Volume 57, Number 10 | December 17, 2010
Is the new stimulus package typical government piling on an economy that was already recovering? This week we got another round of robust data, in particular the strong 0.8% gain in retail sales – on top of a significant upward revision for the previous month to 1.9%. Initial claims, the Philadelphia Fed survey, and even housing starts all indicated a better picture as well. As a result, the consensus forecast for fourth quarter real GDP growth is now north of 3%. That means the US is now in finishing its sixth quarter of positive growth since the recession officially ended in June 2009, with average growth of 2.75% in both the second half of 2010 and for the full year. That would put this year’s growth right on potential – as verified by the fact that the unemployment rate was roughly unchanged at 9.8% this November, compared to 10.0% a year ago.
True, the unemployment rate is too high, but will another $200 billion of stimulus help or hurt the economy? We suspect that the recent rise in long term interest rates from 2.4% to 3.5% is every bit as much a drag on the economy as the $200 billion in fresh stimulus is a boost. Moreover, with growing austerity in Europe and China, we suspect the backdrop for global growth in 2011 is softer. We are not looking for a double dip – or even a dip. We simply believe that growth will remain in the 2.5% – 3.0% range in 2011as higher interest rates reveal new problems in the housing and banking sectors – maybe in nonresidential investment as well. The decline in long term interest rates from roughly 4% in early April to 2.4% in October was clearly a stimulus to the economy via robust refinancing of consumer and business loans. Now that stimulus – which was equivalent to a permanent tax cuts for the beneficiaries — is gone. Consensus suggests that the last 0.5% hike in long term rates was a direct result of higher growth expectations due to the tax deal – not inflation, not a selloff following QE2. Bottom line, once again the Congress has interfered by replacing permanent tax cuts with temporary ones – but ones they can claim credit for. We do not see this as a plus for growth, though it may not be a drag either.
Hey, Big Spender
From our point of view, the key improvement over the past six months has been in small business sentiment. Small business expectations for economic growth had been warming up in the spring – until the health care bill passed. More recently, as the equities market has recovered – led by small businesses – and the Republicans have reclaimed the legislative high ground, small business confidence has returned. A significant part of the improved confidence in this group is simply the fact that they survived until now. A year ago, most firms still did not know whether they would be a survivor despite the initial stimulus package. By now most know, and also know that some of their competitors did not survive. Where a year ago small business owners were hoarding money to either pay down debt or build up reserves, more now are comfortable with their savings cushion and are spending out of cash flow.
Unlike the President, we are most interested here in their spending on consumer goods rather than on jobs or equipment. Though small business owners account for only 10% of the working population, they control roughly 25% of the income. When they save, the saving rate rises. When they spend, retail sales recover – and that is what we have seen in recent months, in particular in luxury goods. While retail sales are up 13.7% over the past four months, sales of cars (up 21.3%) and building materials (up 20.0%) have led the way. This is not a generalized rise in interest sensitive goods, as electronics and furniture are among the weakest sectors of retail. Rather it suggests, and anecdotes confirm, that big spenders with cash are upgrading their capital stock of houses and cars after a couple of years of austerity. While this is no doubt a good sign for the economy, the rebound in small business owners’ spending to a more normal pattern is a one trick pony. They are unlikely to be enticed by stimulus to increase their spending beyond previous norms. The next boost in retail sales is going to have to come from new employees, if and when small businesses increase hiring.
One factor helping the small business sector is the return of the traditional spread between inflation in core goods and core services. For the past twenty years, service providers have benefitted from far lower inflation in the cost of goods – primarily due to imported deflation — as an offset to labor costs. However, between April 2009 and April 2010, core goods inflation exceeded service inflation as the credit bloodbath in the small business world collapsed margins. Now, the inflation rate in non-energy services (up 1.0%, quarter on quarter annualized) has returned to a premium position relative to goods excluding food and energy (which fell -1.2% in the same period). While, the spread is still far narrower than the 3.5% spread during the first seven years of this century, it is a lot better than a year ago.