Is the Worst Yet to Come?

A "perfect storm" may still be looming for the economy

Despite a parade of horribles, the U.S. economy as a whole has shown remarkable resilience so far this year.

The much-publicized horribles include a steep drop in home sales and prices, a near meltdown of the mortgage and related financial markets, declining employment in each of the past seven months, and a stifling surge in oil and gasoline prices. This vicious combination has been characterized by a leading economist—Richard Berner of Morgan Stanley—as a "perfect storm" calculated to drive the economy into a recession.

Yet when the acid-test measure of the nation's economic activity, its gross domestic product, was recently announced, it showed a 1.9 percent annual growth rate during the second quarter of this year. That's well below the 3 to 4 percent growth that most economists would consider robust, but it's also a far cry from the negative numbers that gloom-and-doomers had been forecasting.

This resilience is attributable in largest part to the proclivity of U.S. consumers to keep on spending despite all the vicissitudes. Consumer spending, which accounts for more than 70 percent of GDP, rose 1.5 percent in the second quarter on an inflation-adjusted basis, and there was a lot of adjusting to be done since prices rose at a 4.2 percent annual rate during the quarter.

Still, the fact that the economy has held up as well as it has until now is by no means indicative that it will continue to do so. Economists like Berner insist that a "perfect storm" is still looming—just postponed by the temporary stimulus that upwards of $100 billion in federal income-tax rebates have provided.

As their effect dissipates, he and many others foresee the outlook for consumer spending worsening on several counts. For one, home loan mortgage foreclosure rates continue to soar to their highest level since the 1930s, and default rates on automobile loans and credit card debt are also mounting. This is not only crimping directly affected borrowers, but it's also causing lenders to pull in their horns on extending credit that's been a consumer-spending lubricant. At the same time, double-digit declines in home values in many areas have robbed many still-solvent homeowners of the equity that had been a major source of borrowings.

Equally ominous is the prospect that job losses will get worse in the months ahead. Massive layoffs announced by the hard-hit automobile and airline industries especially haven't taken effect as yet, but when they do the U.S. unemployment rate, which has already risen by a full percent to 5.7 percent in July, could well go to 6 percent for the first time since the bottom of the last recession in 2002. And for every jobless worker who doesn't have a paycheck to spend, there is a fear on the part of others that they could soon be without one, too.

On the proverbial other hand, the deeply depressed housing market could be nearing a bottom that would at least put a halt to further erosion in that sector. By hindsight, the residential real estate bubble that burst in 2006 was a disaster waiting to happen, just as with the bubble at the beginning of this decade. Because month-to-month comparisons of home-start and home-sale data are full of vagaries, analysts generally make year-to-year comparisons, and these are still showing steep decline. But with each passing month, the base against which they have been made gets smaller. A scanning of recent data suggests that new home starts have been stabilized in many sections of the country. This may be a small consolation to builders whose activity levels are less than half of what they were two years ago. But at least it means that housing won't continue to impose a drain on GDP that was estimated at 1 percent in the second quarter. And a just-enacted income-tax credit for first-time home buyers should help.

The big joker in the economic outlook deck is the price of oil. Is the doubling of oil prices over the past year, to a peak of $147 a barrel in early July, a harbinger or just another bubble that's waiting to burst? The recent sell-off to less than $120 a barrel suggests the latter could be the case; and if so, it would mean relief from the high, and highly correlated, price of gasoline. It's estimated that a dollar a gallon difference in the price of gasoline is worth about $100 billion in consumer purchasing power for other goods and services—just about equal to what the tax-rebate stimulus provided.

That's before even mentioning what a reduction to, say, $3 a gallon would do for the automotive, airline, and trucking industries. Nor does it take into account the easing of inflationary pressures that would reduce the inflation rate far below the 4.2 percent annual rate that was imbedded in second quarter GDP. Indeed, but for the big bumps in gasoline prices, overall economic growth so far this year would have been quite wholesome. m