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Recession now certain, economists say
Consumer spending on track for first quarterly decline since early 1990s
By Rex Nutting, MarketWatch
Last update: 6:24 p.m. EDT Oct. 1, 2008
WASHINGTON (MarketWatch) -- Even before the latest squeeze in the credit markets, the U.S. economy had slipped into what could be a relatively lengthy recession, economists say.
The latest data, covering activity in August and September, make it all but certain that the academic economists will eventually declare that the economy is in a recession.
The big economic forecasting firms are in the process of updating their forecasts following the release of key data on consumer spending. While the final numbers aren't available yet, forecasters say it doesn't look good.
The economy seems to be on the "edge of the abyss," said Joel Prakken, chairman of Macroeconomic Advisers, which will update its forecast on Friday.
"Anyone who's wondering if there's a recession should stop wondering," said Nigel Gault, U.S. economist for Global Insight, which will release its updated forecast on Monday. "The recent data were deteriorating sharply" even before factoring in the latest impact of the credit squeeze.
Global Insight doesn't think the recovery will be quick or powerful. The economy will likely contract for three quarters and then show weak growth in the second quarter next year.
If the recession lasts from December 2007 until April 2009, as Gault suspects it will, it would be the longest since the Great Depression. And the recovery, when it comes, won't feel anything like a boom.
"It's difficult to see a real rapid recovery, certainly at the beginning," Gault said. Typically, the economy recovers when the Federal Reserve lowers interest rates to stimulate credit-sensitive consumer purchases of housing and autos. See earlier story on why the recession will be protracted.
But with credit markets jammed and consumers already reeling from too much debt, lower rates won't have the usual impact on the economy. "The Fed won't have any ammo left," Gault said.
Fed policymakers may not try to stimulate the economy too much anyway, figuring that the current crisis stems from exactly that medicine: The Fed kept rates too low for too long after the 2001 recession in a bid to drag the economy out of the jobless recovery.
Contrary to the conventional wisdom, a recession is not defined as two consecutive quarters of declining gross domestic product. So far, we've had just one quarter of negative growth (the fourth quarter of 2007), although revisions next summer could certainly drop one or two quarters this year below zero.
Rather, the economists at the National Bureau of Economic Research, who are the arbiters of recession dating, say that "a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales."
Four of those indicators have been declining significantly since the first of the year. Employment has fallen at a 0.7% annual pace, incomes are down 1% (even with the rebate), output is down 2.8%, and sales are down 1.3%.
Only GDP has bucked the trend, rising at a 1.8% annual rate. How can that be? Can the economy really contract while GDP is growing?
The answer is yes, under certain circumstances like now, when exports are booming while domestic consumption and investment are weak.
GDP is the total value of goods and services produced in the United States, including domestic consumption and investment as well as goods and services sold overseas and unsold goods put into inventories. We get the income from making exports and inventories, but we don't get the utility from using those goods and services.
Gault of Global Insight notes that gross domestic income, which should by definition equal GDP, has not been nearly as strong as the economy measured from the output side. GDI is up just 0.2% from a year ago compared with 2.1% for GDP. Gault suspects that GDP will ultimately be revised lower to match the weaker income figures.
In the past year, our economy has come to look like a banana republic's: All the output goes to exports, and not to domestic consumption and investment.
In the past year, most of the GDP growth has come from increased exports and a reduced appetite by Americans for foreign-made goods. Consumer spending, which typically accounts for 70% of the economy, has contributed only about 40% of the growth over the past year.
And consumer spending seems almost certain to decline in the third quarter, which ended Tuesday. We won't see September consumption data for another month, but the trend through August was horrible. With auto sales dropping to a 16-year low and chain-store sales weak, September may have been even worse. And that was before the credit markets really seized up.
We haven't seen even one quarter of declining consumer spending since 1991, but it could fall as much as 2.3% annualized in the third quarter, said economists for Morgan Stanley. That could be enough downdraft to offset any upside from exports. Housing will continue to be a drag, and business investment seems to be weakening as well.
The unemployment could reach 7% before it's all over, said Prakken.
The major risk now is that the downturn could worsen if the credit squeeze is not fixed. "The further tightening of credit conditions and declines in equity markets will weigh heavily on the outlook for growth in the coming quarters," said Prakken of Macroeconomic Advisers.
"It could be much worse in the short-term," said Gault, adding that the deeper the contraction is now, the sooner the healing process could begin.
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