of unsold homes, which depressed prices and new housing construction, has finally been resolved. The number of homes for sale is back to its long-term average of about 2 million nationwide. It's true that there remains a big inventory of foreclosed units that have not been maintained, but that number is falling too and isn't relevant to most buyers. In other words, the excess supply is gone.

Demand is also helping goose the market. Census Bureau data implies that the U.S. population will grow roughly 8% over the next decade, faster than either Europe's or Japan's. And the household-formation rate (people deciding to rent or buy for the first time) is snapping back. After dropping during the crisis, it has more than doubled from its nadir and is rising steadily. Pent-up formation may push it above the long-term average for some time. This means that residential investment may grow 15% to 20% annually over the next four years. The ripples of that will be felt through the entire economy.

Factor No. 2: The Unexpected Gold Rush

This is the big story that no one saw coming: the U.S. oil-and-gas sector has staged an unexpected and stunning revival--a boom, really--that carries uniformly positive implications for growth, jobs, trade and capital flows. The U.S. has always been a major oil producer, but output had been declining steadily for decades. Production peaked in 1970 and fell to a 62-year low of 5 million barrels a day in 2008. But that decline curve has reversed. Seemingly overnight, production rebounded to nearly 7 million barrels a day and is projected to reach the astonishing level of 9 million to 10 million by 2020.

The natural-gas story is equally dramatic. Traditional gas fields were in long-term decline, and production had fallen to 48 billion cubic feet per day in 2006. Last year, the U.S. produced 65 billion cubic feet per day. Even more important, the U.S. is now believed to possess a 100-year supply of natural gas, and prices have fallen sharply, from $13 per million BTUs in 2008 to less than $4 now.

What explains this phenomenon? The answer is uniquely American technology--a breakthrough in horizontal drilling combined with advanced forms of hydraulic fracturing and seismic exploration. The ability to drill horizontally means that one traditional vertical drilling site can generate additional wells drilled horizontally and at great depth. Together with modern forms of fracturing, this has allowed oil and gas trapped in tight rock formations to be extracted cheaply at huge volumes for the first time. To date, the U.S. is the only nation taking full advantage of this technology.

Consider North Dakota: this quiet and often ignored state has seen its oil production skyrocket from 100,000 barrels a day only five years ago to 800,000 today. That makes it the second biggest oil-producing state in the U.S., behind only Texas. This output is coming from the Bakken Shale formation underneath the northern plains, which the U.S. Geological Survey has described as the largest continuous oil accumulation it has ever seen. The result is that North Dakota now has the lowest unemployment rate in the nation (3.2%) and a $1.7 billion budget surplus.

The national implications are profound too. According to the consulting firm IHS, unconventional oil and gas production currently supports more than 1.7 million jobs in the U.S., and that number will nearly double by the end of the decade. Meanwhile, these new gas reserves are pushing down the price Americans pay for energy to among the lowest in the world. Cheap natural gas is a big stimulus to petrochemical production and a meaningful one for all U.S. manufacturing. And it will provide something like a tax cut for households. As utilities convert from coal-fired power to gas power--and they are steadily doing so--household electrical bills will fall. Indeed, in a few years, average retail utility bills may be $1,000 per year lower than current levels.

Finally, the energy turnaround reduces energy imports, lowering trade deficits and generating large amounts of tax revenue for government at all levels. After decades of U.S. dependence, our oil imports have already dropped from 12 million barrels a day to 8 million and should continue to fall toward 6 million, which would be the lowest import total since 1987.

Factor No. 3: The Sleeping Giant Stirs
About 70% of U.S. Economic activity comes the old-fashioned way: from consumer spending, on everything from autos to apparel to food. The consumer's mood and pocketbook have big impact on the whole country's growth and jobs. And that pocketbook took a tremendous hit in 2008, so much so that it has taken five long years for American households, in aggregate, to recover from the financial damage. Americans conserved cash to pay down debt, and this process pushed down their spending even further.  It's hard to exaggerate the financial damage inflicted on consumers during the recession. Total net worth fell by $13 trillion, or 20%, from its level in 2007--a staggering loss. That hit came at a vulnerable moment when U.S. households were highly leveraged. When the bottom fell out, consumer debt had reached a remarkable 138% of income, a 35-year peak. Within a few months in 2008, household finances were crushed as asset values fell, millions of jobs were lost, countless credit cards were canceled and thousands of homes were foreclosed on. As the financial pressure on families reached acute levels, they had no choice but to cut spending and pay off debt.

Five years on, households have finally repaired their balance sheets. According to the International Monetary Fund, household debt has now fallen back to 105% of household income, a ratio near historical averages. Further, Federal Reserve data shows that U.S. households spent only 10.5% of their after-tax income on debt payments in the early part of this year, the smallest portion since the Fed began keeping track in 1980. This reflects both lower levels of debt itself, given pay-downs, and lower interest rates on remaining debt, especially mortgages.

