Six Key Signals for the U.S. Economy

In the six-plus years of this plodding recovery, sentiment has swung several times from extremes of pessimism to optimism and back again. A good quarterly figure on the real gross domestic product (GDP) or a strong monthly employment report generates a sense among many that at last the economy will break out of its slow-growth pattern and recapture the more favorable pace of expansion enjoyed in the past. Then a bad jobs number or a monthly dip in the industrial production index evokes handwringing about another recessionary turn, sometimes colorfully referred to as a "double dip."

Most recently, the weight of commentary has leaned toward the pessimistic side. Ammunition seems to abound. Many point to China's economic problems and stock-market reverses as reason to fear for this economy's future growth. Others worry that a Federal Reserve rate hike will drag the United States into recession. Two recent pieces in the space (“Checking China's Real Crisis," September 14, and "China's Stock Market: Can Beijing Keep It Steady?" July 27) have explained how unlikely to occur is the widespread concern of a Chinese implosion.

This piece takes the analysis back home and offers four reasons why a U.S. recession now is unlikely. And then, because there is no telling when the pendulum will swing toward optimism, it offers two reasons why a sudden economic acceleration is equally unlikely.

Four Reasons Why No Recession
Among those who periodically forecast another recessionary dip, whether from an implosion in China or some other cause, an underlying concern is the frustratingly slow pace of growth to date. The pessimists seem to worry that the closer to zero the underlying growth rate is, the more likely it might slip into negative territory. There is indeed a role for momentum in the economy, but in general recessions arise less from a lack of drive or from boredom and more so from excesses that demand a correction. In this economy, except for the very special case of the federal government, no such excesses exist. Here are four points to give that assertion substance:

1. The housing market is improving. It is far from booming, and gains surely have progressed unevenly, from one region to the next and from one month to the next. Nonetheless, housing starts have risen 12.5% during the past 12 months,¹ while new home purchases have risen on balance at a rate of 21.6%.² More important, real estate prices have risen 5.0% during this time, at least according to the Case-Shiller Index.³ If not a boom, this picture is undeniably positive, and the U.S. economy has never gone into recession when residential real estate is improving, even if the pace of improvement is sluggish.

2. Business is flush with cash. This is an old story, but it remains relevant. According to the most recent quarterly figures available from the Federal Reserve, non-financial corporations in the United States hold $1.7 trillion in cash equivalents on their balance sheets, an amount equal to fully 10.3% of their total liabilities. For reference, such holdings in the past averaged much less, only 7.7% of total liabilities for instance in 2000 and only 6.4% in 1995 during that decade of great growth.⁴ These holdings testify to the extreme caution exhibited by business in this expansion. Managements, to be sure, are reluctant to hire or to spend on new equipment, premises, even technology. This timidity is one of the reasons why this recovery has proceeded at such an atypically slow pace (more on this below). But the economy does not go into a recession because business is cautious. Rather, it goes into recession because business is squeezed and has no choice but to cut back, and with so much cash on its balance sheet, business is far from squeezed.

3. State and local governments are hiring again. With their finances improving in this albeit slow-growth recovery, states and cities have ceased laying off firemen, policemen, and teachers, and have begun to rehire. Nothing in that last statement is meant to suggest that state and local finances will be in good shape anytime soon. But if such an occasion is at best on a very distant horizon, that fact does not preclude an improvement. State and local revenues, in aggregate, have grown about 4.0% during the past year, far faster than earlier in the recovery.⁵ The turn to hiring also has statistical support. Between 2009 and 2013, for example, state payrolls fell almost 2.0% and local government payrolls fell 3.3%. During the last 12 months, they have grown 1.8 and 1.1%, respectively.⁶ It is far from a boom, and such a rate is incapable of propelling the economy to a rapid pace of growth, but it is nonetheless another proof against recession.

