July 2008 Quarterly Forecast
> Nation
By Ed Leamer
Unemployment Rate: Recession in Gray
Until Friday, June 6, when the May unemployment level was released, I had written the title “Don’t Celebrate; What Comes Next Isn’t Going to Cheer You Up” as if the recession risks had substantially abated and we needed to shift focus to what comes next. Sure, the unemployment numbers in 2007 had risen, but in a rather mild way, consistent with our view that this time the troubles in housing would produce a disappointing outcome but not the catastrophic features of traditional recessions. But that May increase in the unemployment rate to 5.5 from 5.0 has shocked Wall Street and me too. That 5.5 is the only number I know that is clearly in the recession range. And just when I was about ready to take a victory lap, carrying my no-recession banner!
Nevertheless, I am holding on to what is now a shaky view: no recession this year.
It’s a Hiring Strike, Not a Firing Binge
In a recession, jobs are easy to lose but hard to find. This time around jobs have been hard to find, but not easy to lose. The May data continue in that vein. Employment has fallen only a little bit, -24,000 jobs since the first quarter. The rise in the unemployment rate is mostly due to the increase in the labor force by 873,000 since the first quarter. This could be due to high school and college graduates struggling to find jobs in a tight labor market.
The Good News: The Housing Direct Drag on GDP Growth is Almost Over
With the reality of muddied water, let’s turn our attention to some other data, first on housing. By measuring the contribution of residential investment to GDP growth during the sixteen housing downturns since 1947 we can study the total amount that housing subtracted from GDP from peak to trough. We find that the largest of these negative contributions was the 1973-75 period when housing subtracted a total of -2.33 from GDP over a period of 8 quarters for a rate per year of -1.16. The second worst contraction is the one we are now experiencing following the housing cycle peak in 2005Q4. Through 2008Q1, problems in housing have subtracted a total of 2.06 from growth, very close to the leader -2.33. When the data for 2008 Q2 arrive, this may become the most severe housing contraction since the Great Depression. That is one reason for hope: history suggests this cannot go on much longer.
Furthermore, the data reveal that the business cycle peak often follows the housing peak by only a few quarters. By contrast this time, we are already an unprecedented 9 quarters into the housing adjustment and the data for GDP and payroll employment do not yet look like recession data. Thus, added good news: the unwanted recession is way overdue.
The Flip Side--Crude Oil Prices
With the good news comes the bad. Consumers are experiencing a relentless drumbeat of bad news telling them they are not as well off as they think and the unkindest daily slap in all our faces has been the incessant rise in the price of gasoline. Oil Prices: some variation of “since 2006, the price of a barrel of oil has more than doubled, peaking at just over $145 per barrel and as a result, we are actually starting to absorb the reality of much higher crude oil prices by cutting down our driving and trying desperately to unload our used SUVs to some unsuspecting buyers. Equally alarming is our dependence on imported oil that is now higher than it has ever been, increasing by a factor of three since 9/11 from 1% of GDP to over 3% today. The amount that is transferred to foreigners is massive. That represents a diversion of 2% of our income to foreign oil producers. There is going to have to be some serious belt-tightening soon enough.
The Logic of Our No-Recession Forecast
At this point, we need to repeat again why we think that this time the housing collapse will not lead into recession. The logic of our no-recession forecast rests on three disconnects:
(1) the disconnect between housing and the labor market -- Typically, construction jobs plummet with overall employment. Today construction jobs have spiraled downward, even as the rest of the jobs continue to grow, albeit slowly.
(2) the disconnect between the cycle in
construction and the cycle in manufacturing began in 2001. Historically, jobs in construction and manufacturing rise together in expansions and decline together in recessions with the remainder of jobs changing very little. But in 2001, construction jobs plowed through the downturn like it wasn’t there, while manufacturing took a huge loss of 3 million jobs that it never recovered. Manufacturing and construction are typically reliable indicators of recessionary dips in the economy. But this time, construction is saying recession, while manufacturing is saying the same thing it has for years: we need fewer workers here. And because the rest of the job market is holding up, we don’t anticipate having enough job loss to dip into a recession.
and (3) the disconnect between the cycle in housing and the cycle in consumer durables.
Normally, the housing peak is followed by the consumer durables peak within a few quarters. But this time, absent the job loss that normally follows soon after the housing peak, we have not had great weakness in consumer durables. After nine quarters in which housing is subtracting from GDP, we still have consumer durables making a positive contribution. That’s why GDP growth is holding up.
These disconnects have meant that “This time, what happens in housing, stays in housing.”
Don’t Celebrate; What Comes Next Won’t Be That Great
It is possible that the data will get a lot worse very quickly and the U.S. will tip into a real recession. More likely, we think, we will experience only a mild slowdown. A little more of what we already had. Regardless of what happens this year, the future isn’t what it used to be. There is going to have to be some belt-tightening. That’s a recipe for sluggish growth. Autos for sure are going to be weak, with conditions exacerbated by the alarming sharp rise in crude oil prices.
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