The rise of the stock market has also helped, as has the turnaround in home prices. Other Federal Reserve data shows that household net worth recently topped $70 trillion, a record high, which means that the financial losses of 2008, as a whole, have been recovered. (Achieving this recovery in household asset values has been a primary goal of the Federal Reserve's hyperaggressive monetary policy for the simple reason that families need to feel financially healed before they will spend normally.)  Americans are starting to open their wallets. Retail sales grew 5.7% in June compared with the same period last year. The consumer price index also strengthened in June, which suggests that demand is growing as Americans feel more optimistic about the economy. And consumer confidence is near a five-and-a-half-year high.

Factor No. 4: Banks (With Lots Of Help) Bounced Back

In September 2008 the overleveraged and undermanaged U.S. banking system suffered a terrifying collapse. And that, in turn, nearly took the whole country down. Short-term, wholesale lending came to a stop, including from one bank to another. (Keep in mind that the core business of banking is to borrow at one rate, including through deposits, and lend at a higher rate. If banks can't borrow, they can't function.) So when banks got into trouble, lending to businesses and consumers essentially stopped and the whole economy cratered.  Federal authorities mounted a huge and heroic intervention. The Federal Reserve's support for the credit markets reached $13 trillion at its peak, according to Bloomberg. The FDIC provided billions of dollars in federal guarantees on new, long-term borrowings by banks and finance companies. Congress rushed through legislation that established TARP, which invested another $475 billion in new stock issued by these financial institutions.

The rescue worked. Slowly and, at first, unsteadily, banks began to borrow again on their own. Then the regulators initiated a sweeping restructuring of the industry. Capital and liquidity levels were raised through wide-scale divestitures of assets and sales of new stock at low prices. Balance sheets were further cleansed through aggressive write-downs of poor-quality loans and other assets. Improved disclosure practices were also imposed. Old leaders lost their jobs, and new management teams were put in place. It was probably the most successful rescue of private enterprise ever conducted.  Today, most large U.S. banks have the kind of clean balance sheets we last saw 10 years ago. They are again generating large profits, and almost all have resumed paying dividends. Overall, this is now the healthiest banking system in the world, and it is lending strongly again. Total outstanding bank loans to business, according to the Federal Reserve, have reached $1.54 trillion, up 30% from their post-2008 low and just below their historical peak. Consumer loans already have surpassed their previous high and are growing at a robust 8% rate so far in 2013. A continuing soft spot is loans to small businesses, which is still $40 billion below the prior high. But overall, the lending recovery is boosting growth.

Nevertheless, American regulators have not finished turning the screws, nor should they. Some banks remain too big to fail, and that's why there are ongoing regulatory efforts to shrink them. In fact, a set of even tighter capital requirements for banks was approved by the Federal Reserve on July 2.

Factor No. 5: Technology Is Still Our Best Friend

Not only has the U.S. retained its edge in technology, but its advantage has widened in several categories. According to Battelle, the U.S. contributed 29% of global R&D spending in 2012, compared with nearly 14% for China, the next largest contributor. And absolute levels of R&D have grown impressively over the past five years, despite the recession.  Also, the rate of patenting by U.S. inventors is near an all-time high, according to the Brookings Institution. The value of such patents appears to be rising, based on how often these patents are cited or referenced by other patents. Most important, the primacy of the U.S.'s research-focused universities remains unchallenged. According to most rankings, 25 to 27 of the world's 30 leading universities are in the U.S.

Despite claims that more engineering degrees are being awarded elsewhere, the quality of most overseas degrees is lower than that of their American counterparts. It's true, however, that U.S. junior and senior high schools must be strengthened for this technology edge to continue over the long term.  For the time being, the U.S. can readily afford the investments to maintain its top technology ranking. By one measure, the U.S.'s fiscal condition actually is improving. The Congressional Budget Office now estimates that the 2013 budget deficit will come in at about $640 billion. This is still too large, but it represents only 4% of GDP, down from more than 10% in 2009. Higher tax revenue from an improving economy, a slower rise in health care costs and three separate stabs at deficit reduction since 2011 are helping clean up our balance sheet.  By another metric, cash levels in the U.S. corporate sector are at historical highs. That's one reason tech firms are pouring cash into R&D budgets. Microsoft spent $9.8 billion last year, Intel spent $10.1 billion, IBM spent $6.3 billion, and Google spent $6.8 billion. These are four of the five largest tech budgets in the world.

