A Tale of Two Battles
Macroeconomic data vs. earnings reports, and deficit-cutters vs. borrow-and-spend.
12:00 AM, Jul 31, 2010 • By IRWIN M. STELZER
There are two battles going on that will influence how the economy performs for the rest of this year. The first is a battle for attention between the general economic news and the profits performance of America’s leading companies. The second is a battle between austerity advocates and the more-stimulus-please-sir, crowd. In a sense, this latter war is between Europe and Britain, on the one side, and America on the other.
Start with the first battle. The news about the economy has diminished hope that the economic recovery will be rapid and robust. A slowdown in private-sector job creation is producing talk of a “jobless recovery” that, along with the persistent refusal of the housing market to recover, is damaging consumer confidence, which is why the latest GDP report shows that “consumption is sluggish,” to borrow the description of Goldman Sachs’s economists. Home sales are at near-record lows, and the supply of unsold homes, including foreclosed homes, is rising. Some 60 percent of housing analysts are expecting home prices to decline this year, despite a recent up-tick due to the now-lapsed availability of a buyers’ tax credit. It is difficult for consumers to have a bounce in their step as they walk down a street with foreclosure signs, and fret that they might be next in the unemployment queue, perhaps unable to meet their mortgage payments.
The Federal Reserve Board’s survey of business conditions around the country is far from a tale of unremitting gloom. “Economic activity has continued to increase, on balance, since the previous survey…” But several areas of the country report only “modest” increases or a slowing of manufacturing activity, and the latest report of second quarter GDP growth -- +2.4 percent -- shows the economy to be moving forward, but at a slower rate than is needed if lots of new jobs are to be created. Somehow, a moderate recovery is not good enough to produce a “feel good factor” on the street that matters most to politicians facing an election fewer than 100 days from now -- Main Street. New hiring on Wall Street, which by and large is doing well, actually adds to the grumpiness of Main Street, which feels left behind by the various policies adopted by the government to get the economy moving. Bailouts for the big banks, nothing for small businesses being denied credit by those very banks -- that’s a popular view.
Against all of this are reports that corporate earnings are up over 20 percent in the second quarter and headed for even larger gains in the current quarter. FedEx and UPS, which can’t make money unless they are moving goods, are reporting healthy increases in profits, due in important part to shipments of electronic goods from Asia, not exactly a U.S.-jobs-creator. Ford, which mortgaged all of its assets four years ago and eschewed government (i.e. taxpayer) help, reported its most profitable half in more than a decade. General Electric, which participates in almost every sector of the U.S. economy, announced a 20 percent increase in its dividend. Verizon, a good indicator of the health of the wireless business reported gains that exceeded expectations, as did AT&T. Apple reported a 90 percent increase in earnings to the highest non-holiday quarter ever. And Intel says that the second quarter was the best in its 42-year history as large companies began replacing the computers that became a bit obsolete during the virtual freeze of replacement buying during the depths of the recession.
It is fair to say that some of the volatility in share prices is due to the fact that investors see good earnings reports from key companies, and then hear about trends in the overall economy that indicate that a full, jobs-rich recovery might be a long time in taking shape. Some days the earnings reports win the battle, on others a gloomy economic report takes precedence. When the new jobs report is released at the end of next week it well might tip the balance between gloom and glee for the rest of the summer in whichever direction job creation moves. Early reports from Manpower, TrueBlue and Robert Half International -- agencies that provide employers with temporary workers -- suggest that employers prefer taking on these “temps” to adding full-time staff. My guess is that preference is due in part to the inability of employers to predict the health care costs associated with permanent staff additions, and are waiting to see how much of any incremental profits they will keep after the taxman (aka the president of the United States) cometh.
The second battle is on the field of policy. The popular view in Europe is that austerity and deficit reduction are needed to restore business confidence and keep the recovery rolling along. The view of the Obama administration and, most notably, his principal economic adviser, Larry Summers, is that the recovery is fragile, and a second stimulus is needed, with deficit reduction a lesser priority just now.
Both sides make good arguments. The austerity advocates say that by cutting spending and the deficit the U.S. would keep interest rates down, increase business confidence that taxes will not rise, and encourage businesses to spend their $2 trillion cash hoard. The borrow-and-spend group, which for once sees the president’s economic and political advisers on the same side, say that now is not the time to rein in spending -- another stimulus now, deficit reduction later.
As with most arguments about economic theory, both parties cite the same data. The president says that without his $862 billion stimulus, the recession he inherited would have become a deep depression, and that the paltry growth in jobs, although not all he hoped for -- he had predicted a stimulus-induced decline in the unemployment rate to 8 percent -- is a lot better than the massive job losses occurring when he took office. This view received support from distinguished economists Alan Blinder and Mark Zandi in a recent study detailing the stimulative effects of the various anti-recession measures initiated by the Obama administration.
Opponents say that the $862 billion stimulus squeezed out private-sector spending, transferred resources from the more efficient private sector to the less efficient public sector, and built up deficits that will burden future generations with higher taxes that will curtail consumer spending. Consumers, in anticipation of the day of reckoning, are already being extra cautious, which is why the savings rate is inching up.
Democrats in Congress, ordinarily counted on to support the administration’s spending plans, are less inclined to study the economic runes than the polls. Since some 63 percent of Americans favor deficit reduction, even if that means a somewhat slower recovery, they are resisting some of the president’s new spending initiatives. If the Republicans make the gains in Congress now anticipated, the additional spending might nevertheless be approved by a lame duck Congress stocked with representatives with nothing more to lose by defying voters’ wishes.
These two battles -- macroeconomic data vs. earnings reports, and deficit-cutters vs. borrow-and-spend -- will continue to be fought until clearer signs emerge about the economic outlook, perhaps when the jobs report is released. Next up, a fight over whether to raise taxes on “the rich,” including the entrepreneurs who create most of the jobs, or leave the Bush tax cuts in place when they expire at year-end. The president wants to soak “the wealthiest” but some of his troops on his right flank, fearing that a tax increase will slow the economy, and worse still antagonize voters, are inclined to desert him in this battle. Or so they are saying on the stump.
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