CBO Warns of Recession in 2013

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
May 29, 2012

IN THIS ISSUE:

1. US Economic Recovery Remains Tepid

2. Encouraging News on the Housing Market

3. Why is the Economic Recovery So Weak?

4. How the Recovery Went Wrong

5. CBO Warns of Recession in 2013

Overview

The non-partisan Congressional Budget Office (CBO) has calculated the expected negative effects on the US economy if the Bush tax cuts expire at the end of this year. Their numbers just released last week are eye-opening! To give us some perspective, US Gross Domestic Product rose by 2.2% (annual rate) in the 1Q of this year.

The CBO now forecasts that if the Bush tax cuts expire at the end of this year, GDP in the first half of 2013 will plunge to -1.3%. Think about that. We don't know what the economy will do for the rest of this year, but the consensus expectation is that GDP will probably average around 2.5% for 2012, barring any negative surprises. So a drop from around 2.5% this year to negative 1.3% in the first half of next year – if the Bush tax cuts go away - is HUGE!

For all of 2013, the CBO forecasts GDP growth of only 0.5% – if the Bush tax cuts go away, and even that may be too optimistic. I wrote at length on this news from the CBO in my blog last Friday. I will give you a link to that blog posting at the end of today’s E-Letter so you can read it.

What we want to focus on today is why this economic recovery is so weak. We will look at the latest economic reports and ponder why they aren’t stronger. We’ll look at the latest news on the housing market and find that there are some signs of improvement. I will also bring you an independent analysis of why the recovery is so weak (and what caused it) that I think you’ll find very interesting. It’s a lot to cover in one letter, so let’s get started.

US Economic Recovery Remains Tepid

It has been over a month since we last took an in-depth look at the economy. Since then, many forecasters have become concerned that the economic recovery might be stalling. The economic reports over the last month have been a mixed bag, as we will discuss below.

Let’s start with the latest GDP report which was announced on April 27. The Commerce Department reported that 1Q GDP slipped to 2.2% (annual rate), down from 3.0% in the 4Q. Growth in the 1Q came largely from consumer spending, exports and inventory rebuilding. The decline from the 4Q was due to lower government spending at all levels and lower non-residential fixed investment. The next 1Q GDP revision will come out this Thursday. Most forecasters expect the 1Q GDP estimate to be lowered slightly (1.9%- 2.0%) on Thursday.

The Consumer Confidence Index reported this morning fell, surprisingly, to a five month low in May. The Index fell from 68.7 in April to 64.9 this month. This followed monthly declines in March and February. The University of Michigan Consumer Sentiment Index for May, which came out on Friday, showed improvement in confidence, rising from 77.8 in April to 79.3 in May. These two readings can be contradictory from time to time, but it is clear that consumer confidence has waned a bit in the last few months. I don’t see a big change in consumer confidence between now and the election unless the economy turns decidedly stronger or weaker.

One measure of confidence that has improved significantly was the Conference Board’s CEO Confidence Index. This index moved up from a reading of 49 in the 4Q to 63 in the 1Q. Currently, 59% of business leaders foresee an improvement in economic conditions over the next six months, up from only 32% in the 4Q.

As noted above, consumer spending has improved this year but only modestly. Retail sales rose 0.1% in April after rising a brisk 0.7% in March. Personal income rose 0.4% in March (latest data available) following an increase of 0.3% in February. Personal income for April will be out on Friday and should show another modest increase.

Durable goods orders rose 0.2% in April following a much worse than expected drop of -3.7% in March. Industrial production rose 1.1% in April following a decline of 0.6% in March. Factory orders fell 1.5% in March (latest data available) following a rise of 1.1% in February. The ISM manufacturing index rose from 53.4 in March to 54.8 in April. The ISM report for May will be released this Friday.

On the inflation front, the headline Consumer Price Index has trended lower over the past three months and was unchanged in April. Over the 12 months ended April, the CPI rose 2.3%. Wholesale prices (PPI) actually fell .2% in April.

On the jobs front, the official unemployment rate dipped to 8.1% in April, the lowest since February 2009. However, only 115,000 new jobs were created last month following 154,000 in March. The dip in the unemployment rate occurred primarily because almost 350,000 people stopped looking for work in April and are no longer counted as unemployed.

The number of unemployed fell to 12.5 million in April, down from 12.7 million in March. The number of long-term unemployed (27 weeks or more) remained at 5.1 million. The labor force participation rate fell to 63.6%. All in all, the April unemployment report was another disappointment.

Encouraging News on the Housing Market

New home sales rose a better than expected 3.3% in April with 343,000 units sold versus 332,000 in March. Existing home sales and housing starts were both up by a similar percentage in April.

