The recession's over. But the economy still stinks. What's going on?
It's hard to tell from the weekly cavalcade of statistics. Headlines tout big improvements in important parts of the economy like retail sales, housing starts, and unemployment claims—but that's often compared with levels that were deeply depressed to start with. Economists scouring the data see the "preconditions" for a healthy recovery, but it will still be months before real improvements trickle down to ordinary people. And some parts of the economy remain deeply troubled despite all efforts to fix them. Here's a rundown of what's going right and what's not:
Corporate profits. Status: Strong. Companies cut costs aggressively during the recession, and they're now reaping the rewards. After falling for three years, corporate profits have rebounded sharply, with forecasting firm IHS Global Insight predicting a double-digit increase for 2010. And that's happened even as overall revenue has declined at many firms. What's needed now is an increase in top-line revenue, which can only come from a growing economy. If that happens, strong profitability means many companies are in a good position to hire.
Productivity. Status: Strong. Workers may gripe about doing more with less, but all that cost-cutting—including millions of layoffs—has made remaining workers remarkably efficient. With productivity near record highs, companies can't get much leaner. So if demand for their products rises, the only way to meet it is by staffing up.
Interest rates. Status: Strong. Money remains cheap—for those able to get a loan. Mortgages rates, for example, have drifted up since last summer, but they're still near record lows, with the average rate on a 30-year loan hovering just above 5 percent. The catch, of course, is that banks have become extremely stingy with credit and many borrowers don't qualify. That should ease as the economy improves. Interest rates will probably rise as the economy strengthens and the Federal Reserve tightens monetary policy, but a sharp spike in rates seems unlikely.
Housing affordability. Status: Strong. A combination of low interest rates and plummeting home values has made real estate more affordable than ever—for people in a position to buy. Affordability should continue to improve for a number of reasons. Demand for homes could actually weaken this year as federal home-buyer subsidies expire. Prices may continue to fall for a while, and there's nothing in the near-term picture that's likely to send house prices soaring.
Inflation. Status: Strong. Healthcare and college costs are rising, but overall inflation is a mere 2 percent or so. Some economists worry that inflation could take off on account of all the money the Federal Reserve has pumped into the financial system. But so far that's a theoretical worry that hasn't panned out, and the Fed seems poised to act quickly and raise interest rates if there are signs of inflation.
The stock market. Status: Strong. Since bottoming out in March 2009, the S&P 500 has soared by about 75 percent. That hasn't covered all the losses since the peak of the market in 2007, but it has helped many families rebuild their retirement and investment portfolios. The future is uncertain, however. The stock market is much harder to predict than other parts of the economy, and some analysts think a fresh correction is overdue.
GDP growth. Status: So-so. The economy ended 2009 with a bang, as the economy grew by 5.6 percent. That's torrid growth that won't be sustained. At least half of the fourth-quarter growth came from temporary factors like companies rebuilding depleted inventories and government stimulus spending, which is winding down. Moody's Economy.com predicts that the economy will grow by about 3 percent this year and 4 percent in 2011, when the recovery accelerates. That's not bad, but it will still take a long time to repair the damage from the recession and replace the 8 million jobs lost.
Consumer spending. Status: So-so. Shoppers have been buying more than expected lately, with spending up by about 3 percent so far in 2010, compared with the year before. But spending has risen more than wages, which suggests that another pullback is coming. It's also likely that spending gains have been driven largely by the affluent, with lower-income consumers still sitting on their wallets.
Savings. Status: So-so. The flip side of spending is saving, and consumers haven't made their minds up yet about whether to start socking away more. Some economists think the savings rate will rise to as high as 10 percent over the next several years—from lows near zero not long ago—as Americans rebuild wealth they've lost from the housing bust and stock market decline. But after ticking up to about 5 percent, the savings rate has dipped back down as people spend more. A healthy savings rate is probably somewhere between 4 and 8 percent, which would cut into spending today but make Americans better off in the future.
Energy prices. Status: So-so. Gas prices have ticked upward over the past year, and now hover close to $3 per gallon. But after the 2008 spike, when pump prices crested $4 per gallon, consumers and businesses adapted to higher fuel costs. Many drivers have downsized their vehicles or learned to drive more efficiently, and automakers are rolling out lots of new fuel-saving technology. So $3 gas isn't quite the shock it was a few years ago. And with the global economy still somewhat hobbled, oil prices could stay where they are for awhile.
The trade balance. Status: So-so. One thing economists haven't been fretting over lately is the U.S. trade deficit, which improved sharply during the recession as imports to the United States declined by a lot more than U.S. exports. The low dollar has also made U.S.-made products more affordable in other countries. The United States still has a sizeable trade deficit, but as the world economy recovers, exported American goods and services could be a bright spot.
