Economic uncertainty: Cans kicked down the road pile up

This entry was posted on Monday, July 23rd, 2012 at 12:45 pm and is filed under Chamber News, Economic Development. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

Fed Chairman Ben Bernanke’s testimony before the Senate Banking Committee produced ominous headlines such as, “Bernanke gloomy on economic outlook” and “Bernanke: Recession likely if Congress doesn’t act.” While these headlines may cause surprise for some, analysts and economists observed a steady stream of negative data over the last several months as the U.S. and global economies began to deteriorate. So, where are we now?

In the U.S., the Bureau of Labor Statistics (BLS) reported a net gain of just 80,000 jobs in the month of June, making it the third consecutive month with growth under 100,000. This is significant, because according to Chairman Bernanke, the U.S. economy must produce at least 100,000 jobs to avoid deterioration in the labor market.

Falling GDP Estimates

So, why are jobs so important to the economy? Jobs are important, because consumer spending is responsible for approximately 70 percent of U.S. economic activity. On Monday, the Commerce Department released data showing retail sales fell for the third consecutive month in June, decreasing by 0.5 percent. This report comes after the Commerce Department reported savings rates are also increasing. In short, not as much money is being spent and the economy is slowing.

The first look at second quarter GDP in the U.S. will be released on Friday, July 27th. Wall Street firms have been marking down their estimates, which fell even further after the latest retail sales report, with more optimistic firms now estimating real GDP growth in the second quarter of around 1.5 percent. However, several firms are expecting to see that the economy grew at a rate closer to just one percent. This would mean the U.S. economy grew at a rate well under two percent during the first half of 2012.

The question many have is, will conditions improve during the second half of 2012?

The quick answer: not likely.

Accumulation of Risk

At mid-year, I was involved in producing an Economic Outlook for Salt Lake County. The outlook was produced as a joint project between my employer, CBRE and the Salt Lake Chamber. While producing the report, it was apparent that downside risks to the economy were accumulating and would continue to do so without meaningful policy responses. As challenges increase, the economy, already limping along, will not likely hits its stride during the third and fourth quarters of 2012.

Primary risks examined in the report include, Europe’s debt crisis, geopolitical tensions in the Middle East and U.S. fiscal policy. As long-term, sustainable solutions are delayed, the timeframe to deal with these challenges becomes more compressed. This means the margin for error diminishes.

Europe

European leaders continue to test the patience of markets, but it is unclear how much time they will be afforded. Up to this point, policymakers in Europe have been unable to offer up solutions that will address both the short-term issues such as bank re-capitalization and long-term issues like how to increase European integration.

As this crisis drags on, much of the continent will continue in recession. As a result, fewer products are exported to Europe from emerging markets such as China, causing economies around the world to slow. However, the greatest threat to economies around the world is through financial ties. Similar to 2008 when the collapse of Lehman Brothers wreaked havoc on the global financial system, a similar threat of “contagion” exists as Europe’s financial system experiences higher levels of stress.

Middle East

In the Middle East, headlines during the last week indicated concerns over Syria moving its chemical stockpiles and a build-up of U.S. forces in the region, due to tension with Iran over its nuclear program. As sanctions on Iran take effect, rhetoric is increasing. Furthermore, it is widely believed that Iran’s nuclear program will be vulnerable only for a short time longer; meaning decisions regarding any effective military strike must take place soon.

While conflict does not appear to be imminent, this ratcheting up of tension will spook energy markets, limiting any relief for consumers at the pump. In fact, the price of light crude on the New York Mercantile Exchange rebounded from lows in mid-June of around $78 a barrel to close at approximately $88 yesterday, representing a 13 percent increase in less than one month.

U.S. Policy

In the U.S., if issues surrounding the “fiscal cliff” (expiration of tax cuts and automatic spending cuts) and debt ceiling are not addressed before the election, they will need to be addressed within a period of just weeks before they take effect. All together, the potential hit to GDP could reach 4 percent according to analysis from Bloomberg. If these issues are not dealt with before 2013, the Congressional Budget Office (CBO) projects that the U.S. economy will fall into recession, a point Chairman Bernanke brought up during his congressional testimony yesterday.

In addition to the “fiscal cliff”, the U.S. will technically run up against its debt ceiling sometime late this year, but accounting maneuvers will extend the amount of time policymakers have to act until early 2013. All of these major and unresolved issues will weigh on the economy until they are addressed.

However, with near certainty, it should be expected that nothing will get done before the fall election. This reality was acknowledged by U.S. Senator, Chuck Schumer when he stated, “Given the political realities, particularly in this election year, I’m afraid the Fed’s the only game in town.”

Elections

Elections are not just complicating the response to problems in the U.S. Uncertainty surrounding elections in Greece caused many to wonder if the country was on the verge of exiting the Euro and returning to the Drachma. In the end, elections produced a government, which allowed the country to stay in the Eurozone. Even still, Greece will remain in news headlines as its finances continue to deteriorate and short-term fixes prove inadequate.

Meanwhile in France, Socialist Francois Hollande was elected President, along with a majority for his party in parliament. Elections in France set the stage for a more contentious relationship with pro-austerity German Chancellor Angela Merkel, who will certainly be considering German national elections in 2013.

Outside of the U.S. and Europe, even China will experience a transfer of power, starting in 2012, creating some uncertainty there as well.

Cans Piling Up

Through the end of the year, disappointingly weak GDP growth in the U.S. is likely to continue. Job growth will reflect the generally weak state of the economy and market volatility will increase as downside risks come into focus. Furthermore, because the resolution of major problems is dependent on policy outcomes, uncertainty will be amplified as fall elections approach.

The bottom line is this: it is becoming clear that policymakers must soon address major issues restraining the global economy, because they will not retain the ability to continue delaying politically difficult decisions. The term, “kicking the can down the road” is often used to describe the response of politicians to difficult problems. However, the end of the road is approaching and the cans are piling up. The next six to nine months will be critically important for the global, U.S. and Utah economies.

 

This article was written by Darin Mellot, senior analyst at CBRE, and was originally featured on KSL.com. Mr. Mellott is a member of the Chamber’s Utah Economic Council.


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