According to the latest quarterly report by the National Association of Realtors (NAR), median existing single-family home prices are firming in many metropolitan areas, while improving sales and declining inventory are creating more balanced conditions.

NAR reported that the median existing single-family home price rose in 74 out of 146 metropolitan statistical areas based on closings in the 1Q from the same quarter in 2011, while 72 areas had price declines or were static. In the 4Q of 2011, only 29 areas were showing gains from a year earlier.

Lawrence Yun, NAR chief economist, said there is some volatility in the price performance. “Home prices are more volatile than normal because of sudden upswings in buyer activity in some localities, and also are affected by the prevalence of distressed sales,” he said. “Home prices lag sales activity because the transactions were negotiated mostly in the previous quarter. Given the steadily dwindling supply of inventory and notably higher listing prices that are being negotiated today, prices are expected to show further improvements in the near future.”

Yun said a big part of the story is housing inventory. “We now have broad shortages of lower priced homes in much of the country, with very tight supply in Western states for homes through the middle price ranges. This is good news for many sellers who wish to list now, or for those waiting for prices to improve.”

At the end of the1Q there were 2.37 million existing homes available for sale, which is 21.8% below the close of the 1Q of 2011 when there were 3.03 million homes on the market. There has been a sustained downtrend since inventories set a record of 4.04 million in the summer of 2007.

The national median existing single-family home price was $158,100 in the 1Q, which is 0.4% below $158,700 in the 1Q of 2011. (The median is where half of the homes sold for more and half sold for less.) Distressed homes – foreclosures and short sales which sold at deep discounts – accounted for 32% of 1Q sales, as compared to 38% in the 1Q of 2011.

Total existing-home sales, including single-family and condo, increased 4.7% to a seasonally adjusted annual rate of 4.57 million units in the 1Q, as compared to 4.34 million in the 1Q of 2011. “This is the highest first quarter sales pace since 2007,” Yun said. “With strong market fundamentals, total home sales this year should rise 7 to 10 percent.”

First-time buyers purchased 33% of homes in the 1Q, about the same as in the 1Q of 2011. The share of all-cash home purchases in the 1Q was 32%, about the same as this time last year. Investors, drawn by bargain prices and who make up the bulk of cash purchasers, accounted for 22% of all transactions in the 1Q.

Regionally, existing-home sales in the Northeast jumped 8.6% in the 1Q and were 6.6% above the 1Q of 2011. The median existing single-family home price in the Northeast declined 3.2% to $226,300 in the 1Q from a year ago.

In the Midwest, existing-home sales rose 5.5% in the 1Q and were 11.7% higher than a year ago. The median existing single-family home price in the Midwest increased 0.8% to $125,300 in the 1Q from the same quarter in 2011.

Existing-home sales in the South increased 2.1% in the 1Q and were 4.1% above the 1Q in 2011. The median existing single-family home price in the South rose 1.2% to $143,600 in the 1Q from a year earlier.

Existing-home sales in the West rose 5.9% in the 1Q and were 1.4% higher than a year ago. The median existing single-family home price in the West slipped 0.9% to $196,200 in the 1Q.

While the NAR’s latest quarterly report had some very encouraging news, let us not forget that 72 of the 146 metro areas continue to see falling or flat home prices and sales levels. While just over half of the areas reported improvement in the 1Q, the housing slump is still not over. Average home prices were down 2.6% from a year earlier in March according to the latest Case-Shiller home price index released this morning.

Why is the Economic Recovery So Weak?

This is the question that millions are asking. We’ve added $5 trillion to the national debt since President Obama took office, with much of it aimed at stimulating the economy. The following editorial from Harvey Golub writing in The Wall Street Journal addresses the reasons for the slow recovery as well as any I have read:

“How the Recovery Went Wrong

Of the 11 recoveries in the last 60 years, this one is at or near the bottom in job growth and every other economic indicator.

President Obama, in speech after speech, proudly makes the following point: Although we inherited the worst recession since the Great Depression, we have generated net new jobs every month, and while we need to do more, we are going in the right direction.

Of course, recoveries always go in the right direction—that is, things get better over time. But merely going in the right direction is an incredibly low performance standard. Moreover, since deep recessions are generally followed by more robust recoveries, this should have been one of the strongest recoveries ever.

So what went wrong? All the available Keynesian levers for achieving economic growth have been pulled, yet the recovery is one of the weakest since World War II. The problem lies with the way the "stimulus" was carried out, the uncertainty of looming higher taxes, and the antibusiness rhetoric and regulatory strong-arming of this administration.

