William Strauss has two words for those who are comparing this recession — and what could happen the rest of this year — to The Great Depression.
Stop it.
“The worst GDP drop we saw over the last 40 to 50 years has been 3.1%,” said Strauss, senior economist and economic advisor for the Federal Reserve Bank of Chicago, in his Economic Assessment during the Heavy Duty Dialogue. “During the depression, it fell by 26%. The worst unemployment since the 1960s was 10.8%, which was reached in the early 1980s. During the depression, we reached 25%. We're clearly in a whole different league. The Fed has been far more aggressive this time around. We're seeing very positive responses this time.”
Not that he doesn't see the dire signs that things likely will get worse during the next two quarters.
“This is going to be a tough year,” he said. “The outlook is for the US economy to struggle through most of this year. Employment is expected to remain weak this year, leading to a continued rise in the unemployment rate. Slackness in the economy will lead to a lower inflation rate over the coming year. The volatile credit markets and the weak housing market are the biggest risk on the horizon for the US economy. This drag on the economy will stop once the housing sector begins to moderate, and expectations are that will happen sometime this year.
“In addition, since World War II, we have grown far more often than we've dropped down. People like to do business. That's the driving force that has economies going higher rather than lower. Eighty-six percent of months since World War II have been growth months. So it's far more likely that the economy will expand rather than contract.”
He said the economy entered a recession in the first quarter of 2008, but this one has been “unique.”
“We typically say there's nothing typical about a recession,” he said. “It's often defined as two consecutive negative quarters of GDP growth, and that's not true. In 2001, we didn't have two consecutive negative quarters. For the first two quarters of this recession, GDP actually went up — in the second quarter, substantially. It fell slightly in the third (0.5%) and then in the fourth, it really fell off (3.9%).”
GDP growth weak
Strauss said GDP growth is forecast to be quite weak this year — minus 4.9% in the first quarter, minus 1.3% in the second, up 0.9% in the third, and up 2% in the fourth.
“Which means that we're going to be looking at an economy that is growing below trends,” he said. “So it's going be a tough year. Year over year, we're looking at it being minus 0.9% growth. All of 2008 was minus 0.2%. This is the weakest growth we've seen in many decades. But is there light at the end of the tunnel? Yes, and it's not an oncoming train. 2010 growth will be 2.9%, slightly above the trend. So certainly, the view of economists is that we are in a business cycle and it's going to be deep and long, but we will come out of it.
“We're in the 13th month of an economic downturn. If the economy turns around in the middle of the year, we'll be looking at something around 18 months. We'll be setting a record since World War II for an economic downturn. Some think it will be the end of the year — 24 months.”
He said inflation reversed its upward trajectory from 4.3% in the middle of 2008 to 0.7% by the end of year, in large part due to the movement of oil prices. That fall of gasoline from over $4 a gallon in the third quarter of 2008 to an average nationwide price of $1.92 in the first week of February has had a dramatic impact.
“Every one penny reduction in the price of gasoline adds $1 billion to consumer spending,” he said.
He said that adjusted for inflation, current oil prices are well below early 1980s prices. Also, expenditures on energy plunged in the second half of 2008 from a high of 7%, and they currently are at 5% — well below the historical average, which hit 9.6% in the early 1980s.
Productivity growth solid
He said inflation is anticipated to moderate this year and then rise by 2% percent in 2010. Employment has fallen by 3.6 million jobs since December 2007, and the unemployment rate has risen quite sharply from 4.8% at the beginning of 2008 to 7.6% in January. Consumer spending fell sharply in the second half of 2008 — down 3.9% in the third quarter and 3.8% in the fourth.
“Productivity growth remains solid and is expected to do well,” he said. “This is a measure of how well we are doing in terms of being able to produce more and more without adding more workers and hours. This is directly attributable to improving standards of living.”
Net exports contributed quite a bit to GDP growth last year, he said, then demand fell off in the third and fourth quarters of 2008.
Given the large trade deficit, the dollar has been under pressure since the beginning of 2002, losing 16.5% of its value over this period.
“Import growth has been below export growth since early in 2005, so we have led the world into this economic downturn,” he said. “I will also say we have been more aggressive earlier in stimulus action than the rest of the world, and it's my expectation that because of that, we will lead the world out of the economic downturn.”
Industrial production fell off sharply in the second half of 2008, and Strauss said he was impressed at how quickly manufacturing reacted to the economic downturn.
“I think that has a lot to do with having your finger on the pulse of what's happening with the economy,” he said “The response was impressive in the pullback on the production side. Historically, businesses would have waited for inventories to begin to rise. Shelves would have become too full. But this was well anticipated. Inventories all in all are in pretty good shape. So we'll be able to see much quicker production response than would normally occur.”
He said industrial production — which was down 6% in 2008 — will struggle in the first half of this year and then begin to improve. For all of 2009, it should be up 2.7%, and then up 3.4% in 2010.
With manufacturing capacity utilization falling sharply in the second half of 2008, light-vehicle sales collapsed. They didn't hit 16 million in any year until 2000, then were above that every year until 2007. They were down 19% in 2008, with light-truck sales down 25% and passenger-car sales down 12%.
He said the market share of the Detroit Three has gone from 70% in 1980 to 46% this year.
“For the first time ever, we have more vehicles sold in this country that are foreign-made than by the Detroit Three,” he said.
Trailer loads have been falling and were down 8% in 2008 over previous year. Medium-duty truck orders were down over 35% in 2008 over the year before, with heavy-duty truck orders down 30% and backlogs remaining low.
Housing downturn
Turning to the housing industry, Strauss said residential investment fell off sharply beginning in 2006 and was down 23% in the fourth quarter of last year.
“We're probably closer to the bottom than the top,” he said. “There's only so long you can fall at a 20% rate. From a macro standpoint, a 20% decline in housing today is not equal to 20% three years ago, when housing markets represented over a 6% share of GDP. Because of the dramatic fall, its share of GDP has been cut in half. So in terms of its impact, it's going to have less effect on us.”
He said residential investment as a share of GDP is setting a new low. The supply of new single-family homes is extremely high, with a 13-month supply by the end of 2008. Housing starts had been cut back 40% to start the year.
“This is an industry that is really trying very hard to balance itself to get production in line,” he said. “If we look at what's happening to the level, it fell to 600,000 housing starts, as opposed to over two million in 2006.”
Mortgage rates remain very low — all the way down to 5%, compared to over 7% in 2002.
Home-price declines have been huge, particularly in California, Nevada, Arizona and Florida — all four had declines of between 10% and 21% in 2008. Foreclosure filings have been quite high in those states — between between 4% and 7.3%, compared to 1.8% nationally.
He said that while housing affordability has improved dramatically, consumer attitudes for buying a home remain very low. Lending standards for mortgage loans remain tight, but they have begun to ease.
“The credit crisis has hit hard,” he said. “It's far more difficult to obtain funding, and that is the oil in the engine in our economy, and it has drained out quite significantly. So our engine is not running well.”