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Economic data look mild, but feeling is gloomy

Is the U.S. in the early stages of a full-blown recession? Or is this a brief downturn before the economy gets up another head of steam later in the year?  By's John W. Schoen.
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House prices are falling, food and energy prices are rising and consumers are gloomier than they’ve been in decades. But the latest data on the U.S. economy shows it still has a feeble pulse.

So which is it? Are we in the early stages of a full-blown recession? Or is this a brief downturn before the economy gets up another head of steam later in the year?

Though the start of a recession can only be seen in the rear-view mirror, many economists now believe the U.S. economy is close to recession or in one. That’s based largely on a string of monthly reports showing the economy has lost about 260,000 jobs so far this year.

“Since the 1950s we've never had a period of four months of job losses without that signaling that we were in a recession,” said Jared Bernstein, senior economist of the Economic Policy Institute. “If and when (a recession is confirmed), it will probably be dated based on these payroll numbers as starting sometime around December or January.”

But other economic signals are flashing yellow, not red. The government recently reported the gross domestic product grew slightly in the first quarter, while generally GDP shrinks in a recession. Last week's employment report for April showed the economy lost only 20,000 jobs, fewer than in previous months.

On Thursday, retailers reported better-than-expected sales for April. But most of those gains came from discounters and wholesale clubs, a sign that consumers are tightening their budgets.

Part of the puzzle may rest in the data itself. Monthly jobs data can be volatile, especially when hiring is slowing. The GDP data represents the economy's average performance in the quarter and is subject to revision in coming months.

“If you compare where the economy was at the end of March with where we were at the beginning of the year, there is no question the economy is down by just about every measure,” said Martin Feldstein, the former chief economic adviser to Ronald Reagan who now heads the National Bureau of Economic Research, which formally "declares" U.S. recessions.

Even without the confirmation of a down quarter, about half of the economists polled last month by the Blue Chip Economic Indicators survey said they believe the U.S. economy has already slipped into recession or will do so this year.

The majority said they don’t expect the downturn to be especially deep or last very long. The consensus forecast calls for the GDP to eke out a 0.1 percent advance in each of the first two quarters of this year before picking up speed in the second half and ending the year with modest 1.4 percent growth. That is down from earlier consensus forecasts of 1.5 percent in March and 2.6 percent last September, when the Federal Reserve first began to cut interest rates.

That’s not the view of Americans consumers, most of whom see the economic glass as less than half full, according to the latest survey of consumer sentiment. Americans are gloomier about the economy than at any time since the early 1980s, when the economy was emerging from a decade of weak economic growth and rampant inflation. Nearly nine in 10 consumers think the economy is in recession, according to the Reuters/University of Michigan survey.

Some economists are at a loss to explain that level of pessimism given that, so far, the data indicate the economy isn't in such bad shape.

“While there’s no question the economy is struggling, just how anyone could confuse the current environment with the worst economy since the Great Depression is baffling to say the least,” said Wachovia chief economist John Silvia.

The answer to that riddle may be that consumers see trouble ahead that the data isn’t picking up yet. The big worry is that falling house prices will continue to chew up the home equity that has become the main financial asset for many Americans.

Feldstein notes that home prices have fallen 13 percent in the past year and have been falling at a 25 percent rate over the past three months, leaving more than 8 million homeowners stuck with mortgages that are bigger than their house is worth. Many of them are tempted to simply walk away and mail the keys to their lenders.

“If we see a big increase in defaults, and ultimately in foreclosures, that's going to, I think, push us definitely into a significant recession," Feldstein said.

Even if the worst case doesn’t play out, consumer anxiety about home equity has a direct impact on the economic outlook because consumer spending accounts for about 70 cents of every dollar of GDP.

Some retailers reported Thursday that spending perked up in April after months of dismal sales. But the gains were concentrated among discounters like Wal-Mart and Costco. Consumers are still shying away from stores selling clothes and other non-necessities; most mall-based apparel stores struggled last month.

Spending has already been crimped by higher food and energy prices. And though job losses shrank in April, American workers saw their hours cut back and average hourly earnings pretty much flat. If you factor in the effects of inflation, wages have begun heading into negative territory. The last time that happened was in 2001, the start of the last U.S. recession.

“It’s clear that households have very little spending firepower at the moment through their inflation-adjusted paychecks,” said Credit Suisse chief economist Neil Soss.

Consumers are getting a boost from tax rebates that are being paid out to some 130 million households. But the sharp jump in gasoline prices already has taken a huge bite of that spending power.

All of which has some economists worried that the economy may not have hit bottom yet.

“There's good reason why confidence is as low as it’s been since 1982,” said Mark Zandi, chief economist for Moody's “It can go lower. Gasoline prices are going to continue to rise. House prices aren't going to stop falling. We haven't seen the end of the job losses. I don't see any reason why we should expect consumer spending to not weaken even further.”  

So far the surprising bright spot in the U.S. economy has been the manufacturing sector, especially companies that do strong business in exports. The weak dollar gets most of the credit, but the strength in exports has gone a long way toward offsetting the sharp decline in the housing market and the periodic freeze-up of the credit markets that provide the lifeblood for the economy.

Strong export demand has also kept inventories relatively lean, which means that even if the economy continues to slow, businesses are less likely to get stuck with a lot of unsold merchandise. Big inventory backlogs often prolong a recession even after the pace of sales begins to pick up again. If inventories stay lean, that could speed the economy’s rebound when business picks up again.

And just as they’ve kept inventories lean, businesses also have kept their payrolls fairly tight during the economic expansion that began in late 2001. That could help limit job losses during the current downturn.

A lot will also depend on whether homeowners stuck in mortgages due to reset to higher payments in the next few years can refinance into more affordable loans. While Congress has debated a number of solutions, the government has been relying on borrowers and lenders to work out new terms voluntarily.

“The trouble with the voluntary restructurings is there's nobody to talk to,” said Feldstein. “Sure, if your mortgage was taken out with a local bank that kept that mortgage, yes, you can sit down and talk. But if it has been securitized and (sold off to investors), there’s nobody there on the other side. That's why the Treasury's proposal in that direction has had so little impact.”