4. Households, still some 70% of the economy, have improved their finances impressively. In the last five-plus years, households have shed almost $1.0 trillion in mortgage debt. Household net worth has increased $3.8 trillion, or some 4.7% during the year ended this past June (the most recent period for which such data exist). The burden of debt service has dropped, from more than 18% of aftertax household income in 2007, as the economy approached the last cyclical peak, to barely more than 15% at the end of the second quarter.⁷ Meanwhile, business, rather than hire many new full-time employees, has increased overtime, so that the average work week in this country has expanded, from a low of just a little more than 33 hours in 2009 to a bit less than 35 hours most recently. The average factory work week now exceeds 40 hours, so that manufacturing workers receive almost 3.5 hours of overtime pay each week.⁸ This jump has done little to re-employ the many who still have not found work, but it has increased the disposable incomes of those who do have jobs. Despite the historically slow 1.5% annual rate of jobs growth, these influences have pushed up household incomes from wages and salaries close to 4.5% during the past 12 months.⁹ After adjusting for the lower burden of debt servicing, this measure of spendable income gains rises toward 5.0%. This is hardly enough to create a boom, but it points to an increase in confidence as well as spending ability. It serves as another powerful reason why a recession is highly unlikely.

Two Reasons Why No Acceleration
If the odds of a recession look low, the odds of the much looked for growth acceleration are equally slim. A full analysis of why this recovery has proceeded at such a historically substandard pace has yet to appear. No doubt it will take years before academic economists and financial historians identify all the reasons. But two major influences are evident, and neither is likely to disappear anytime soon:

1. Business managers, lenders, investors, investment bankers, small-business owners, and consumers remain deeply scarred by the experiences of the financial crisis of 2007–09 and the consequent Great Recession. The losses of the financial crisis and the huge business downturn that followed have created a general reluctance by businesses and individuals to spend and expand as aggressively as they have in past recoveries. The lack of hiring by business and the preference for part-time help (outlined in last week's Economic Insights) is indicative, as is businesses’ reluctance to spend on new equipment, premises, and technology. (See, also, Economic Insights, "Where's the Capital Spending Recovery?" October 5.) The preference for huge amounts of cash on balance sheets also speaks to this timidity. (See above.) So also is the reluctance by households to deploy their financial resources fully. Indicative in this regard is their reaction to last year's drop in energy prices. It effectively added just less than 6.0% to households' real disposable household incomes. Rather than spend it—and, accordingly, spur economic activity, as they might have in the past—households responded by raising their rate of savings by 1.3 percentage points of aftertax income.¹⁰ Though there is virtue in more savings, that move kept this immediate engine of growth running slower than during previous recoveries.

2. Complex and disruptive legislation passed by Washington continues to create uncertainty. The year 2010 saw the passage of the Affordable Care Act (ACA) and Dodd-Frank Financial Reform legislation. Whatever the ultimate virtues and vices of these bills, none can dispute that they are sweeping, complex, and so, inevitably, have created huge uncertainties about the future cost of hiring, the future cost and availability of credit, and the future burdens of reporting and compliance. Those uncertainties have magnified the timidity of business and households already established by the financial crisis and the Great Recession. Under normal circumstances, the economy would have long since understood the provisions of legislation passed five years ago and so weighed the costs. Yet these bills were not only massive but they also remain ambiguous, even now. The administration has since modified the ACA several times, and has repeatedly delayed implementing aspects of it, so that at present no one can weigh its full future impact and thus clearly picture the likely costs of hiring and expansion decisions. Dodd-Frank is written in such a way that its provisions require considerable rule-writing by the Federal Reserve, the Securities Exchange Commission (SEC), other regulatory agencies, and new ones created by the legislation itself. Since even to this day all those rules are not yet written, many uncertainties brought by this legislation remain, weigh on decision-making, and, accordingly, hold back the pace of growth.

Time ultimately will lift these growth impediments. It will erase the worst fears engendered by the pain of the 2007–09 experience. It will ultimately bring clarity on this sweeping legislation. But it is apparent from behavior until now and the still unfinished state of these regulations that such relief will wait some time to arrive, possibly years yet. During that time, both these influences will tend to make business and households more timid than previously and so less likely, at least anytime soon, to produce the growth rates of past recoveries. The economy then escapes recession, but remains slow by past standards.