Income. Status: Weak. Incomes dropped sharply during the recession, and although they've rebounded a little, much of the gain is from government stimulus programs and federal subsidies, which are temporary. And with an oversupply of workers in many industries, income growth will probably remain weak. Low inflation eases the pain, but many consumers will simply have less purchasing power than in the past.
Wealth. Status: Weak. Americans have lost about $12 trillion in net worth over the past three years, according to the Federal Reserve. That's about $102,000 per U.S. household. The stock market rally over the past year has helped recover some losses, but home values are still falling, adding to the bogey. And there's no magic formula for regaining all that lost wealth. Mostly, it will come from building up savings, which suggests spending could be suppressed for a long time.
Credit. Status: Weak. The banking sector has recovered, thanks to government intervention, but banks are still stingy with loans. And consumers themselves are seeking to borrow less. The new frugality is helping Americans pare down their debt, but scarce credit is particularly onerous on small businesses, and it's depressing sales of homes and cars. For the economy to be healthy, credit needs to flow more freely and banks need to take more risks. Some economists think credit will ease by late this year or 2011.
Housing prices. Status: Weak. The housing bust seems almost over—but not quite. Home values have fallen about 30 percent from the peak in 2006, and they're still drifting down. Moody's Economy.com predicts that house prices could still fall another 5 to 10 percent through the end of this year. Since many families still have the majority of their wealth invested in their homes, the economy can't really get healthy again as long as such a huge household asset is falling in value. The end of the federal home-buyer tax credit and other government programs throughout the year will test whether the housing market can stand on its own. If it can't, the government might have to step back in.
Foreclosures. Status: Weak. As home prices continue to fall, about 16 million homeowners—nearly 20 percent of the total—are "underwater" on their homes, owing more than the property is worth. And nearly 5 million borrowers are severely late on their payments or in the process of foreclosure. The mounting tally of foreclosures further erodes home values and perpetuates the housing bust. The Obama administration has rolled out a new loan-modification plan to help some borrowers stay in their homes. But the participation of banks is voluntary and prior programs have been largely ineffective. If there's any good news, it's that distress sales are likely to peak this year, which might finally lead the housing market to turn the corner and start recovering.
Commercial real estate. Status: Weak. There's a bust in commercial real-estate too, as the value of office buildings, retail space, and apartment complexes declines in many cities. That doesn't affect consumers directly, but it's adding to stress in construction and related industries and causing prolonged losses at many regional and local banks, which further curtails other types of lending.
Corporate spending. Status: Weak. With profits up, big companies have been stockpiling cash. The problem is, they're not spending it. Many CEOs remain skeptical that the recovery has roots, which makes them reluctant to invest in new employees, equipment, or real estate. If the evidence of a recovery becomes more convincing, companies are in a good position to boost their spending.
Confidence. Status: Weak. Consumers and business executives alike are still gloomy about the economy's prospects. Confidence levels in various surveys are up from the lowest moments of the recession, but since last fall, optimism has generally plateaued. Consumers worry about scarce jobs and falling pay. CEOs worry about worried consumers. The malaise, for now, is self-reinforcing.
Jobs. Status: Weak to terrible. Economists are encouraged by steady improvement in the "preconditions" for job growth: rising corporate profits, surging productivity, and more stability in the financial system. And the economy may finally have stopped shedding jobs and started adding them. But there are huge holes in the labor market that will take years to repair. With many industries in a state of transformation, many of the 8 million jobs lost during the recession are probably gone for good. With so many homes underwater, it's hard for some workers to leave depressed areas and move to where job prospects are better. And technology and cheap overseas labor gives employers more reasons not to hire Americans. Even with a growing economy, the unemployment rate will probably stay above 8 percent for another two years.
[See 8 sneaky ways to raise taxes.]
The national debt. Status: Terrible. America's total debt has ballooned to nearly $13 trillion—roughly equal to the nation's entire GDP in a given year—and it's not going down any time soon. The government habitually spends more than it earns, with annual deficits expected to add another $6 trillion to the debt over the next decade. At some point, investors loaning America all that money will demand higher interest rates and the borrowing binge will become unsustainable. That matters today because it portends big tax increases or spending cuts or both, causes uncertainty, eats up increasing amounts of taxpayer dollars just to pay interest on government securities, and degrades confidence in the U.S. government among its own citizens. "There are a lot of sensible ways to deal with this, but politicians don't want to touch it," says Nariman Behravesh, chief economist at IHS Global Insight. "The real problem for the United States is the lack of political leadership." As if a weak economy weren't bad enough.