Paul Krugman and "That 1937 Feeling"
Yesterday Paul Krugman wrote an op-ed column in the New York Times discussing the current economic situation. Let's take a look at That 1937 Feeling.
As you read the economic news, it will be important to remember, first of all, that blips — occasional good numbers, signifying nothing — are common even when the economy is, in fact, mired in a prolonged slump. In early 2002, for example, initial reports showed the economy growing at a 5.8 percent annual rate. But the unemployment rate kept rising for another year.
And in early 1996 preliminary reports showed the Japanese economy growing at an annual rate of more than 12 percent, leading to triumphant proclamations that “the economy has finally entered a phase of self-propelled recovery.” In fact, Japan was only halfway through its lost decade.
Such blips are often, in part, statistical illusions. But even more important, they’re usually caused by an “inventory bounce.” When the economy slumps, companies typically find themselves with large stocks of unsold goods. To work off their excess inventories, they slash production; once the excess has been disposed of, they raise production again, which shows up as a burst of growth in G.D.P. Unfortunately, growth caused by an inventory bounce is a one-shot affair unless underlying sources of demand, such as consumer spending and long-term investment, pick up.
I think Krugman is onto something here. We may be getting some positive economic data lately, but are these 'blips' or are these permanent improvements? Looking at the rising bankruptcies, rising default rates, contracting credit, and many other factors, its hard to imagine that these positive economic numbers could be very permanent.
Which brings us to the still grim fundamentals of the economic situation.
During the good years of the last decade, such as they were, growth was driven by a housing boom and a consumer spending surge. Neither is coming back. There can’t be a new housing boom while the nation is still strewn with vacant houses and apartments left behind by the previous boom, and consumers — who are $11 trillion poorer than they were before the housing bust — are in no position to return to the buy-now-save-never habits of yore.
What’s left? A boom in business investment would be really helpful right now. But it’s hard to see where such a boom would come from: industry is awash in excess capacity, and commercial rents are plunging in the face of a huge oversupply of office space.
This is the real meat of the matter, and Krugman nails it on the head. Consumer spending is not coming back; nor is the housing boom. These things are gone. Consumers are down $11 trillion dollars, and that isn't coming back either. What does this mean for companies earnings that rely on consumer spending?
Krugman also points out that a boom would be "helpful." While I don't think that blowing another bubble to get us out of this mess like we did in 2001-2003 should be considered "good," I do agree with Krugman that it is hard to see where such a boom would come from. The housing bubble temporarily kept us afloat after the tech bubble burst, creating many jobs in the mortgage industry, as well as loads of easy consumer credit. Today it is hard to see any sector or industry that is going to really drive job creation.
Can the Fed blow another bubble? While it may seem pretty unlikely, we can be guaranteed that they are going to try as best they can.
So the odds are that any good economic news you hear in the near future will be a blip, not an indication that we’re on our way to sustained recovery.
And there you have it; I couldn't agree more.