CNB Weekly Economic Commentary: Aug 2

 To: Everyone
From: Gregory S. MacKay, Senior Vice President & Chief Economist
Date: 07/30/10

Several years ago my younger daughter convinced me to rise from my warm bed at some ridiculous hour on the day after Thanksgiving and stand in a snowy line for one of a very limited number of “Talking Elmo” dolls. It didn’t make sense to me at the time. Seemed a little commercial… and a lot cold. As Christmas approached, and no more Elmos appeared in stores, my memory of the snow frozen to my eyebrows faded – and evaporated completely when my granddaughter lovingly held up Elmo first and said “Look what Santa brought me, Papa.” Wow – home run! So my investment of a little time and money was rewarded, and I renewed my belief in “The early bird gets the worm.” That’s the memory running through my head as people ask – and tell – me what’s wrong with the economy. Let me explain – but first, more on our slow recovery.

The Federal Reserve Bank of St. Louis puts out a monthly report on the economy collected from business leaders around the country. It’s called “The Beige Book”, and is meant to be a commentary on the way business people – not Fed members or Fed staffers – see the economy in each of the twelve Federal Reserve Bank Districts. Testimony and speeches in the past month from Fed members have driven home the point that Fed people see a slow economic recovery, no chance for a double dip recession, slow job recovery, and little inflation worries. The Beige Book release of July 28 is summarized as follows: “Economic activity has continued to increase, on balance, since the previous survey (June)… manufacturing activity continued to expand in most Districts… activity in the services sector improved across most Districts since the previous report… reports on retail sales during the early summer months were generally positive, although in most Districts the increases were modest… nearly all Districts reported sluggish housing markets in the months since the homebuyers tax credit expired on April 30… commercial and industrial real estate markets continued to struggle in all twelve Districts… construction activity remained weak in most Districts… reports on banking conditions were largely mixed across the Districts… most Districts reporting on credit standards continued to note that lending standards remain restrictive… Labor market conditions improved gradually in several Districts… wage pressures remained largely contained across most Districts… prices of final goods and services were relatively stable in most Districts… several Districts indicated that prices of raw materials also held steady, and only a few Districts reported input price increases.” The message, on the surface, is that business people are seeing the economy much like the Fed is: slow job growth, slow economic expansion, little inflation. When one reads the full report, one can begin to understand the intricacies of our economy: Boston and San Francisco manufacturing up (computer related), Atlanta down; retail sales up in New York, Philadelphia, Minneapolis and Dallas, down in Richmond, flat in Kansas City; housing starts expected to decline in Dallas, but increase in Kansas City. The list goes on, but each sector of the country may be a leader in one category, a laggard in another, and average in a third. The point is that the national economy is not a homogeneous addition of many data points from all twelve Districts, but a complex system that is currently moving mostly forward, at different speeds.

Second quarter Gross Domestic Product grew at a 2.4% annual rate according to the first estimate this week. At first glance, the improvement seems a bit low, and won’t provide a hearty boost to the economy, but suggests more of the ongoing lukewarm improvement. The report shows real disposable personal income rose 4.4% in the second quarter (versus 1.7% in the first), while personal outlays only increased 1.4% (versus 3.8% in the first quarter). The rest went into raising the savings rate to 6.2%. So consumers spent more in the second quarter – real personal consumption expenditures rose 1.6% versus 1.9% in the first quarter – but the upturn wasn’t a significant boost to the economy. Help to economic growth came from some diverse sources. Both real residential and non-residential fixed investment had large increases, but recent home sales levels suggest some cooling coming. Imports rose, as consumer purchases switched to less expensive foreign goods. Spending at all levels of government increased, as various subsidy programs continued. So I’m happy to see the economy moving forward, but a little concerned with the apparent lack of consumer strength.

So we’re back to the question, “What’s wrong with the economy?” Bank capital has been replaced, jobs are beginning to recover, the home foreclosure glut is working off (the latest S&P/Case-Shiller 20 city index of home prices increased 4.6% in the past year), inflation is slightly above 1% as measured by several methods, households are deleveraging and saving more of their income, and business profits continue to improve. But this disjointed forward movement of the economy, apparent in different levels in different sections of the country, is not helping the missing piece of the recovery… the intangible called confidence… confidence at all levels… consumers to spend, businesses to invest, the federal government to spend less, so that it may tax less, and keep capital in the hands of consumers. Sure there’s confidence out there, but not enough to drive a quicker recovery… and maybe that’s the way it will be… slower than a normal recovery. But the bargains in goods and services out there are at once-in-a-decade-or better prices. Are you an early bird? While there are not a lot of shortages now, some of these values will seem ridiculous in 10 years.

Equity prices continue to march in place, still looking for signs of some recovery accelerator. At 11:10 a.m., for the week and year: 

 

Both Treasury and Municipal yields contracted this week, as the mild G.D.P. data showed no signs of inflation.