AMMAN, Jordan (MarketWatch) - The U.S. economy is poised to grow for the first time in more than a year during the current quarter, but it will still feel like a recession because unemployment and debt levels remain too high to support a sustainable recovery.
When the first estimates for the just-concluded second quarter are released next week, they'll probably show that gross domestic product growth was negative for the fourth quarter in a row, the first time that's happened since the Great Depression of the 1930s.
But in the third quarter (which began July 1), the GDP will probably turn positive. Some will take that news as a sign that the recession is over, that fiscal stimulus should be abandoned, that money growth should be reined in, and that the Federal Reserve should begin raising its interest rate target back to a normal level.
However, a wide range of economists - from Nouriel Roubini to Ben Bernanke - say the economy will remain weak for a year or longer.
"Job insecurity, together with declines in home values and tight credit, is likely to limit gains in consumer spending," Fed Chairman Bernanke told Congress earlier this week "The possibility that the recent stabilization in household spending will prove transient is an important downside risk to the outlook."
"The over-indebted U.S. consumer -- whose deleveraging process yet has to start -- will likely continue to put the brakes on consumption, while the savings rate continues to creep up," said Roubini, head of RGE Monitor and one of the few economists credited with seeing this recession coming.
GDP counts output, not outcomes
To understand how GDP could be up with the economy still down, it helps to know how GDP is calculated. GDP is a measure of output, not outcomes. In the short run, the economy can produce more stuff without creating more jobs, and without boosting wages, profits or living standards.
GDP is calculated as the sum of all goods and services produced in the United States. It counts the production of goods and services sold to consumers, businesses, government agencies, and foreign buyers (while subtracting imported stuff that we consume). It counts investments in homes, businesses, and government projects. And finally, it counts the things that were made, but not sold - in other words, inventories.
Inventories fell by a record amount in the first and second quarters. At some point, probably in this quarter, businesses will decide they've reduced their overstocks enough to match the lower level of sales.
A similar process has been occurring in the home building sector for nearly four years. The decline in building has slowed and has perhaps bottomed. Home building could actually add to GDP in the third quarter for the first time since 2005.
The trade balance is also likely to add to growth in the third quarter. Imports continue to fall while exports could be ready to rise again as the global recession winds down.
If inventories, exports and home building each add a bit to growth, and business investments drop only modestly after their record plunge in the first quarter, the economy could reach a positive GDP number without any contribution from the consumer sector at all.
Final demand flat
To get sustainable growth, however, you need sales to increase, and there is no sign that final demand from consumers or businesses is improving. Retail sales, auto sales, home sales and capital good orders are no longer falling as they were late last year, but they aren't rising either.
"Most elements of demand are essentially flat-lining, and the engine of growth for the recovery is not yet clear," said Andrew Tilton, an economist for Goldman Sachs.
In a normal business cycle, this would be the time for consumers to drag the economy out of the ditch. Buoyed by lower interest rates and improved confidence in their jobs, in past recessions consumers have purchased homes, cars and other durable goods, restoring jobs lost in the downturn and persuading businesses to invest again.
But this time it's different, because consumers don't have the ability to increase their spending. They don't have the income, or the credit. They may not have the desire.
Consumer debt has risen to a record 128% of disposable income, twice the debt level they carried 25 years ago. Their wealth has been shredded, and wages are falling. Credit is hard to obtain, yes, but many consumers are actively trying to reduce their debts, not add to them.
Consumers are in no position to drive the economy forward and, until they are, businesses won't expand. Already, industrial capacity utilization has fallen to a record-low rate, indicating that companies have plenty of idle capacity to deploy before they need to build more.
The American economy has become more and more dependent on consumer spending over the years. In the 1960s, consumer spending accounted for about 63% of GDP. In the 1990s, it rose to 67%. But now it's at a record 72%, thanks to the massive debt load consumers are carrying.
To achieve sustainable growth, either the consumer must spend more, or the economy must restructure to become less reliant on the consumer.
Unfortunately, either option will take time. Researchers at the San Francisco Fed found that it could take until 2018 for consumers to deleverage enough to be satisfied. If consumers raise their savings rate from near zero during the bubble to 10% by 2018, it would cut three-quarters of a percentage point off the typical 3.5% growth in consumer spending, according to researchers Reuven Glick and Kevin Lansing.
No jobs, no wage growth
It might take years for the labor market to fully recover as well: Most members of the Federal Open Market Committee said they expected it "to take five or six years" to bring the unemployment rate down to its long-run potential of around 5%.
Job losses have slowed, but they haven't stopped. The unemployment rate is expected to peak near 11%, according to Roubini. With a current jobless rate of 9.5%, there are now nearly six unemployed people for every job opening. For the first time since the Depression, most of those who are unemployed have lost their jobs permanently.
With so much competition for jobs, wages are dropping. The total wage bill for private industry has fallen at a nearly 5% annual rate over the past six months, the largest decline in the 50 years those data have been kept.
The only thing adding to income growth right now is government transfers, either from automatic stabilizers such as unemployment insurance or from the tax cuts in the stimulus package. Income from private sources declined in all 50 states during the first quarter.
The stimulus has now ramped up. While more money will be coming from Washington each month, the level won't increase. Economist Dean Baker of the Center for Economic and Policy Research figures we need $1 trillion in extra stimulus per year to drive the employment back to 5%, but we're getting only about a third of that.
The worst of the economic crisis is now behind us, but that doesn't mean the economy is all fixed.
Rex Nutting is Washington bureau chief of MarketWatch - Jul 24, 2009, 12:42 p.m. ESThttp://www.marketwatch.com/story/...o-lead-economy-forward-2009-07-24