John Mitchell: Economy sinks under too many pillows


{safe_alt_text}The U.S. economy entered year seven of the upturn at the end of 2007 amid slow growth in output and decelerating employment gains.

 

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The U.S. economy entered year seven of the upturn at the end of 2007 amid slow growth in output and decelerating employment gains. Economic performance emerged quickly as the major campaign issue with the media focused on every squiggle in the data and candidates hurling charges during interminable primaries. The opening months of 2008 brought declines in employment, weak retail sales and, most likely, the onset of the second recession of the 21st century. We will not know that for sure until somewhere between six and 18 months after the start when the official arbiters make the call. The boredom of a long expansion has given way to the excitement of slow growth and a rare recession. This is a new notion to many because the last serious recession in the U.S. was in the early 1980s. Since 1982, the nation has experienced 16 months of recession: July 1990 to March 1991, and March 2001 to November 2001.

{safe_alt_text} BY JOHN MITCHELL

While engaged in a hard-fought game of the “Princess and the Pea” with my 4-year-old granddaughter, Cali, I realized it could be used to illustrate the cycle. The game is based on the children’s story and involves layering mattresses and pillows atop a bed frame with a wooden pea in it until the pillows are all used or the pile falls over. Playing with an exuberant 4-year-old, the pile usually falls over.

The American economy has had an increasing number of pillows piled on it that, even through the end of last year, did not result in an output decline. But the pile kept increasing to the point that the expansion has probably ended. We are in the third year of declining residential construction activity with permits down about 50% from their peak. The housing boom — fueled by low rates, new types of mortgages, loose underwriting and speculation — increased homeownership levels and supported an army of builders, realtors, mortgage brokers, appraisers and home-furnishing operations. Prices soared until affordability limitations, defaults, tighter credit standards, and excess supply began to weaken them. All but one major metro area (Charlotte, N.C.) is now experiencing price declines, according to the Case-Shiller Index.

Consumer and nonprofit balance sheet data for the fourth quarter of 2007 showed a decline in net worth of $533 billion from real estate as well as the stock market. The financial implosion resulting from the loose underwriting standards, leveraged positions and failure to comprehend risks has tightened credit markets across the planet, affecting even people and businesses without housing-related exposure. This constitutes another drag that is challenging policymakers to keep credit markets functioning and not contribute to moral hazard (i.e.: making people responsible for their actions).

Another drag is caused by a run-up in food and energy prices. Strong demand for energy in developing nations along with supply constraints and the dollar decline helped push crude to more than $100 per barrel. The U.S. imports most of its crude oil and the price jump has created a decline in the standard of living. Food prices have surged because of robust demand, poor grain harvests and a headlong rush to biofuels. In the short run, it’s a squeeze on family budgets and another pillow on the pile.

Stimulus checks will start to arrive later this month, the Fed has been creative in trying to keep markets functioning, and there will be more intervention in the housing area. Markets are adjusting, with February seeing an increase in home sales and falling prices. Each cycle is different, and this period will be remembered for housing performance. There will be a regulatory response and a generation will forever think differently about housing.

Oregon has fared differently in different cycles. Some can remember the 1979-82 period when the eastbound lane of the Oregon Trail was reopened and the state experienced an 11.7% decline in employment and a drop in population. The next downturn in 1990-91 was almost a non-event here with an employment decline of 0.2% on annual average basis. The 2001 national recession was more serious in Oregon. The major decline was in business investment, which heavily impacted the state’s technology sector and resulted in three years of falling employment. This time, with robust exports, prosperous agriculture, strength in metals and aerospace, and fewer real estate problems than many other areas, Oregon will hold up better, but will not be immune.


John Mitchell is the former chief economist for US Bancorp.

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