The economic rebound that some forecasters have been predicting for more than two years finally seems to be materializing, raising hopes for another strong quarter of earnings and buoying the stock market. But a report from the Federal Reserve this week raises fresh questions about how long the latest boom in consumer spending can be sustained without job growth — and job growth, so far, is nowhere to be found.
The Fed's policy-making Open Market Committee meets Tuesday, and while the central bankers are not expected to cut short-term interest rates from their current low levels, they probably will curb their enthusiasm about the third-quarter growth spurt. After all, it was almost inevitable that the economy would respond to the combination of record-low interest rates, a massive federal tax cut and a weaker dollar.
Few analysts expect the economy to sustain the current quarter’s pace of growth, estimated at 5 percent or more by some analysts, which could make it the best result since late 1999. The question is whether the economy continues to grow at or above its long-term “trend” rate of about 3.5 percent, the level needed to create a so-called virtuous cycle of rising employment and growing demand without triggering inflation.
There are several reasons to question whether the economy can meet that target in 2004, including the problem of rising household debt, as reported in the Fed’s own quarterly flow-of-funds report this week.
Households have been accumulating debt at a growing rate in recent quarters, largely because they have been tapping their home equity in wave after wave of mortgage refinancing. The Fed report shows that household debt surged at an 11.5 percent rate in the second quarter, up from 9.9 percent in the first quarter and 10 percent in 2002.
That growing debt, which has helped fuel surprisingly strong sales of cars and other durable goods this year, has not posed a significant problem for consumers because steadily declining interest rates have allowed them to keep monthly payments under control — or even reduce them in many cases through “serial” mortgage refinancing.
But now that long-term interest rates have risen substantially from the 45-year lows hit in mid-June, it seems unlikely that consumers can continue expanding their debt at recent rates. If they do, monthly debt service quickly will rise beyond the current level of 13.9 percent of disposable income, already near the top of the historical range, said Goldman Sachs economist Jan Hatzius. The only other choice would be for consumers to scale back the pace of borrowing, he notes in a report titled “Household Debt: Between a Rock and a Hard Place.”
“In the long term, this is the preferable response. But the short-term impact on household spending power would probably be even greater,” Hatzius said. “The conclusion is that, when combined with the apparent end to the bond bull market, the current debt growth pace provides a strong argument for an eventual consumer retrenchment.”
Household debt is hardly the only hurdle facing economic growth, but it looms large in an economy that is failing to create jobs. Hatzius called rising household debt the “most important factor” likely to restrain consumer spending next year, although he also cited a “somewhat restrictive fiscal policy” compared with the huge boost provided by this year’s federal tax cut and advance refund.
With consumers having tapped out their home equity, any significant growth in demand for goods and services will have to come from new jobs. But news on that front has been discouraging.
The economy lost another 93,000 jobs in August, the seventh consecutive month of job losses, defying predictions that payrolls would rise by about 5,000. About 422,000 people filed initial claims for unemployment benefits in the latest week, the third straight week the figure has risen, dashing last month’s hopes that the labor market was stabilizing.
“The pace of layoffs may have slowed down, but we still do not have job creation,” said Mary Ann Hurley, a bond trader for D.A. Davidson in Seattle. She expects strong economic growth through the fourth quarter but questions what will happen early next year, when the stimulus from the recent one-time tax refund checks is no longer boosting consumer spending.
The other logical place to look for growth is in business investment, but Merrill Lynch economist Ron Wexler cautions against expecting too much from the nation’s big companies.
In a recent series of reports, Wexler analyzed profits of companies in the S&P 500 and noted that while gross profits are up 8.5 percent since the end of the recession in late 2001, cash flow from operations is up only 2.6 percent. Profits have been boosted by foreign currency translation but also by declining depreciation costs, suggesting to Wexler that companies are depreciating their assets over a longer period of time.
“Taken together, these results suggest that (capital spending) growth will be limited to a replacement cycle for the foreseeable future, which means that this economic recovery will feel subpar well into 2004,” Wexler said.
None of this is to suggest that the economy is in danger of slipping into another recession. The economy has been expanding steadily since late 2001 and is likely to continue expanding.
“We definitely see a cyclical upturn here,” said Wexler. But he noted that by historical standards, the economy should have added 5 million jobs by this point in an expansion. This time around, the economy has lost nearly 1 million jobs since the recession ended.
“There is a lot of structural excess here,” Wexler said. “We think the economy is going to continue to struggle to grow at trend rates.”