First, exactly how weak has this recovery been? The Federal Reserve Bank of Minneapolis tracks economic performance for each recovery and compares gross-domestic-product growth and job growth, the two most important indicators of economic performance. Over the past 60 years, there have been 11 recessions and 11 recoveries.

Sadly, this recovery is near the bottom of all 11. Cumulative nonfarm job growth is just 1.9% 34 months into recovery, the ninth-worst performance and well below the average job growth of 6.5%. Cumulative GDP growth is just 6.8% 11 quarters into this recovery, less than half the average (15.2%) and the worst of all 11.

But wouldn't things be even worse without massive fiscal and monetary stimulus? It's true that monetary policy by the Federal Reserve has resulted in extraordinarily low interest rates, almost zero for the past three years. Normally, low interest rates would result in increased borrowing by individuals and businesses, generating increased economic activity. Its positive effects in this recovery, however, have mainly been to help the government borrow more cheaply, large banks recapitalize quickly, and homeowners refinance at low rates.

Uncertainty regarding ObamaCare and higher taxes on businesses and individuals has discouraged the type of borrowing and lending that low rates generally encourage. Near-zero interest rates have also resulted in historically low yields on savings and encouraged riskier investments. In effect, we have subsidized increased spending by penalizing savings.

Fiscal policy, under the control of the president and his party, increased expenditures by about $700 billion per year since 2008 and launched a spending package of about $800 billion (along with various "targeted" temporary tax reductions), all of which resulted in an increase in national debt of over $5 trillion. In other words, we borrowed $5 trillion, for which we will pay interest for who knows how long, in order to stimulate the economy now.

There's little doubt that this level of spending—$5 trillion in an economy with an annual GDP of about $15 trillion—has a temporary stimulative effect. The question is, was it a good investment? For the most part the money was spent poorly and we will get very little future value from it. Billions were spent to reward favored constituencies like government employees and the auto industry. Billions more were spent on training programs that don't work and unemployment insurance that reduces incentives to actually find work. Little went toward building infrastructure or other assets that will help the nation create wealth over time.

So, yes, we are going in the right direction—but far too slowly to create reasonable economic growth and needed jobs. By their very nature, recoveries involve people and businesses making investments and spending money and borrowing to do both. However, for rational people to spend or invest requires confidence in the future. The "animal spirits" so necessary for a true recovery have been dampened by this administration's policies and rhetoric.

Indeed, this administration has been overtly hostile to business across the economy except for progressive favorites like electric cars or wind and solar power. It has tightened regulatory screws on the coal industry and all other fossil-fuel providers, enacted health-care "reform" based on false estimates of its likely costs and effects, unleashed a hostile National Labor Relations Board on businesses, and passed financial regulations in the form of Dodd-Frank along with hundreds of other regulatory actions that put increased burdens on the private sector. Meanwhile, the president has yet to pass a budget or announce a plan to rein in government expenditures.

The president has said, over and over again, that he wants to increase taxes on businesses—small and large—and on financially successful individuals. He doesn't quite articulate the point that way, but that is the effect. After all, he says millionaires and billionaires aren't paying their fair share. He forgets, or simply does not know, that the top 1% of earners actually pay as much as the bottom 90%, and the bottom half pay no income taxes at all.

In this negative environment, businesses are less willing to invest in the future, and individuals are less willing to spend what they can. Meanwhile, savers and retirees have seen much of their income decline because of low interest rates. The massive costs of all the stimulus have been wasted because of the heavy counterweight put on the economy by the administration's antibusiness and pro-redistribution policies.”

Mr. Golub, a former chairman and CEO of American Express, is the chairman of Miller Buckfire and serves on the executive committee of the American Enterprise Institute.

CBO Warns of Recession in 2013 if Bush Tax Cuts Expire

As noted at the beginning, the Congressional Budget Office warned last week that if the Bush tax cuts expire at the end of this year, GDP in the first half of 2013 will likely plunge to -1.3%. That’s a recession folks! This new forecast from the CBO was a real shocker. I wrote about this in detail in my Blog on Friday. You need to read this now!

If you have not signed up to receive my weekly Blog, that means you’re missing key information that is not included with my weekly E-Letters that go out on Tuesdays. My Blog is free and I encourage you to sign up today.

Hoping you had a great Memorial Day weekend,

Gary D. Halbert

SPECIAL ARTICLES

The Economist: The future of the European Union
http://www.economist.com/node/21555916

Weekly economic commentary
http://www.realclearmarkets.com/blog/WeeklyEconomicFinancialCommentary_05252012%5B1%5D.pdf