The Challenges

Given all the positive signs, it's surprising that this story is so little known. That probably reflects the attention on Washington and its controversies over surveillance, immigration reform and political gridlock, as well as violence and instability in the Middle East. The President's recent speech notwithstanding, it's surprising that the Obama Administration has not been more vocal about the economy's rebound.  Especially because the comeback is so badly needed. American labor markets remain weak, and years of continued growth will be necessary to repair them. According to the Department of Labor, 2.4 million fewer citizens were working as of June 2013 than just before the 2008 collapse. The unemployment rate remains high at 7.6%, and 4 million Americans have been out of work for longer than six months. The labor-participation rate is at a 30-year low, which means many people have stopped looking for work altogether.

In addition, according to the Census Bureau, median household income in 2011 was $50,054, down 8% from 2007. With the stock market strong, this income weakness illustrates the growing inequality challenge. Incomes of the top fifth of Americans may have grown in 2011, but they fell for everyone else.  The U.S. is not the first country to see strengthened growth after a deep financial crisis. We saw it in South Korea following the Asian financial crisis in 1997, in Mexico after the collapse of its currency in 1994, and in parts of Latin America after its sovereign-debt crisis in the 1980s.  The U.S. is waging a surprising economic comeback. Uniquely American strengths and powerful cyclical forces are driving it. And it couldn't come at a better time for Americans.


But Wait! It's Still A Wimpy Recovery
(By Rana Foroohar, Time Magazine, 12 August 2013)

For some time now, the U.S. has been the prettiest house on what is an ugly economic block. Look around: China and many of the other major emerging markets are slowing down, and Europe is in recession. The U.S., on the other hand, finally seems to be moving beyond 2% annual economic growth toward a more robust recovery. The big question is whether it will be a recovery for everyone.  The answer so far seems to be a definitive no. The percentage of Americans in the labor force, arguably the most important measure of economic health, dropped to a 34-year low in May. That's as bad as it's been since women entered the labor force en masse in the 1980s, and it speaks to the fact that this recovery is weaker and has taken longer than rebounds of the past. We're 30 months on from when GDP returned to prerecession levels, but even at June's high level of job creation (195,000) it will take 15 months more to replace the jobs that were lost. While the unemployment figure is slowly ticking downward from the crisis' peak of 10%, it remains in double digits for certain groups, such as young people without college degrees and African Americans. Meanwhile, economic inequality has increased, since minorities were disproportionately hit in the housing crisis, and wages have stayed flat. It's hard to envision an inclusive recovery when a majority of Americans simply haven't got more money in their pockets.

That puts the American Dream at risk. "If young Americans are to live better than their parents did, we have to expand employment, make the workforce more competitive and accelerate productivity growth," which is strongly correlated with rising wages, says Susan Lund, a principal at the McKinsey Global Institute, which just released a report titled "Game Changers" on how to build a more robust recovery in the U.S. One key challenge will be to create more sustainable demand in an economy that is 70% driven by consumer spending. Yes, Americans have gone a long way toward repairing their balance sheets since 2008. Fewer of us have debt than we did back then. But those who do, including vulnerable groups like students and seniors, have 40% more debt than they did before the financial crisis, according to the Census Bureau. And consumer spending is still spotty. While overall retail sales have grown over the past year, June numbers came in far weaker than expected. Department-store sales were down for the fifth month in a row, and restaurant spending was sharply down as consumers once again ate in to save a dollar. People even bought fewer electronic gadgets for a third month running. The latest GDP figure--1.7%--shows we are still struggling to stay in a 2% economy. "To say we're doing better than Europe is meager consolation," says Lund. "We need to do much better."

Of course, the economy is cyclical, and one bad quarter won't derail a recovery. What you want to see is sustained job growth, and the most recent new-hire numbers were stellar. The question is whether they were a blip or a real directional shift from what we've seen over the past several years. Even before the financial crisis, there were signs that the U.S. jobs engine was sputtering. Job creation from 2000 to 2007 was far weaker than in decades past. This is in part because small and new companies, which do much of the real hiring in the U.S., still have problems getting bank loans. Indeed, Urban Institute senior fellow Gene Steuerle believes that one key reason for the declining number of jobs being created by new businesses is that entrepreneurs have exhausted their personal savings, which most of them use in lieu of loans to fund investment. Banks, which claim they are trying to meet higher capital requirements, won't step in to help.

This underscores the fact that five years on from the crisis, finance is still disconnected from the real economy. Sure, banks are recording record profits, but numerous studies show that as finance as a percentage of the economy grows, business creation actually tends to stall. A banking recovery isn't enough to turn the economy around--we need manufacturing and services to grow too. Yes, a manufacturing renaissance is under way. But it isn't your grandfather's manufacturing. Well-paid union jobs have given way to cheaper labor and to robots that do work that people used to do, which is partly why wages have remained flat.  That's just another reason that too many Americans won't feel the buoyancy of this divided rebound for many years to come.

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