How Much More Can We Handle

A former government economist dissects the numbers.

The United States remains in the midst of several years of economic turmoil caused by a gross imbalance between financial commitments and the ability to pay them. Whether they are mortgages written on homes that have lost value, sovereign bonds to countries that are running large deficits, or under-funded retirement promises spread throughout Western society, many of these obligations will eventually have to be written off. A full recovery is unlikely to happen until this is done.

Beyond that, the future looks very bright. New technology will continue to change every industry, generating wealth and improving living standards. China and other developing countries will experience the rising wages and increased consumer demand that come with economic growth. This will open up vast new markets for American companies even as it eases the competitive pressures facing our domestic industries. Once unemployment falls and savings levels recover, American consumers will resume their insatiable demand for higher living standards. Most important, the fundamental strengths of the American economy, which remains better positioned than any other, will reassert themselves. This will take some time, however.

As the United States enters 2012, the economy looks stable but weak. We certainly have not had the strong growth that often followed past recessions. After declining sharply in the 1st Quarter of 2011, GDP growth accelerated steadily through the remainder of the year, but growth remains at only two percent. As of late November, the latest economic indicators were ambiguous: non-farm payroll employment had increased 342,000 over the past three months; interest rates were offset by high credit standards; and core inflation remained contained even though the price of food and energy increased. According to the October ISM survey, the overall index of activity remains slightly above 50, indicating expansion. More important, new orders were accelerating and inventories were rated as low. The Conference Board’s index of leading indicators has also been trending up, while its index of coincident indicators has held steady (Chart 1).

Change in Real GDP and Investment

The past few years have been especially rough on manufacturers. While the overall economy experienced a significant recession, the drop in activity and subsequent rebound was much more pronounced in private domestic investment in plant and equipment (Chart 2). The last year has seen steady improvement for the gases and welding industry. Shipments, inventories and new orders have all trended up throughout the year, while unfilled orders have risen even more impressively. Yet activity is just now approaching its pre-recession levels.

The Challenges Facing Us
A backward look shows how uncertain the future can be. In January, 2008, the Bureau of Economic Advisors announced that GDP growth had slipped to just 0.6 percent in the 4th Quarter of 2007. That same month, the Congressional Budget Office predicted that growth would be 1.7 percent in 2008 and 2.8 percent the following year. We now know that the economy had already entered the Great Recession and would not begin to grow again for 18 months. Could a similar surprise await us now?

Despite positive signs, a great deal of unease exists today. Some of this is due to the nature of the recovery. In addition to the modest rate of growth, the most discouraging fact about the last year has been the slow rate of job creation. The unemployment rate remains at nine percent, with the number of workers who have been unemployed for a year or more at an all time high. These workers may have a great deal of difficulty reentering the workforce.

Leading and Coincident Indicators

We also face significant challenges. The crisis in Europe continues to spread from one country to another as governments periodically announce plans that are too little too late. The Euro could fall apart, either because struggling countries like Greece and Portugal are no longer willing to undergo the severe structural changes needed to remain in it, or because healthier countries like Germany and Finland are no longer willing to subsidize others. Europe is almost certain to enter a recession. The potential impact on the U.S. economy remains to be seen.

Meanwhile the United States must struggle through its own problems. Three are dominant. All are related. The first is the continued weakness in the financial sector. It is a shock that a company as prominent as ML Global was able to maintain such high leverage on such risky assets so soon after the financial collapse. The fact that the company apparently diverted client funds creates further concern about the degree to which U.S. regulators know what is going on within large financial institutions.

The second challenge is the continued weakness in the housing sector. Although housing now accounts for a much smaller share of the economy, home ownership continues to play a large role in the finances of many American workers. A large backload of delinquencies and foreclosures will delay any recovery for several years. This uncertainty is compounded by the fact that over 29 percent of all mortgagees owe more than their houses are worth. Continued litigation over past practices adds yet more uncertainty and delay.

Government is the third source of uncertainty. The federal government continues to run annual deficits that were once unimaginable. Although most economists agree on the need to balance the budget, the political system seems unable to produce the necessary compromise. Meanwhile, state and local governments face their own fiscal challenges, forcing many to cut back on services and employment and renegotiate retirement benefits.

Dim Prospects for Stimulus
It is almost certain that there will be no significant fiscal stimulus in 2012. Instead, government at all levels is likely to produce a slight fiscal drag as leaders seek to fix broken balance sheets by either cutting spending or raising taxes.

The outlook for monetary policy is more mixed. The Federal Reserve has taken the unprecedented step of lowering the federal funds rate almost to zero and committing to hold it there into 2013. But will they do more?  There appears to be an active debate within the Fed on this very question. At least four members of the Board of Governors have expressed support for a third round of quantitative easing in which the Fed would purchase large amounts of mortgages and other long-term debt in an attempt to lift stock prices and drive long-term interest rates down even further. This move would be highly controversial, jeopardizing the Fed’s independence. More important, it probably would not address the nation’s fundamental economic problems.

Corporations are sitting on an estimated two trillion dollars in accumulated capital. They seem unlikely to commit it until the economic situation is much clearer.

The Obama Administration seems committed to proceeding with a large number of new regulatory initiatives dealing with Wall Street, health care, the environment and labor relations. Each of these is likely to impose additional costs on employers, but the final nature of these requirements will not emerge for several more months. It seems very unlikely that this political uncertainty will be cleared up before the 2012 elections, and perhaps not even then.

The Promise Ahead
In the midst of all this uncertainty, what are companies to do? Many of them apparently do not know. Corporations are sitting on an estimated two trillion dollars in accumulated capital. They seem unlikely to commit it until the economic situation is much clearer.

However, there are several hopeful signs. American companies continue to earn large profits overseas. Domestically, exports continue to look promising. In the short-term, it is very possible that the dollar will rise as investors flee to the safety of the American Treasury in times of international uncertainty. Once the worst is behind us, much of this money will leave for higher returns and the dollar should find a new, lower level against our major competitors. Even China seems to recognize the inevitability of this move; the yuan has risen 3.7 percent against dollar the since the beginning of the year.

There are also promising signs in the energy sector. New discoveries and new technology promise a revival of drilling for both oil and natural gas. If encouraged by the administration (and so far the support has been lukewarm), this activity could increase our energy independence and eliminate a large amount of current imports. It would also become a large source of new jobs and investment.

We continue to move toward the Internet of Things, where improvements in price, size, communications speed and processing power allow everything to be connected to the Internet. This will enable the industry to deliver new sources of value to its customers, making it easier to build and deliver goods cheaper, faster and better.

The fundamental strength of American industry lies in its ability to deal with constant uncertainty. This capacity has seldom been challenged more than recent times. Unfortunately, much of the current uncertainty has been caused by government policy, both in imposing new regulations and failing to deal forcefully with financial imbalances. It is quite possible that these failures will once again push us to the brink. But if they do not, America is likely to emerge from this long period of restructuring stronger and with renewed confidence. The gases and welding industry will be a direct beneficiary of this rebirth.

Gases and Welding Distributors Association
Joseph V. Kennedy Joseph V. Kennedy is a former chief economist for the U.S. Department of Commerce. He has provided economic and legal advice to private and public sector executives. He can be reached at joe
kennedy22206@yahoo.com.