U.S. Review
GDP: Recovery Yes, But at What Pace? Jobs?
- This week’s GDP report signals recovery. Federal spending, as well as tax credit programs for housing and autos, were big positives. The issue going forward will be what the sustainable pace of growth is once the fiscal and monetary stimulus goes away.
- Once again, a jobless recovery appears to be the story for at least the next three months. This pattern where jobs lag growth has become the norm in recent cycles. This suggests that personal income growth and thereby consumer spending will be improve slowly and be subpar relative to the past..
Third quarter GDP rose 3.5 percent with significant positive contributions from personal consumption, housing, federal spending and inventories. For consumption and housing the improvements reflect tax credit programs. Inventory gains also added nearly one percentage point. Therefore, final sales continue to improve and this provides the underlying demand for growth. However, our expectations are for moderate growth—not a boom.
Sustainable consumer spending requires income and thereby job and wage gains. The latest jobless claims data suggest that jobs remain scarce and that wage gains are likely to be very limited as well. Residential investment and equipment spending are also expected to gradually improve. Federal spending stimulus will also add to growth in the fourth quarter this year and the first quarter next year. Therefore, our expectation is that the recovery is sustainable and we anticipate that growth will be at 2.4 percent next year. Inflation remained low in the third quarter with the core PCE deflator up just 1.4 percent, which should allow the Fed to leave the funds rate unchanged for now.
Jobs: Lagging the Recovery Again?
Jobless claims remain stubbornly high at 530,000 consistent with continued jobs losses in the fourth quarter. The emerging pattern in recent economic recoveries is that jobs increasingly lag the recovery. In part, productivity gains in manufacturing have allowed businesses to build output and put existing equipment and plants to work without adding workers right away. Firms hoard skilled labor in a recession and therefore keep workers on the payroll even if they are not always busy. Firms do this because of their concerns about the cost and availability of skilled labor as the recovery begins. For the outlook, the jobs issue becomes an income issue and therefore a challenge to getting the economy up to speed. With weak consumer income gains the pace of consumer spending is also likely to be limited. Our view is that real disposable income will grow just 1.2 percent in 2010 compared to 2.2 percent in 2007. We expect personal consumption to rise just one percent in 2010 compared to 2.6 percent in 2007. Such modest gains in consumer incomes and spending suggest that the demand for auto and mortgage credit will also be subdued relative to the past. This has been noted in the Senior Loan Officer Surveys published by the Fed.
Fundamental Rethink for America?
For our society, modest gains in housing and autos may be reflecting a longer-term change in consumer habits. The deleveraging/increased saving by the consumer suggests that the pace of consumer spending may indicate a slower pace of gains in local property taxes and state income taxes—clearly a challenge to state and local budgets. Slower housing starts and more modest home price appreciation suggests a challenge to the massive housing/home improvement/suburbanization infrastructure that America has built up since World War II. The pace of gains for income and jobs in many states may have to be rethought if the American consumer adopts, or is forced to adopt, a more financially conservative hair shirt..
Global Review
Sustainable Recovery in Korea Appears to be Underway
- Real GDP in South Korea rose at an annualized rate of 12.3 percent in the third quarter, the second consecutive quarter of double-digit growth. Although the outturn was flattered by less de-stocking, which cannot lift GDP indefinitely, a self-sustaining recovery appears to be taking hold in Korea.
- Will authorities tighten policy now that prospects for continued growth appear favorable? Benign inflation means that the central bank does not need to slam on the brakes, but we look for it to begin normalizing rates early next year.
Data released this week showed that real GDP in Korea rose at an annualized rate of 12.3 percent in the third quarter, marking the second consecutive quarter in which the Korean economy has expanded at a double-digit rate (see graph on front page). At first glance, one could dismiss the strong growth in the third quarter as nothing more than a short-lived inventory swing. Korean businesses slashed inventories earlier this year when they were convinced that the economy was on the cusp of a very deep recession, but they ended up cutting too deeply. Although businesses continued to pare stocks in the third quarter, the less rapid pace of inventory liquidation helped to lift GDP growth by more than 11 percentage points. Won’t the economy roll over again when the frenetic pace of restocking comes to an end?
Probably not, because a closer look at the GDP details shows that a sustainable recovery appears to be taking hold. For starters, consumer spending grew nearly six percent during the third quarter, which follows the 16 percent increase registered in the previous quarter. A widely followed measure of consumer confidence has shot up since the spring as the labor market has started to recover. Earlier this year, employment growth was negative on a year-over-year basis. However, payrolls are starting to increase again, helping to boost income. After reaching an eight year high of 4.0 percent in June, the unemployment rate has subsequently declined steadily.
In addition, growth in fixed investment spending was up nearly four percent in the third quarter. Some of the increase likely reflects temporary infrastructure spending that the government has put in place, but private sources of investment appear to be recovering. Construction spending edged lower in the third quarter, which represents some payback for strength observed during the two previous quarters, but business spending on machinery and equipment rebounded in the third quarter. Moreover, economic recovery in the rest of the world, especially in other Asian countries, to which Korea sends 50 percent of its exports, is helping to stimulate growth in Korea. On a year-over-year basis, real export growth has now returned to positive territory (middle chart). The sequential GDP growth rate in the third quarter would have been even stronger had imports not shot up 30 percent.
Growth in Korea clearly will slow in the quarters ahead. No economy, especially an advanced one like Korea’s, can continue to post double-digit growth rates ad infinitum. As noted above, however, a self-sustaining recovery appears to be taking hold, and we look for solid Korean GDP growth over the next two years. So will prospects of continued growth cause Korean authorities to tighten policy? The global economic meltdown led the Bank of Korea (BoK) to slash its main policy rate from 5.50 percent to 2.00 percent between October 2008 and February 2009. Although the BoK won’t cut any further, a rate hike doesn’t look imminent either with the rate of CPI inflation currently benign (bottom chart). That said, most analysts, we included, look for the BoK to begin normalizing rates by early next year.
